While the private sector is poised to increase both its capital spending and its hiring, the public sector will be forced to make operational cuts, to shed businesses, most likely through privatization and to lay off employees.
The result will be a shrinking of the public sector piece of the economic pie which is good in the long run for economic growth and for profits and thus for the stock market. However, in the short run it will only prolong the major economic and social problem in this country, namely unemployment.
The downsizing by many towns, cities and states over the next several years will have a negative impact on the rate of GDP improvement in the country. I expect that the economy will average only modest growth in 2011—on the order of 2 – 3 percent. This is well below its potential.
Last year at this time I predicted that year-end unemployment in December 2010 would be over 9 percent. I make the same prediction for December 2011, and I hope that somehow I will be wrong.
The cause of the sustained and unacceptably high level of unemployment will be from the required cuts in public sector spending, as cities and states are forced to deal with budget deficits and runaway pension costs. Increases in fees and local tax rates will not be sufficient to close the gap between income and spending.
Despite the rising price of oil and a number of industrial and agricultural commodities, inflation will not materialize in 2011. Rising material prices will not have a spillover effect on either total production costs or on pass-through pricing. As a little aside, it is interesting to note that the actual cost of the agricultural commodities in food is only 5 percent of the price of the final product.
Labor costs (in the private sector at least) are not rising in a meaningful way. Home prices are continuing to fall overall, and while there are cities in the country where housing is stable and improving, it is apparent that there is still massive oversupply of housing stock, significant foreclosure activity ahead in the coming year and no incentive for new construction.
Energy prices will likely continue to rise and that will act more as a deterrent to economic growth than as a stimulant to inflation.
I believe that 2011 will be a good year for the U.S. stock market, reflecting another year of solid growth in profits. The path of the stock market will likely be volatile as it was this year, but stocks in general are not expensive and growth in earnings will be reflected in rising prices.
Volatility will likely result from headline events that sound scary but ultimately will not bring the market down. Included in the ‘scary headline’ category will be the fears of insolvency on the part of some states and cities. Bankruptcy and bailouts will be debated and opined upon, but I do not foresee any rush by the U.S. Government, i.e. the taxpayers, to resolve the financial problems facing the public sector of the economy. Nor do I envision their problems to cause a repeat of the financial crisis that hit the world in 2008.