ED Futures Newsletter

Dear ED Futures Subscriber:

Shortly we will welcome a new year into our lives. Hopefully as you reflect upon 2005 you will discover there was more joy than suffering in your work and your community.

We here at ED Futures give thanks to all our readers and clients. This was a very good year for us on most fronts. We were honored to serve you in 2005 and look forward to continuing the dialogue during 2006.

For many communities, 2005 was a year of mixed results--some good and some not so good. Overall, growth in economic output was very favorable. While there were a few bright spots in terms of job creation and personal income growth, it is my impression that both lagged expectations in both fast and slow-growth local economies.

What lies ahead in 2006?

According to the World Bank, world GDP is estimated to have increased by 3.2 percent in 2005, down from 3.8 in 2004. Growth is projected to be stable in 2006, before strengthening somewhat in 2007.

The slowdown that began in the second half of 2004, was experienced throughout the industrialized world, with growth in Europe still under performing potential. In contrast, despite having slowed, the economies of Japan and the United States are expanding at close to their maximum sustainable rate.

Among large developing economies, GDP in 2005 continued to expand rapidly in China and India (in excess of 9 and about 7 percent, respectively), but slowed in Russia as growth in oil production slowed.

High oil prices, in combination with domestic capacity constraints, and slower import demand from high-income countries are estimated to have reduced growth among oil-importing developing countries from 6.9 to 6.1 percent.

During 2006 the expansion among high-income countries is projected to be stable at about 2.5 percent before picking up a bit in 2007. This reflects a combination of improved performance in Europe, and stable growth in the United States and Japan. In the United States, higher oil prices and tighter monetary policy are expected to offset the positive stimulus to growth from past depreciations.

Global current account imbalances and the U.S. current account deficit, which is expected to exceed $750 billion in 2005, remain important medium-term problems. During late 2004 and early 2005 tensions eased somewhat.

Here is some news for economic developers. Business investment in the biggest economies is heading higher in 2006 after reaching a record 15 percent of global output this year, according to Stephen Roach, chief global economist with Morgan Stanley in New York. U.S. companies plan to increase spending about 9 percent next year, according to surveys by the Institute for Supply Management and Financial Executives International.

A very large majority of CEOs expect capital spending to increase, which is really important once consumer spending has had its major impact," said Hank McKinnell, the chairman and chief executive of Pfizer and the Business Roundtable chairman..

The rebound in corporate expenditure is not limited to the United States. Large manufacturers in Japan plan to increase investment at the fastest pace since 1990, according to the Bank of Japan, whose Tankan index of business confidence rose this month to its highest level in a year. Investment in the dozen countries sharing the euro surged 3.2 percent in the third quarter from a year earlier, the fastest pace in almost five years.

In looking at the stock market, Merrill Lynch believes the global economy will do well in 2006, that equities and commodities will outperform fixed-income assets, and that the U.S. dollar will underperform other major currencies. In the equity market, Merrill Lynch (ML) prefers Asia and Japan, as well as U.S. large-cap growth stocks. In the fixed-income market, ML think that U.S. portfolios should concentrate on 5-to-15-year municipal issues and that non-U.S. portfolios should move up in quality and shorten duration.

Looking at the midwestern economy, job growth could be brighter in 2006. According to the Federal Reserve Bank of Minneapolis, the outlook for labor markets in 2006 is positive, reflecting expectations for increased economic growth. The strongest growth is expected in Montana, while the slowest growth is expected in the Upper Peninsula of Michigan. District business leaders indicate that labor markets are tightening. While a majority of respondents to the poll expect to increase employment at their companies, many are beginning to indicate difficulty finding qualified workers. Hiring in the services, manufacturing and construction sectors will expand. In contrast, the agriculture and retail sectors anticipate decreases in employment levels.

A less optimistic picture of the coming year is offered by the UCLA Economic Forecast Center, which sees problematic conditions in the national economy through 2007, but not enough to be called a recession. Manifest problems in the housing sector will result in sluggish economic conditions, but with few jobs to lose in an already moribund manufacturing sector, no true recession is foreseen. The California Forecast mirrors that of the Nation. The housing market will cool off, consumer spending will slow and there may be some job loss in construction and other real estate related industries. California “probably will not see a full-blown recession.”

Finally, let's look at some of Global Insight's top predictions for 2006 and beyond.

Solid Growth Will Last for at Least Another Year. Strong growth momentum in the United States and Asia has been both the underlying cause of record-high energy prices and the reason why the global economy has managed to shrug them off. Global Insight expects both the U.S. and global economies to grow at a rate of about 3.5% next year (compared with 3.7% and 3.4%, respectively, in 2005). In the case of the United States, an expected slowdown in consumer spending and housing will be offset by strength in capital spending and exports, helped by a fiscal boost from hurricane-related reconstruction.

China and the Rest of Asia Will Remain the Star Performers of the Global Economy. The Asia-Pacific region, excluding Japan, will be able to sustain growth of around 6% next year. While the Chinese economy is expected to cool off a little, Global Insight predicts that next year's growth will be at least 8.4% (compared with 9.3% this year). Other key economies will also be expanding rapidly (e.g., India at 6.7% and South Korea at 6.0%). While exports continue to drive growth in these economies, domestic demand has also been robust (capital spending in the case of China and consumer spending in other economies, such as South Korea).

Oil Prices Will Slide Gradually—But the Risks Are on the Upside. Oil and gasoline prices have fallen substantially since hitting record highs (before adjusting for inflation) in the wake of hurricanes Katrina and Rita. Global Insight expects that the price per barrel of West Texas Intermediate crude will continue to slide from around $60 per barrel in early December to $52 by the end of 2006. However, with real GDP growth and energy demand predicted to stay robust, oil market conditions will not ease up by much. This means that the risk of another spike in oil prices—triggered by a weather-related or geopolitical disruption—is still uncomfortably high.

Core U.S. Inflation Will Edge Upward. So far, inflation has remained a low-level threat worldwide, despite strong growth and high energy prices. However, since the United States has been growing above trend for the past two years, it has become more vulnerable to inflationary pressures. Global Insight expects core CPI inflation to edge up from 2.2% in 2005 to 2.3% in 2006. But inflation is unlikely to get out of control. Productivity growth has stayed strong (keeping a lid on unit labor costs) and compensation growth is still pretty tame, reflecting continued slack in labor markets. Outside the United States, inflation is even less of a threat—in Europe because growth has been below trend, and in China because of its investment-led boom.

There Will Be No Recession in the Next Couple of Years, Without the Convergence of Two or More Big Shocks. The U.S. and global economies were able to withstand a number of major shocks in 2005—one of the worst tsunamis on record (which actually occurred at the very end of 2004), one of the worst hurricanes on record, and the highest energy prices ever—without missing a beat. This remarkable resilience indicates that growth will be sustained over the next couple of years despite most shocks. Only if two or more severe shocks were to happen simultaneously would a recession become inevitable. Using its proprietary Global Scenario Model, Global Insight recently addressed the question: what would it take to trigger a global recession? The answer: a combination of oil prices above $100 per barrel, inflation and interest rates running 3 percentage points above current levels, and a 10% drop in home prices across many industrial country markets. All possible, but unlikely in either 2006 or 2007.

Forecasts are not destiny, but they do give us a sense of what may lie ahead. We hope that your economic path is filled with light and the right catalytic projects take off in your communities in 2006.

Please stop by ED Futures website and see firsthand what we have been saying. To access the site, simply click here.

Best wishes for 2006!

Happy New Year.

Don Iannone
ED Future Publisher
Email: dtia@don-iannone.com
Tel: 440.449.0753