Clouds over 2011 may yield to rays of hope for 2012

Two months before 2011 even begins, many financial advisers wish they could fast-forward to 2012.

That’s because they don’t have much optimism that the economy will come roaring back anytime soon, even though the “great recession” technically ended more than a year ago. And while nearly 70% of advisers in InvestmentNews’ 2010 Industry Attitudes survey believe that the odds of slipping back into a recession in the next two years are less than 25%, few are bullish about the economy.

“We’re in the camp of muted, sluggish, uncomfortable growth,” said Darell Krasnoff, an adviser with Bel Air Investment Advisors LLC. “But we expect growth nonetheless.”

There are plenty of reasons to worry about the economy, including the staggering budget deficits, and total debt of the United States and other developed countries, Mr. Krasnoff said. His two biggest concerns, though, are employment and housing.

The Labor Department reports that the jobless rate has equaled or surpassed 9.5% for 14 consecutive months, making it the longest period without a rate decrease since the data were first recorded in 1948. The lack of jobs topped the list of key issues by advisers in this year’s survey, with 33.1% saying that “persistent unemployment” was their No. 1 concern. Last year, only 13.9% listed unemployment as the country’s top economic issue.

HOME PRICES STAGNANT

On the homes front, an S&P/Case-Shiller Home Price Report released late last month showed that prices nationally have risen almost 7% since the market bottomed out in April 2009, but they still remain about 28% below the July 2006 peak.

Financial advisers and economists worry that if housing prices continue to stagnate, the lack of equity in homes will lead to more foreclosures and defaults. Some Federal Reserve members have said the board will continue monetary easing if unemployment rates keep rising and housing prices decline.

“Both inflation and deflation worry us,” said Mr. Krasnoff, whose firm manages about $4.5 billion in assets. The policy response to the possibility of deflation — a decrease in the price of goods and services — “will be so aggressive that the ensuing inflation will be the greater concern.”

Mr. Krasnoff’s concerns were echoed in the survey, as 70.4% of the respondents said they are either “somewhat concerned” or “very concerned” about inflation, and 59.5% said they are “somewhat concerned” or “very concerned” about deflation.

Grant Rawdin, a financial adviser with Wescott Financial Advisory Group LLC, said companies have shed jobs or have done what they’ve needed to do to get through the recession and now are waiting for some positive indicators to persuade them to add employees. The next step in the economic recovery will be the expansion of companies, along with consumer demand, he said.

“This is not something that will happen in the next couple quarters,” said Mr. Rawdin, whose firm manages $1.5 billion in assets. “It will be 2012 before the recovery will have fully found its legs.”

Some economists believe that it will be longer.

DECADE OF SLOW GROWTH

Vincent Reinhart, a resident scholar at the American Enterprise Institute for Public Policy Research, said the nation is likely to experience “an extended period of sluggish growth.” An analysis that he and his wife, Carmen Reinhart, conducted of 15 severe economic periods since World War II showed that economies grow more slowly for a full 10 years after a crisis. That could mean slow growth and high unemployment in the United States through 2017, said Mr. Reinhart, who was director of the Federal Reserve’s Division of Monetary Affairs from 2001 to 2007.

One bright spot in the Reinharts’ assessment is that the stock market, which typically declines in the first two years after a crisis, generally rebounds faster than the housing market and economy overall.

Financial advisers said clients are generally confused and even more pessimistic about the economy than the advisers are, which has led to changes in how they discuss investments and planning decisions.

Jonathan Becker, an adviser with California Financial Advisors, has ratcheted down the rate of expected raises when creating or reviewing financial plans for younger and middle-age clients who are still working.

“Raises of 3% to 4% a year used to seem reasonable, but now we’re thinking more like 1% to 2%,” said Mr. Becker, whose firm manages $750 million in client assets.

He also explains to clients that equity returns are not likely to be what they were a few years ago. He is increasing international exposure and emphasizing defensively oriented mutual funds such as the T. Rowe Price Capital Appreciation Fund (PRNCX) and First Eagle Overseas Fund (SGOVX) for domestic equities.

Finally, he’s been increasing the proportion of fixed-income investments in portfolios to produce a minimum income to cover client expenses for a certain number of years. “If we can show that no matter what happens in the market … they are OK for 10 years or more, that helps them sleep easier at night,” he said.

Of course, not every adviser expects a murky 2011.

Walter Meranze, an adviser affiliated with Wells Fargo Advisors LLC, believes that both the economy and the markets are improving and will be positive next year. That is especially likely if Republicans gain a majority in Congress following the November elections, he said.

“People say the stimulus package didn’t work, but it did,” said Mr. Meranze, whose office advises on about $2.5 billion in assets. “People don’t remember what it was like when there was panic and calls of the Dow going down to 400.”

The economy is improving, Mr. Meranze said, citing events such as Caterpillar Inc.’s opening a new manufacturing plant and FedEx Corp.’s buying new planes.

‘FROM THE BRINK’

President Barack Obama and his economic team “pulled us from the brink of the abyss,” Mr. Meranze said. However, he added, it will be better legislatively if Congress is controlled by an opposing party. “If the Republicans gain control, they’ll feel a certain sense of responsibility to get something done,” Mr. Meranze said.

Just the possibilty of Congress’ being in the hands of a Republican majority will benefit the economy and the markets because “it will be viewed as the industrial complex having a say in the government again,” he said.

Regardless of whether the economy chugs along or sputters next year, advisers agree that they will need to work harder and communicate with clients more to make sure investors are comfortable with how their portfolios are likely to perform under different economic scenarios.

“There is some distrust,” Mr. Krasnoff said. “It makes people wonder whether they can trust the equity market to be a storer and grower of wealth.”