Forecast 2011: Recovery Hinges on Consumer Activity | economic recovery, Moody's Analytics, GDP

What lies ahead in 2011? If you're like most business owners, you're ready for a rebound in sales after two years of recession. But you may be dogged by a common question: How will the unsettled economy affect your company's success?

First, the good news: Businesses are currently operating in an economic environment that is slowly but surely on the mend.

"The recovery will start to ramp up in 2011, then really expand quite strongly in 2012 and 2013," says Sophia Koropeckyj, managing director of industry economics at Moody's Analytics.

Recalled to Life
Most economists agree with that assessment. Today's economy is like a convalescent patient: It needs time to return to full health, but at least it's no longer on life support.

Consider Gross Domestic Product (GDP) a standard barometer of economic well-being. In a healthy economy, this measure of general business activity grows robustly.

"We estimate that GDP will grow at 2.7 percent for 2010 when numbers are finalized," Koropeckyj says. That number represents a virtually flat growth rate, considering that it follows a GDP decline of 2.6 percent in 2009.

But GDP is expected to grow by 3.1 percent in the coming 12 months, according to Koropeckyj. That's a much healthier number, since it's calculated from a decent previous year figure. For an economy experiencing average growth, annual GDP increases at around 2.5 percent.

Strong Profits
Some current factors are especially conducive to a rebound. Perhaps the most important is the strong state of corporate profits. "Medium and large companies have been very profitable over the past 12 months, thanks partly to low interest rates, minimal hiring, and no wage pressures," Koropeckyj says. While 2009 corporate profits were flat, they are expected to increase by approximately 28 percent in 2010, 4 percent in 2011, and 14 percent in 2012.

These enterprises are accumulating lots of cash and earning close to no interest. "They are well positioned to expand both hiring and capital investments," Koropeckyj says. Both effects would stimulate consumers and retailers.

But many companies continue to refuse to invest aggressively in the future. They cite several concerns, including the unstable housing market, the European debt crisis, and uncertainty in the federal government regarding taxation, healthcare, and the environment.

Perhaps the most important concern of business owners is the low level of consumer confidence. The public's faith in the future is vital to a strong overall marketplace, since consumer activity represents 70 percent of the economy.

But the situation in this arena is not so good. "Consumers are majorly depressed," says Scott Hoyt, senior director of consumer economics at Moody's. "Consumer confidence has been at levels characteristic of a deep recession for over a year." That's inconsistent with expectations, considering that the recession officially ended in 2009.

Stubborn Unemployment
Why the gloom? Consumers are clearly worried about jobs, as the recovery has not yet translated into an uptick in employment. By late 2010, unemployment measured 9.6 percent. That figure, up slightly from the 9.3 percent of 2009, is expected to increase in the coming months.

"Once job creation kicks into higher gear, people on the sidelines will perceive the labor market as more hospitable and will start applying for work," Koropeckyj says. She expects unemployment to average 9.9 percent for 2011, eventually easing down to 9.5 percent late that year. The 2012 rate is expected to average 8.3 percent.

Those numbers are reining in consumer spending. "When people hear the unemployment figures, they are not going to tell anyone they are happy," Hoyt says. Additionally, consumers have lost massive amounts of wealth in their homes and stock portfolios, and are making little money on their savings due to low interest rates.

Corporations will avoid investment as long as consumers remain parked on the sidelines. "Investing in a business has a lot to do with confidence - in yourself, your market, and your customers," says Michael Smeltzer, executive director of the Manufacturers Association of South Central Pennsylvania, a trade group whose members employ some 220,000 workers. "That confidence is where the weakness is today."

Companies with resources to invest are also concerned about the erosion of the middle class - a population segment that has long been the bulwark of the nation. "Too many governmental policies are encouraging companies to expand offshore where governments embrace the opportunity to host new businesses," Smeltzer says. "Manufacturing has always been a great wealth generator for our country and is the number one driver for middle class prosperity. Offshore migration is a significant risk for the future."

Housing Woes
Consumers, like business owners, are also concerned about the continuing glut of homes. "The housing market is still performing quite poorly and is not expected to stabilize until later in 2011," Koropeckyj says. "The big problem is the huge inventory of unsold homes."

Housing starts are expected to total 590,000 when 2010 numbers are tallied, up from the 550,000 of 2009. And they are expected to rebound to 830,000 in 2011. While that figure seems like a vast improvement, "It's not really a boom historically," Koropeckyj says. "Housing starts were averaging 1.6 million before the recession. The 2011 rebound represents some renewed activity in select undersupplied markets."

A related and equally serious problem is that homeowners won't benefit from increased property values for the foreseeable future. The median price for existing home sales is expected to be $162,800 in 2011. That represents a decline from the $171,400 average for 2010, despite existing home sales that are expected to rise to 5.9 million in 2011 from the previous year's 5.2 million.

Why the disparity? "Many foreclosed homes are still going on the market and being sold at big discounts," Koropeckyj says. "Sales of foreclosed homes do affect the selling prices of other houses." Stable or dropping home values make consumers feel less flush, negatively affecting spending.

Figures for the economy's retail sector reflect concern about unemployment and housing. At first glance, recent store performance looks strong: Hoyt expects core retail sales (which exclude the volatile auto and gasoline segments) to increase 3.6 percent when 2010 numbers are finalized. However, that increase succeeds a dismal 1.9 percent decline in 2009.

Even so, Hoyt expects the gradually improving economy to enliven consumers. Retail sales are expected to improve by 4.2 percent in 2011. "We are expecting better performance in almost every segment of retailing." (Average annual core retail sales growth measured approximately 4.6 percent as of mid-October 2010).

Shy Borrowers
Until consumer confidence rebounds, companies with money to spend are not only closing their purses, but shying away from assuming debt. This reluctance to borrow is emerging after the recession-based credit freeze has largely thawed.

"Banks are now open to lend and the money is available, but demand from entrepreneurs is down," says Walter Simson, principal of Ventor Consulting. "Banks are telling me they are having trouble finding people who want to take business risks."

Consumers are also borrowing less. "Three years ago, people were spending their home equity at retailers," says James Dion, president of Dionco Inc. "Then, all of a sudden, that money disappeared. Also, credit card issuers have tightened up credit lines. People who had $2,000 limits before might only have $900 or $1,100 now. As a result, the use of credit cards has dropped dramatically in favor of debit cards and cash."

Ready to Spend
In the long term, consumers refinancing their mortgages will earn more cash to spend as a result of lower debt payments. Low interest rates and minimal inflation - two conditions economists expect to persist through 2011 - are feeding this trend.

The question remains: When will a robust rebound happen? It depends on consumers' confidence in their own balance sheets. "At some point, consumers are going to say, `I have started saving, my finances are in better shape, and now I need to replace my car and buy some new things that I have been avoiding,'" Simson says. "Then demand will be back, and it will be dramatic."