Strategists bracing for "recovery lite"

NEW YORK Thu Jun 18, 2009 5:33pm EDT

NEW YORK (Reuters) - The severe U.S. recession is likely to end by year-end but the recovery will be weak and leave the economy vulnerable to new shocks, according to some of Wall Streets top strategists.

Americans are trying to repair their household finances after losing trillions in home values and investments -- and as the savings rate goes up, spending will stay weak, strategists at the Reuters Investment Outlook Summit in New York said this week.

Several strategists said the economy would likely grow by only 1 to 2 percent in 2010 after exiting what has been the longest recession in decades in the third or fourth quarter of this year.

Dino Kos, a managing director of Portales Partners, said "2 percent would look really, really good" for 2010 given the economy's current profound weakness and the headwinds that still lie ahead.

Most agreed that consumer spending, long the engine of U.S. economic growth, could not be counted on -- especially as many expect the unemployment rate to continue to rise even after the recession ends.

The U.S. jobless rate could hit 11 percent before starting to recede, said Nouriel Roubini, chairman of economics research firm RGE Monitor. In May, unemployment hit a 26-year high of 9.4 percent.

PARADOX OF THRIFT

The so-called "paradox of thrift" has been at work in recent months as shaken Americans slash spending, and try to rebuild their personal safety nets, at a time their shopping dollars have been desperately needed.

The U.S. savings rate hit 5.7 percent in April, a 14-year high. During the boom years the savings rate turned negative as consumers felt confident about spending, buoyed by rising household wealth, especially home prices.

But since the onset of the recession in December 2007, a few months into a credit and banking crisis that ultimately took down some of the biggest names on Wall Street, housing values have plummeted and consumer confidence has been undermined by millions of job losses.

The renewed inclination to save is likely to last well past the end of recession.

"We will probably be in a 6 percent to 8 percent range (for savings) for the next few years, which means that some of the spunk that we saw in consumption growth will not be there," said Abby Joseph Cohen, senior investment strategist at Goldman Sachs.

Another challenge could be rising gasoline prices, "a negative for real disposable income" in the United States and many other countries, Roubini said.

Crude oil prices helped tip the global economy into recession when they climbed toward $150 per barrel in July 2008, and with the relatively weaker economy now, a price near $100 "would be a similar kind of shock," he said.

Oil prices have been climbing recently, reaching an eight-month high above $73 a barrel last week, more than double their winter lows.

ANEMIC DECADE ON TAP?

All the elements add up to a recovery that will simply not feel like much of a rebound, said Brian Fabbri, chief U.S. economist at BNP Paribas.

The United States will likely shift into a period of below-potential growth that could last for years, Fabbri said. "I think we're going to wind up with an anemic decade."

The Federal Reserve has pulled out all stops to support the economy, and has been matched by the White House's massive fiscal stimulus programs.

Those efforts have helped fertilize a few "green shoots" since the start of the year. Job losses, while still heavy, seem to be tapering off, and measures of manufacturing activity appear to have hit bottom and started improving as well.

On Thursday, the Philadelphia Fed's closely-watched survey of factory activity in the U.S. mid-Atlantic region showed a much smaller contraction in June and reached its highest level since September.

FINANCIAL MELTDOWN OVER

Fabbri said groundwork for a recovery was laid by stabilization in the financial sector, helped by the government's so-called stress tests, which assessed the adequacy of banks' capital levels to protect against potential losses. Those tests boosted investor confidence, he said.

"The most important aspect of the stress test is that it demonstrated just how valuable confidence is in financial markets" he added.

As confidence has returned, prices across a range of assets has risen. Several strategists tied the rise in U.S. Treasury bond yields since then to an unwinding of highly defensive, "safety first" positioning by investors.

Still, many conclude that the significant jump in asset values does not portend a similar V-shaped recovery for the economy, one where growth quickly returns to strong levels.

Roubini was an outlier even in a crop of cautious forecasts. He said growth will not resume until very late this year, and even then will remain meek.

A W-shaped trend, where the economy grows for a few quarters only to reenter recession, is possible by late 2010, he added.

"In addition to green shoots there are also yellow weeds," he said.

(Additional reporting by Burton Frierson, Herbert Lash, Jonathan Stempel, Pedro Da Costa and Caroline Valetkevitch; Editing by Leslie Adler)

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