How Safe is the Economy Now?

Let’s assume we can put away the bungee cord. The president and the Congress reach an agreement that will avoid the massive fiscal tightening scheduled in present law. The deal will impose some immediate revenue increases and spending cuts together with changes that further reduce deficits in future years. For the long run, more will probably need to be done to contain medical costs. But we are past the acute risk that we might impose a severe fiscal tightening on an already slow expansion.

So where does this leave economic prospects for 2013 and how should it change households plans for investing in retirement accounts?

The risk of renewed recession is greatly reduced. Still fiscal policy will tighten next year, and with measures such as higher payroll taxes taking immediate effect, consumer demand will get off to a slow start. But there are also bright spots. Recent increases in housing and autos, where a backlog of demand accumulated during the extended slump, should continue. And business investment, which was probably held back recently by recession risk, should soon improve. Adding it all up, the most likely outcome is a moderate expansion of GDP and employment as the year goes on.

As for retirement accounts, the record over the 5 years since stocks peaked in the US is instructive. The economy in this period has gone through the deepest recession and the most uncertain recovery in 80 years. It is understandable that many households were wary of being invested in stocks during this period.

A dedicated long term investor who put a part of each pay check in a broad US equity mutual fund would be way ahead today. The holdings from the end of 2007 would be back to even and the investments made in the intervening months would show a substantial profit. Those made in the first year of the crash would be up about 50 percent.

The economy is still very far from full employment and monetary policy is dedicated to promoting expansion to restore it. If a too restrictive fiscal policy – falling off the cliff comes to mind – does not get in the way, it should succeed. And that would be a good long term environment for equities.