Fayez Sarofim & Co. Investment Counselor / Consultant

As the US economic recovery enters its second year, unsettling headlines and weaker economic releases have renewed concerns about the strength and sustainability of the expansion. Numerous factors suggest that economic momentum may continue to decelerate near term. Although only about half of the government stimulus money has been spent, incremental spending is declining. Housing activity has slumped after the expiration of the first-time home buyers’ tax credit, with new home sales in May hitting an all-time low. The lift to GDP from the inventory cycle also seems to be nearing a peak. The advance estimate of first quarter GDP growth has been reduced twice reflecting a smaller increase in consumer spending, and retail sales trends have continued to slacken. The Conference Board’s index of consumer confidence registered a disturbingly steep decline in June. Furthermore, the index of leading economic indicators, though still at an elevated level, has rolled over. Heightened market volatility suggests the market is both acknowledging these issues and reinforcing the likelihood of slowing growth.

The Federal Reserve’s Federal Open Market Committee, after making steadily more upbeat statements earlier in the year, issued a more cautious assessment in June, noting that “financial conditions have become less supportive of economic growth on balance, largely reflecting developments abroad.” Indeed, the sovereign debt crisis in Europe and the resulting sharp drop in the euro have dampened investor sentiment and accentuated the market correction. Weakened demand in Europe, however, is unlikely to have a disabling impact on US exports, US corporate profits or global growth. The region as a whole has contributed notably little to global growth over the last five years. Nonetheless, the crisis has stirred fears that a potentially weakened banking system in the region could destabilize financial markets and lead to significantly tighter credit conditions on this side of the Atlantic at a time when the US recovery is vulnerable and domestic bank lending is still contracting. Although European authorities have acted quickly to put together a credible rescue plan, concerns about precarious financial and economic conditions in Europe are likely to persist.