Feb. 24, 2014
Fifth Third Private Bank
  Since the economic downturn of 2008, Americans have become all too familiar with the term, a "vicious cycle," a downward spiral of events where bad outcomes promote worse outcomes. Economists - those cheery practitioners of the dismal science - also recognize that markets, sometimes with a push from government intervention, have self-correcting features. Negative trends should not be extrapolated forever, and with time, economic healing enables the the reversal of the decline, and the potential for self-reinforcing growth, i.e., a virtuous cycle.

We believe that the U.S. economy has crossed that all-important threshold as the cycles that drive the U.S. economy have now turned from vicious to virtuous. In the following piece, Jeff Korzenik, Fifth Third Private Bank's chief investment strategist explores the transition from vicious to virtuous.

I have also included a link to our 2014 Outlook video that I encourage you to watch to find out more about what we believe 2014 will look like for investors.

I hope you find these pieces helpful. Please contact me with any questions; it is a top priority for me to keep you informed on the market in general and about your personal situation.
  From Vicious to Virtuous
By Jeff Korzenik, Chief Investment Strategist, Fifth Third Private Bank

Those who have followed our research at Fifth Third know that we are proponents of understanding our current economic times through the lens of a long-term indebtedness cycle. The use of debt and leverage is neither inherently good nor bad, but excess indebtedness is undeniably dangerous. In fact, taken to extremes, unsustainable debt creates the type of downturn we witnessed in 2008-09. Nineteenth century economists would instantly have recognized our recent recession as a "financial panic," the start of a vicious cycle of which initially reduces GDP and later impedes a recovery.

We now see clear evidence that debt levels have been reduced sufficiently to allow for growth in borrowing again, heralding the start of a virtuous cycle. Business borrowing is rising, households mortgage balances are increasing on new home purchases, and state and local governments are on the way to reforming pension obligations so that they can once again grow their workforces and expenditures. While the federal debt remains a concern, we do note that the federal debt next year will likely grow no faster than the economy as a whole, pointing to Washington as more of a neutral player in the economy that is neither spurring nor inhibiting growth. In aggregate, we have entered a virtuous cycle, where new borrowing supports further economic activity, making room for continued financing of investment and consumption.

Housing on the Upswing
Housing is the clearest example of a virtuous cycle at work. The decline in mortgage interest rates enabled owners with sufficient equity to refinance, upping their disposable income. The expenditure of this income supported job growth, which supported more home purchases, lifting home values, enabling more refinancing, and improving the collateral at banks, improving credit availability, which in turn supported home purchases, which now is prompting hiring in construction, which… perpetuates this beneficial activity. We believe the vicious cycle of 2008-2010 is abandoned, and we fortunately have entered a positive feedback loop of great significance and benefit to the U.S. economy.

Energy is a Bright Spot
Beyond the credit cycle and the related virtuous cycle in housing, we see other sectors of the economy shifting from negative to positive feedback loops. Declining levels of energy production created a greater need for imports of crude oil, thus weakening the U.S. dollar through a widening trade deficit, further exacerbating our import needs and raising the price of all commodities through our currency decline. However, the resultant increase in energy prices has now spurred the adoption of new technologies that have grown U.S. production. We have now entered a virtuous energy cycle of lower imports helping support the dollar, which in turn, helps keep commodity prices reasonable, supporting broad economic activity. In 2013, the United States overtook Russia as the world's largest energy producing nation.

The abundance of energy in the United States is closely linked to another cycle that has turned from vicious to virtuous. For decades, corporations replaced U.S.-based manufacturing work with production overseas, primarily in emerging markets. Initially, this enabled those countries to build infrastructure and expertise, attracting even more production away from the U.S. That vicious cycle that drew employment opportunities away from our shores, has now taken a virtuous turn. The success of the developing world's manufacturing has driven a sharp acceleration in wages in those countries, both allowing U.S. workers to be more competitive and creating whole new markets for U.S. exporters.

Risks Do Remain
We are not blind, of course, to the risks ahead. The U.S. needs to right-size the federal budget and its entitlement obligations; the resolution of these imbalances will likely result in a drag on growth, however necessary the reform. An abundance of regulations, including uncertainties associated with the launch of the Affordable Care Act could all inhibit growth. Geopolitical risks are always present, but perhaps are heightened in an era without the clarity of the Cold War and an American public which increasingly prefers a more passive foreign policy. On balance, however, this remains a period when the forces supporting growth are likely to dominate.

In the past, we have characterized the economy as being on a "journey to normal." The Federal Reserve's recent decision to reduce their asset purchase program, quantitative easing, is but one signpost that we continue on the path. We may not yet be at a point where U.S. economic growth is self-sustaining or commensurate with the abundance of underutilized labor and industrial capacity, but we now have the destination to our journey in our sights.