The U.S. economy is well on its way to recovery, according to most mutual fund CIOs, and just about all the economic charts show key growth criteria improving, barring an unexpected jolt.

Most experts seem to agree that unemployment has nearly peaked, inflation fears are far-off, and U.S. large-cap stocks still provide some of the best bargains around.

"The financial crisis has ended," said David Kelly, chief market strategist at JPMorgan Funds. "We have embarked upon a recovery, but it will be a long time before we are back to a fully normal economy."

The U.S. is participating in the biggest, synchronized global recovery since 1971, said James Swanson, chief investment strategist at MFS Investment Management.

"The U.S. consumer has been remarkably resilient," he said.

The drop in gasoline and heating oil prices has put an extra $160 million back into American households, he said, and the increase in productivity amid falling labor costs is bolstering the profitability of U.S. companies. In a few months, profits should return to where they were pre-Lehman Brothers, he said.

"The market is trading at fair levels and is perhaps undervalued," said Michael Roberge, executive vice president and chief investment officer of U.S. investments at MFS Investment Management.

Cyclical indicators like light vehicles sales, housing starts, capital goods orders and changes in private inventories are creeping upwards.

"We expect a cyclical recovery, but secular, long-term issues will dampen growth," Roberge said. "There are opportunities in large-cap stocks, but we expect these secular issues to keep growth low."

Higher-quality companies have lagged behind their lower-quality brethren for the past six months, but there will be a rotation back to quality, he said.

"There are opportunities in the aftermath of what we've been through," Kelly said. "These markets are twisted out of shape. Emotions lead to mispricing, and there are opportunities for long-term investors who can make logical rather than emotional decisions. Profits get crushed in a recession, but bounce high after. What falls the most bounces back the most."

Kelly said that by a nose, this current recession was the biggest post-war recession. The decline in gross domestic product for the current recession is 3.8%, compared to a 3.2% decline in GDP in the early 1970s. By contrast, GDP declined by a staggering 26.7% during the Great Depression of the 1920s and '30s, he said.

"Last year was a 100-year flood," Kelly said. "Hopefully we won't see this again in our lifetimes, but if you build your flood walls high enough to protect against a 100-year flood, what are you missing out on?"

Unemployment

It can be hard to be positive about the job outlook when many companies are still laying off employees and the national unemployment rate has risen above 10%, but experts say the end is near.

"We are very close to the end of job losses," Kelly said. "On average, unemployment peaks six months after a recession ends. The stock market typically leads the recovery. Don't wait for unemployment to return first."

Most firms know that their employees are their most-valuable assets, but they also realize that their workforce is one of their biggest expenditures. For many firms, survival depends on keeping labor costs as low as possible for as long as possible. This trimming of excess fat has resulted in short-term profitability, but it's not sustainable.

"Businesses are stretching workers," Roberge said. "At some point, they will have to bring hiring levels back up. As consumer income grows, consumption will grow and begin a virtuous cycle."

Many employers are intentionally delaying the filling of vacant positions, but as the economy picks up again, the boost in workload will force them to fill these holes.

According to FUSE Research Network, 47% of asset managers plan to expand their full-time product management staff in the next year (see story, page five), but they don't expect employment levels to return to pre-crisis levels anytime soon. Thirteen percent said they might lay off additional staff in 2010, and 7% said they plan to add freelance contractors.

Swanson said he expects to see net job gains by February.

Inflation Fears

Many economists are concerned about inflation, considering our huge national deficit, enormous Federal Reserve balance sheet and target interest rates stuck at zero to 0.25% and showing no signs of rising, but some money experts say these concerns are misplaced.

"Do not worry about inflation," Kelly said. "There is not the slightest chance that inflation will be a problem in the next few years. There is still far too much slack in the economy."

Kelly says deflation, rather than inflation, is a far greater risk for the time being.

"The Fed knows that deflation may be the worst of all possible worlds," Swanson said. In a deflationary environment, the prices of goods and services decline, while union wages typically do not. The result is lower output and higher unemployment.

"We will need an awful lot of data before this Fed raises rates," Swanson said.

Until inflation fears return, Treasuries, Treasury Inflation-Protected Securities and other stable-value investments offer very low opportunities for growth, Kelly said. In the meantime, domestic, international and emerging market stocks are looking too hot to ignore.

Forty years ago, the U.S. had two thirds of the world's market capital. That has changed dramatically, noted David Antonelli, executive vice president and chief investment officer of non-U.S. and global equity investments at MFS Investment Management. Now, the U.S. makes up about 42%, emerging markets make up about 13% and the rest of the world makes up the remaining 45%, he said.

"The percentage of market capital in emerging markets will continue to grow," he said. "They will take a much bigger slice of the world's capitalization."

Part of the reason for the rapid growth of investment in countries like Brazil, Russia, India and China is due to the way these economies are uncorrelated with the West and more developed countries, but a disproportionate level of investment could be unhealthy.

"There has been a dramatic improvement in global confidence since March," Antonelli said. "Emerging markets do look a little expensive compared to history, but I would by no means call it a bubble. China's economy slowed a bit during the recession, but it looks like they're back on. We are seeing tremendous growth all around that region."

 

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