A year ago the consensus expected GDP to grow by 1.2% in 2010, according to the Treasury's monthly survey of forecasters. The outturn is likely to be between 1.6% and 1.8% (depending on fourth-quarter performance and revisions). The latest Treasury survey shows an average projection for 2011 of 1.9% but this may again prove too low. Three alternative forecasting approaches, described below, all suggest growth of about 2.5%. A stronger performance is possible if global demand remains robust.
 
The first approach is a simple rule-of-thumb that classifies GDP prospects for the coming calendar year as strong, average or weak depending on whether December levels of real (i.e. inflation-adjusted) broad money growth and share prices are higher or lower than a year earlier. The two indicators gave a joint positive signal on 15 occasions between 1965 and 2008; GDP growth averaged 3.8% in the subsequent calendar year. A joint negative signal, meanwhile, occurred in 12 years and was followed, on average, by a GDP rise of only 0.3%. Such a negative reading was given in December 2008 before a 5.0% slump in GDP in 2009. Currently, real broad money growth is lower than in December 2009 while real share prices are higher. This combination occurred 11 times and was associated with average GDP growth of 2.5%.
 
The second approach uses a statistical forecasting model that projects annual GDP growth three quarters ahead based on current and lagged values of interest rates, real narrow and broad money supply growth, the effective exchange rate, the corporate liquidity ratio (i.e. companies' bank deposits divided by bank borrowing), credit spreads and share prices. The current projection is for GDP to rise by 2.6% in the year to the third quarter of 2011, slightly down on the 2.8% gain in the year to the third quarter of 2010 (according to the latest official estimate). Assuming that the increase is spread evenly across quarters and growth continues at the same pace in the final quarter of 2011, the implied calendar year GDP rise is 2.8%.
 
A third approach is to base a forecast on the progression of GDP in previous recovery phases. The chart compares the fall and rebound in GDP from a high in the first quarter of 2008 with movements following cyclical peaks in the second quarter of 1973, second quarter of 1979 and second quarter of 1990. The recession and recovery to date bear the closest resemblance to the 1979-81 downturn and subsequent revival. The dashed blue line is a "projection" that assumes that the levels of GDP in the fourth quarters of 2011 and 2012 are the equivalent distance from the pre-recession peak as at the same points in the early 1980s recovery. This projection implies calendar year growth of 2.7% in 2011, rising to 3.5% in 2012. (Note that, in addition to the decline in GDP being larger in the early 1980s compared with the mid 1970s and early 1990s, growth was slower at this stage of the recovery. A forecast based on GDP progression in the 1970s or 1990s, therefore, would deliver a stronger number for 2011.)

The Federal Reserve's QE2 securities purchases have started to lift the US monetary base (i.e. currency in circulation plus bank reserves) but it remains 8% below its February 2010 peak.

US stocks broadly tracked the monetary base between QE1 in late 2008 and this summer but broke to the upside when the Fed signalled QE2 – see first chart. They may need to tread water or correct over the next couple of months, although the base should eventually rise well beyond the level currently implied by the market if the Fed fulfills its intention of buying $600 billion by mid 2011 and fails to sterilise the impact on reserves (i.e. to about $2.5 trillion versus the current $1.98 trillion).

A comparison of the recent recovery in US stocks with an average of performance after six prior big bear markets, discussed in several previous posts, also suggests near-term consolidation – second chart. The market is exactly in line with the "six-bear average", which meanders around the current level before another advance next spring.

US stocks traded above the six-bear average during the first year of the rally from March 2009 but have been mostly in line or below since G7 real narrow money growth fell beneath industrial output expansion in early 2010. As previously discussed, however, a positive "liquidity cross-over" could occur in early 2011. (Caveat: the range spanned by the historical recoveries widens as the distance from the 2009 low extends, suggesting that the average will become less useful for "anchoring" a forecast.)

Last week's purchasing managers' surveys for November were respectable but weighted-average G7 new orders failed to follow through on October's strong gain – see first chart. The message is that industrial output expansion is reviving after a recent slowdown but should remain well below its pace in the first year of the recovery.

Country surveys show considerable divergence, with strength in China and the UK contrasting with notable weakness in Japan, partly reflecting this year's surge in the yen – second chart. Chinese buoyancy, however, is no longer "good news" for the world economy and equity markets, since associated overheating pressures guarantee further significant policy tightening.

The small fall in the G7 new orders measure reflected slippage in the US component, which continues to follow the pattern of previous cycles – third chart. This comparison suggests further easing into early 2011, a prospect consistent with some slowdown in stockbuilding from its recent rapid pace.

As previously noted, G7 real narrow money continues to grow moderately, offering a reassuring message about the sustainability of the economic recovery, at least through mid 2011.