For investors, the economic picture nationally and gloabally is cheerier than it appears.

The U.S. business cycle has still got some momentum, and bandages applied to the European economy – including a bailout of Spanish banks over the weekend - are enough to allow a business recovery this year, according to a top Wall Street strategist.

The mid-year investment outlook from Jim Swanson, chief investment strategist at MFS Investments, was upbeat. In spite of woeful headlines about recently disappointing economic data from Washington, he told a conference call this morning: “The U.S. economy remains the bright spot.”

He started with Europe, the top worry for many investors. He believes the “root cause” of the problem is not too much debt in the peripheral countries of Greece and Spain, but the extremely high unit labor costs and inefficiencies of Europe’s labor market. “Europe has been losing its share of the export market for years,” he said, adding, “With a stagnant or slow-growing population, the route out of a debt problem is growth, which is impossible if you can’t gain share of the export market.” He noted that the United States ratcheted down unit labor costs after the last recession, and saw its exports recover. He added that none of the actions taken by European leaders to grapple with the current crisis address this problem.

He said that the real answer to the European crisis will have to come from German taxpayers. He said they must realize that for their own good, they will have to grit their teeth and take on the debt of neighbors who are retiring younger in sunnier climes. He pointed out that 50% of Germany’s GDP is from exports: compare that with 12% for the U.S., the world’s largest economy. The German economy – which is still not in recession, unlike most of the rest of Europe – is heavily dependent on being able to sell its goods abroad. If the contagion from the region’s ailing banks spread, and the Germans allowed the currency union to break up, “Germany would suffer huge consequences in terms of its trade with its partners. It would be a collapse worse than Lehman [in 2008-2009],” he said. He explained that the current European recession is not as severe as the one following the collapse of Lehman Brothers, because now the flow of credit has merely slowed, not completely broken down. He said if the Euro collapsed, Germany would likely see its currency behave like the Swiss franc, and climb too high to support the economy. 

In the meantime, he expects to see Europe suffer though a “garden variety recession” of two to three quarters.

In the emerging markets, the picture is brighter, as China’s economy is slowing, but not crashing, and other large economies, including Brazil and India, have started to respond to monetary policy changes. He said that the inflation scares around commodities have subsided with a return to record crops and a more normal weather pattern. He expects the area, with the exception of Argentina, to return to trend growth. What’s more, he said the credit quality of the emerging markets’ bonds have improved as well.

In the U.S., with corporate profit margins rising, he believes the economy is half-way through the business cycle with yet more room for growth. This is counter to other observers who have suggested the cycle may be near the end. He noted that going back to World War II, the typical business cycle runs five years “so we’re roughly half-way there.”

He cited another statistic to support optimism: in the 11 recessions since World War II, seven have come from interest rate increases or oil shocks, neither of which appear on the horizon now.

He said the drivers of the business cycle are still pushing momentum forward, citing rises in each of the following: corporate profit margins, personal consumer expenditures, the housing market and car sales. He said a key to the climbing profits are U.S. labor productivity – in stark contrast to Europe. Another positive he cited is U.S. companies’ success in deleveraging balance sheets, making them more resilient in case of a recession. What’s more, free cash flow is at a high not seen since the 1950s. ‘The corporate story is very healthy. That’s a good sign for future jobs,” he said.

Swanson said that he sees opportunities for investors in high quality U.S. companies, notably large cap companies, and dividend paying stocks – which are often the same. The high quality companies – those with stable balance sheets, positive earnings growth and established management – often outperform the broader markets. He said that while the U.S. market is the most expensive in the world, it is also cheap compared with historic norms.

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