By Frank Byrt, TheStreet

While Americans focus on debt and budget negotiations in Congress, the nation's already fragile economy may be heading toward another recession.

As an example of how bad things are, the Institute for Supply Management said Monday that its index of manufacturing activity dropped to a reading of 50.9 in July from 55.3 in June. Economists had expected the gauge to remain unchanged.

The Commerce Department also said last week that gross domestic product (GDP) growth -- a measure of all goods and services produced in the U.S. -- rose at a meager 1.3% annual rate in the second quarter, well below economists' projected 1.8% growth. A year ago, the economy expanded by 3.8%.

The dour data come as President Barack Obama and Congress try to end a stalemate over the budget deficit and whether to raise the debt ceiling. During the weekend, Democrats and Republicans agreed to a plan to raise the debt ceiling in two steps and reduce federal spending by $2.4 trillion over 10 years. Concern over how to sustain U.S. spending in the long term lingers as the current proposal prevents a U.S. default but doesn't discuss where spending cuts would be.

While Republican House Speaker John Boehner still faces the challenge of garnering enough Republican votes to pass the proposal, the latest agreement is seen as the most promising considered so far. The debate has roiled global markets and threatened consumer confidence.

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That's troubling because consumer spending, which makes up about 70% of GDP, was already a big part of the underperformance last quarter. It fell to a 0.1% rate of growth, the weakest since the recession ended two years ago.

Mark Zandi, a chief economist for Moody's Analytics, now projects that GDP will end 2012 almost $75 billion lower than previously projected, which is almost half a percentage point of GDP, and that's due largely to expected cutbacks in consumer spending.

Contributing to skepticism about the government's ability to accurately monitor the economy, the Commerce Department dramatically cut its revised GDP growth measurement for the first quarter to 0.4% from its previously reported 1.9% and then cut the growth rate for the fourth quarter of 2010 to 2.3% from its previous 3.1% estimate.

On top of that, the government says it recalculated data from the 2007-09 recession and found that the economic decline was much worse than previously reported, with economic output declining by 5.1% instead of 4.1%.

Scott Brown, a chief economist at Raymond James in St. Petersburg, Fla., said the revisions are a "real shock" because the economy clearly has a lot less momentum than the nation was led to believe. "So, obviously, it's a big concern, and then we have this nonsense on the debt ceiling issue, which is totally unnecessary, but it has created a crisis that we're seeing the economic implications of now."

Paul Larson, an equities market analyst for Morningstar, said the lower GDP numbers are especially disappointing, given that "in the first quarter we were in the heart of QE2 (the government's economy-boosting program) and there were still some remnants of the stimulus spending" from last year that was also aimed at boosting economic growth.

"To have this low rate of growth with this sort of government spending going on, which it now looks like we probably can't afford, is pretty disappointing," Larson said.

Indicative of investors' concerns, Brown said, people are taking money out of money market funds, which are typically backed by Treasurys and agency debt from Fannie Mae and Freddie Mac, and putting it into cash, since they are concerned about the rates they'll get if Treasurys get downgraded if Congress fails to approve Sunday's plan on the debt ceiling by Tuesday.

A credit-rating downgrade of Treasurys would also affect thousands of municipal bonds, because their rates are tied to Treasurys, which means already cash-strapped states and cities would have to pay more in interest on their debt.

The high rate of unemployment remains another major problem. Government statistics put it at 9.2%, and although new claims were reported down slightly in the week ended July 23, the figure doesn't include people who have exhausted their claims and fallen off the unemployment rolls and have given up looking for work or are working part time and want to work full time.

Zandi wrote in a July 11 research note: "June's dismal employment report highlights the severity of the current economic slowdown. Job growth has all but stalled, and unemployment is inching higher again. With so many idle U.S. workers, wages are barely growing."

Brown said one of the contributors to the strong corporate profits seen in the first half of this year is management's ability to keep a lid on labor costs.

Larson said that, conversely, "from a corporate perspective, there's not much to complain about, because they're in relatively healthy financial condition."

He said most major companies' cash holdings are at or near all-time highs and corporate profit margins are also close to all-time bests. "There are really no signs of material economic weakness in the earnings we've seen in the second quarter."

But Zandi notes rather ominously that "the odds of a new recession in the next year have risen to 1 in 4. U.S. sentiment is extraordinarily fragile. It is not hard to imagine  consumers pulling back and businesses cutting payrolls if anything else goes wrong.

"A failure by lawmakers to quickly raise the debt ceiling and agree on a deficit-reduction strategy certainly qualifies, as does a near-term Greek default or a bumpy landing in China," Zandi said.

Investors are seeking safe-harbor investments to avoid the volatility that the debt crisis has caused and to avoid a market crash if there is no resolution from Congress.

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Morningstar's Larson said gold is a popular choice for investors, although it has no real economic utility. But they are also investing in the currencies of AAA-rated countries such as Switzerland, Canada, New Zealand and Australia.

He cited two health care stocks as relatively solid choices in the current turmoil because they are relatively "economic insensitive" as necessities. They are the drugmakers Abbott Laboratories (ABT) and Pfizer (PFE).

Larson said Pfizer is going to have to deal with the loss of its top moneymaking drug, Lipitor, which faces patent expiration later this year. "But if you look beyond that, the company said it expects to earn above $2 a share in 2012 and it's trading at just over $19 per share, and has a 4.13% dividend yield.

Another stock that should weather the economic turmoil in good shape, he said, is Exelon (EXC), a diversified electric power producer, and the largest nuclear power producer in the U.S.

Larson said Exelon should benefit from steadily rising energy costs. It is trading at a relatively cheap 14 times forward earnings estimates. "We think it's worth $58 per share" and it's now trading around $44 and has a dividend yield of 4.7%.