GDP came in more or less in-line with expectations and the market seems to like the underlying news. There were a lot of moving parts here, but some are clearly more important than others. On the weak side we had business investment, housing, personal consumption, and inventories. On the strong side we have the trade gap and a rebound in government spending. This appears to neatly summarize the driver of hope that has been the last few months. Despite continued declines in personal consumption and house prices, large components such as government spending continue to offset the overall weakness.
Much like the cost cutting that has led to “better than expected” earnings we have to ask ourselves how much of this GDP report is sustainable? Will housing turn into a positive or will it continue to be a drag? Will personal consumption continue to be weak? Can the government continue to spend enough to offset the overall weakness? The overall U.S. economy is very similar to a corporation. In this case the top line growth comes mainly from personal consumption. Are we in essence, doing the same thing that our corporations are doing – improving the near-term without the necessary long-term driver of top line growth? This GDP report would certainly reflect that.
As I generally try to do, I’ll cut out the fat and get right to the meat. In this consumer driven economy the PCE component of GDP should scare investors. While we’re seeing recovery in many sectors of the economy it is still very clear that the consumer is not recovering. PCE was down 1.2% versus last quarter’s 0.6% rise. The weekly sales reports here at TPC reflect these figures. There is little to no recovery in the consumer.
Charles Rotblut at Zacks makes an excellent point with regards to future GDP:
Furthermore, the economy still has a long way to go just to get back to breakeven. GDP fell at a 6.4% pace in the first quarter and a 5.4% pace in the fourth quarter. Even if the more optimistic forecasts prove to be correct, the economy will end 2010 with pretty much not showing any growth during the first 2 years of the Obama presidency.
For stocks, this means a prolonged trading range will likely form. That is not a bad thing, but it’s not a bull market rally either.
That’s not an unreasonable expectation. You could essentially argue now, after a 50% rally, that recovery has been almost entirely priced into stocks. We will need to see real growth in order to justify taking on equity risk exposure going forward.
Lost in the mix this morning was the Chicago PMI. The Chicago PMI nicely summarizes the economic outlook during the last few months and just how steep the decline was in Q3 ’08. It’s important to note, that while improving, we are still below the long-term trend line in the deterioration of the economy. So, what we have to ask ourselves now, is whether things are truly going to improve going forward or are we still in this lingering weak economic environment with below trend growth? My guess is the latter.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.