The Independent Market Observer

1/30/13 – Bad Is Good

Posted by Brad McMillan, CFA®, CFP®

Find me on:

This entry was posted on Jan 30, 2013 1:33:41 PM

and tagged Fiscal Cliff, Market Updates

Leave a comment

013013So, gross domestic product—that is, the U.S. economy—declined a bit (by 0.1 percent, to be exact) for the fourth quarter of last year. Is this it? Is a recession starting? What about all the good news I’ve been discussing? Aaaaaaaaaaaah!!!

Okay, I feel better now. In fact, while no one wants to see a decline in GDP, if we have to have one, this is exactly how we want it to happen.

Let’s look at the underlying data:

  • Consumer spending, which represents about two-thirds of the economy, was up by 2.2 percent, accelerating from the previous quarter’s figure of 1.6 percent. Not only is a major part of the economy continuing to improve, it’s doing so at a faster pace, despite Hurricane Sandy and the fiscal cliff. Pretty encouraging.
  • Next, one of the missing pieces in this recovery has been business investment, which popped by 8.4 percent, more than reversing the 1.8-percent decline in the third quarter. Again, this reversal came in the face of the fiscal cliff and, if it heralds a sustained return in business investment, will provide the last piece of the recovery.
  • Residential investment popped by more than 15 percent, continuing the housing recovery.

Each of these components is very positive news. So what went wrong?

Three things: inventories, net exports, and a strange drop in defense spending. Inventories are expected to be a one-time adjustment, knocking about 1.3 percent off of GDP, while the net export figure is probably a longer-term drag, with imports continuing to exceed exports as the U.S. economy recovers. Both of these were somewhat expected, partially reversing a very strong third quarter.

The big mystery here is a 15-percent drop in government spending, driven by a 22-percent drop in defense spending, which knocked another 1.3 percent off of GDP. This drop hasn’t shown up in Treasury statements and is not consistent with defense-industry revenue figures, so no one knows yet where it came from. Best guess at this point is that it has something to do with accounting inconsistencies introduced by the fiscal cliff and pending sequester. Again, this should be a one-time adjustment and may well end up being revised away.

Together, these three factors knocked 2.9 percent off of growth in the quarter, after adding 1.9 percent in the third quarter. Other negative factors included warm weather, which, by reducing spending on utilities such as heat, actually reduced reported GDP by an estimated 0.5 percent.

Overall, the weak GDP figure for the fourth quarter appears to represent something of a mix of technical payback for a strong third quarter, one-time factors, and strange seasonal adjustments. Something is funny here, especially in the drop in government spending. This quarter does not represent a substantial weakening of the economy or a reversal of the recovery.

For 2012 as a whole, GDP grew 2.2 percent, up from 1.8 percent in 2011. The recovery, while slow, continues to strengthen despite the occasional statistical blip, and this should not be the start of a new recession.

That said, growth in the first quarter will face its own challenges, primarily the tax increases that are now showing up in the form of reduced take-home pay. Consumer confidence surveys have already taken a hit as a result of this. Other confidence-reducing events pending are the debt ceiling negotiations, the spending sequester, and the expiration of government spending.

We’re not out of the woods yet, but the details of the GDP report are actually much more encouraging than the headline number would suggest, especially on the consumer spending and business investment side. The recovery continues, for the moment.


Subscribe via Email

Crash-Test Investing

Hot Topics



New Call-to-action

Conversations

Archives

see all

Subscribe


Disclosure

The information on this website is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets.

The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices are unmanaged and investors cannot invest directly in an index.

The MSCI EAFE (Europe, Australia, Far East) Index is a free float‐adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of 21 developed market country indices.

One basis point (bp) is equal to 1/100th of 1 percent, or 0.01 percent.

The VIX (CBOE Volatility Index) measures the market’s expectation of 30-day volatility across a wide range of S&P 500 options.

The forward price-to-earnings (P/E) ratio divides the current share price of the index by its estimated future earnings.

Third-party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided on these websites. Information on such sites, including third-party links contained within, should not be construed as an endorsement or adoption by Commonwealth of any kind. You should consult with a financial advisor regarding your specific situation.

Member FINRASIPC

Please review our Terms of Use

Commonwealth Financial Network®