FMX | Connect – www.fmxconnect.com - (Reported 7/30/2010)
Excerpt from MARKET MUSINGS & DATA DECIPHERING
SLOW MOTION RECOVERY
The economy underperformed expectations in the second quarter with the initial estimate of real GDP growth coming in at a 2.4% annual rate. The revisions to the back-data also showed the Great Recession to be even greater than initially thought with the economic loss now totaling 4.1% from 3.7% previously. And the revisions also reveal a policy- and inventory-induced recovery that is now losing steam at a faster rate than was thought before, especially with respect to consumer spending – the 2.4% GDP pace is down from 3.7% in the first quarter and 5% in the fourth quarter of last year.
There are legions of economists out there who claim that it is normal to see the economy take a breather at this stage of the cycle, but in truth, what is “normal” in the context of a post-WWII recovery is that four quarters into it, real GDP expands at over a 6% annual rate. That puts 2.4% into a certain perspective. And with the revisions now showing the downturn deeper, the level of economic activity in real terms is still 1% below the pre-recession peak. Again, when you look back at 55 years worth of post-war data, what is normal 2-1/2 years after a recession begins is that by now we are at a new peak already (breaking above the prior high in GDP by 8%, on average).
The big story in the second quarter as has been the case for much of the past year was the contribution from inventories – there was a “build” of $75.7 billion and this added over a percentage point to headline GDP growth. This follows a “build” of $44 billion in the first quarter so this is no longer the case that companies are merely reducing the pace of inventory withdrawal. Businesses actually added to their stockpiles at the fastest rate in five years. And with sales lagging behind, this inventory contribution is likely to fade fast in coming quarters. Real final sales – representing the rest of GDP (excluding inventories) – came in at a paltry 1.3% annual rate last quarter and has averaged 1.2% since the economy hit rock bottom a year ago in what is clearly the weakest revival in recorded history.
Normally, real final sales are expanding at closer to a 4% annual rate in the year after a recession officially ends. Then again, we haven’t heard anything official just yet about the one that began in December 2007 and so the fact that it is averaging at around one-third that typical pace in the face of unprecedented policy stimulus is rather telling. And frightening.
CANADA’S GROWTH MACHINE SPUTTERS
Canadian GDP also came in below expected – the monthly data for May was +0.1% versus expectations of +0.2%. If not for a near-record 3.4% surge in activity in the energy patch, the economy would have actually contracted fractionally.
UPDATE ON EARNINGS
Over half the S&P 500 have reported (304 to be precise) and so far the season has been rather jolly with 75% beating bottom-line estimates and even 63% doing likewise on the revenue line – both above average (of 70% and 60%, respectively in recent quarters). It now looks like EPS growth is going to test +50% YoY, which is impressive indeed. Companies are retaining more than 10% of their profits (post all operating costs), which is good news for bondholders, that is for sure.
So why isn’t the equity market reacting better? A few reasons:
First, a lot of this good news was already priced in to begin with.
Second, the second quarter is a bit like ancient history right now – guidance has not been that good with three companies providing downbeat assessments for the coming quarter for every one that had something positive to say about the near-term outlook. Over the long-term, that negative-positive ratio is generally closer to two-to-one than three-to-one .
BUY BONDS NOW!
St. Louis FRB President James Bullard (the “monetarist’ district bank) came the closest to the truth in his statement yesterday (even closer than Bernanke’s recent “unusually uncertain” assessment of the economic outlook – see “Within the Fed, Subtle Worries of Deflation” on page B1 of the NYT):
“The U.S. is closer to a Japanese-style outcome today than at any time in recent history … a better policy response to a negative shock is to expand the quantitative easing program through the purchase of Treasury securities.”
With the policy rate at 0%, and the longer-end of the Treasury curve some 100 basis points higher today than they were at the cycle lows, the Fed may indeed want to embark on action that, at the margin, will restimulate the economy. All the more so now that the public’s appetite for more fiscal largesse has clearly waned.
THIS ‘I’ IS NOT EVIL
We are talking about Income here – and not necessarily just in the government bond space. The front page of the WSJ runs with “Bonds Soar Around the World” and it’s all about how corporate borrowers globally are flooding the market with new debt to take advantage of this recent down-leg in yields. Junk bond issuance has been particularly active. But this isn’t reflecting anything more than refinancing old debt at better prices.
David A. Rosenberg
Chief Economist & Strategist Economic Commentary
drosenberg@gluskinsheff.com
+ 1 416 681 8919
Source: Market Musings & Data Deciphering
http://www.fmxconnect.com/
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