We Had Growth — Where Is The Impact?

On February 3rd, 2012, posted in: Economic News, Newsletter by

It was announced real GDP grew at a 2.8% annual rate in the fourth quarter, up from 1.7% in Q3 and its strongest growth since Q2 2010.  The Q4 increase came in just slightly below the consensus estimate of 3%.  However the market reaction was less than favorable. WHY? Consumption and business investment were weaker than expected and while inventories jumped there may be no prolonged impact.

The largest positive contributions to the real GDP growth rate came from inventory increases and a slight rise in personal consumption. The weakest element of the real GDP measure was government purchases, which reduced the real GDP growth rate by 0.9 points.

The GDP price index increased at a 0.4% annual rate in Q4. Nominal GDP – real GDP plus inflation – rose at a 3.2% rate in Q4 and was up 3.7% in 2011.

Many of the commentators looked at the 4Q numbers and concluded the “good news” was really not all that good. They pointed to these factors as not being sustainable and that future growth would most certainly fall to much lower levels.  Here’s why:

Almost all of the 4Q gains came from inventory accumulation. They question whether this can continue  to increase in 2012.

Consumer spending was only slightly up.

Investment spending dropped dramatically and even though corporate profits are high the balance sheets show a lot of cash.

Exports fell. This is a trend that’s likely to continue as Europe dips into a recession.

Government spending reduced for the fifth consecutive quarter. This reduced GDP growth by almost 1% in 4Q.

Other economists do not agree with this disappointment.  The weakest part of the report definitely was the reduction in government purchases. But this was driven by a wind-down of operations in Iraq and continued state and local spending cuts.  Excluding government impact, the real GDP grew at a robust 4.5% annual rate in Q4 and was up 2.6% for 2011 as a whole.

Home building was up at a 10.9% annual rate in Q4.  If you exclude a couple of quarters in 2009-10, which were artificially and temporarily inflated by the homebuyer tax credits, this is the fastest growth in residential construction since 2004. That has to be encouraging.

But here is something lost in the data, real GDP has now accelerated for three quarters in a row. (Real GDP reflects inflation, nominal GDP doesn’t). Orders for durable goods have jumped for the past two months and suggest business investment will accelerate in 2012.  With housing and investment improving, the Federal Reserve will have a difficult time justifying a QE3 strategy.  Nominal GDP (no inflation factor) grew at a 3.2% annual rate in Q4, which is a slowdown from recent quarters.  Was this a false signal?  Nominal GDP grew 3.7% in 2011 and is up 4.2% annually in the past two years.  The Federal Reserve’s long-run outlook is a 4.5% growth rate for nominal GDP.  This suggests zero percent interest rates are too low and using an easy money policy would be a mistake. The Fed should not consider a third round of quantitative easing. It is not needed and it is likely the Fed will raise rates before its current forecast of late 2014 or beyond. This is a good benchmark to track.

New single-family home sales fell 2.2% in December to a 307,000 annual rate. The consensus expected a rate of 321,000. Sales were down in the South and Midwest, but up in the Northeast and West. At the current sales pace, the months’ supply of new homes (how long it takes to sell the homes in inventory) rose slightly to 6.1.

Although new home sales came in below the consensus 321,000 in December, sales did remain in the narrow range they have maintained since May 2010.  Sometime over the next several years, it is expected new home sales will rise to an annual pace of 950,000.  But, with tight credit conditions and the large inventory of existing homes – particularly those in foreclosure or short sales – this will take time.

The best news in the current stats was the continuing decline in new home inventories.  The number of unsold new homes under construction is at a new record low and the number of unsold completed new homes is close to a record low.  For a sustained housing recovery, both of these factors have to be in place coupled with favorable interest rates and few alternative housing choices. Builders are wise to the rapid reductions in inventories.  Building permits are gradually rising – up 12% in the past three months.

As to pricing, median new home prices are down 12.8% from a year ago while average prices are down 8.8% from a year ago.  Pending home sales declined 3.5% in December.  However, with the 7.3% gain in November, existing home sales probably rose in January. But the proof is in the numbers. Meanwhile, the FHFA index, which tracks prices on homes financed by conforming mortgages, increased 1% in November and is down only 1.8% versus a year ago.  Home prices could rise in 2012.

New orders for durable goods increased 3.0% in December, beating the consensus of 2.0%. Orders exclude transportation which rose 2.1%, well above consensus 0.9%. Overall new orders are up 17.0% from a year ago, while orders excluding transportation are up 7.0%. The gain in overall orders was led by civilian aircraft. Machinery and primary metals were also strong, and most other categories gained.


The government calculates business investment for GDP purposes by using shipments of non-defense capital goods excluding aircraft.  That measure rose 2.9% in December (+2.7% including downward revisions). These shipments were flat in Q4 versus the Q3 average. Unfilled orders increased 1.5% in December and are up 9.7% from last year.

This is really terrific news on durables. With new durable orders up 3% in December and up an even stronger 3.6% including adjustments to November, this portends a strong increase in sales for many companies. The extremely volatile transportation sector fueled the change. But, the underlying trend is better represented by activity outside the transportation sector. Orders, ex-transportation, were up 2.1% and appear to be accelerating, up 7% from a year ago and at an 11.9% annual rate during the past six months and an 18.2% annual rate in the past three months. “Core” capital goods shipments, which exclude defense and aircraft, were up sharply in December (2.9%). Also, unfilled orders for core capital goods hit another all-time record high in December and are up 13.4% versus a year ago.

It looks like business investment is poised to march higher over the next few years as corporate profits and cash on the balance sheets of non-financial companies are at record highs. Some may believe these stronger orders were due to an expiring tax provision regarding accelerated depreciation, but this is not correct.  Equipment must be in place and functioning (not just ordered) to qualify for the tax break. So that could not possibly be the explanation.

Unemployment insurance claims, which have been in the news consistently, rose 21,000 in the middle of the month but fell as January ended to 365,000.  Continuing claims for state benefits increased 88,000 to 3.55 million. However, these gains are dwarfed by the huge drop in claims two weeks ago and should continue to make their way lower over time.

The Richmond Fed index, a measure of manufacturing activity in the mid-Atlantic, increased to +12 in January from +3 in December.  The gain easily beat consensus expectations of +6 and was the highest since March 2011.  Shipments and new orders were particularly strong, signaling more robust reports on durables in the months ahead.

If you put this all together, what do you have? – An economy that is growing, but at a much slower pace than anyone would like to see. Unemployment may dip slightly, but this is mostly due to a flat workforce rather than the creation of a lot of new jobs.  Initial jobless claims increased sharply last week to 377,000.

Economy.com is upbeat about these long term prospects.  Their analysis concludes, “Growth will strengthen throughout 2012, with real GDP expanding about 2.5%.  There will be a very strong expansion in 2013, 2014, and 2015, with annual growth of more than 3% each year.”

If they’re right, this could mean a good year for stocks, especially given the fact this is a presidential election year.  As usual, we’ll have to wait to find out.


The markets looked at the results of the Fed’s FOMC meeting (announcing short-term rates will remain low through 2014), the 4Q GDP report (inventory accumulation can’t grow much more in 2012) and came to negative conclusions.  The Dow slipped a little at the end of the month [+3.40%], the S & P 500 [+5.28%} was up as was the NASDAQ Composite [+9.28%] which continued its strong January performance.  The NASDAQ benefited from another strong quarter from Apple (APPL), which never seems to be able to produce enough product to match the demand for its “i.” Past performance is no guarantee of future results. Indexes are not available fo direct investment.

The Federal Reserve meeting ended as it started.

The big news was the Fed went on record saying it would maintain these low rates into late 2014 shifting from the last announcement of mid-2013. However, this change will have no impact on the current monetary policy. This is best measured by the gap between the federal funds rate and the trend growth rate in nominal GDP (that’s real GDP plus inflation).

The Fed also edited their statement. The most important change was removing – the Fed “will continue to pay close attention to the evolution of inflation and inflation expectations.” This signals the Fed’s willingness to prolong the period of essentially zero percent short-term rates, which ultimately means the US will have more inflation down the road. Markets are markets and they will always make up for interference and intervention.

The Fed also restated the obvious; the Fed “expects to maintain a highly accommodative stance for monetary policy.”  An even more noteworthy change was saying, the Fed expected growth over coming quarters will be “modest,” rather than “moderate.” This announcement signaled the FED is not planning a third round of quantitative easing.

However, investors should take note, Chairman Bernanke made it clear if the Fed’s economic forecast proves either too optimistic or too pessimistic, it would change its forecast and alter its policy expectations for the funds rate as well. The importance of this statement cannot be underestimated. Since there is likely to be faster economic growth, lower unemployment, and higher inflation than the Fed projects over the next few years, it is reasonable to expect the Fed will start raising interest rates well before late 2014.


Long-term Treasury rates slipped lower, perhaps due to the FOMC announcement.  The announced policy will keep short-term rates near zero for a year or so beyond its original mid-2013 timeline.  Investors with money in money-market funds had to be disappointed.

Given the Fed announcement, what is going to happen to the nearly $3 trillion sitting in money fund investments today?  – Probably nothing, until after the election. This election is stacking up to be a real game-changer, no matter who wins.

After the election, money will start to move. It will either go to longer maturities or into the stock market.  Either decision is fraught with risk compared to the mid 2000s. In the long-run, stock prices will be driven by U. S. growth and corporate profitability.  In the short-run, however, the uncertainty in Europe will continue to cause volatility to the U. S. markets.  Look at March 20 as the next marker. This is when Greece will have to refinance a huge amount of its maturing debt. Hold on to your hats.

Greece will have to “legally commit itself to giving absolute priority to future debt service” and “accept shifting budgetary sovereignty to the European level”. If Greece is not willing to do this, the troika would presumably turn off the taps of bailout money and Greece would default. This means they would have no access to market or official financing.  Greece would be forced to exit the Eurozone.

Germany’s proposal for Greece seemed to have caught most by surprise, but why? The ruling German Christian Democrat party (CDU) published this idea in November 2011. According to their proposal, if a country is unable to meet its debt obligations, “the European Commission should provide the affected Eurozone country with a commissioner responsible for budgetary savings. His job would be to oversee the use of budgetary funds and implement any restructuring measures required.” The CDU goes on to propose a clause in the Lisbon Treaty to allow a country to voluntarily withdraw from the Eurozone without exiting the EU.

This clause for a voluntary Eurozone exit increasingly seems like a preview for things to come for Greece. Greece is currently in the midst of negotiating a new deal. If they fail, Greece faces a hard default when it must roll over €14.5bn on March 20th. This is an extremely tight schedule even without the huge distraction of Greece fighting for its fiscal sovereignty. Best case, Greece reaches an agreement, but then what? If the Greek government does not sign up to the German proposal and Germany does not back down, a hard default by Greece is assured.

Most believe Greece cannot finance this debt without (1) taking a discount or considerable loss on the part of bondholders and/or (2) getting substantial aid from someone – the European Central Bank, the International Monetary Fund, or maybe even the US?  Regardless, our markets are likely to be impacted by Europe’s problems, which will likely take years to eventually resolve.


www.aaii.com – the website for the American Association of Individual Investors; provides a wide range of data and articles on investments and investing.


US Government

* U.S. Tax revenue: $2,170,000,000,000
* U.S. Spending: $3,820,000,000,000
* New debt: $ 1,650,000,000,000
* National debt: $14,271,000,000,000
* Recent planned spending cuts: $38,500,000,000

Let’s now remove 8 zeros and pretend it’s a household budget:

* Annual family income: $21,700
* Money the family spent: $38,200
* New debt on the credit card: $16,500
* Outstanding balance on the credit card: $142,710
* Total planned spending cuts: $385

The Federal Reserve reported recently it contributed $76.9 billion in profits to the U. S. Treasury Department in 2011.  Almost 97% of the Fed’s income was generated by interest payments from its investment portfolio, which includes $2.5 trillion in Treasury securities and mortgage-backed securities.


This information is compiled by Guy Baker from an assortment of news feeds including First Trust, Yahoo Finance, Bloomburg and others. This information is intended to be informational only. This newsletter contains forward-looking statements about various economic trends and strategies. You are cautioned that such forward-looking statements are subject to significant business, economic and competitive uncertainties and actual results could be materially different. There are no guarantees associated with any forecast and the opinions stated here are subject to change at any time and are the opinion of the individual strategist. Investing involves risk, including the potential for loss of principal. Data comes from the following sources: Census Bureau, Bureau of Labor Statistics, Bureau of Economic Analysis, the Federal Reserve Board, and Haver Analytics. Data is taken from sources generally believed to be reliable but no guarantee is given to its accuracy.





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