By Robert Brusca
Chief Economist, Ecobest Consulting
Apr 29, 2001 08:00 AM
With the Commerce Department reporting a first quarter gross domestic product growth rate of 2 percent on an annual basis, many have been crowing that talk of recession is a thing of the past and that the Fed might not need to cut interest rates again in May.
Does the first quarter acceleration in growth mean that the Fed is all done? Is that what the bond market is saying? If so, why did stock prices soar, then sag? It's because we are still in a period of transition. Do not be too quick to assume that the economy has put the worst behind us. The markets still harbor their fears and some of them are inconsistent.
One reason to be wary of the first quarter GDP report is that it has some strange, inconsistent, and not sustainable trends embodied in it. Look at the most glaring oddity. GDP was weak largely because the trade deficit contracted sharply. Exports fell by 2.2 percent but imports plunged at a 10 percent annual rate! What's that about? Imports are a derived demand. They represent an excess demand of US demand relative to supply.
Traditionally, imports run at a much faster speed than U.S. GDP growth. If GDP (in real terms) rises by 2 percent, imports (in real terms) typically would rise by 4 to 5 percent. But with GDP rising by 2 percent in the first quarter of 2001, imports fell by 10 percent -- this is weird and inconsistent! When we saw the monthly import report earlier in the month, many of us thought it reflected a sharp slowdown in U.S.demand.
This GDP report says either, that is not true or just not true...yet. Another thing to be wary of is the large portion of GDP that is estimated. The two big swing items in the report, inventories and international trade, are based on one month of pretty good data, one month of highly tentative data and one month of totally 'made up' data. The possibility for revision to these two series is very real and highly likely. Finally don't get complacent. Capital spending trends remain weak. Moreover, the sharp slowdown in consumer service sector spending is troubling since the service sector employs 80% of those working.
Moree than looking back at last month, or last quarter, the Fed and investors are trying to look ahead. The GDP report, typically, is most useful for what it tells us about where we are going. And this one is not real helpful in that regard. The trade picture is nonsensical. Housing is holding up (but we knew that). Capital spending trends are still weak - knew that, too. A lot of inventory adjustment seems to have been accomplished, but that depends heavily on numbers that have been 'made up' -Ah, assume it and it's so! Moreover, as this number 'prints' we hear auto analysts are cutting their sales forecasts -uh, oh. Another chiller is that the downshift in consumer spending for services in the first quarter of 2001 dovetails with the drop in service sector jobs posted in March.
All of that 'fits' quite unfortunately with the renewed drop in consumer confidence, especially the surveyed portion about 'current conditions'. After all, consumer confidence is all about jobs. The jump last week in jobless claims to above the 400,000 mark is another very worrisome development and it's not about the 400,000 mark itself. Claims are a good recession predictor. And if claims stay above 400,000 for the next month (of May), they will trigger a recession signal that has not been wrong over the last 35 years. Whenever the monthly average of claims has risen by 50,000 over a three-month period and done that for two months in a row we have had recessions; and, in turn, that type of extended surge in claims has happened in every recession over that period. It has been an unimpeachable signal. Don't get too comfy with the idea that we dodged a bullet here. The next shot might come from a howitzer.
It is unsatisfying to describe market behavior by saying stocks expect one thing and bond expect another. But, oddly, the crazy volatile market reactions we have been witnessing reflect the imposition of cautious investor reactions. Some of these reactions were meant to lock in past gains rather than to be forward-looking assessments. Bonds had rallied this year on the idea that we were headed for recession due to a ponderous Fed. The inter-meeting rate cut jarred the notion of Fed ponderousness and its recession conclusion.
As a result, the bond market is coming to terms with a changed point of view. No longer is a recession 'in place' (or inevitable), but now it is 'out of the question', according to some. Yet, recent economic data have been quite weak. The worst of this for bonds is that they have broken some key trend lines and the ongoing nature of the bull market rally is in question. So investors there have been booking profits on past positions rather than looking ahead. Meanwhile, on the stock side, no one is quite sure how strong this growth will be. So while bonds 'act like the economy will grow' stocks are unconvinced. They are still weak in the tech sector where lagging capital goods spending still stings sharply
In this environment, look for the Fed to continue to cut rates in May. Right now I favor a downshift to a 25 basis point cut. But if we lose 100,000 or more jobs in April (a real possibility) a bigger cut would be likely. Fear the weekly jobless claims report. Watch it like hawk. Don't use silly statements with excessive certainty in them when talking about the economy. Unequivocal forecasts are not made by real economists with clear crystal balls at times such as these. You don't need crystal balls to engage in this kind of Captain Kirk impetuousness: Boldly forecasting what no one has before. Nobody knows what comes next. Spare your ego and don't spoil your portfolio. The times and the odds are a changin'. The situation is still in flux, and as long as it is the Fed will cut rates. It is managing the situation. Avoid listening to forecasts that feature excessive certainty. That is what the markets are doing. It's why markets are volatile as they sort things out, day by day
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