Q4 Contraction Does Not Tarnish Outlook For 2013 GDP

Includes: DIA, QQQ
by: Erik Dellith

By now, the surprising contraction in the US economy during the fourth quarter of last year has already been investigated, dissected and dismissed. Still, the latest GDP figures provide a good reason to ponder what we can expect in the coming year.

Earlier this week saw news that consumer confidence took a hit recently, as people became more concerned with taxes and the fiscal cliff. Nonetheless, the latest GDP figures show that consumers continued to shop. This is possibly one of the more optimistic signs we've seen in a while. Personal consumption spending accelerated during the second half of last year. One could reasonably argue, though, that people spent more during the final months of last year because they were fearful of pending tax increases and decided to spend money while they had it. Still, I would like to believe, perhaps naively, that people were genuinely becoming more optimistic.

Years ago, I worked as an economist in the printing industry. My boss at the time, the organization's chief economist, taught me a very important lesson. It amounts to this: Confidence indices are nice, but people can tell you anything they want. If you really want to see how people feel about their future prospects, look at whether or not they are spending money. This particularly applies to big-ticket durable-goods orders. If someone is fearing for their job, they're not going out and spending a boatload of cash.

This is a key reason why I believe that people have been genuinely becoming more optimistic. Spending on consumer durable goods has been accelerating in recent quarters, advancing 8.9% in Q3 and 13.9% in Q4.

I do not necessarily anticipate that durable-goods spending will remain throughout 2013 at the same brisk pace we saw in the final three months of last year. I would not be surprised, though, to see it average in the mid- to high single-digits. That will largely be the result of continued, albeit sluggish, improvement in the labor market.

On average, the US economy has created about 150,000 jobs each month over the last two years, based on BLS data. I've written in the past about this jobless recovery. Still, it might be helpful to recognize that, through December of last year, the US economy is down nearly 4 million jobs since January 2008. I do not foresee any considerable catalyst for job creation this year, so I anticipate that the pace of payroll growth will likely continue to creep along at or near the monthly average for the last two years. That stated, we are still looking at about two more years of lackluster job growth before we get back the number of jobs lost during the recent crisis.

At the same time, the real estate market continues to show some signs of improvement. Residential spending accelerated during the last six months of last year, from the second quarter's pace. While it is tempting to claim that this is the wild card that will drive job growth, there are considerable caveats here. It is important to note where these improvements are coming from, that many areas are still hurting, etc. Continued improvement here is likely, but the pace depends on the region. Areas of the east coast devastated by Hurricane Sandy will need to be rebuilt. Construction in many other areas is not so dire.

For all of 2012, the US economy expanded at a pace of 2.2%, up from 2011's clip of 1.8%. Reflecting on the ongoing nature of the key factors facing the American consumer, one can reasonably anticipate, at present, that improvement in US GDP will remain in the same range and climb by about 2% this year.

Caveats clearly exist. For example, my focus here was on the consumer and the residential spending aspect of investment. Obviously, that omits a lot. However, those are key areas to watch. If we want to focus on trade and the net exports portion of GDP, then we need to examine each country and that will take a while. In general, though, Europe is a mess and, if you listen to Barry Eichengreen, then you will believe that Europe will likely remain a mess for a while. Investors need to be aware that those unresolved issues on the other side of the Atlantic can flare-up and contribute to volatility here. In the absence of a significant catalyst for growth, one can expect continued lethargy in much of the rest of the region.

At the same time, we are still struggling with our own budget issues, and that can impact the government spending part of the GDP equation. Political leadership has demonstrated a willingness to let the economy go over the fiscal cliff, even if just for a short time, before reaching a non-substantial agreement. Further budget show-downs should not be surprising, as leaders continue to reach one sub-optimal resolution after another. This, too, could add extra volatility to the financial markets, which could create attractive short-term valuations and buying opportunities for careful investors.

Asset-price valuation is already a concern. Sure, the economy expanded at a relatively sluggish pace for last year. Yet, over the last twelve months or so, the Dow Jones Industrial Average and the S&P 500 Index have climbed about 10% and 14%, respectively. This leads one to wonder about the potential for richly valued or overvalued stocks. To this point, Richard Suttmeier, in a recent article, mentioned about how nearly 60% of the stocks he examines are overvalued. More specifically, he discussed how every sector was overvalued.

Reflecting on the frothy valuations and outlook for relatively unremarkable economic growth, it seems that the immediate market environment will be better suited for investors who are successful stock pickers than more passive index investors. Of course, the trick there is being really successful with the stock picking. Good luck.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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