The U.S. economy - the tale of two economies
Investors may find telling clues about the future by looking beyond the standard economic figures. While some of the statistics evidence ongoing economic growth and momentum, which suggests continued advancement in the equities markets, others suggest a potential retreat. This is indeed further proof that one needs to look at more than one or two statistics in isolation to judge the strength of momentum in the economy. Should investors and analysts take stock in a correlation between the market and the economy, given the conflicting statistic in the direction of the U.S. economy, market follows may be in a state of confusion. Certainly with the market at or near all time highs, investors must be aware of signposts that may suggest a change in market direction.
In a seemingly neutral to slightly positive release, last week the Department of Commerce stated that the U.S. economy grew at a faster than expected 0.4% in the fourth quarter of 2012. Indeed, the annualized figure was better than previous estimates of 0.1% growth, reflecting increased investments in plant and equipment. Market watchers viewed this news positively. Nonetheless, despite the upward revision, the Department cautioned that the economy remained sluggish, which suggests that the foundation of the economy and solid market may be cracking.
Digging a bit deeper, a decrease in defense spending and government expenditures hurt economic output, said the department. This has caused a dramatic slowdown from the third quarter. Given the continued decrease in federal spending, one must question the private sector's ability to increase spending at a stronger pace than the reduction in government spending? There is more evidence that consumer spend remains uneven.
Defense stocks are all trading at below implied fair value. The decline in the U.S. defense budget has and will continue to negatively impact these companies' ability to grow earnings and find new investment opportunities. While the near-term risks are worth consideration but long-term, most of these companies should be able to navigate through this rough patch and valuations already discount a negative impact. For those investors that are in for the longer term, this may be a buying opportunity for companies, such as Lockheed Martin (LMT), FLIR Systems (FLIR), General Dynamics (GD) and Hexcel (HXL).
Furthermore, given the recent trends, it is increasingly less likely that the GDP will outpace the growth achieved in 2012 in which the GDP grew 2.2%. As an illustration of the government's view of the still sluggish economy, in a recent report, the U.S. Federal Reserve said, despite the modest strengthening of the economy additional stimulus measures are required to underpin the recovery. This indeed suggests a continuation of low interest rates, pushing yield chasers into the equities market.
In looking at another statistic, one could conclude that the economy is weakening. Despite the reduction in U.S. joblessness claims, the number of people on federal food stamps has reached an all-time record in the U.S. According to the United States Department of Agriculture, in 2012, the food stamps program was the biggest it's ever been, with an average of 46,609,072 people on the program every month of 2012. 47,791,996 people were on the program in the month of December 2012. The federal government also says that the number of households on food stamps was 22,329,713. This certainly doesn't justify positive momentum in the economy. News like this, chips away at consumer confidence, which slowly trickles through all levels of the economy, suggesting the retail and hard goods related equities would weaken as the year progresses. Against this backdrop and consumers' increasing preference for online shopping, certain retailers such as JC Penney (JCP) and Staples Inc. (SPLS) may face increasing headwinds.
By looking at the government numbers, the aforementioned discussion on the slow growth in the GDP, and the slightly improving trends of unemployment, one must question the absolute strength of the U.S. economy. One more often missed statistic, the real unemployment rate, which is the U.S. joblessness rate plus the people that are underemployed or gave up on looking for employment, is approximately 14.4%. Not exactly a low number. Clearly the astonishing statistics on the food stamps paint a very concerning picture of the state of the U.S. economy. With the concerns about the Eurozone, and the recent events in Cyprus, the U.S. economy is certainly not out of the woods. Indeed, it is on very shaky ground, as any tremor could knock the seemingly ever-budding economy off-track.
So why exactly are the U.S. markets at or near record levels? Perhaps this too is on shaky ground. Investors need to be diligent in watching all the information that is available, and look for the signposts pointing to the direction of the market.