GDP Report Offers Positive Headline, But Negative Details

Friday’s GDP release was a sight for sore eyes. After experiencing sharp declines in the US economy for three consecutive quarters, the data for Q2 showed a decline of only 1% compared to the 1.5% that analysts were expecting. The news was enough to cause a number of economists to increase their forecasts regarding the “economic recovery” and was helpful in pushing stocks higher throughout most of the trading day.

A 1% drop is significantly better than the 6.4% drop we had in the first quarter right? Actually, the answer is NO! A drop is still a drop. Consider the fact that we had the worst decline in 27 years for the first quarter, and that in the second quarter we were still declining. It’s tough to find a silver lining with this dark cloud, but that doesn’t keep analysts from spinning it in order to attempt to prop up the equity markets. As Mark Twain so eloquently said, “There are three kinds of lies: lies, damned lies and statistics.” The point is that you can make statistics indicate whatever you want to if you spin the data correctly.

Looking at the components which make up GDP, it is clear that we are still in a very stressful time economically. Consumer spending continued to fall and was down 1.2% more than analyst expectations. The positive surprise in the headline number came almost entirely from government spending (which is not exactly subject to economic forces - especially with this administration). While the government can - and most likely will - continue to spend and prop up the economic data, the cost of that spending will ultimately be paid either in the form of higher taxes, or a lower value for the dollar. Neither of these outcomes will do much good for the real state of our economy.

Business and residential investment continued to be horrific. While some may consider it positive that business investment only declined by 9% this quarter (compared to 39%) last quarter, I will reiterate that continued decline from the depressed state of Q1 is sobering. Residential investment fell another 29% after the 38% drop in Q1. And employment numbers continue to drop with many expecting the unemployment rate to hit 10% this year. To quote Richard Yamarone from Argus Research:

How do you have a recovery when you’re furloughing half a million jobs a month?

So why are stocks continuing to show strength even while the economy contracts? Equities are 40% above their lows from five months ago and many stocks have grown by 100%, 200% or even more. Shouldn’t the weak economy translate into lower stock prices?

Well, unfortunately in the short run, stock prices often deviate significantly from what we might consider “normal” values. Since the price of a stock is based on what a buyer is willing to pay, or what a seller demands in return, prices are often swayed significantly by the optimism or pessimism associated with the broad investing public. Currently it appears that investors are buying the notion that the economy is getting better. Many who have been sitting cautiously with money on the sidelines are now wondering if they have missed the turn in the market. Fear of under-performing can be a overwhelming motivator for institutional investors as well who could see bonuses cut or even jobs lost as a result of trailing a benchmark.

These forces of greed and fear can often temporarily move markets significantly above or below an “appropriate” economic value. But irrational moves also give us as traders an opportunity to profit from the swings as emotional trades rarely result in long-term gains.

Today’s market appears to be following one of two possible courses:

1. We are in the middle of a bear market rally (50% rallies are not uncommon within the context of larger bear moves) and the market is vulnerable to a sharp reversal lower. This scenario would likely see us breaching the March lows sometime in the next year, but could also simply mean that we continue to be range bound below the highs from 2007 for some time.
2. We are experiencing a genuine recovery in which the market accurately recognizes the coming economic improvement, and trades higher ahead of the recovery. This type of move also has historical precedent as most recessions recover only after the broad market has signaled that things are getting better.

So while the question of which scenario we are in is certainly pertinent, it’s also important to consider the ramifications of each scenario. If this is indeed a recovery, we have already begun to experience a sharp move in the market and are now waiting for the fundamental data to confirm what the market has already figured out. It seems that even positive economic news would not move the market significantly higher because we already made the recovery move. Of course a new bull market could last for years, but if this is a true new bull market, then we will have ample time to pick out individual investments and buy them at attractive times along the way.

The significance of the second scenario is what worries me. If the market is wrong and investors are chasing performance without economic strength, then the coming losses could be catastrophic. Consumers who have been pummelled by declining house values, slashed retirement accounts, and employment concerns can not afford to take another hit in the stock market. So if this rally begins to falter, I am concerned that panic could set in and the market could fall quickly even without a significant catalyst. Heaven forbid we get another macro issue to deal with such as powerful losses from commercial real estate.

So while the eventual economic outcome is a bit uncertain, the risks seem stacked against investors who may consider committing new capital to the markets at this time. One must not only consider the likelihood of each scenario, but also the ramifications of each outcome (one of which has much more magnitude than the other). While a stronger economy is definitely in our best interest and can be hoped for, remember that risk control is what keeps investors in the game for the long haul. A missed opportunity is ten times easier to make up than lost capital.

Comments

[enigmaman:]

Very logical thought process to describe this very illogical market, old tried and true market adages seem to be no longer relevant as it relates to the markets so called recovery, short term gains are paramount now, the market will worry about tomorrow some other time because logic is not what this market is all about.
" A mind all logic is like a knife all blade it makes the hand bleed that uses it"

Its a mad world, world markets are hitting news highs, I guess they are just happy to still be alive.

Aug 03 11:06 AM

[thiazole:]

"A 1% drop is significantly better than the 6.4% drop we had in the first quarter right? Actually, the answer is NO! A drop is still a drop. Consider the fact that we had the worst decline in 27 years for the first quarter, and that in the second quarter we were still declining. It’s tough to find a silver lining with this dark cloud"

How's this for a silver lining - if the GDP was dropping so fast in 1st quarter, it was probably dropping very fast in April as well. It may not have been dropping as fast in May as April, but it was probably still dropping. So what does that mean about June? It means the economy was probably growing in June and that will eventually be marked as the official end of the recession.

Aug 03 11:08 AM

[thiazole:]

Just to give you a mathematical model of what may have happened over the 3 months (I'll just use a normalized GDP to make the numbers easier to follow): Lets say the GDP was "100 units" at the end of March. It probably fell at an annualized rate of 5% in April, which leaves the GDP at 99.58 units (5% / 12months = 0.42%). Then contraction slowed in May to only a 1.2% annualized contraction leaving the GDP at 99.48 units. So, for the entire quarter to have contracted by 1% annualized, you have an actual contraction of 1% / 4 quarters = 0.25% which would leave the GDP at the end of June at 99.75 units, which is higher than what we showed at the end of May by 0.27%, which gives us 3.24% annualized growth in June. Now those are just estimates, but they are pretty reasonable and VERY significant.

Aug 03 11:17 AM

[Mad Hedge F...:]

I think so too. My favorite coincident economic indicator, the “Boot Index,” is showing that we may be entering a very modest economic recovery. That is the price at which you can buy Asolo’s top line mountaineering boot at the REI member sales. I bought this hiker’s dream for $5 last March (click here to see report) , and yesterday the price had climbed back up to $27. Of course, this is not the full retail price it should be selling for of $280, with tax. Similarly, we should be equally cautious about Friday’s report of Q2 GPD growth of minus 1%, and the downward revision of Q1 from minus 5.5% to minus 6.4%. To say this is an improvement is like taking money out of one pocket and putting it in the other, then booking a profit on the transaction. The hard truth is that consumer spending, business investment, housing, and inventories are still in terrible shape. Consumers are broke and getting broker, a big problem when they account for 71% of GDP. Only massive federal government spending is supporting the economy, and what happens when that runs out? The next $2 trillion in stimulus is going to be a lot more expensive than the first. Sorry, but I remain a skeptic. I’d rather go hiking in the Sierras than put money in the market here.

Aug 03 11:25 AM

[enigmaman:]

very informational remarks, my question is if such things as GDP are so easily calculated why then are we not hearing this from the Fed and or others, they never speak in specifics only possibilities and then with a caveat. I only ask because your assumptions seems logical and straight forward, why then doesnt the Gov come out and do the same.


On Aug 03 11:17 AM thiazole wrote:

> Just to give you a mathematical model of what may have happened over
> the 3 months (I'll just use a normalized GDP to make the numbers
> easier to follow): Lets say the GDP was "100 units" at the end of
> March. It probably fell at an annualized rate of 5% in April, which
> leaves the GDP at 99.58 units (5% / 12months = 0.42%). Then contraction
> slowed in May to only a 1.2% annualized contraction leaving the GDP
> at 99.48 units. So, for the entire quarter to have contracted by
> 1% annualized, you have an actual contraction of 1% / 4 quarters
> = 0.25% which would leave the GDP at the end of June at 99.75 units,
> which is higher than what we showed at the end of May by 0.27%, which
> gives us 3.24% annualized growth in June. Now those are just estimates,
> but they are pretty reasonable and VERY significant.

Aug 03 11:32 AM

[thiazole:]

I have no idea, but they never have tried to break the numbers down by month. In the UK, they do, and they started seeing monthly GDP growth just recently. They're monthly numbers might be a "not too terrible" estimate for what is really happening here.


On Aug 03 11:32 AM enigmaman wrote:

> very informational remarks, my question is if such things as GDP
> are so easily calculated why then are we not hearing this from the
> Fed and or others, they never speak in specifics only possibilities
> and then with a caveat. I only ask because your assumptions seems
> logical and straight forward, why then doesnt the Gov come out and
> do the same.

Aug 03 12:23 PM

[thiazole:]

I might be wrong about UK - I swear I recently read some monthly GDP data for the UK, but now I can't find it to verify. It might have been a different country, not sure.


On Aug 03 12:23 PM thiazole wrote:

> I have no idea, but they never have tried to break the numbers down
> by month. In the UK, they do, and they started seeing monthly GDP
> growth just recently. They're monthly numbers might be a "not too
> terrible" estimate for what is really happening here.

Aug 03 12:54 PM

[ETFdesk.com:]

Consumer spending came in at -1.2% annualized, twice the decline expected by the consensus, in the face of huge fiscal stimulus. Leaves me wondering how the critical 70% chunk of GDP is going to perform as the cash-flow boost from Gov’s generosity recedes in the second half of the year. Imagine, government transfers to the household sector exploded at a 33% annual rate, while tax payments imploded at a 33% annual rate and the best we can do is a -1.2% annualized decline in consumer spending in real terms and flat in nominal terms? What do that mean for a sustained recovery?

Aug 03 01:05 PM

[Zachary Sch...:]

Mad HFT - I like your analogy of taking money out of one pocket, putting it in the other, and calling it a profit. The statistics show significant weakness - as a whole - and in specific areas. While we may not be falling at the same rate as the first quarter, *falling* still means that the trend is lower.

Thiazole - I suppose there is a chance that Q3 shows growth, but it seems highly unlikely. Even if we DO see GDP tick slightly higher in Q3 it will only be as a result of higher government spending which in the long run will come back to bite us. That's not an increase to our true domestic product - it's an accounting gimmick - like many corporations have been punished for using.

Monthly reporting may be helpful to see what is going on in a bit more detail, but remember that the more often you take samples, the more "noise" or statistical irrelevant information you must sort through. I personally think it's better to use quarterly reporting but then to look at some of the monthly figures such as retail sales, unemployment levels, etc to see what is going on on a shorter-term basis.

ETF desk - very good point. How bad would consumer spending be without Uncle Sam shoving future taxpayer money into the retail pocket and then begging him to spend it?

Thanks for the good comments guys - keep em coming!
zachstocks.com

Aug 03 01:33 PM

[thiazole:]

Here is my prediction for 3rd quarter - 3.8% GDP growth. And yes, 2.8% will be from stimulus spending, but the other 1% won't be. It is what it is - I've said before that much of the initial recovery will be from stimulus spending and that it will have adverse effects later on. It is reality, though, not attempt to emphasize every little bit of negative a person can extract out of every report like I see here.


On Aug 03 01:33 PM Zachary Scheidt wrote:

> Mad HFT - I like your analogy of taking money out of one pocket,
> putting it in the other, and calling it a profit. The statistics
> show significant weakness - as a whole - and in specific areas. While
> we may not be falling at the same rate as the first quarter, *falling*
> still means that the trend is lower.
>
> Thiazole - I suppose there is a chance that Q3 shows growth, but
> it seems highly unlikely. Even if we DO see GDP tick slightly higher
> in Q3 it will only be as a result of higher government spending which
> in the long run will come back to bite us. That's not an increase
> to our true domestic product - it's an accounting gimmick - like
> many corporations have been punished for using.
>
> Monthly reporting may be helpful to see what is going on in a bit
> more detail, but remember that the more often you take samples, the
> more "noise" or statistical irrelevant information you must sort
> through. I personally think it's better to use quarterly reporting
> but then to look at some of the monthly figures such as retail sales,
> unemployment levels, etc to see what is going on on a shorter-term
> basis.
>
> ETF desk - very good point. How bad would consumer spending be without
> Uncle Sam shoving future taxpayer money into the retail pocket and
> then begging him to spend it?
>
> Thanks for the good comments guys - keep em coming!
> zachstocks.com

Aug 03 02:41 PM

[thiazole:]

Here is a post I made almost 3 months ago explaining my 3rd quarter GDP predictions. Unlike the bears here, I'm not embarrassed to show posts I made months ago because they can withstand the test of time (I wasn't predicting the end of the world or the Dow going to 1000). If anything, things have turned out a little better than I predicted:

seekingalpha.com/user/...

Aug 03 03:28 PM

[Graham and ...:]

So the first derivative is down but the second derivative is up.

Aug 03 04:56 PM

[FB5000:]

Exactly. -1% is way better than -6%. Logic dictates that June was neutral to positive. The recession is over. The recovery is here.

Straw in the wind. MGM Mirage is running at 90% occupancy, rail tonnages are up, Manufacturing data, housing data all point higher.

This debate about bear market rally and "L" or "W" shaped recovery or no recovery is midguided.

Recovery is here. The issue is how fast not if or when.

That's all.


On Aug 03 11:08 AM thiazole wrote:

> "A 1% drop is significantly better than the 6.4% drop we had in the
> first quarter right? Actually, the answer is NO! A drop is still
> a drop. Consider the fact that we had the worst decline in 27 years
> for the first quarter, and that in the second quarter we were still
> declining. It’s tough to find a silver lining with this dark cloud"
>
>
> How's this for a silver lining - if the GDP was dropping so fast
> in 1st quarter, it was probably dropping very fast in April as well.
> It may not have been dropping as fast in May as April, but it was
> probably still dropping. So what does that mean about June? It means
> the economy was probably growing in June and that will eventually
> be marked as the official end of the recession.

Aug 04 12:30 AM

[FB5000:]

Zach, my man. You kid, right? I hope you have a day job. You are pretty well wrong across the board. Editor? Is there no QC on this site?

Q3 GDP is unlikely to be positive? You sure about that? Wow. That is just about as boneheaded as I have heard of a while. Look when you are wrong - you just need to admit. If the data does not fit your view of the world. Change your view. Don't misinterpret the data. You can go broke doing that. Seriously. Look at the data. Q2 GDP is old news and very lumpy. If you could look at the data as a series of 3 separate months you would see a different picture. Let's speculate. April is awful, May is better and June is neutral to positive. Actually you - don't really need to speculate - you can figure this out if you actually do some work and look at weekly and monthly stats. Do you understand seasonal adjustment? The June data which is reflected in initial claims seasonally adjusted and housing is a pretty good tell. There are others signs of recovery. Rail tonnages, Housing. Recovery is here champ.

You don't like government spending - it is an an accounting gimmick - does not add to growth? This is a political statement - surely. Secong tip of the day. Political ideology has no place in economic analysis. First of all - money is money. It is fungible. Let's do a little history. Keynes figured out that when the private sector loses confidence and stops spending that it is a nice idea for goverment to step in and smooth demand. This fine tuning worked really well until the 60's. The money can be got through taxation, or borrowing or printing. Not enough time here to go into the pros and cons of all of these. Generally printing money is not favored - unless you are in a dire emergency. It is the equivalent of breaking the glass and pressing the fire button. They did some in the 30's and they have done it recently. In the 60's we discovered inflation. Enter the Monetarists. Friedman said that you can tame inflation and vary money supply to modulate growth. So these are the tools. Not enough time to expound. Read some books- it will help you to stay out of trouble. Samuelson is a good author to give you an understanding. Anything by Adam Smith - I don't mean the famous Scottish economist (although you should read the Wealth of Nations - but the guy who wrote "The Money Game", "Papermoney" and "SuperMoney" - all very good reads and very useful. There are others but again - no time. Fast forward to today. Bernanke did his thing - intrest rates at zero, quant. easing/printing money and without any velocity and capitalmarkets frozen not a lot happened. Then fiscal policy. That is what we call all of that evil Goverment stuff. The stimulus etc. As Keynes predicted. Even just the idea that Government does something and moves can act as a circuit breaker and kick start the economy. The policy response has been messay but appropriate. the TARP was weird but it was a weird situatin. History will be kind to Geitner and Co. The worry is that stupid congressmen will try to put in a second stimulus bill - there is no need for more stimulus and/or they will go protectionist - also very stupid move. The one will be infaltionary. The other will kill recovery.

O'k. I know I have been a little hard on you. Look. Yes. You are absolutely right. We are in for negative GDP in Q3 and Q4 and probably after that Hyperinflation. (not sure how we get negative growth and hyperinflation but there are plenty of geniuses on these threads who are arguing that - so I will let them fill in the blanks). The leading indicators are just all wrong. Or maybe the media is just lying to us. Better tune into Fox to get the truth. The evil government spending - once it stops - will result in a crash. The market is just fuelled by fools. It's over. I got my stash of spam and gold and a gun. Meet you on the other side of the new dark age that we have started. We can rebuild...together. Enjoy.

That's all.

That's all.




On Aug 03 01:33 PM Zachary Scheidt wrote:

> Mad HFT - I like your analogy of taking money out of one pocket,
> putting it in the other, and calling it a profit. The statistics
> show significant weakness - as a whole - and in specific areas. While
> we may not be falling at the same rate as the first quarter, *falling*
> still means that the trend is lower.
>
> Thiazole - I suppose there is a chance that Q3 shows growth, but
> it seems highly unlikely. Even if we DO see GDP tick slightly higher
> in Q3 it will only be as a result of higher government spending which
> in the long run will come back to bite us. That's not an increase
> to our true domestic product - it's an accounting gimmick - like
> many corporations have been punished for using.
>
> Monthly reporting may be helpful to see what is going on in a bit
> more detail, but remember that the more often you take samples, the
> more "noise" or statistical irrelevant information you must sort
> through. I personally think it's better to use quarterly reporting
> but then to look at some of the monthly figures such as retail sales,
> unemployment levels, etc to see what is going on on a shorter-term
> basis.
>
> ETF desk - very good point. How bad would consumer spending be without
> Uncle Sam shoving future taxpayer money into the retail pocket and
> then begging him to spend it?
>
> Thanks for the good comments guys - keep em coming!
> zachstocks.com/

Aug 04 01:08 AM

[TLassen:]

FB5000.....very few analysts and 'noise makers' with experience are contibuting to SA it appears. Thanks once again for stating facts. Keep up the good work. My thinking is that young novice investors can benefit from reading your comments.

"O'k. I know I have been a little hard on you. Look. Yes. You are absolutely right. We are in for negative GDP in Q3 and Q4 and probably after that Hyperinflation. (not sure how we get negative growth and hyperinflation but there are plenty of geniuses on these threads who are arguing that - so I will let them fill in the blanks). The leading indicators are just all wrong. Or maybe the media is just lying to us. Better tune into Fox to get the truth. The evil government spending - once it stops - will result in a crash. The market is just fuelled by fools. It's over. I got my stash of spam and gold and a gun. Meet you on the other side of the new dark age that we have started. We can rebuild...together. Enjoy."

Great, love the sarcasm. LOL

Aug 04 09:39 AM

[Benito Camela:]

Momentum players have the upper hand, but fundamentals will prevail -- not sure when.

With income going down, how can the consumer pull this? It is nonsense to believe that we will go back to normal anytimes soon after an abnormal crisis...

Aug 04 12:48 PM

[Zachary Sch...:]

Sr. EM - sometimes fewer words can yield greater wisdom. Yes I think you're right.

FB5000 your points are well taken - although not necessarily agreed with. I don't think the economic indicators are as clear as you make them out to be. I'm not the "gold gun and grub" guy in a bunker, but I do think it pays to understand that this is not an ordinary recession that works its way out in a few quarters. There are serious issues we need to grapple with and until we are willing to actually FIX problems and not try to re-inflate another bubble, we will continue to have unsustainable recoveries and then crashes.

You can bash Fox and I'll bash CNN and maybe the two of us can end up somewhere in the middle...

To use your line, that's all
zachstocks.com

Aug 05 02:39 PM