U.S. Economy: Who In The World Will Save Us When We Fall?

 |  Includes: DLTR, FDO, IWM, MDY, XLU
by: Eric Parnell, CFA

The U.S. economy continues to weaken. This comes after several years of already sluggish growth in the wake of the financial crisis and a looming fiscal cliff at the end of the year. And with Europe increasingly teetering on the brink of crisis - the world's 12th largest economy in Spain accepted a bailout this weekend - the threat is building that the U.S. economy may ultimately experience another economic flashpoint that could be even worse than the 2008 episode.

This possibility raises an important question. Who in the world will help support U.S. economic growth if and when we fall? This question is relevant for the following reason. When the U.S. economy plunged into crisis and contracted by -4% from 2008 Q2 to 2009 Q2, an improvement in Net Exports totaling +$408 billion, or roughly 3% of total GDP at the time, helped to meaningfully offset the decline. For had Net Exports stayed unchanged during this time period, GDP would have contracted by a far more dramatic -7%.

Thus, it is worthwhile to consider exactly where this improvement was derived from in 2008 to determine whether we might potentially see similar support to GDP once again during any future crisis episode. An analysis of Foreign Trade data by country from the U.S. Department of Commerce is useful in trying to make this determination.

The following is a list of the countries in order that were most responsible for the improvement in U.S. Net Exports from 2008 Q2 to 2009 Q2 including the estimated percentage of the total improvement based on the Commerce data. Of course, Net Exports are equal to Exports minus Imports.

Canada 17.3%

China 10.2%

Japan 10.0%

Saudi Arabia 8.9%

Mexico 7.3%

Nigeria 7.1%

Venezuela 7.0%

Germany 5.9%

Algeria 3.9%

Iraq 3.7%

Angola 3.2%

France 2.1%

Italy 2.1%

The twelve countries listed above were accountable for nearly 90% of the improvement in U.S. Net Exports from 2008 Q2 to 2009 Q2. As a result, it is worthwhile to consider the characteristics of how trade evolved with these countries to determine if comparable support is likely during a future event.

First, it is worth noting that with none of the above countries did U.S. Exports actually increase during that time. In the case of most of the Middle East and oil producing nations, U.S. Exports remained essentially flat to slightly lower. And in the case of the developed nations and China, U.S. Exports actually decreased considerably.

Where then was the improvement in Net Exports derived? It came from the dramatic decrease in U.S. Imports from these nations. Overall, U.S. Imports from the above countries collapsed by an average of -47% during this time while U.S. Exports to these countries fell by a more modest -19% on average. In other words, although we stopped buying goods from these other countries by half during this time period, their purchase of goods from us stayed relatively more steady. So while the "X" in Net Exports declined, the "M" declined by much more. Hence the +$408 billion "improvement" in Net Exports during the depths of the crisis.

Where do we stand today in regards to trade with these same countries? From 2009 Q2 to 2012 Q1, foreign trade with most of these countries has essentially normalized to pre crisis levels. Any decline in U.S. Exports to these nations has been completely recovered and more. And virtually all of the precipitous drop off in U.S. Imports from these nations has been recovered. As a result, four years since the days just before the outbreak of the financial crisis and we are effectively back where we started.

What could we reasonably expect in regards to foreign trade given the outbreak of another crisis episode going forward?

First, we would likely see another precipitous decline in U.S. Imports. Perhaps it would not be as pronounced given the fact that the U.S. is not likely to be the epicenter of any new crisis event like it was back in 2008, but it would still be profound.

But the fact that the focus of the crisis is likely to emanate from abroad implies that it will likely be far more difficult for our trading partners to maintain the purchase of our Exports at even remotely comparable levels. More specifically, Exports to countries such as Germany, France and Italy could come under meaningful pressure. And none of this takes into account the ability of other important trading partners in the region not listed above such as the United Kingdom, the Netherlands, Switzerland or Belgium to maintain demand for U.S. Exports in their own right. And with Asian economies such as China and Japan already facing the threat of recession, the potential exists that they may pullback much further on U.S. Export purchases during a second crisis episode than they did during the first. As for our North American trading partners, it is more likely that the change in Net Exports with Canada and Mexico would be closer to even instead of heavily in favor of the U.S. next time around.

Thus, while a strong improvement in Net Exports provided a meaningful boost to U.S. GDP during the depths of the financial crisis, we cannot rely on a repeat of this support during any future crisis. Instead, Net Exports could ultimately prove to be a drag on economic output in the end.

In regards to portfolio positioning, this suggests focusing stock exposures during any future crisis episode on businesses that are more domestically focused may be beneficial. This includes most Utilities (NYSEARCA:XLU), retailers including deep discount stores such as Family Dollar (NYSE:FDO) or Dollar Tree (NASDAQ:DLTR), and many names in the Mid-Cap (NYSEARCA:MDY) and Small Cap (NYSEARCA:IWM) universe.

So as we watch events unfold around the world in the coming months, it will remain important to consider how the impact of these developments will feedback into the U.S. economy. For although the epicenter of the crisis may ultimately come from across the Atlantic, the drags on the U.S. economy have the potential to be even more dramatic than before.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclosure: This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.