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Erik Dellith
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Erik Dellith is an adjunct professor. He teaches economics and finance to college and MBA students. Before entering academia, Erik worked for more than a decade as a securities analyst, covering US and foreign stocks, domestic and global equity and fixed-income mutual funds, ETFs and precious... More
My blog:
Economic Ideas
My book:
Necromancer's Madness
  • Oh, That's Not Good 0 comments
    Aug 9, 2011 9:35 PM

    As I thought about the Fed's statement this afternoon, I figured the stock market would tank.  And then it did.  But then it caught me offguard and rallied, a lot.

    I am not sure what other investors heard or read from the Fed's statement, but it apparently was not the same thing that I took out of it.

    Let me focus on a couple of key points from the first paragraph of the report:

    • Information received since the Federal Open Market Committee met in June indicates that economic growth so far this year has been considerably slower than the Committee had expected.
    I think economic growth has been a lot slower than a lot of people have expected.  The downward revisions in GDP for Q4-2010 and Q1-2011 significantly eroded the momentum in the pace of growth, and we saw the American consumer effectively fall flat in the second quarter. 
    • Indicators suggest a deterioration in overall labor market conditions in recent months, and the unemployment rate has moved up.  Household spending has flattened out, investment in nonresidential structures is still weak, and the housing sector remains depressed. 
    A weak labor market will impact consumer spending more than political wrangling in DC and volatility in the financial markets, and, let's face it, the economy is not adding jobs all that quickly.
    • However, business investment in equipment and software continues to expand.
    Sure, spending in this area continues to expand.  Spending here grew 5.7% in the second quarter.  This is the slowest pace since spending turned positive in Q3-2009.  It follows 8.7% (Q1-11), 8.1% (Q4-10), 14% (Q3-10), 23% (Q2-10), and about 22% (Q1-10).  Sure, it continues to expand, but the pace is coming down.
    • Temporary factors, including the damping effect of higher food and energy prices on consumer purchasing power and spending as well as supply chain disruptions associated with the tragic events in Japan, appear to account for only some of the recent weakness in economic activity. 
    What?  I'm sorry... What?  My expectations for a pick-up in the pace of GDP growth in the second half of this year had been predicated on the assumption that much of the slowdown we saw in the first half was the result of temporary factors.  The BEA's GDP release and the Fed's Beige Book report had already downplayed a bit the longer-term impact of the horrific events in Japan and the damage caused by unfortunate weather here in the States.

    But the Fed is basically saying here that the slowdown resulted, not from these temporary factors, but from longer running dynamics.  Well... there goes my expectations for a rebound in the second half.

    Now here is where things get much, much worse...  Jump down to the third paragraph:
    • The Committee currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.
    Hold the phone!  So, not only are current conditions worse than previously thought, and not only is our current sad state the result of longer-running weakness and not just temporary factors, but the Fed also does not see any significant improvement for at least two years.  If the Fed is correct, we are going to be mired in a slow-growth, low-job-creation environment for at least two more years!

    While I can appreciate the perspective of some people to like the idea that some uncertainty is off the table, specifically that interest rates will remain low for an extended period of time, it is important to keep in mind the reason why the interest rates will be low for that extended period of time. 

    In an environment where the US economy is effectively stagnant (for at least two more years), Europe's economy is going through a tough time, and we see growth slowing in the emerging markets, I have difficulty finding a catalyst to drive earnings growth.  In fact, I wouldn't be surprised if earnings estimates have to get pulled back next year.  And with that in mind, I have considerable difficulty rationalizing the rally in the equity markets, which helped the Dow close up nearly 430 points.
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