The GDP Revision: Our Foot Is Off Accelerator

Includes: EWJ, SPY
by: Brian Rezny

Acceleration has nothing to do with going fast, per se. Acceleration involves changing velocity: an object has to change its rate of velocity in order to accelerate. In other words, accelerating is about changes in how quickly an object moves, not just about moving fast.

The Conference Board Leading Economic Index

(Click to enlarge)

So, we are losing steam and velocity. And we are losing time. Why? We are in the midst of a lost decade … a decade without stock market returns and a decade of lackluster growth.

Japan has been through a lost decade, too. In late 1989, the Bank of Japan shocked the markets with a harsh interest rate increase, meant to calm an asset bubble. What followed was a market crash and a credit crisis. The asset bubble slowly deflated, and so did the Japanese economy. And they have yet to rebound; they are still fighting lingering deflationary pressure.

Japan has a couple of problems. First, last month the Cabinet Office reported that the economy grew less than expected: 4.9% versus 5.5%. The problem is that the government can’t fuel growth by lowering interest rates – they are already near zero. And they have an aging population, combined with low birth rates and next to no immigration (a touchy subject). And the Organization for Economic Cooperation and Development (OECD) estimates that Japan’s debt is approaching 200% of GDP (the largest in the world). None of this bodes well for economic growth.

One thing that has helped Japan: borrowing costs have been kept in line because most of the government’s debt is held by the Japanese public; unlike the US, Japan is not beholden to foreign investors.

Last Friday, Japan signed an agreement with the US to relocate marines within the island of Okinawa. This deal between the world’s two largest economies was seen as an abject failure on the part of Japan’s prime minister, after his campaign promises that the US base would be relocated off the island. His public support rating has fallen to 20%, according to the Economist.

The question now is whether the Japanese people will offer their support in June, when the government unveils a fiscal plan designed to decrease the debt burden. And that fiscal plan needs to be "well-defined," because a "weaker plan would probably add some pressure" to Japan’s Aa2 credit rating, according to Moody’s (Standard & Poor’s cut the country’s rating in January).

Like Japan, the US is on the radar of rating agencies, as we have a soaring deficit and no projections for substantive growth. And (like Japan), our foot is off the accelerator … we haven’t quite hit the brakes … but we will slow down.

For a while there, our economy was accelerating. In the fourth quarter of 2009, we saw growth of 5.6%. But then, the initial estimate of GDP for the first quarter this year was 3.2%.

Last week, the Commerce Department released the first revision of GDP, down to 3%: now we are really decelerating. While it was a disappointment, it wasn’t a surprise.

And this was met with bad news from the Economic Cycle Research Institute (ECRI). The forecasting group’s Weekly Leading Index fell steadily through May, down to 125.6 (the lowest level since last August). What does that mean for growth? According to ECRI managing director Lakshman Achuthan:

The downturn in WLI growth evident since early 2010 has recently intensified, so it should be no surprise when US economic growth slows noticeably in the months ahead.

And then the Conference Board announced that its Leading Economic Index (LEI) fell 0.1% in April, the first decline in over a year. That is a clear sign of slowing velocity. And the Conference Board thinks so too. According to Conference Board economist Ken Goldstein:

These latest results suggest a recovery that will continue through the summer, although it could lose a little steam.

Disclosure: No positions