The U.S. Economy: Reasons For The Anemic Growth

Includes: CAT, DE, GLD, SHY, SPY, UUP
by: Vision Capital M.

The recent value of the U.S. Leading Economic Index (LEI), which the Conference Board published on Thursday last week showed a decline of 0.3% in June, following an increase of 0.4% in May and a 0.1% decline in April. The index's "six-month growth rate has eased in the last three months" says Ataman Ozyildirim, economist at The Conference Board.

In an open world the United States depends on the health of others to prosper continuously. Generally a country's economy could grow internally, externally, or both. Externally it grows by trading with the world and internally - by personal consumption, domestic investments and government activities.

In order to evaluate the current growth opportunities we would examine the external environment of the U.S. first. The export businesses are important providers of employment, which supports personal consumption (the internal growth component) and because of this their health and international perspectives matter.

Currently the U.S. exports amount to about 14% of the country's GDP. Combined with the imports the trade balance is negative, which decreases the GDP. This tendency is nothing new as the country relies to a great extend on its domestic personal consumption (71% of GDP for 2011) in order to grow the economy. We could see the recent quarterly changes in the weights of personal consumption, exports and imports in the U.S. GDP in the following table:

Quarterly Change
2011 2012
Exports 4.59% 3.02% 1.63% -0.28% 1.85%
Imports 6.57% 3.35% -0.03% 0.59% 2.19%
Personal consumption 1.48% 0.99% 1.02% 0.81% 1.25%

Exports Imports Personal Consumption Quarterly Changes

The table and the graph above show that although there were increases marked in the first quarter of 2012, the trend of slowing exports and imports that started in the second quarter of 2011 might be still operating. Personal consumption's weight of GDP was also lower than the one measured at the beginning of 2011.

The recent negative value of LEI does not seem so unexpected when considered in the perspective of the changes of the GDP components shown above combined together with another index value released in the beginning of July - the PMI of the Institute for Supply Management. It showed a contraction in the manufacturing economy by falling to 49.7% from a reading of 53.5% in May. That was the first time of contraction since July 2009. A respondent in the survey from the machinery industry said "Business is still strong, with some nagging question whether it will be sustained." This could make us pay closer attention to the expected financial results of machinery companies like Caterpillar Inc. (NYSE:CAT) or Deere & Co. (NYSE:DE), especially in the light of their quality of earnings.

At the same time the U.S. dollar's appreciation against the major currencies continues for more than a year. Since May 2011 till the end of the first quarter of 2012 it has gained almost 10% against the euro. The exports to the euro area (which account for about 14% of all the U.S. exports as of that time) fell with about 6% for the period. Until now the dollar has gained another 9% against the euro. Data to be released during September will show if there really was another decrease in the exports but given the economy logic and the leading indicators like LEI and PMI such a decrease should not be a surprise.

China is another interesting trade partner of the U.S. upon whom many place big expectations. Contrary on the euro area situation where the current level of U.S. exports (14%) is below its 10-year average of 17%, the exports to China are still on the rise with an average annual increase of 19% for the last 10 years. They now take 6% of all the U.S. exports, which is above their 10-year average level of 5%. There is however a slowdown seen in the pace of increase for the last two years, which is also confirmed by the currently available quarterly data for 2012.

The reasons for the slowdown of exports could be searched in two directions - the strong U.S. dollar and the weak international environment.

The appreciation of the USD could have a significant impact on the external demand for U.S. goods and services but given its general decreasing effect on commodities prices, increases in manufacturing costs could be offset by lower materials costs, to some extend.

Concerning the international environment, recent data show that China's economy slows down and Europe is still fighting with the sovereign debt crisis. The economic sentiment in Europe fell further during the last week. Its trade balance however remained positive and amounted to €6.3B, not surprisingly given the depreciation of the euro.

The other U.S. trading partners are not in a significantly better economic position.

The combination of a strong U.S. dollar and weak trading partners logically lead us to the conclusion that in the current international environment the external factor would have a small positive contribution (if any) to the near-term growth of the U.S. economy. But could the country's internal resources be enough to support the needed GDP growth?

One of the important factors for growth from within is the personal domestic consumption. The changes there are not so volatile as those seen in the exports and imports' weights. However due to its big part in the GDP (more than 70%) those slight differences could have a significant impact on the economy development.

Consumption depends generally on the amount of money and wealth available.

The continuing unemployment could weigh heavy on the domestic consumption growth as it deprives households of available money. Monthly data show that after April's 2012 value of 8.1% (the lowest level measured since February 2009) a slight increase to 8.2% followed through the summer. The initial jobless claims surged again last week (reaching a value of 386K), which suggests an increase in the unemployment level could be ahead.

Another source of available money is investing. In order to get a clearer picture of this fuel for the domestic consumption we could check the recent flow of funds data and examine the assets base.

Concerning the households and non-for-profit organizations the nonfinancial assets take about 31% of all assets. The other 69% consist of financial assets. While the nonfinancial assets are still almost 16% below their value of year 2007, the financial assets of those entities have caught up with the 2007 value and even surpassed it by 1%. The biggest increase is in time and savings deposits and mutual funds shares.

Looking at the nonfinancial corporate businesses, the nonfinancial assets comprise almost 50% of their assets. Those nonfinancial assets are 9% below their 2007 value. The financial assets of these entities however are already 11% higher than they were in 2007. The biggest increases there is seen in trade receivables (9%) and miscellaneous assets (11%). The growth of trade receivables is particularly important because generally it could pose a higher risk on the corporate earnings given the world economic situation gets worse.

The potential problem with financial assets valued at market value (which are the majority of those with the highest increases during the last 5 years) is that they could experience undesired volatility. In case the markets go down those assets would lose some of their value. In the households and nonprofit organizations case this could be particularly unpleasant given the high proportion the financial assets occupy in their assets mix.

The examined asset base combined with high unemployment and declining economic activity outside the U.S. do not seem to provide a steady enough foundation for a long-term growth of the American economy. This could reflect on the equity market, as already happened during Thursday and Friday last week when some negative readings of economic indicators came out. The price of ETFs like SPDR S&P 500 fund (NYSEARCA:SPY) would also suffer from any vanishing prospects of economic growth because this ETF tracks the performance of the largest companies on the U.S. equity market.

In order to protect their investments given the U.S. growth continues to be so anemic or even turns negative investors have different options.

One would include diversifying investments with an asset that has a zero or better yet a negative correlation with the equity markets. Treasuries (including the U.S. ones) could provide such opportunity. The potential profit there is relatively low but they would be able to decrease the risk of a portfolio. The investments could be done directly or by using some of the available ETFs that measure the performance of the U.S. treasuries. Barclays 1-3 Year Treasury Bond Fund (NYSEARCA:SHY) is the biggest available fund of this kind, with assets close to $10B. It has an expense ratio of 0.15% and measures the performance of U.S. treasuries with remaining maturity between 1 and 3 years.

An investment in an ETF that tracks the appreciation of the U.S. dollar could also be an option. DB USD Index Bullish (NYSEARCA:UUP) is one. It tracks the performance of the dollar against six other major currencies and has an expense ratio of 0.5%. The current monthly correlation between UUP and S&P500 based on data since the inception of the ETF goes to -0.41.

Another asset with a higher appreciation potential that still exhibits a negative correlation to the U.S. equities is gold. Recently some proposed regulatory changes concerning gold could make it even a more attractive option. A position there could be taken by either buying gold bullion or investing in and ETF like the SPDR Gold Trust (NYSEARCA:GLD). This ETF tracks the spot price of gold bullion and has an expense ratio of 0.40%.

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

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