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Is The U.S. Economy Really In Trouble? A Debate

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
November 3, 2015

IN THIS ISSUE

1. 3Q GDP Report Disappoints, But Not All Bad News

2. Widespread Fears That America is on the “Wrong Track”

3. Editorial: “Is the Economy Really in Trouble? A Debate”

4. Conclusions: 2008 Was Not a Once-a-Century Kind of Storm

Overview

Today we’ll take a closer look at last Thursday’s disappointing GDP report for the 3Q. It turns out that the report was not quite as bad as the headline 1.5% growth suggested. Following that, we’ll look at some polls which show that about two-thirds of Americans are worried about the direction the country/economy is headed.

Along that line, I have reprinted a very interesting column from The New York Times’ senior economics writer, Neil Irwin. In a debate with himself, Mr. Irwin discusses the many pros and cons regarding the economic outlook, and suggests that maybe we worry too much. While you might not agree with him, he quotes a lot of economic stats and the article will make you think.

3Q GDP Report Disappoints, But Not All Bad News          

Last Thursday’s advance report on 3Q GDP showed disappointing growth of only 1.5% (annual rate), down from the sizzling 3.9% rate in the 2Q, and below the pre-report consensus of 1.7%. But on further review, some of the internals of the report were actually encouraging and suggest the economy could be doing better in the 4Q. Let’s take a look.

America’s economy pulled back in the 3Q mainly because companies reduced inventory growth. Slower inventory growth counts as a drag on the economy. Yet beneath the headline number of 1.5%, the government’s latest tally of GDP showed buoyant consumer and business spending.

Consumer spending which makes up almost 70% of GDP remained firm in the 3Q at 3.2% (annual rate), down only modestly from 3.6% in the 2Q – even as inventories were worked down and sales to overseas customers were lower.

Stable employment in 2015 and cheaper prices at the pump have helped pad Americans’ pocketbooks. While payrolls advanced at a slower pace than forecast in August and September, the pace of hiring this year has averaged almost 200,000 a month, beating the annual average for seven of the 10 years through 2014.

After-tax household incomes adjusted for inflation climbed at a 3.5% annual rate in the 3Q, almost three times the 1.2% percent gain in the 2Q. That allowed the US savings rate to increase to 4.7% from 4.6% in the 2Q, indicating consumers have increasing buying power to continue to drive growth. 

Solid Foundation?
Figure 1

Source: US Bureau of Economic Analysis; Bloomberg

The bottom line is, without the drag from slower inventory growth, the economy would have grown by almost 3% in the 3Q. Since inventory slowdown is normally a temporary phenomenon, we could see an improvement in the GDP report for the 4Q. Of course, we won’t see the first report on 4Q GDP until late January next year.

Widespread Fears That America is on the “Wrong Track”

Most Americans worry that the economy is headed for worse times, perhaps a new recession before long. According to Rasmussen, almost two-thirds (65%) believe the economy is heading on the “wrong track,” whereas only 27% believe the country is moving in the “right direction.” The RealClearPolitics poll asking the same question has almost identical results.

With so much data out there in this digital age, and so many ways to crunch it, you can build just about any scenario you want – optimistic or pessimistic. For whatever reasons, most of us choose the pessimistic. I suspect the underlying culprit is our gargantuan national debt of $18.4 trillion (and growing every year) that we silently know will never be paid back.

In any case, it’s easy to worry about the country, the economy and where it’s headed. On Sunday, I read the latest column from The New York Times’ senior economics writer Neil Irwin who has an interesting take on the argument over where the country is headed. He’s confused, like many of us, so he decided to have a debate on the pros and conswith himself.

I think you’ll enjoy it, so I have reprinted it for you below (along with a few charts I added.)

Is the Economy Really in Trouble? A Debate
by Neil Irwin, New York Times
October 30, 2015

I write about economics for a living. Part of my job is to look into the maw of economic data, financial market indicators, anecdotal reports from businesses and whatever else I can get my hands on, and turn it all into a crisp, clear narrative about the United States and global economies.

But right now I’m stuck. I have no idea how the United States economy is doing. And the closer I look at the data, the more contradictory it looks.

A strong case could be made that it is in its most vulnerable spot in years, at risk of a new recession amid a global slowdown. The market for many types of risky bonds is in disarray, and “the dangers facing the global economy are more severe than at any time since the Lehman Brothers bankruptcy in 2008,” the former Treasury Secretary Lawrence H. Summers wrote recently.

There is also a strong case that the United States economy is robust enough to withstand whatever challenges might arise from overseas, and that the evidence of a slowdown is scattered and overstated. Fewer people have filed for unemployment insurance in recent weekly readings, for example, than any time since 1973.

I’ve tried several times in the last few weeks to convince myself that one of those stories is correct, but just can’t decide between them. And because The New York Times is not fond of headlines that include the “shruggie” emoticon (for the uninitiated, that would be ¯_()_/¯), I have held off writing anything.

Figure 2[Gary here: Emoticons are cartoon facial representations
of a writer’s mood, such as the happy face or the sad face.
The “shruggie” suggests that the writer is confused or uncertain – IdunnoBack to the article.]  

Why am I telling you all this? Because sometimes the most accurate portrayal of a situation revolves around uncertainty — and because we journalists aren’t always honest about that. This is my effort to be a little more honest.

Rather than picking an analytical case and pretending to be more certain than I am, I want to walk readers through the conflicting evidence. Below, I do so in the form of the debate that has been playing out within my own head — and, very likely, around conference tables at every economic research group and central bank you can think of.

It sure feels as if we’re on the verge of something bad. The expansion is six years old, making it already the fourth-longest since World War II. If the economy does soften, the Federal Reserve is out of ammunition to do much of anything about it. This feels a little like late 2000, when there were signs the economy was losing momentum even though growth was still technically positive. Then in 2001 there was a mild recession.

Whoa, not so fast. Back then there was a huge correction in the stock market and downturn in business investment that caused the recession. What are the sectors that you see correcting in 2015 or 2016 that put the economy at that much risk?

Emerging markets, especially China? They’ve had years of huge capital inflows, in no small part because of Fed policies, that papered over longer-term problems. Now the capital is flowing in the other direction, and the correction is looking to be vicious.

Sure, but why would that cause anything more than modest ripples for the United States economy? Total exports to China were $124 billion last year, about 0.7 percent of United States G.D.P. And I know you’re going to mention financial linkages, but it’s not as if American banks are sitting on a ton of Chinese government debt. Even if things get worse in emerging markets, isn’t this more like 1998, when an emerging markets crisis enveloped East Asia and Russia? As a reminder, the United States economy grew 4.7 percent in 1999, faster than in the preceding 15 years.

Yeah, but there’s no doubt that the financial markets, including in the United States, have been flashing warning signs since this summer.

Sure, markets have been jumpy lately. But when you step back and take a bit of a long view, is it really anything to sweat about? The Standard & Poor’s 500-stock index was actually up very slightly for the year at Monday’s close (up 0.6 percent, to be precise). Long-term Treasury bond rates have fallen a good bit since the summer but are still higher than they were back in the spring, meaning that the bond market isn’t exactly panicking.

Figure 3

​Maybe Wall Street is just whining because after five years in which asset prices soared much more than the real economy, markets are taking a breather while the rest of the economy catches up?

Maybe, but there are some cracks showing in the data on the real economy too. The last couple of jobs reports have been really bad! This month the data on retail sales and surveys of businesses have shown the same kind of softness. Maybe the economy is like Wile E. Coyote running off the cliff, and as soon as we look down we’ll see it was all a mirage and fall.

Come on, that’s not how the economy works.

For the economy to fall into recession, something has to cause it. A financial crisis that freezes up the credit system, tight monetary policy intended to fend off inflation, a collapse in the stock market, something. Recessions don’t just happen for no particular reason.

It’s true that the economy is starting to feel an impact of the strong dollar (resulting in weaker exports) and cheaper oil (which means less oil and gas exploration). But we’ve seen soft patches like this many times before. For example, job growth has been really weak the last couple of months, but it was about equally weak in June and July of 2013, and nobody even remembers that soft patch.

And if you look at the broadest measures of the economy, there’s not much sign of a downturn at all. For example, over the first nine months of 2015, United States gross domestic product rose at about a 2 percent annual rate, including a 1.5 percent third-quarter pace reported Thursday, broadly similar to the last several years. This could just be a case where people are freaked out by the market moves and are straining to discern a downshift in the economy that isn’t really there.

Figure 4

Yeah, but look at all the anxiety we’re hearing this earnings season. Big, stalwart companies like Caterpillar and Walmart have downgraded their forecasts. Surely those are the canaries in the recessionary coal mine.

There you go with the clichés again. When you look a little more closely at some of these disappointing forecasts, what they’re really telling us about the state of the economy is far more ambiguous.

Take Caterpillar. Yes, it slashed its revenue forecast for 2015 and said it would cut 10,000 jobs in the next three years. But the major reason is the downturn in mining and energy exploration because of cheaper oil and other commodities. Obviously, it’s too bad for those people who will lose their jobs, but the flip side is cheaper gasoline and other fuels for American consumers, which is an economic boost.

The story out of Walmart is even more promising for the economy. Sure, the company’s stock dropped 10 percent in a single day two weeks ago as it downgraded its earnings projections. But look at why it downgraded those projections — because it is investing more to upgrade its stores, and paying its workers more, both of which will weigh on profits.

We’ve had years in which the problem in the economy has been companies that won’t invest and workers who aren’t getting pay raises. Walmart’s earnings are suffering because of the opposite! That’s good news for the economy, even if it’s bad news for Walmart shareholders.

O.K., Pollyanna, anything out there that does make you nervous?

Oh, sure. The drop in stock prices and rise in borrowing costs for riskier companies means that capital is more expensive, and the dollar keeps strengthening on currency markets that will keep holding things back. And if I’m wrong about any of this, the economy really does lack the shock absorbers right now that would help it: The Fed’s most effective tools are pretty well spent, and there’s no way a Republican Congress would even consider fiscal stimulus.

So I get being nervous, but this doesn’t feel like a moment when there are huge imbalances sitting out there due for a correction.

I hope you’re right. But if the 2008 crisis taught us anything, it’s that trouble can spread in ways that are hard to predict, even if you think you know what’s going on.

Yeah, but what happened in 2008 was a once-a-century kind of storm. If you always think that the big one is imminent, most of the time you’ll turn out to be wrong.

END QUOTE

Conclusions: 2008 Was Not a Once-a-Century Kind of Storm

Mr. Irwin starts off being confused about where the economy is headed, but after debating with himself, he ends up on a positive note and suggests we shouldn’t worry so much. He also seems to believe that 2% GDP growth is acceptable – most of us do not. GDP growth of 2% barely provides enough new jobs to cover population growth.

As for his assertion that 2008 was “a once-a-century kind of storm,” I couldn’t disagree more! A financial crisis can occur at any time. Just because the Great Depression occurred 79 years prior to 2008, that doesn’t mean it won’t happen for another 80 years or so.

With most of the world so heavily leveraged with debt, as is the US, it won’t take a lot of negative surprises to set off another financial crisis. This is why I maintain that most investors should have a sizable portion of their investible assets in strategies that can move out of the markets or “hedge” long positions, in the event of another financial crisis.

WEBINAR With Potomac Fund Management Tomorrow

Our next money manager webinar will feature Potomac Fund Management, a manager we have recommended continuously since 1996. The webinar will be tomorrow, November 4, at 3:00 pm Eastern Time. Potomac has three different investment strategies, and its Senior Portfolio Manager will discuss them in detail, with a Q&A session at the end. Be sure to join us. You can register here

 

Very best regards,

Gary D. Halbert

 

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