Today’s fourth quarter GDP report, which showed a preliminary reading of -0.1% growth-yes, the U.S. economy contracted during the fourth quarter-shows that the economy faltered during the fourth quarter as a result of hurricane Sandy and the Fiscal Cliff issues. Digging into the components of GDP, we find that several areas, including home building (+15.3% annualized), consumer spending (+2.2% annualized), and capital spending (+8.4% annualized) that were positive during the quarter. Government spending (-6.6% annualized) and inventories (-$40 billion) were weak. Many pundits are focusing on the positive components of GDP to discount the importance of the top-line number. To me this is exactly like analysts who developed new methods for valuing internet companies back before the tech bubble burst to justify ever higher stock prices for companies that were not making any money. We all know the result of that exercise. Sure, in any economic report we can pick out certain positives or negative to justify an opposing position. The problem with this report is that we are talking about GDP-the largest measure of overall economic activity for the U.S. economy. To ignore the implications of negative U.S. GDP for any reason is simply naive and dangerous.
Investors too shrugged-off this report. Although stocks started today’s session in the red after this report, they soon rebounded and currently stand pretty close to even for the day. This reaction, or lack of reaction, provides further support for my position, which is that small investors, who largely missed the market rally last year, are scrambling to get into stocks. As we know from history, small investors are rarely correct on timing – they buy when they should be selling and sell when they should be buying.
The current action in the stock market appears to confirm the historical record. To address those who would discount the glaring negatives in the GDP report, I offer the following response:
Consumer spending always rises in the 4th Q for the holidays; business investment looked good, but that’s only because it has been so dismal leading into Q4 (check the data and you will see this); home building is only up because builders have nothing better to do with their crews and would prefer to have them do something rather than pay them to sit on their asses; inventories were down because of lack of demand and with the payroll tax increase and the pending spending cuts by the government, companies have no good reason to increase inventories; and government spending, which was down hard in Q4, is only going to go down a lot more after the spending cuts to come, and that’s before we deal with the debt ceiling. Add all this up and although pundits are spinning this as some kind of reverse psychology positive, it is clear to see that the U.S. economy is in trouble. Add this to the fact that stocks are at multi-year highs and you have the makings of a serious stock market collapse.