This morning’s GDP report shows the economy expanded at a 3.2 percent annual rate in the first quarter. The report further detailed the growth of consumer spending accelerating to 3.6 percent in the January-March period, more than double the 1.6 percent pace in the fourth quarter.
Consumer spending normally accounts for 70 percent of U.S. economic activity, and while there has been much concern over the sustainability of consumer spending, this GDP report seems to suggest that concern for the consumer is exaggerated. Is it?
The consumer is holding his or her own in the face of difficult job conditions for now, but we should not assume the consumer will continue to spend as government extended benefits totaling 10 Billion per month begin to wane. Closer inspection of today’s report shows the consumer financed the uptick in spending with a drawdown of savings. The economy must begin to add jobs in a meaningful way for the consumer to do its part. So how long will it take the current 10 percent unemployment rate to decline to a 5 percent level that will ensure a sustainable consumer? The following chart from the Department of Labor and Goldman Sachs provides a glimpse.
Consider that GDP growth is the demand side of the equation and Productivity Growth is the supply side of our equation. Further determine based on your own views of the recovery what rate you believe our corresponding growth rates will be (I have included a second chart showing Goldman Sachs GDP forecasts versus consensus – if you split the difference you could assume a 3% GDP growth rate). The factors in the productivity Growth or supply side are such things as Capital, Energy, and Labor – remember we are talking about capacity growth here, so a lower number would bring jobs back to the economy more quickly. Let’s assume a middle of the road 2.6% Productivity Growth – a quick glance at the table shows it would take 24 years for the unemployment rate to return to a 5 percent number.
While we don’t require a 5 percent unemployment rate overnight, the consumer is either going to have to have a meaningful job or a continuation of meaningful handouts to ensure sustainable spending by the consumer. I won’t dwell on the point but some credible analysts suggest that the consumer is getting their own bailout by not making mortgage payments while simultaneously paying down other debt and increasing spending on such things as travel and meals out.
Cliff Wachtel, a Seeking Alpha contributor posted on 4/30/10 an interesting assessment called “The Coming Crash: Pros and Cons” which I think is excellent and have included it below for your consideration:
“To paraphrase Charles Dickens, it is the best of times (low rates, improving earnings and data), it is the worst of times (multiple crash threats). Here’s a quick review of the balance of bullish and bearish forces to watch for 2010-11.
In the course of preparing for an interview with Allthingsforex.com, I was musing over the array of bullish and bearish forces that will shape the coming years, and the below thoughts should also be useful to readers in clarifying their own strategies and plans.
Crash or No Crash In 2010-11? That Is the Question
Prices for equities, commodities, and high yielding or commodity based currencies remain close to 52 week highs, yet:
- The EU teeters on the brink of a wave of sovereign defaults and ensuing banking crisis that threatens the global economy like nothing since the Lehman Brothers crash in the Autumn of 2008
- The US faces a potential second wave of mortgage defaults of a magnitude not seen since the subprime crisis that ultimately sank the global economy-which was stronger back then.
- China and India are trying to slow their growth rates to more sustainable levels
- Interest rates are generally very low and will need to rise over the coming years, creating potentially severe headwinds for most developed economies because they are so dependent on long term low rates.
- The key question for analyzing trading/investing opportunities for the rest of 2010 is: Are we facing a major pullback or crash back to Autumn 2008 or March 2009 lows, or can markets continue to their “risk on / risk off” pattern of the first quarter?
Four Primary Bullish Forces Keeping Markets Afloat
- Low interest rates
- Slowly but steadily improving economic data and earnings
- Growth in emerging markets
- State Economic Creativity
If the above forces prevail, given the bearish clouds hanging over markets discussed below, the best case scenario appears to be perhaps a bit more upside at most, with markets stagnating but not collapsing through 2011.
Four Horsemen of the Coming Crash
When it comes, one or more of these will bring it.
- EU Debt Crisis: A likely wave of sovereign defaults and resulting bank failure contagion that has likely become a question of when, not if.
- US Subprime Crisis II: As first pointed out to me by Graham Summers in U.S. Housing: The Big Picture, the US begins to see another wave of mortgages resetting at higher rates in July. The last time a wave of this magnitude hit it caused the subprime crisis which ultimately crashed the global markets and economies.
- China- Slowdown or Crash? James Chanos, Marc Faber, and the Chinese government all seem to see a bubble in Chinese housing construction and real estate. The Chinese are actively trying to let the air out slowly, but governments do not have a great track record at controlling the pace of economic expansion and contraction, especially once a bubble is in place – and all indications are that it is (see Edward Chancellor’s Ten ways to spot a bubble in China and Edward Harrison’s Andy Wie Will Tell You When Chinese Bubble Is About to Burst ).…and if the markets are still standing…
- Rising Interest Rates: Either via central banks promised tightening short term rates or bond markets raising long term rates on fears of rising default risk from rising deficits.
Conclusion
That’s how the bullish and bearish forces are arrayed: four bullish, four bearish. Regular readers know we believe that while the global economy is improving, the evidence suggests another serious pullback at least. A complete crash of Great Depression magnitude is also a real possibility.”
While here at Alpha Fiduciary we remain focused on all forces bullish and bearish, my conclusion is that tactical allocation of your portfolio across ten asset classes will provide you with the optimal risk and reward relationship enabling prosperity and survival regardless of the outcome of the ongoing battle between all forces bearish and bullish.
Good analysis of the potential issues. I think the new web site, w/ videos, looks great and expains the philosophy very well.
so what are you doing to protect the down side?