Saturday, February 02, 2013

The Truth About The U.S. Economy

On Wednesday the government announced that the gross domestic product (GDP), the total value of goods produced and services provided, fell at an annual rate of 0.1 percent during the fourth quarter of 2012.  That officially marks the worst performance of the economy since the end of the recession in 2009.  The announcement took analysts and economists by surprise since those polled by Reuters were reportedly expecting the economy to rise by 1.1 percent.

The Associated Press reported that the driving factors behind the contraction were, “the biggest cut in defense spending in 40 years, fewer exports and sluggish growth in company stockpiles.”  They pointed out that this could cause new fears with regards to the recent tax increases and planned government spending cuts but quickly postulated that, “the weakness may be because of one-time factors. Government spending cuts and slower inventory growth subtracted a total of 2.6 percentage points from growth.”  However, the fourth quarter saw a 2.2% increase in consumer spending and a large number of companies experiencing earnings growth for the quarter, driving their stock prices up.  These factors lead many to believe that this is an isolated incident

But let’s look at this a little closer.  First of all, fourth quarter includes the Christmas shopping season during which consumers traditionally spend more than normal.  The Social Security tax cut expired at the end of 2012, raising payroll taxes by 2%, or roughly $1,000 on households earning $50,000 a year.  That is sure to depress consumer spending.  Additionally, deeper government spending cuts are set to take effect in March unless Congress takes action, which is certain to have a negative effect on the economy as well.

Next is the issue of lower corporate inventories.  Caterpillar, Inc. reported a $2 billion reduction in inventory as well as a reduction in profits during the fourth quarter while Apple reported a 50% reduction in parts purchases.  There are two reasons why companies will reduce their inventories.  The first is if they found themselves with too much on hand the previous quarter.  The second is if they expect lower sales in the future.  Quite often an inventory surplus in the previous quarter can be attributed to slower than expected sales.  This can lead to lower sales forecasts and a consequential reduction in inventory stocks.  These factors ultimately will impact corporate earnings for the next quarter.

Finally, although there were a large number of companies reporting earnings growth for the quarter, it was below trend.  As Colin Lokey points out, “according to Goldman Sachs, the percentage of firms reporting positive earnings surprises at this point into earnings season has run at around 47% over the last 40 quarters, at around 40% over the last four quarters, at around 36% during last year's third quarter earnings season, and at just 34% during the current earnings season”.

While it’s impossible to foretell the future with any certainty, at this point it time it looks like this could possibly be the start of another recession.  Only time will tell.