The Commerce Department gave the stock market a very tasty Halloween treat today while friendly neighbor Ben Bernanke offered more candy later in the day. Allegedly, the economy grew at a 3.9% rate from July to September. Eyebrows shot up. For one thing, this was an acceleration from the 2nd Quarter and the period it encompassed was rife with the prospect of the housing market being at its worst in American history and a nascent credit crunch that exposed more than just a few statistical noises in the balance sheets of major financial firms. Most interesting about the GDP report, perhaps, was that the GDP price deflator only grew at a 0.8% annual rate. This simply means the amount of inflation that impacts the GDP. Nominal GDP grew 4.7%, real GDP grew 3.9%, thus the 0.8% difference. In other words, this was the slowest pace since 1963! Does this make any sense whatsoever? Hop into the Bernanke Copter for a ride to the rest of this story.
The news would sound more comforting were it not, first, very confusing and, second, verified by consumer sentiment. When I first saw this, I had little reaction. For one thing, I have put less and less weight on the GDP. Unfortunately, it seems that economic conditions over the years are such that the GDP as we know it is becoming obsolete.
Suffice it to say that many who saw this were justified in their skepticism. As the dollar continues to weaken, we have seen oil roar to over $94 and gold reach $800 without incident for the first time since the high inflation days of 1979 and 1980. The inflation gallops were quite noticeable this September as the price of wheat and other food staples jumped sharply. Ben Bernanke revved up his super fast helicopter today with all his way-cool Federal Reserve colleagues to cut interest rates. Stocks were delighted.
The first thing I would like to look at is this one ironic trend we have in place. Even though employment is clearly slowing, the economy is apparently accelerating. Jobless claims have begun to spike again, as new unemployment benefits for two weeks ago rose at the sharpest pace since February and were even revised up from 336,000 to 339,000 after the fact. The last week, it was at 330,000. Some consider 350,000 to be the recessionary zone, but this is not yet established as a trend. More jobless numbers are coming in tomorrow which should give a clearer picture.
Annualized Employment Growth
4Q 2006: 1.6%
1Q 2007: 1.3%
2Q 2007: 1.1%
3Q 2007: 0.8%
Annualized Gross Domestic Product Growth
4Q 2006: 2.1%
1Q 2007: 0.6%
2Q 2007: 3.8%
3Q 2007: 3.9%
Why is the price deflator clocking only 0.8% when there has clearly been a very strong rise in commodity and energy futures? Are the GDP numbers really that "advance" and therefore too sketchy to consider reliable at this point?
Annualized GDP Price Deflator Growth (see GDP table above for comparison)
4Q 2006: 1.7%
1Q 2007: 4.2%
2Q 2007: 2.6%
3Q 2007: 0.8%
Oil has risen 15% in October. The price of gasoline has yet to respond to this, though my guess is that we should expect an uptick soon. The nationwide average price of regular gasoline is $2.86as of October 29th and my guess is that we'll be back to $3 by Thanksgiving and possibly even higher going into New Year's 2008 if oil prices stay elevated. My one hunch that oil prices will probably hit $100 a barrel in November and stay above $90 for a while longer is because the gains have been consolidated. Oil seems to have established a bottom at the high 80's.
Gold, on the other hand, has been impressive. In July, 21 oz. of gold could buy you one share on the Dow Jones Industrial. At the end of October, you would only need 17.5 oz. of gold, a drop of about 17%. That means that, compared to gold, the stock market has been sharply losing value since it originally hit 14,000 in July. For a more historical perspective, in 2000, about 41 oz. of gold would buy one Dow Jones stock. Values are declining, even though stock prices are going up. This DJIA-to-gold ratio dropped significantly in October. Since the Fed cut rates on September 18th, the price of gold has risen more than 12%. This is astonishing.
There is no way the economy is that strong to grow nearly 4%. I would expect some big downward revisions coming from a rising price deflator. That alone could easily shave 2% off of the advance GDP figures. As it is, this would not prevent the possibility of a sharp slowdown in the economy in the fourth quarter. Why?
•Corporate earnings are coming in far lower than expected (Merrill Lynch reported that its writedowns were at $10 billion compared with a forecast of $4.5 billion, prompting CEO Stan O'Neal to leave.) Other than rumor, there is not much saying that things will get any better soon.
•Chicago PMI reports recessionary number of 49.7 for overall business activity in the Midwest.
•Four-week average jobless claims on the rise.
•Weekly same-store sales have been on a considerable decline in October, giving a bad preview of the October retail numbers.
•The housing market continues to get worse. The S&P/Case-Schiller Index shows home prices down a sharp 4.2% from last year. In terms of percentage declines, this is already putting this bust at worse levels than in the 1990-1991 recession. There are now fewer home sales than there were BEFORE the boom (thus, at 2000-2001 lows.) This means this is not simply a "correction" but in fact a very severe housing recession (some would say depression.)
•Now that the interest rates have been cut to 4.5%, expect the dollar to further weaken. While this means a strengthening of exports, imports will also continue to strengthen in price (which takes away from the GDP)!