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Saturday, August 8, 2009

Taking Stock of the Economy

Over the last four weeks or so almost all major corporations announced their earnings, the second quarter GDP came out, and July's employment numbers came out. There's a lot to view positively about the numbers, however there is also still plenty of work to be done.

Of the 500 companies on the S&P 500 about three in four either beat or matched their earnings estimates. That's great, however there's a few things to keep in mind. First, the first quarter of this year was one of the most awful in the last 30 years. Our economy contracted by 6.4% and the earnings in that quarter and the earnings of all these companies reflected that. So, estimates for the second quarter were based in some part on just how bad the first quarter was. So, while a lot of companies beat their earnings estimates, they were beating fairly conservative estimates for the most part. Since this quarter was better than expected, estimates going forward will reflect that. If earnings continue to beat estimates in Q3, then we are seeing a very positive trend. Now, we should all be cautiously optimistic.

The most significantly positive news was the second quarter Gross Domestic Product number. The economy only contracted by 1%. I say only because estimates were a contraction of 1.5%. Furthermore, given that the economy contracted by 6.4% in the quarter previous, that's a massive improvement. Now, this marked the fourth quarter in a row of contraction. That was once a definition of a depression though most economists no longer hold to that strict definition. It's also the six straight quarter of below par economic growth. It's very possible that the economy will actually grow in the third quarter as the Fed has predicted. That of course doesn't mean we are out of the woods at all. When an economy goes through this severe a contraction, it needs a serious jolt before we'll all feel out of the recession. The economy will either need to grow by 5% or more in a given quarter or it will need sustained, four or more quarters, of 3+% growth.

We are still a long way away from that. If the economy grows toward the end of the year, the president will use that to boost his popularity. It will no doubt be a good sign if the economy grows slightly like 1%, and certainly better than continued contraction. Still, the final verdict on our economic recovery is still a long ways off. I personally believe that the massive borrowing will stunt the recovery and keep the economy from growing at the pace necessary to make up for the sustained contraction. Whether I'll be proven right or wrong is still at least a year off.

Finally, we had the July unemployment numbers. There was a lot to get excited about there also. First, these were the best numbers in almost a year. The economy only lost 247,000. I say only because not only did it beat estimates, but again, it was the best number since last summer. Furthermore, two troubling trends reversed themselves. Workers were working more hours this month, 33.2, than last month. Worker hours had been contracting for several months. Furthermore, wages began increasing again after a couple months of decreasing wages. Employment continues to be totally unpredictable. We've gone from a high of 700,000 jobs lost in February down to 247,000 in July. Yet, in May were supposed to lose nearly 500,000 jobs but only lost 345,000. Meanwhile, in June were supposed to lose just more than 300,000 jobs and instead lost 460,000 jobs. The trend is definitely improving but also unpredictable. Furthermore, it's important to keep in mind that our economy needs to gain roughly 150,000 jobs in a month just to keep pace with added workforce. We've been losing about 350,000 jobs for nearly two years. 250,000 lost jobs represents a 400,000 shortfall still. It's still at least a year before we are just gaining enough jobs to keep up with added workforce. In the meantime, we are almost certain to see double digit unemployment.

Finally, the news is not all good. Both oil and interest rates have risen in response to all this good economic news. Both can have corrosive effects on the recovery. Oil is now trading at near $72 a barrel. A hundred dollars a barrel represents somewhere between $3.25-$3.50 a gallon gasoline. In fact, lately consumer spending has gone up nearly entirely because of increased gas prices. We aren't going to have much of a recovery if everyone is paying $3.50 a gallon to fill up their tank. Meanwhile, interest rates have also risen since many of these positive economic numbers have materialized. The 30 year mortgage is back above 5.5%. The ten year U.S. Treasury Bond is approaching highs over the las twelve months. Unfortunately, massive borrowing has weakened the dollar and put upward pressure on all rates and thus contributes to both. Those are two of many reasons why I believe that the president's massive borrowing scheme will ultimately doom this recovery.

Finally, everyone wants to take credit for the recent spat of economic numbers. The president has proclaimed that his stimulus has contributed to bringing the economy back from the brink. White House adviser Christina Romer even proclaimed that the President's recovery package added 2% to the GDP. This is of course a statement that can't possibly be proven and so it's good only for political posturing. It's hard to see how the recovery plan played much of a role given that most of it is still not spent. Some argue that the prospect of government spending helps create confidence, however we didn't see the same "confidence" when the Fed brought rates to zero. Ultimately, no one will ever know what did what. We'll never know if it was the stimulus, the Fed, or if the economy simply recovered on its own. (despite what some pols will tell you economies have cylces and after a bust there is a recovery and that's actually natural)

All that we can guage now is that this economic recession will be somewhere between the one in the early 1980's and the one in the 1930's. How close to each is still to be determined.


Anonymous said...

Hey, if the data couldn't be made to say whatever we think it does, we wouldn't all be running around the place calling each other liars!

Quantum_Flux said...

I'll bet that Obama is banking his bets on the idea that businesses will reinvest more of their profits in order to write off more transactions as business deductions because of the higher taxes in Q3 and Q4. That might have a positive effect unforseen, yet another crash in the following quarters of next year due to low demand and higher unemployment.