US ECONOMY faces a precarious recovery path

Feb 11 2010

Ranga Chand’s Notes on the Global Economy & World Financial Markets – February 2010
 
US ECONOMY faces a precarious recovery path
 
Headline GDP Number Masks Half-Hearted Recovery
The January 29 release of the fourth quarter 2009 GDP preliminary numbers by the Commerce Department confirmed that the US economy has emphatically pulled out of recession and a recovery is now well underway. After shrinking for four consecutive quarters, with output declining by 3.8% from its peak in Q2 2008 to its trough in Q2 2009, growth resumed in the second half of last year. What’s more, after expanding at an annualized rate of 2.2% in Q3 2009, the pace of growth accelerated in the final three months of last year with GDP expanding by 5.7%.
 
While the headline GDP growth number has given the bulls a momentary victory in their claim that a V-shaped recovery was finally here, it is apparent that on a closer examination of the breakdown in GDP figures that this is a half-hearted recovery. Nearly three-fifths of the rise in GDP was accounted for by firms replenishing their inventories. But a look at the final sales to domestic purchasers numbers (which strips out the change in inventories and measures all the goods and services US residents have bought irrespective of where they were produced and gives a more accurate picture of the underlying strength of US demand) shows that final sales actually slipped to 1.7% in the fourth quarter, down from 2.3% in the previous three months.
 
In addition, it’s interesting to note that in the first six months of the recovery following the deep recessions of 1973-75 and 1981-82, where GDP declined by 3.2% and 2.6% respectively, final sales to domestic purchasers surged by 4.7% and 6.5% compared to 2% in the current recovery (see Table 1).
 
 
TABLE 1
ACTUAL GAINS IN GDP AND FINAL SALES IN FIRST 6 MONTHS FOLLOWING MAJOR U.S. RECESSIONS
 
Recession Trough Quarter
 
Q2 2009
Q4 1982
Q1 1975
GDP
4.0
7.2
5.0
Final Sales*
2.0
6.5
4.7
* Final Sales to Domestic Purchasers = GDP + Imports - Exports - Change in Inventories. Sources: NBER; Department of Commerce
 
Market Reaction – From Euphoria to Despondency
The initial reaction of the major US equity markets to the GDP numbers was positive but on sober reflection as investors started to digest the data and question the recovery’s sustainability, the markets sold off. At the end of the day all ended in negative territory with the Dow Jones losing 0.5%, the S&P 500 1% and the NASDAQ shedding 1.5%.
 
The underlying worry among investors is that the recovery so far is being artifically driven by both the government’s various stimulus measures including the ‘cash for clunkers’ program, where Americans trade in their old cars for new models, and tax credits for first time homebuyers, and the rebuilding of inventories. The assumption amongst US policy makers is that as these programs start to wind down and the boost from inventory rebuilding fades, consumer spending and business investment will pick up the slack and drive growth. But, that assumption could face some strong headwinds.
 
Factors Constraining US Growth to Persist
Faced with a myriad of problems, it is unlikley that the private sector will be healthy enough to be an engine for self-sustaining growth in the forseable future. Despite the resumption in growth, the economy continues to shed jobs. It lost a further 20,000 jobs in January and since the downturn began in December 2007, 8.4 million jobs have been eliminated. With the economy still shedding jobs, it goes without saying that Americans will not be able to ramp-up consumer spending.
 
Moreover, weighed down with a heavy debt-load and worried about the future, consumers are paying down their debts at a record pace. Latest data for December shows that consumer borrowing has dropped for an unprecedented eleven consecutive months. Consumers are not only borrowing less money, but they are also saving more. As a percent of disposable income, the savings rate has gone up from 1.7% in 2007 to 4.6% in 2009. In monetary terms, consumers saved $180 billion in 2007 but socked away $500 billion last year. Whether by choice or not, it is apparent that being thrifty is now becoming the ‘new normal’ for the American consumer.
 
So, until there is a sustained and meaningful contribution from consumption, which accounts for 70% of US GDP, this recovery is certain to be disappointing.
 
On the monetary policy front, to jump-start the economy the Federal Reserve has kept its benchmark interest rate near zero for the past fourteen months. But, this has failed to ignite demand. Credit conditions remain tight and the demand for both business and household loans continues to weaken. According to the Fed since December 2008, commercial and industrial loans have dropped to $1.32 trillion from $1.62 trillion, commercial real- estate loans have declined to $1.63 trillion from $1.73 trillion, and consumer loans have fallen to $814 billion from $861 billion. Without a pick-up in credit demand, the economy cannot expand and growth will stagnate.
 
Risk of a Double Dip Recession Remains
The above developments hardly point to an economy that is gearing up for a period of rapid growth. On the contrary, should these trends persist, there is a very real danger that the US economy could stumble again. After a quarter or two of positive growth, GDP could slide back into negative territory. Hence, one cannot categorically rule out the possibility of the US experiencing a double-dip recession.
 
Predicting the economic future is always hazardous but what we can be sure about is that the future path of growth will not be linear but will zigzag as the US economy struggles to get back to its long-term trend rate of growth.
 
A Patchy US Recovery Spells Trouble for the World Economy
An on-again/off-again US recovery does not bode well for the world economy. Despite China’s high-speed growth over the past two decades and its rapid climb up the worlds GDP rankings, the United States remains by far the most dominant economy in the world. Based on the latest World Bank estimates the US accounts for about 24% of global GDP at current market exchange rates, and China 7%. Given its size and close trade linkages with the rest of the world, it is clear that a weak and halting US recovery will have a dampening impact on the growth rates of other countries.
 
In particular, the impact will be felt most keenly in those countries where the US is the main destination for their exports and also for those where the US accounts for a significant portion of their overall exports. Interestingly, although the US is the top destination for China’s exports, it only accounts for less than 18% of its total exports.
 
Canada & Mexico Stand to Lose the Most
However, both Canada and Mexico, with their heavy reliance on the US market which accounts for about 80% of their total exports, stand to lose the most from a sub-par US recovery. While the North American Free Trade Agreement (NAFTA) cemented their access to the huge US domestic market and significantly boosted each country’s exports in the past decade, the adjustment to lower demand by a crippled US economy will dent future growth in both Canada and Mexico.
 
The longer it takes for the US economy to fully recover, the harder it will be for Canada and Mexico to return to their full potential.
 
© Copyright 2010 Chand Carmichael & Company Limited
 
 

About Ranga Chand
Ranga ChandRanga Chand is recognized both domestically and internationally as one of Canada's leading economists and mutual fund analysts. Professionally, he held senior positions with Canada's Department of Finance, then served as a director of the Conference Board of Canada, before joining a major stock brokerage firm. He has also taught economics at the University of Waterloo, published extensively in the field of economics, and represented Canada at numerous economic forums, including the OECD in Paris, the United Nations, and the World Institute of Economics in Germany.
A media personality with a huge following, his popular television show "Talking Mutual Funds with Ranga Chand" aired weekly on Canada’s Report on Business Television (ROBTV) for three years from 2000 to 2003 and reached over 4.3 million viewers nationwide. Much in demand by organizations, industries, and associations throughout North America, Ranga is well known for his down-to-earth, clear, and informative presentations on the subjects of the global economy and investing.

He is the author of a number of best-selling books including:
  • Ranga Chand's Top 50 Mutual Funds
  • Ranga Chand's Getting Started with Mutual Funds
  • Best of the Best Mutual Funds, Featuring America's top 50 Heavy Hitter funds
  • Is Your Retirement at Risk? Winning Strategies for a Financially Secure Future.
Highly respected in the investment community, Ranga Chand is founder and President of the research and consulting firm Chand Carmichael & Company Limited, located in Ottawa, Ontario.
 

 

 

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