Sentiment is tense, investors are antsy, fundamentals are weak and volume trends are poor.
At times like these, bulls will grasp for straws, and that is when they look at the economy for help. Surely some hope could emerge there.
Or not. Most economists were expecting a -5.4% contraction in gross domestic product (GDP) in the fourth quarter. But the number came in at -3.8%.
Party time? Not so fast. Following a -0.5% decline in the third quarter, the October-December span was the worst shrinkage in the economy since 1982.
It gets worse if you ignore inflation: At -4.1%, the nominal GDP reading was the worst in 50 years.
The negative contributors were consumer spending (-2.47%), business investment (-2.19%), housing-sector activity (-0.85%) and commercial real estate activity (-0.07%).
Positive contributors included a shrinking trade balance deficit as imports fell more than exports (2.93%), an increase in inventories (1.32%) and government spending (0.38%).
Digging a little deeper into the numbers uncovers more weakness. The 1.3% benefit from inventory accumulation should be ignored because it’s a temporary boost that will just amplify the coming manufacturing slowdown and pull down future GDP results.
MBA students call this the “bullwhip effect.” It occurs when bad forecasting, a lack of coordination in the supply chain and management overreaction to economic conditions magnifies shifts in consumer demand.
Basically, companies over-ordered and while that was good for Q4 08 it will be bad for Q1 09.
The bullwhip effect will be especially strong given…
>
The bullwhip effect will be especially strong given the huge 43.3% annualized contraction in durable goods sales. Retailers will cut order books more than necessary, forcing factory closures and layoffs and thereby deepening the downturn more than necessary.
John Williams of Shadow Government Statistics, who has done a great job in calling the economy over the past couple of years, said this amounts to a “depression-like” contraction.
Another issue concerns the inflation estimate used to “deflate” the nominal or non-inflation adjusted GDP measure. Stay with me here. You know that I’m not a tin-hat type, but we need to be attentive to government massaging of data.
Remember that confidence, or what economist John Maynard Keynes called the “animal spirits” in his 1936 classic “The General Theory of Employment, Interest and Money,” is critically important to a vibrant economy. With confidence already soft, it appears Commerce Department bureaucrats tried to weaken the blow by tweaking the inflation reading.
For much of the year, it appeared that the government was underreporting inflation as oil raced to $147 a barrel. That helped boost real GDP numbers earlier in the year. Now, it appears that the decline in food and fuel prices is being exaggerated, which again helps boost the real GDP figure. As you can see in last gray bar on the far right in the chart above, the quarterly GDP Price Index fell off a cliff and moved into negative territory (-0.1%) for the first time since 1954.
Why this matters: In an inflationary environment like earlier this year economists subtract the price index from the nominal GDP print. If in a deflationary environment, they add the price index back to nominal GDP. You can see how government statisticians can use this trick to make the number almost anything they want it to be.
My conclusion is that the massive fall in the price index between the third and fourth quarters is simply not credible. While it’s true that gasoline prices adjust quickly, the price changes on just about everything else is much slower. Retailers like Wal-Mart, the global leader in retail cost cutting, is just beginning to put pressure on its wholesale vendors to lower prices now that raw material costs have fallen. I expect the price index to be revised higher and into positive territory in the coming months, which will probably move future real GDP revisions closer to -5%.
The takeaway: The economy is weaker than reported. And things can still get worse if policy makers don’t act fast. To learn how to trade in this type of environment, check out my Trader’s Advantage newsletter.
This article was written by Jon Markman, contributor to InvestorPlace Media. For more actionable insights likes this, visit www.InvestorPlace.com.
