In our view the economy is disappointing, even allowing
for the bad weather. We’ve been saying for some time that, following major
credit crises, economic growth is sub-par for many years to follow, and that
is, indeed, what has been happening. For
the last few years growth has generally trended at about 2% annualized,
sometimes a bit more and other times a bit less. Every time growth exceeded 2% the pundits
believed that the economy was achieving “escape velocity” only to see it drop
back into renewed weakness.
Before the bad weather hit, the economy was already
sputtering. Real disposable income was
increasing at only a 0.6% annual rate, and consumers were able to increase
spending only by reducing their savings rate to the lowest point of the recovery. Second half GDP was goosed by a jump in
unwanted inventories that had to be worked off in coming periods. The year-over-year increase in payroll employment was within the same range it had been in for the prior three years. The housing industry had also turned down. Existing home sales for November were down
year-over-year for the first time in three years, and the mortgage purchase
index was declining----all before the bad weather settled in.
Granted, the weather has been a factor and has slowed the
economy down even more. When conditions
return to normal, it is logical to believe that there will be some
snapback. However, when that happens
growth is likely to return only to the same tepid pace it was on before the
winter began.
Let’s take payroll employment as an example. Employment in November, prior to the poor
results in December and January, increased 1.82% year-to-year, compared to recovery peak of 1.88% in March 2012. In January the rate dropped to 1.65%. In order for the year-to-year growth rate in
March to return to the November level, the economy would have to add 652,000
jobs, an average of 326,000 for each of the next two months. And if February is also disappointing, we
could actually see a big catch-up in March on the order of 400,000 or 500,000
jobs. Even then, however, that would
only be enough to return to the November annual rate, which is in the
inadequate range of the last two years.
Keep in mind, too, that in prior post-war recoveries, employment
typically rose by 3.5%-to-5% annualized for many months, far above anything
seen in the current cycle.
In addition, the global economy is faltering as
well. The IMF has stated that the world
economy is still weak and that “significant downside risks still remain”. Europe is barely growing while China is
showing signs of slackening growth even by the government’s suspect official
numbers. Even more disturbing are reports
we've been reading about problems in their shadow banking system. China has about $1.8 trillion invested in
so-called “trusts”, and a large portion is apparently in danger of default. Over 40% of these trusts mature this
year. A few have already defaulted. We don’t know any more than that, but any
continuation of the trend could have exceedingly ominous consequences for the Chinese
economy.
All in all, it seems
to us that investors are viewing both the U.S. and global economies through
rose-colored glasses, and that the risks to the market are unusually high.