The headlines touting 4th quarter GDP results
as giving rise to a new breakout in economic growth are highly misleading. The
3.2% rise in 4th quarter GDP as well as the 3rd quarter
increase of 4.1% is unsustainable, and it is likely that the peak for the GDP
in the current cycle has already been made.
Final domestic demand growth (GDP less inventories and
foreign trade) were up a tepid 2.3% in the 3rd quarter and only 1.4%
in the 3rd. Together, the
increased inventories and foreign trade were responsible for 1.7% of the 3.2%
climb in GDP. In addition, the 3.3% rise
in consumer spending was largely accounted for by a lower household savings
rate rather than an increase of income. Real
disposable income for the quarter was up only 0.8%.
The so-called resurgence of consumer spending is not
soundly based since it does not reflect a commensurate rise of income. For example, in the 4th quarter
consumers increased their spending by $89 billion, but accomplished this only
by reducing savings $72 billion. Therefore
81% of the spending increase was fueled by reduced savings. Given the underlying factors behind 4th
quarter GDP growth, it is highly likely that the 1st quarter will reflect
lower growth in consumer spending, inventories and foreign trade that accounted
for a combined 4% of the 3.2% growth in 4th quarter GDP.
All of the above should be evaluated against the
longer-term background of the consumer balance sheet recession that we have mentioned
in numerous past comments. While a lot
of progress has been made in reducing household debt, there is still a long way
to go. At its 2007 peak, the ratio of
household debt to disposable income was 130% and has now been reduced to
104%. However, the long-term average
ratio was about 76% during a period when consumer spending was far more robust
than it is today.
The latest figures indicate annualized disposable income
of $12.6 trillion and household debt of $13.1 trillion. In order for debt to be back down to its more
normal level of say 80% of DPI, it would have to drop by about $2.6 trillion, an
amount that is 23% of consumer spending.
Since this obviously won’t happen all at once, the process will be drawn
out over a number of years and put constant downward pressure on consumer
spending for a long time to come. That
is what usually happens after a severe credit crisis, and that is what has been
happening over the last few years. And,
since consumer spending accounts for about 70% of GDP, overall economic growth
is likely to remain below average as well.
Despite the tepid growth of the last few years, the
market has rebounded strongly, propped up by massive monetary easing in the
form of near-zero interest rates and a huge expansion in the Fed’s balance
sheet as well as by increased corporate income.
Now, however, these positives are receding as the Fed intends to eliminate
quantitative easing by year-end, and the ability of corporations to increase
profit margins in the absence of adequate revenue growth is rapidly
diminishing. At the same time the
withdrawal of quantitative easing is having unintended negative consequences on
a number of emerging market economies while stock market valuations are
stretched on the high side and sentiment is more bullish than at any time in the
last 25 years. In our view, a major
market decline is likely in the period ahead, and may already have started.