The first quarter GDP was released yesterday and to our surprise showed an expansion of 0.6%. The stock market, measured by the Dow Jones Industrial Average, immediately rose triple digits and stayed there most of the day. We have stated many times in the recent past that we believed we were in the midst of a recession. We are still convinced that we are in a recession with the catalyst being home price declines that will make the recession long and/or deep.
Some economists were inspired by the release. Jared Bernstein, senior economist at Economic Institute of Washington, stated that "the argument that we're not in a recession certainly gets a little more of a boost from this report". We couldn't wait to dig into the numbers to try to understand why there was expansion albeit at a very slow rate. We were not surprised to see that the economy would have declined at a 0.2% rate if it were not for a build in inventories. And although additions to inventory do add to GDP, it is clear that any business where inventories are building does not bode well for the past quarter or the future. According to the Wall Street Journal this was the first decline in GDP ex-inventories in 16 years. If inventories and exports (reflecting strength abroad) were excluded, the GDP would have contracted at a 0.4% rate after increasing 1.3% in the 4th quarter of 2007. Consumer expenditures rose at an annual rate of 1%. This was the weakest performance since 2001. Consumer spending fell for a broad range of goods and services that could be considered optional, including cars, auto parts, furniture, food and recreation. On the other hand, the areas of necessity like health care, housing, and utilities purchases rose. Another report from the Labor Department yesterday showed that workers' compensation, including wages and benefits grew 0.7% in the first quarter. This was the slowest pace in two years and suggests that the weak labor market is making the employers less generous with their compensation policies. In fact, Challenger Gray & Christmas just reported that employers announced 290,671 job cuts in 2008 with over 90,000 cuts in April, the highest in 19 months and up 27% more than a year ago. Unemployment insurance claims also jumped 35,000 to 380,000 while continuing claims exceeded 3,000,000 the highest since April of 2004. We would not expect a positive employment number tomorrow.
Housing values are so significant to the net worth and psychological well being of the average American that we believe as long as the housing prices continue falling, the spill over into the broad economy will only get worse. We are talking about the huge sum of $25 TRILLION (at the peak) of asset values melting down. The news on this front just keeps getting worse-in the GDP report yesterday for the first quarter record-high foreclosures dumped more unsold homes on the market, adding to builder's headaches. Builders slashed spending on housing projects by a whopping 26.7%, on an annualized basis, the most in 27 years. That was the biggest drag on the economy. It is hard for us to believe the meltdown of this incredible bubble won't drive the economy into a significant recession accompanied by a bear market in stocks.
It is also hard to believe that a recession in the U.S., the strongest economy in the world, won't spill over to our trading partners and the rest of the world. We are not just the largest economy but we are the largest by about 3 times the next largest economy. The U.S. with a GDP of $14 trillion dwarfs Japan at about $5 trillion, China at $3.3 trillion, Germany at $3 trillion, France at $2.2 trillion, and the UK at $2 trillion.
The rally in today's market was based upon the Fed pausing or stopping the interest rate declines which should support the U.S. dollar. This may be the case, and it is better than the competitive devaluations that we were using as the nations policy over the past eight years(trade weighted dollar declined from 121 to 73). However, with the tremendous current account and trade deficits with a weak dollar policy, imagine what will happen to these deficits with a strong dollar. There are no easy answers to this mess we are in!!
