Strategy for a Second Gear Economy
April 22, 2013
by David Kelly
of J.P. Morgan Funds
American investors could be forgiven for feeling just a little confused. One week after the stock market posted its strongest first-quarter gains since 1998, the Bureau of Labor Statistics announced the weakest monthly job growth in nine months. Real GDP growth was just 0.4% in the fourth quarter but appears to have been much stronger in the first. So is the economy getting stronger or weaker, how is the Federal Reserve likely to react to it and what, if anything, should investors do about it?
On the negative side, the March jobs report was genuinely weak - 88,000 non-farm payroll jobs added when consensus was expecting over 190,000. The unemployment rate fell, but only because half a million people left the labor force, pushing the participation rate down to its lowest level since 1979. Other labor market indicators were more mixed with upward revisions to payrolls for prior months and a gain in the employment component of the ISM manufacturing index being offset by recently rising unemployment claims and layoff announcements. Overall, job creation remains far short of what the economy needs.
However, jobs are only one aspect of the economic picture. On the output side, vehicle sales and housing starts both appear to have hit post-recession highs in the first quarter. Moreover, slightly faster-rising inventories and improved trade, combined with a solid 3%+ gain in real consumer spending, could boost first quarter real GDP growth to above 3%. So which economy is this?
The truth is that the U.S. economy is stuck in second gear. It is being supported by pent-up demand for houses, consumer goods and investment equipment following a deep recession and four years of half-hearted recovery. It is also being helped by a rebound in wealth, with higher stock prices and home prices adding roughly $3 trillion to household net worth in the first quarter alone.
On the flip side, the economy is contending with a sharp fiscal drag. According to the CBO, the federal budget deficit for the first three months of 2013 was roughly $307 billion, down $150 billion from the same three months a year earlier. Indeed, on current trends, due to the combined effects of some economic growth, sharp tax hikes and some spending cuts, the deficit this fiscal year could be as low as 4.9% of GDP compared to 7.0% of GDP in fiscal 2012 (which ended on Sept. 30th 2012).
In addition, the Federal Reserve’s extremely aggressive monetary policy may well be doing the economy more harm than good as very low long-term interest rates discourage lenders from lending, while low short-term rates suppress consumer interest income more than interest expense. Finally, overseas economies are a mixed bag with some strength in emerging markets but dismal recession in Europe.
Given that the Federal Reserve was already employing an aggressively dovish monetary policy before the employment report, weaker job numbers will, if anything, make them even more reluctant to hint at when they might ease up on the easing. However, if we are right in doubting the positive effects of this monetary stimulus, further quantitative easing will do little to quicken growth. Although the economy appears to be in little danger of renewed recession, Washington and the world will have to get friendlier if America is to grow faster.
While a warm-up in either fiscal conditions or the global economy seems unlikely in the short-run, today’s U.S.
economy probably still justifies an overweight position towards equities. With both short-term and long-term interest rates at treacherously low levels, and earnings still likely on a slow growth path, there should be a steady tide of money moving out of fixed income into asset classes, most notably stocks, that have a better promise of long-term gains.
The bottom line is that, given current relative valuations, an overweight to stocks starting from an appropriately balanced portfolio remains justified not by the strength of the expansion but merely by its existence.
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© JPMorgan Chase & Co., April 2013
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