Iron Capital Insights

  • Iron Capital Insights
  • November 2, 2009
  • Chuck Osborne

Trick or Treat?

GDP grew 3.5% in the third quarter of this year, exceeding expectations of 3.2% and sending the markets up nicely after a week-long downturn…then back down, and then…is the recession over? Well…maybe.

In digging into the GDP numbers more deeply it becomes a more complicated story.  Consumer spending was up 3.4%, but this was largely driven by the “cash for clunkers” program that boosted auto sales.  Will the consumer continue to spend in the absence of government incentives?

Exports increased 14.7% and imports increased 16.4%.  (Exports are additive to GDP, imports are subtracted from GDP.)  Both of these should be seen as good signs, as global trade had fallen off dramatically and it will be difficult to have a sustained recovery without robust global trade.

Inventory buildup played a major role, but was not as dominant as some economists had projected.  This is good news, as this means there is still more to be done to rebuild inventories and any increase in demand should boost production.

Government spending increased 7.9%, which adds to the GDP for this quarter.  However, government money must come from somewhere.  Personal taxes increased $4.8 billion while disposable personal income decreased $20.4 billion or 0.7%, and real disposable personal income (adjusted for inflation) dropped 3.4%.

This is truly a mixed bag. There is some genuinely good news and some genuinely bad news. Economists’ reactions have been as mixed as the data.  Some fear this is simply a “sugar high” from government programs, while other feel this is the beginning of the real thing.

It isn’t just the economic data either.  While the vast majority of companies have reported better-than-expected earnings in the quarter, there have been some notable exceptions. Exxon’s earnings were down 68%, just a few days after their British competitor BP delivered much better-than-expected results.

I find myself siding with the pessimists.  This is surprising, because my outlook usually swings from bullish to extremely bullish, but it is hard to see how economic growth can be sustained when disposable income is decreasing through a combination of higher taxes and higher unemployment.

The most likely scenario from here is that we muddle along, with the economy and the market going nowhere.  But, that isn’t all bad: to go nowhere, some companies must win while others lose. This is a stock-pickers market, and that should continue to bode well for us.

Chuck Osborne, CFA
Managing Director