Corporate profits appear to have returned in full, manufacturing is picking up around the world, commodities prices have rallied and the Standard & Poor's 500 Index is up about 60% since last March.
That makes a pretty compelling case for what some analysts are calling a "V-shaped" recovery. But even with all the momentum the economic recovery has accrued, that kind of talk may be a bit premature.
To be sure, anyone looking to make the case for a V-shaped recovery has plenty of data to fall back on:
- The U.S. economy expanded by 5.6% in the fourth quarter of 2009, and most analysts believe it grew by another 3% in the first quarter of this year.
- The economy added jobs at the fastest pace in three years in March, as payrolls edged up by 167,000.
- And earnings for companies in the S&P 500 – which more than doubled in the fourth quarter of 2009 – likely rose an additional 30% in the three months ended in March, according to analysts' estimates compiled by Bloomberg.
All of this data indicates that the U.S. economy is on far more stable ground than many analysts had originally anticipated it would be. And the result has been a huge bull-run in stocks.
Still, a closer look at the data shows that any appearance of a V-shaped rebound is illusory.
U.S. GDP: All Sizzle and No Steak
To begin with, the expansion of U.S. gross domestic product (GDP) has been impressive, but it also is largely dependent on a resurgent manufacturing sector, which has been working overtime to restock business' inventories.
Roughly two thirds of the fourth-quarter GDP growth came from businesses restocking inventories. Efforts to rebuild inventories contributed 3.79 percentage points to GDP growth – the most in two decades. But there wasn't a lot of "sell-through." In fact, excluding the change in inventories, final sales increased at a 2.2% annual rate, a signal that the economy remained weak despite strong top-line numbers.
"When you strip out inventories, you see real final sales were 2.2%. This is not a fantastic number," said Tom Porcelli, senior economist at RBC Capital Markets (NYSE: RY). "If you compare this to the '75 and '82 recessions, [and look at the] real final sales in the first two quarters after, we averaged 5% after the '82 recession, and about 4% after the '75. By comparison, we obviously are looking pretty weak."
No doubt, manufacturing has been on a tear, but not because the American consumer is back out and spending. In fact, consumer spending, which accounts for about 70% of the economy, increased at a pace of just 1.6% in the fourth quarter — weaker than the government's prior estimate and down from a 2.8% growth rate in the third quarter. And consumer confidence is still tepid at best.
The Conference Board's U.S. consumer confidence index for March rose to 52.5, but only after slipping 10.1 points in February, to 46.4. The reading still remains below December's levels.
"We continue to operate in an uncertain environment," Family Dollar Stores Inc. (NYSE: FDO) Chairman and Chief Executive Officer Howard R. Levine told analysts on April 7. "While economic conditions appear to be stabilizing it is unclear whether we will see sustainable improvement."
Consumers say their personal finance position is deteriorating rather than improving at a ratio of 2-to-1, according to the preliminary Reuters/University of Michigan Consumer Sentiment Index for April.
Respondents to the survey said they don't expect much of a gain in real income, which makes sense considering hourly earnings averaged $22.47 for March – a decline of 2 cents from the month before.
Additionally, consumers are still working to reduce their level of debt, which makes less credit available for shopping. Consumer credit in the U.S. declined in February for the 12th time in 13 months.
Revolving debt, such as credit cards, declined by $9.4 billion in February, the most in three months, according to the U.S. Federal Reserve. Non-revolving debt, including loans for cars and mobile homes, dropped by $2.1 billion.
So while investors are frothing with confidence, fueling one of the strongest bull markets in American history, U.S. consumers – many of whom are unemployed and behind on their mortgages – are less enthused.
Labor Market Lagging the Recovery
Unemployment is the biggest challenge facing the U.S. consumer and the economy as a whole. Household purchases fell 0.6% last year – the biggest drop since 1974 – as the national jobless rate hit the double-digit level for the first time in two decades.
And while we've seen some improvement, the unemployment rate remains stubbornly high at 9.7% — about 15 million Americans.
On average, there are five or six unemployed people competing for each new job opening. At the present rate, it could be four or five years before the jobless rate drops back to the more-normal range of 5% to 6%.
It's true that initial jobless claims last week fell by 24,000, but that's not necessarily a harbinger of sustained growth. The four-week moving average of initial claims, which smoothes out volatility, actually increased to 460,250, up from 457,500. And that measure doesn't even include the number of Americans receiving extended benefits under federal programs.
In fact, the number of people who had exhausted their unemployment benefits and moved on to emergency and extended payments was 5.49 million as of April 3.
There's also the regional picture to consider. Forty-two states and territories saw an increase in jobless claims – only 11 saw declines. Notably, California saw an increase of 23,785 and New York saw its claims jump by 23,876.
The unemployment rate in California rose to a new high of 12.6% last month and in New York it was 10%. The jobless rate last month was 14.1% in Michigan, 12.3% in Florida, 13.4% in Nevada, and 11% in Ohio.
California and more than 30 other U.S. states have taken out loans to pay for jobless benefits. Worse, many of these cash-strapped states have raised unemployment insurance taxes – further discouraging employers and potential employers from adding new jobs to the economy.
The Golden State has borrowed $8.8 billion so far to cover jobless benefits, and the U.S. Labor Department expects 40 states to be in debt to the federal government by year's end, according to Reuters.
The federal economic stimulus program enacted last year suspended interest on the loans to states for two years. But barring extension, interest payments would resume next year and Washington could raise payroll taxes on employers in delinquent states if loan balances remain outstanding.
Such an occurrence "would inevitably have the effect of stifling growth, halting reemployment and dragging out the employment crisis even further," Connecticut Gov. Jodi Rell said in a recent letter to her state's Congressional delegation.
By 2012, employers in 25 states, including California, New York and Texas, could face rising federal payroll taxes if unemployment loans remain outstanding, which analysts expect they will, Rich Hobbie, executive director of the National Association of State Workforce Agencies, told Reuters.
"They can't completely solve their problems in the near term," Hobbie said. "If we have eight years of sustained growth as we had back in the 1980s then the states have a shot of repaying their loans."
So if neither the job market nor the overall economy is improving as quickly as the blatant data suggests, what does that say about corporate earnings?
Perhaps it suggests that the glowing earnings reports we've seen of late have more to do with cost cutting, favorable comparisons to weak year-ago results, and the U.S. Federal Reserve's loose monetary policy.
After all, the Fed has broadened its balance sheet to a record $2.34 trillion. At a record low range of 0-0.25%, the Fed's benchmark interest rate has been negative since November in real terms, adjusted for inflation.
"What's real and what's artificial, what's organic growth and what's juiced by easy money" can't be determined with rates at current levels, Peter Boockvar, an equity strategist at Miller Tabak & Co. wrote in an e-mailed note to Bloomberg. The question will only be answered, he added, when rates start to increase and the economy must function "without the crutch of cheap money."
The Fed acknowledged as much in the minutes from its March 16 meeting. It also pointed out the positive – and likely temporary – effect of "inventory rebalancing."
"While participants saw incoming information as broadly consistent with continued strengthening of economic activity, they also highlighted a variety of factors that would be likely to restrain the overall pace of recovery, especially in light of the waning effects of fiscal stimulus and inventory rebalancing over coming quarters," the minutes said.
Also, Elizabeth Duke, a Federal Reserve governor, last week cautioned that while the 162,000 new positions created in March "may be the first welcome sign that the worst is over in terms of job loss, we have not yet seen any substantial improvement in hiring rates."
Futures on federal funds indicate the central bank may abandon its zero-rate policy in November or December, according to data compiled by Bloomberg. The odds of a higher target rate in those months are 51% and 69%, respectively.
The Federal Open Market Committee's (FOMC) next meeting takes place Tuesday.
An Untimely End for the "V-Shaped" Recovery?
Indeed, it's the lack of a self-sustaining recovery that has the Federal Reserve Chairman Ben S. Bernanke determined to leave interest rates unchanged. But such accommodative monetary policy could also spell an untimely end for the "V-shaped" recovery the economy is allegedly experiencing.
Many economists believe the Fed's easy money policy will lead to an unstable surge in inflation. A Wall Street Journal survey found that an overwhelming 87% of the 56 economists polled are more concerned about inflation over the next five years than they are deflation. That compares to a 50-50 split over whether or not inflation or deflation will pose a bigger threat over the next 12 months.
Money Morning Contributing Editor Martin Hutchinson is one economist who believes inflationary pressures all but guarantee that any V-shaped recovery is doomed to "blow up."
"In short, rapid expansion at 5% per annum for the next two years, the minimum necessary for this to be termed a true V-shaped recovery and not just a blip, will run into one of two constraints," says Hutchinson. "Either inflation will take off, reaching an annual rate of at least 20% by 2012 as commodity and energy prices continue their inexorable climb, so forming a larger and larger part of the consumer's purchase basket. Or, alternatively, a collapse in the government bond market, panicking at the rapid acceleration in inflation, will choke off economic recovery, plunging asset prices including housing back into the depths of gloom and sparking off another banking crisis caused by yet another wave of home mortgage defaults."
"In other words," he added, "a true V-shaped recovery is impossible, at least without some very unpleasant consequences indeed."
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Fourth Quarter U.S. GDP Report is All Sizzle and No Steak