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BULLS ON THE ECONOMY are taking victory laps after Friday's news of 5.7% growth in gross domestic product in the fourth quarter. But even if you believe in that fairy-tale number, there's little reason to have confidence in a sustained-robust expansion in the face of continued tight credit and the likelihood of sharply-higher taxes.
My colleague on the print side, Alan Abelson, deftly dissected the GDP number in his Up and Down Wall Street column of Barron's this week and found the sum of the parts wholly underwhelming.
After stripping away the effects of reduced-inventory liquidation and a smaller trade deficit, what's left (dubbed "real final sales to domestic producers" in economists' inelegant terminology) actually slowed down to a 1.7% annual rate of expansion after inflation in the latest quarter, Gluskin Sheff's David Rosenberg pointed out. That was down from the 2.3% pace in the third quarter -- just the opposite of the pickup in headline GDP to 5.7% from 2.2%.
And to add one more point, real final sales to domestic producers is what policy makers can influence, since it represents broadly what U.S. consumers, businesses and government buy. If those purchases come off the shelves of inventory or from abroad, it will detract from GDP. Conversely, it is the rate of change of inventories that affects GDP; a slower rate of liquidation translates to a plus in the most widely watched economic measure.
But forget all this macroeconomic mumbo-jumbo. Do you think the voters of Massachusetts believed the economy accelerated to a booming 5.7% annual-growth rate in the fourth quarter from 2.2%, as the GDP data indicated? Or did they think the economy slowed to a sluggish 1.7% pace from an already tepid 2.3%, as the real-final sales to domestic producers indicated? And did they see any improvement in jobs as a result?
The latest readings from the Institute for Supply Management did seem to confirm the sunny view of the economy, however. The purchasing managers' index for January popped to a higher-than-expected 58.4, from 54.9 in December, and well above the 50 mark denoting increasing factory activity.
As Ian Shepherdson, chief U.S. economist at High Frequency Economics, observes, the nonmanufacturing-ISM gauge has been tracking some 5.1 points under the factory number, or three times the usual gap. And given manufacturing's fading importance to the U.S. economy, the nonmanufacturing-ISM gauge (due out Wednesday) carries lots more weight.
Apart from what the statistical bean-counters in Washington or the ISM publish, better to pay attention to what Mr. Market is saying. Michael Kahn, writing in his Getting Technical column Monday, pointed out big cyclical stocks have gotten hit hard . Big industrial stocks such as Caterpillar (CAT), Alcoa (AA), CSX (CSX) and Steel Dynamics (STLD) have broken down on the charts in the face of all the happy talk on the economy.
The typical accelerants to ignite a recovery -- expanding credit and fiscal stimulus -- are lacking however.
The Federal Reserve found no let-up in tight bank-lending standards in its latest quarterly survey of senior bank-lending officers released Monday.
And the Obama Administration's proposed fiscal 2011 budget includes massive tax increases on upper incomes -- those who pay the lion's share of taxes and are most likely to invest, expand new businesses, and hire employees.
The tap on bank lending was shut tightly in the credit collapse of the fourth-quarter 2008, and as yet hasn't been opened up meaningfully. The only faint sign of easing in the latest survey was in commercial and industrial loans for large and mid-sized firms -- just the sort of borrowers that can tap the capital markets, where credit is readily available, and thus have no need for bank loans. Precisely three banks in the Fed's survey said they were loosening up a bit, while 52 said they were maintaining their previous -- that is, stringent -- standards.
As Gluskin Sheff's Rosenberg noted in his Monday missive to clients, bank lending continued to contract in the latest reporting week, with C&I loans down $500 million, real-estate loans down by $2 billion and consumer loans down by $4.6 billion. All told, the contraction in bank credit has totaled some $600 billion. This may be why the sustainability of the recovery once government stimulus programs end is being questioned by Mr. Market, he adds.
On the fiscal side, the reversion of taxes to former peak-marginal rates as high as 39.6% on high-income individuals would come as part of a $1.9 trillion tax hike across the economy under the proposed Obama Administration budget for 2011. Regardless of your opinion of the equity of those tax rates, the increased burden won't help the feeble economy.
In addition, the budget proposes increasing the current 15% federal-tax rate on dividends and capital gains to 20%. All in all, the only winning investment to come out of the budget proposals appears to be tax-exempt bonds.
A long-term 4.5% municipal bond would be equivalent to a 9% taxable yield for an investor facing a combined federal, state and local bracket. But then you'd have to avoid bonds from state and local issuers being squeezed in the vise between falling tax revenues and rising expenditures.
Nothing is easy, least of all when the economy is sluggish at best and the only thing certain to rise is taxes.
Comments: randall.forsyth@barrons.com
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