GDP Too Good

Vincent Farrell, Jr. is Chief Investment Officer of Scotsman Capital Management LLC., a New York based investment management company. Over his long career on Wall Street, he has worked for numerous distinguished firms. Mr. Farrell graduated from Princeton University in 1969 and received his M.B.A. from the Iona College Graduate School of Business in 1972.

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Q4 Gross Domestic Product came in much better than expected, falling “only” 3.8%. But, and there seems to always be a but, inventories grew and added 1.3% to the final number. We had been hoping for inventory liquidation so we could have a sort of wash out quarter. Since inventories will still need to be pared back I would guess that the first quarter GDP will be more in line with the quarter just reported.

If you look at the bum economic quarters since WW II most have been followed by a subsequently better quarter. If you take all the quarters where GDP fell by 4% or more (11 in total) the average decline has been around 5.5% and the average recovery quarter has been a positive 1.7%. The numbers are all over the lot and there is a wide disparity in performance, but that is how it breaks out. It would have been better to have had a worse Q4 and get some of the pain over with. I do suspect that anyone that had a dream for a second half recovery will need to push back the time horizon.

That does not mean the stock market needs to fall to new lows. It could. But as we have been saying bottoms usually take 6 to 12 months to form and the news will stay unrelentingly bad during the process. We are only four months into what I hope will prove to be the process that marks a bottom so the calendar is on schedule – market against the economy. And while the market has not gone down recently on bad news, it has not gone up either. We’ll be more in the clear when stocks rally on bad news.

If the stock market is to have hope for tomorrow the credit markets need to heal themselves. The news there has been, on balance, more encouraging than not. The TED spread we look at so often is now less than 100 basis points. That is the difference between the three month Libor rate and the three month US Treasury bill rate. “Normal” is around 50 basis points. The ten year Treasury has moved from a 2.2% yield to its current 2.8%. That is probably the markets acknowledgment of the large supply of paper that will need to be sold by the Treasury to finance the stimulus package and the growing deficit. 30 year fixed rate mortgages are around 5.1% so the difference between the two is 2.3% and the historic spread is around 170 basis points. So even though the 10 year bond has moved up in yield, it should be no surprise with the volume of financing needed and the good news is the spreads are improving.

The commercial paper market seems to be back on its feet as the latest report shows that the Fed’s holdings of commercial paper fell by over $90 billion which means other financing methods were available to those companies.

Lastly there is a lot of noise and pro/con debate about the bad bank concept. Hopefully we will get the government’s thoughts soon, since I think it’s needed and although imperfect, better than what we aren’t doing right now.

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