Tuesday, October 13, 2009

Reviewing the Latest Evidence

Based on the available data so far, annualized GDP growth is likely to come in close to 3.0% in the third quarter (release scheduled for October 29th). As we have argued before, the GDP numbers do not always tell an accurate story and can, at times, even be misleading, as they are largely a mechanical exercise that can be subject to various distortions. But it is fair to say that a quarterly annualized growth rate of close to 3% is a much more encouraging outcome than, say, a 1 % contraction.

The available information upon which such a GDP estimate for Q3 is currently based is incomplete, as key pieces of data (consumption, residential investment, international trade, and inventory data for September) have not been released yet. On that score, this week's retail sales numbers for September (and any accompanying revisions to the August sales data) will go a long way toward shaping the key personal consumption component for the quarter. Consumption is slated to rebound at a rate of about 3% in Q3, supported, to a considerable extent, by the "cash-for-clunkers" program. A much slower pace of inventory liquidation last quarter is likely to be the other major contributor to growth for that period, helping offset a modest decline in capital spending.

But moving away from the intricate details of the various categories in GDP, the most encouraging aspect of the various economic reports recently is their relative consistency in pointing to a steady improvement in the broader economic environment. The manufacturing sector is staging a comeback (with the ISM having returned solidly to pre-recession levels despite shrinking auto output), consumer spending is perking up (beyond the recent auto incentives program) and initial unemployment claims continue to drift lower on a trend basis. In addition, the economic climate is turning up globally, with the Euro-zone, Japan, and China all showing credible signs of rebounding from their respective troughs.

Skeptics of the legitimacy of the unfolding economic recovery continue to point to the still considerable monthly net losses in nonfarm payrolls (albeit dramatically smaller compared to the early part of the year) and the still tight bank lending conditions as evidence that the sustainability of the recent improvement should be viewed as suspect.

While both of these factors are undeniable characteristics of the current economic landscape, it is important to recognize two things: a) It is a well-established fact that the economic data often tend to send mixed signals at major inflection points of the business cycle, as achieving an unimpeachable consistency in such data is something that takes quite some time to emerge after the trough of the cycle. The mixed tone of the various employment statistics may not dissipate until the first quarter of next year, when monthly payrolls start growing again. b) The bank lending situation is far more likely to have a moderating effect on the forward momentum of the recovery rather than impeding the recovery from taking hold altogether in the first place.

Without underestimating the challenges ahead, quietly, but steadily, an economic recovery is already taking hold.

Anthony Karydakis