Market Commentary

In my view fourth quarter GDP was considerably stronger
February 01, 2010

In my view fourth quarter GDP was considerably stronger than expected.  The 5.7% headline rate was the greatest pace since the third quarter of 2003, exceeding the consensus view of a 4.7% gain.  For all of 2009 the economy shrank by 2.4%, the worst since year since 1946 when the economy fell by 10.9%. [Bloomberg] 

I find the components of 4Q GDP report encouraging.  Real final sales of domestic product, which is GDP less inventories, rose by 2.2% versus estimates of 1.4%. Third quarter this statistic rose by 1.5%.  Inventories added 3.4% to GDP versus the consensus view of 3.8%, suggesting future growth is not sacrificed via excessive inventory rebuilding. 

There was a big 13% rise in equipment and software which is suggesting businesses are feeling more confident to invest in new investment spending instead of hoarding cash.  This was the greatest rise since 2006.

As noted several times capital spending decisions are cashflow dependent not interest rate sensitive.  If a company is not making money, capital spending will be delayed.  As widely noted fourth quarter profits are increasing at a pace greater than the 62% expected pace breaking a record nine consecutive quarters of decline.  Such an increase in capital spending is consistent with history, perhaps amplified today by the lack of expenditures during the previous two years because of declining profitability.

In my view, a surprising aspect of 4Q GDP was the 0.1% increase in government spending. During the third quarter, government spending rose by 8%.  State and local government spending fell by 0.3%, the fourth drop in five quarters.  In my opinion, this data point is significant as it suggest the vast majority of fourth quarter growth came from the private sector not the government.

A continuing theme of these comments is not that change occurs but rather the velocity of change.  Expect the unexpected.  We started 2009 with the GDP declining by 5% to 6%.   Six months ago the consensus view was a weak second half recovery with growth around 1.75%.  Second half growth was twice this amount…3.95%.

Continuing on the velocity of change theme, year to date all averages are down between 3.5% and 5.3%, trading back to around early November 2009 levels.  About two weeks ago all averages were trading around 15 month highs but have since declined between 6.1% and 7.5%.  The stated reason…uncertainty in Washington, potential curbing of Chinese banking, sovereign debt fears and perhaps the classic buy on rumor and sell fact scenario.

As stated in prior remarks I thought the markets would decline between 5% and 7.5% following earning season, the result of the fearing the inevitable change in monetary policy.  My timing and catalyst wrong but direction was right.

I think the averages could potentially trade to around the 9750 level before stabilizing.  The reason…jobs growth.  What are the odds that Friday nonfarm payrolls will be positive?  Consensus is estimating a 13K increase, the first such positive estimate in 28 months.

If consensus is met, I think more will become convinced that fourth quarter GDP was not a fluke, a one off event hence suggesting stability in equities.

As noted above, the markets are faced with a series of tier I data points, including various private employment surveys, manufacturing data, pending home sales, and personal spending/income.

Last night the foreign markets were mixed. London was up 0.33%, Paris down 0.01% and Frankfurt up 0.22%.  Japan was up 0.07% and Hang Sang up 0.61%.

The Dow should open moderately higher on speculation that manufacturing is recovering worldwide.  The 10-year is off10/32 to yield 3.62%.