Cornerstone’s Week on Wall Street
Stocks had a rocky week selling off significantly to end the month. Investors sought safety as the situation regarding coronavirus became more serious. The S&P 500 fell more than 2.0% for the week, dragged lower by Energy (-5.6%), Materials (-3.5%) and Healthcare (-3.2%). Utilities (0.9%), Consumer Discretionary (+0.2%), and Consumer Staples (-0.8%) held up better than the broader market. Treasury yields took another leg lower to end the week at 1.52%, the lowest level since October, and the curve briefly inverted (meaning long-term rates fell below those of short-term rates). Stocks outside the U.S. fared worse, led lower by Emerging Market stocks, down 4.2%, while commodities were also hit hard on global growth concerns, down 3.2% for the week.
On January 30, the Bureau of Economic Analysis (BEA) released the first estimate of 4th quarter GDP for 2019. The estimate of 2.1% growth beat the consensus estimates of 1.9% growth, and on the surface appears to be a strong print. In this week’s missive, we’ll peel back the onion to better gauge the real state of the economy. Let’s dig in.
Economics 101 classes teach novice economic students what is affectionately called the “GDP expenditure formula.” This neat formula categorizes GDP into four buckets: the stuff that you and I buy, Personal Consumption Expenditures (C); the amount businesses reinvest for growth, Gross Private Investment (I); the amount spent by the government, Government Purchases (G), and Net exports, (X – M), the amounts of goods and services we send to other countries, exports (X), less the amounts of good and services that we buy, imports (M). The formula reads as follows:
GDP = C + I + G + (X – M)
Now plugging in the data for 4Q 2019 we get the following:
GDP = 1.2 + (-1.1) + 0.5 + (0.2 – (-1.3) = 2.1
In looking at the GDP makeup, we can see that the consumer (C) + investment (I), only accounted for about 10 basis points of GDP growth. This is the lowest net contribution of these factors since Q1 2011. Consequently, the boost in government spending (G) and net exports (X – M), drove a whopping 2% of the total 2.1% growth (or 95%) of GDP during the quarter. Because of the way the math works, a drop in imports is additive to overall GDP. This was the single most important factor for the GDP beat. (less is more!) This data is hardly encouraging for an equity market at all-time highs, and for a global economy which has yet to report the effects of the nascent virus outbreak. Quarter over quarter, (C) slowed 43%, while (I) slowed 450% on their respective rate of change bases. For an economy that relies largely on the consumer for growth, the fact that growth is slowing is not a good sign. One report does not call for panic by any means, but we’ll be laser-focused on consumer data for signs of deterioration. For now, equity markets are only focused on the headline GDP number. As long as the Fed and other central banks remain accommodative and barring a worse-than-expected outcome of coronavirus outbreak, markets can remain elevated and overvalued.
We will continue to stick with our risk management process as we navigate what 2020 has in store. We continue to believe that the markets remain disconnected from the fundamentals and that the US and global economy will continue to slow. As John Maynard Keynes famously said, “Markets can stay irrational, longer than you can stay solvent.” Fortunately, our process doesn’t rely on feelings or crystal balls regarding elections or viruses, so we’ll stick with what we do; analyze market and high-frequency economic data on a daily basis to position our clients for the highest probability of experiencing positive returns.
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