Thursday, November 5, 2009

Did the Economy Really Grow at a 3.5% Pace?

The latest GDP figures released last week indicated the economy grew a 3.5% rate in Q3,the largest increase since Q4, 2004. This surprised many people and even some economists because it does not seem like the economy is improving that much.

Estimating GDP is a complicated process based on many calculations and assumptions. It is not an exact number, but it is the established standard in measuring economic growth. Ed Wallace (Business Week) believes that no one really knows where the economy now stands because all of our measuring tools do not work as well due to the scope and severity of this recession. See Article

One simple factor that impacts most economic statistics is that they are often quoted as a percentage change against a base number. Because these base numbers are much lower during this recession, it makes announced percentage increases sound better than they actually are. For example, take an industry where the average yearly output is 200,000 units. Due to the recession, 2009 output will be only 100,000 units. When it is announced next year that the industry has increased 20%, the real gain is only 20,000 units and the total output is still only 120,000 or 40% below average. This factor helps explain that while the economy may be growing, it is going to feel like we are still in a recession for awhile.

Is the economy really improving? Yes it is. Almost all other the major indicators are showing signs of life. The ISM (purchasing manager’s index) increased again in October; auto sales are growing, factory orders are up. The two major leading indicator indexes (ECRI and the Survey of Leading Economic Indicators) have been showing very positive signs. The economy did grow in Q3, although maybe not at 3.5% and the recession probably officially ended in July.

What Is Happening In Transportation?

Even though the transportation industry is a leading indicator going into a slump, it is a lagging indicator coming out of one. The transportation industry lags recovery because there is always slack (too much over capacity) that has to be consumed by economic growth before things improve. But if the economy really grew 3.5% in Q3, the transportation industry should be showing some improvement now in Q4. So what impact is a 3.5% growth rate having on the transportation industry?

Not much. Trucking firms have stopped shrinking their fleets, but freight volumes are improving slowly at an uneven pace. FTR Associates reported that freight did increase in September but was still down 7% from last year. The American Trucking Association Truck Tonnage Index fell in September after two increases. The CASS freight index slipped in October also after two increases. Similarly, rail carload freight remains down 10-14% from last year.

What About Q4?

Based on the evidence it does not appear the 3.5% growth rate, even if real, is sustainable. Only 17% of the Wall Street Journal’s Top Economists Panel are forecasting a higher Q4 GDP versus Q3. Even the Fed said that economic activity is likely to remain weak for a time. However, economic growth at a slow and steady pace should continue.

The stock market however may have priced in a stronger recovery. The 3.5% GDP is consistent with the recent increase in the S&P 500. If the economy continues at a 3.5% pace, stock prices will be able to hold and even increase. If growth slows, there is a danger that the market is overpriced and a correction would be expected.

Because the “Model T” is based on transportation industry factors and these factors have not improved much, the model is still predicting a bottom of around 580 for the S & P 500 Index. This bottom would be reached sometime in mid-2010, with a recovery starting late in the year.

Disclaimer Statement
The information contained in this blog is for strictly discussion and reference purposes only. In no way and under no circumstances should the information presented here be intended as investment advice. Statement s made on this blog do not represent a recommendation on buying or selling equities or securities nor which ones to trade. Please make your own responsible investment decisions based on your own research.

The information in this blog is solely the opinion of the writer (except for comments made by people to the posts or references in the posts attributed to other people).

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