A Deficit of Logic

The US media played its typical good news/bad news game Tuesday over March trade data. On one hand, the trade deficit decreased in March—hooray! But it might also cause Q1 GDP to get revised down—boo! As usual, the debate is an interesting Rorschach test of sentiment, but the broader argument is flat misplaced. The trade deficit is still an overall wacky, useless indicator, and even if Q1 GDP turns down, it shouldn’t much matter for investors—it’s backward-looking. Just as the contraction in Q1 2011 didn’t disrupt the current expansion, plenty of evidence suggests US and global growth overall should continue regardless of whether we eventually find out the US dipped a bit.

The trade deficit always gets attention, but it isn’t much use as a measure of economic health (or at all, really). It counts imports as a negative and exports as positive, even though rising imports indicate healthy domestic demand. If imports tanked, the trade deficit would look great, but the economy probably wouldn’t. Plus, simply looking at the gap between exports and imports doesn’t tell you what either is actually doing. The US could have $40.4 billion in imports and exactly zero exports—or $5 trillion in exports and $5.0404 trillion in imports. Both disastrous and unfathomably wonderful trade totals could yield the same deficit. That’s why we think total trade—exports plus imports—is more meaningful. From a total trade standpoint, March was good. Imports rose $2.5 billion and exports $3.9 billion from February—5.9% y/y and 5% y/y increases, respectively. Demand is growing at home and abroad.

GDP calculations see this differently, though, including only the trade gap. Hence the widespread worry over whether the deficit narrowed enough to avoid a downward GDP revision into contractionary territory. Because full March trade data weren’t available for the preliminary GDP estimate, the stat heads used a rough estimate: $38.9 billion. Now we know it was about $1.5 billion higher, which would shave $1.5 billion off estimated growth—and based on some projections, that could tip GDP into its first dip in three years. It’s a rather suspect claim, in our view—trade is just one piece of GDP. Maybe consumer spending or private investment get revised up! Or maybe not. Maybe it gets revised down now, then bumped back up years from now. For stocks, it doesn’t really matter. We’re in May. Forward-looking markets aren’t weighing data from January, February and March.

But let’s say GDP does get revised down to a minus. Does a contraction spell trouble ahead? There isn’t much (if any) evidence it does. Blip dips aren’t unheard of during expansions. The May 1954 - August 1957 expansion saw two minor contractions in Q1 and Q3 1956. GDP took a -0.8% breather in Q3 1959, but the expansion beginning in 1958 still lasted till April 1960. Q1 2011 GDP was revised down to a -1.3% contraction in July 2013, but the expansion continues today. A small Q4 2012 dip was eventually revised up. This doesn’t mean Q2 2014 GDP will rise. Predicting one quarter’s growth is as futile as predicting the next three months of stock returns. Nor does next quarter much matter—stocks tend to move on what’s likeliest over the next 12 to 18 months.

Which means the best tactic now, in our view, is to ignore old data and look forward. The US’s Leading Economic Index (LEI) rose 0.8% in March—a high and rising LEI is inconsistent with a teetering economy. As is a yield curve that has steepened over the past year and loan growth that’s accelerating—both point to more fuel for growth. The new orders sub-indexes of the ISM’s service sector and manufacturing Purchasing Managers’ Indexes (PMI) remained well into expansion in April, at 58.2 and 55.1, respectively. Today’s orders are tomorrow’s output.

Plus, it’s a big world—for global investors, global growth is what matters. The eurozone recovery is continuing and broadening, with Markit’s Composite PMI rising to 54 in April—its highest level since May 2011 (readings above 50 indicate expansion). Germany, France, Italy and Spain all showed growth. The UK’s services, manufacturing and construction PMIs hit 58.7, 57.3 and 60.8, respectively. UK and eurozone LEIs are rising. So is China’s, which accelerated to 1.2% m/m in March. And JP Morgan’s Global Composite PMI stayed in expansion for the 19^th straight month in April, at 52.8, with new orders accelerating a tad to 52.9. Nothing here suggests a weakening world.

The preponderance of evidence points to a still-growing economy in the US and abroad. This is what stocks are looking at—not a GDP revision guessing game. Tune out the noise and look forward, and you should see plenty of reasons for stocks to keep rising over the foreseeable future.