Zero Sum Sentiment

As widely expected, the US expansion continued in Q4 2013, as GDP grew at a 3.2% seasonally adjusted annualized rate. Most took the news in stride, seeing a number of positives in the underlying data. But for every positive noted, the media seemed to pull at least one negative out of the woodwork, too. Even after four and half years of growth, popular sentiment still has one foot in optimism and one lingering in skepticism—the bull’s wall of worry seemingly remains.

The media was largely pleased with the quarter’s growth, applauding consumer spending’s (which makes up 70% of GDP) 3.2% rise and exports’ 11.4% jump. Investment showed nice growth at 3.4% overall, with strong representation from its business investment subset. Even inventories—a category many feared would drag in Q4—contributed 0.42 percentage point to the headline growth rate.

But most takes on Q4’s growth paired each positive with a corresponding (alleged) negative. Some claim consumption grew only at the expense of saving, as the savings rate fell 60bps to 4.3%. Others fear recent selloffs in some Emerging Markets (EM) could both weaken foreign demand for US exports and hurt US investors’ portfolios—making them feel less wealthy and therefore less willing to keep spending. Still others are concerned longer-term growth is slower, pointing out how 2013’s 1.9% growth lagged 2012’s 2.8%. Many still fear an upcoming drag from inventories—after another rise in Q4, most expect weakness in Q1. Then there are the contradicting theories inflation will either hurt growth because businesses can’t raise prices when it’s so low, OR it will hurt consumer spending as it rises.

All miss the mark, in our view. For one, economic growth has little if anything to do with how wealthy people feel. The wealth effect isn’t real: People don’t eat out more or buy new gadgets because their houses or portfolios increase in value. Disposable personal income drives spending, and it grew in Q4. Plus, saving and spending aren’t mutually exclusive—especially when you consider the savings rate doesn’t accurately reflect how much money people are stocking away. It excludes portfolio investment—a big source of savings. It also charges “owner imputed rent,” the hypothetical amount homeowners would pay if they rented their home instead of owned it. That’s money never spent in reality!

As for that 2012 vs. 2013 comparison, looking at full years isn’t telling in this case. 2013’s latter half was the strongest six-month period since 2005 and better than any point in 2012—that full-year growth wasn’t as gangbusters only shows how quickly Q3 and Q4 accelerated from a low base. Inventories aren’t guaranteed to drag looking forward, considering they’re still low, with the inventory to sales ratio at a tight 1.29. Businesses are likely still trying to keep up with growing demand. And that many are conflicted whether low or rising inflation is hurting growth more simply shows how few in the media understand inflation! Inflation is a monetary phenomenon—too much money chasing too few goods and services—and it’s currently low. Money supply isn’t running away from output—we’re in an economic sweet spot Goldilocks would envy.

One frequently discussed detractor, however, wasn’t completely off base. Federal spending dropped -12.6% in Q4 (-15.1% in 2013), dragging on overall growth yet again. Many blamed October’s government shutdown—and maybe it had some impact. But Federal spending has fallen in 13 of this expansion’s 18 quarters. Yet the economy grew in 17. All but once, the private sector more than offset the government’s drag.

The private sector is still carrying the expansion. Business investment grew 3.8% y/y, while US firms bulked up on big ticket items. Most reports buried this news—if they mentioned it at all—or found more to jeer than cheer. Business equipment’s 6.9% y/y growth was largely chalked up to their replacing antiquated infrastructure and technology, allegedly implying they aren’t investing in the future. But businesses don’t spend big sums of money—on anything!—unless they’re confident in future growth. If their outlook is dim, they’ll hoard cash. With new manufacturing and service orders up last year, it’s tough to argue businesses see slow demand ahead. And as far as investing in the future, R&D spending rose (3.3% y/y). US firms are growing, profits are sky high and balance sheets are cash-rich—firms have plenty of latitude to keep spending and investing.

The media has begun to recognize private sector strength in its own wonky way, but headlines still lament how government expenditures could have added to GDP if X, Y and/or Z had gone differently. But hypotheticals aren’t important for economic growth—fundamentals are, and according to them, growth is poised to continue. Not just per the backward-looking stuff either: The Leading Economic Index is high and rising. That reality is much better than most expect is bullish! The longer people don’t expect the economy to do well, the more room there is for reality to surprise them. That’s a powerful force for stock prices.