Building Blocks or Stumbling Blocks
In recent days, a number of clients have asked me to comment on the economy and the outlook for the markets. Maybe this inquiry stems from the fact that we have been in “recovery mode” for seven years, long by recovery standards, or maybe it is related to end of year prognostications, or perhaps it is due to the political transition period that we find ourselves in. Whatever the cause, it brings up a very good question that deserves some serious thought and perspective. Why? Simple answer: it matters.
To measure our economy, standard practice is to evaluate Gross National Product (GNP). Without getting too technical, four basic components comprise this figure: consumer spending, business spending, government spending, and net exports. These four building blocks of our economy do not move at the same rate or even close to it. As mentioned earlier, for the last seven years our economy has expanded but there were only a couple of quarters when all four components produced a positive year-over-year result at the same time. The third quarter of 2016 marked one such event, and the third quarter of 2014 was the previous instance.
Let’s take a closer look at these four factors. Consumer spending is the biggest part of GNP. Consumers today are spending, and spending nicely. This building block is the strongest component of GNP, and it has been every quarter since 2009. Business spending --which includes capital expenditures for new plant and equipment, inventory building, increased training, etc. –- has been missing during this recovery. In fact, hints of increased business spending have proven to be short-lived. At some point, I believe this stumbling block will transform into a crucial building block. I think this may be the best surprise of 2017.
Government spending includes all levels of government – national, state, and local – and is under pressure as a result of a variety of challenges. Our neighbors in New Jersey are experiencing a massive amount of angst as they wrestle with a faulty tax structure, an underfunded pension system, and political disagreement as to the best way to solve these problems. It used to be government spending always rose, but the past decade has changed this tune. At best, this component should be judged as it should be; government spending is the least preferred method to higher GNP. Side note: Apologies to the Keynesians out there (but not really).
Net exports are the biggest challenge. This stumbling block reflects the ongoing European malaise and a significant reduction in demand from emerging markets, especially China and Brazil. There is a useful old saying: “When the U.S. gets a cold, emerging markets get the flu.” Emerging markets have remained sick despite the U.S. recovery. If we see increasing net exports it may reflect improved global demand, and it could have a powerful impact on our economy.
Markets respond to changes in GNP, but more importantly the markets anticipate these changes. And while not all of the market’s predictions turn out to be valid, it is quite possible that stumbling blocks are now turning into building blocks, and the market likes it.
Bottom line: Let’s keep an eye on GNP and let’s keep increasing our knowledge so we become more intelligent investors.
Ralph McDevitt
Opinions expressed are not necessarily those of Raymond James & Associates. Information contained was received from sources believed to be reliable, but accuracy is not guaranteed.International investing involves special risks, including currency fluctuations, differing financial accounting standards, and possible political and economic volatility.
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