Real GDP in the US grew by around 1% in the first half of the year, a rate just above stalling and one
that contributes to worries about the state of the economy. Although we acknowledge the downside risks, we continue to believe that a US recession is not in the cards.
One bright spot is that gross domestic income (GDI) in the US grew faster than GDP over the first six months of 2011.
GDI is an equally valid measure of the state of the overall economy, and this difference suggests the possibility that GDP data may yet be revised higher.
Double-dip
In addition, if the US economy is about to fall into recession, we would likely be seeing weakness in unemployment claims, capital expenditures and corporate profits, none of which is occurring. As a result, we do not believe a recession will be forthcoming anytime soon.
In some ways, whether or not the economy does sink into recession is a technical point. If we do see a double-dip recession, any such contraction should be mild. If the economy avoids a recession, growth will still be weak. From an earnings perspective, any decline that comes about in earnings growth due to economic weakness should also be smaller than the average contraction that occurs during a typical recession. Looking ahead, our forecast is that earnings growth flattens out while GDP remains very low.
While expectations had been growing that the Federal Reserve would signal additional quantitative easing measures, those expectations faded somewhat by Friday when Fed Chairman Ben Bernanke delivered his highly anticipated speech at Jackson Hole.
At this point, we are not anticipating that additional easing measures (beyond keeping rates extremely low) will be forthcoming. There is some disagreement within the Fed over what should be done, the political environment surrounding Fed action has turned contentious and core inflation has moved up somewhat. As a result, we do not believe the Fed will be taking additional action unless renewed deflation risks emerge.
Equity positives
Although President Obama has indicated that he would like to see a new stimulus and jobs plan to help the troubled economy, we do not believe that any such program is likely given the current political backdrop.
Meanwhile, members of the staff of the so-called ‘super committee’ charged with identifying deficit reduction options have been indicating that they may be coming to some sort of understanding. This may be an overly optimistic view, but we do think there is a reasonable chance that the super committee could arrive at a deal by their 23 October 23, particularly since senior members of the Democratic and Republican parties appear to understand that failure is not an option.
Since the Great Recession, equity markets have been hit by a huge risk premium, and this premium seems to be getting larger as a result of political squabbles in the US, policy paralysis in Europe and the poor performance of key economic indicators around the world. Unless and until the uncertainty around these issues fades, stock multiples could easily remain depressed.
In any case, however, we do believe that stocks remain quite attractive, particularly compared to alternatives. The dividend yield on the S&P 500 Index exceeds the yield of the ten-year Treasury. Such time periods are rare, and when they occur they are typically followed by good equity returns. We are hopeful that that also happens this time.
