From frightened to fearless

What a difference a day makes!

Yesterday I opined that a better-than-expected GDP reading today could turn the market around and send stocks up again. That’s just what happened: 3rd-quarter GDP came out at +3.5%, better than the +3.3% “consensus” estimate. Stocks shot up right out of the gate and did not look back. By the time the closing bell sounded, the Dow was up 200 points (+2.1%) and the S&P 500 had jumped 23.5 points (+2.3%). Today also represents the biggest one-day rise since July 23.

So is the correction over already? It could be, as the length and depth of the drop has been similar to the several we have seen since March. Also, we are entering a seasonally strong period (November through May), which typically sees the best gains of the year. On the other hand, the market is much pricier now than it was just a few months ago, meaning that the bar is moving higher for good news to have a positive impact. Though I personally believe that we will see more positive surprises than negative ones over the next few quarters, that doesn’t mean we won’t have periodic setbacks.

You may have heard in the news that a lot of the growth in GDP last quarter came from government programs, such as “cash for clunkers” and the home buyers’ credit. One article said that “stripping out auto output, the economy would have expanded at only a 1.9 percent rate in the third quarter.” There are at least two problems with these statements. One is that it doesn’t matter why people buy something: a purchase is a purchase. Government incentives may be driving some sales now, but once they fade, other reasons could take over. The argument that consumption will suddenly stagnate without government incentives is specious.

The second problem with these statements is that they are just plain wrong. My own calculations from actual government data show that if one stripped out all auto sales directly attributable to the cash for clunkers program (670,557 vehicles at an average price of $28,400 = $19 billion), the economy still would have expanded by $93.5 billion last quarter, or 3.0% annualized. This is still a respectable advance, and well above the 1.9% claimed above. (You could calculate a growth of just over 2% if you stripped out all durable goods sales, including not just cars and trucks, but washing machines, furniture, heavy equipment, iPhones, etc.) On top of this, a large percentage of people who bought cars under the government’s program said they would have done so anyway.

What about the homebuyer’s credit? This is harder to calculate, because only new home construction and real estate commissions affect GDP; sales of existing homes or new homes sitting vacant since the prior quarter are not counted. It’s difficult to discern whether the home buyer credit caused an increase in the construction of new homes, and by how much, but I’m going to try. A study by Goldman-Sachs estimates that the tax credit has enticed about 200,000 more homebuyers to enter the market. About 1.5 million homes sold in the 3rd quarter. Let’s assume that all 200,000 of those first-time homebuyers bought a home last quarter; this would mean that 13% of sales were from these government-incentivized buyers. Let’s further assume that home construction increased proportionately.

According to the government GDP release, new home construction added 0.53% to GDP last quarter. (This is, by the way, the first time that residential construction was a positive contributor to the economy, rather than a drag, since 4th quarter 2005, when it added a whopping 0.1%!) If 13% of that was caused by the home buyer credit, then this government program added all of 0.07% to GDP. So without the credit, GDP growth last quarter would “only” have been +3.43%.

Take out both programs, and GDP would still have risen by about +2.9%, considerably better than economists were estimating just a month ago. What about direct government expenditures, or the rest of the stimulus program? Non-defense federal expenditures and investment added all of 0.17% to GDP last quarter, about the same as 2nd quarter; this is actually less than it contributed during several quarters in 2003 to 2006, when the economy was doing well. So direct government expenditures are not driving our economy, either. (As a comparison, during WWII military expenditures added a whopping 29% to GDP in 1942 and 19.5% in 1943; today they add between 0 and 0.4%.)

So those who say that government stimulus is primarily supporting our economy are misreading the data. Interestingly, these are often the same people who say that government stimulus programs don’t work. Now I’m not going to get into the economics nor the politics of this hot potato. I’m just going to conclude that the recession is over, the economy has started growing again—with or without government help—and good times will eventually follow.