U.S. stocks gained some good ground on Friday as economists scurry to raise their GDP forecasts for 2011 – surely a result of the tax compromise; we discuss this story below.  For the week, the S&P 500 gained 1.28%; the NASDAQ Composite rallied 1.78%; the Dow closed the week about flat. 

All 10 major industry groups gained ground on Friday, led by industrials and health-care.  Consumer shares were the laggards – both discretionary and staples stocks were the weakest performing groups.

The CRB Index pulled back a bit as precious metals and energy prices saw some profit taking.  Copper kept its rally alive though and in making another new high this morning.  Those precious metals are back on their horse this morning with gold up $7/oz. to $1391.50, silver up $1 to $29.23, and crude up $1.26/barrel to $89.05.

The market has all but erased its emergency/crisis-related damage as the S&P 500 is just 10 points from the pre-Lehman level of 1250.  We are currently just 21% below the 2007 peak – a decline that is more typical of the normal recession.  However, the Fed continues to act as though the economy remains in crisis mode as they don’t only refuse to remove the emergency level of accommodation but continue to do more.  So, the question is:  Is the market signaling the economy is out of the woods or is it merely back to the current level because the Fed continues to backstop the risk trade? 

Market Activity for December 10, 2010

Trade Balance

The trade gap narrowed 13% in October as exports posted a strong 3.2% increase for the month, while imports fell 0.5% and have declined since June.   In fact, export growth had cooled big time over the previous five months; the jump in October follows a four-month stretch that saw exports rise just 1%. 

A strong 8.1% increase in industrial goods is what propelled the export figure higher – this segment had been flat since April.  A 4.6% increase in auto exports (also flat since June) also contributed.

Every industrial-related segment of imports fell big in October, led by an 11% slump in crude-oil imports.  Computer accessories were down 5.6%, telecom equipment fell 4.3%, industrial supplies were down 3.5%, and semiconductors were off by 2.1%.  Consumer goods rose as pharmaceutical  imports jumped 10.7% and apparel was up 9.1%.

What I see in this data is hardly anything that should get one excited unless it is followed through with a couple more months of strong export activity.  As I tried to suggest above, the jump in exports may very well have been due to the fact that they’ve been flat for several months.  What it does do though is get the fourth-quarter off to a good start as the large narrowing in the trade gap will boost GDP if it’s not followed by widening over the next two reporting months.  What the past few months of data seems to relay is that trade activity will continue to wane, following the pretty strong rebound earlier in the year – a bounce off of the worst slump since the depression. 

U of M Confidence

The preliminary look at consumer confidence via the Rueters/University of Michigan’s survey showed a third-straight month of improvement – we’ll get the final look at this number in two weeks.  The reading rose to 74.2, mainly due to a 4.5 point move within the current conditions segment.  The outlook segment (respondents’ view of their finances a year from now) rose two points. 

We can probably thank the continued rebound in stocks for this improvement, as job growth remains lacking and official unemployment at 9.8% and under-employment at 17%.  The U of M’s consumer confidence measure does seem to more closely track the direction of the stock market than does the Conference Board’s measure on the subject, which remains at a level that’s just barely above the worst points of the past five recessions.  

The Tax Compromise and Higher GDP Forecasts

A slew of economists raised their GDP forecasts for 2011 late last week, undoubtedly due to the tax compromise as the demand-side segments of the plan (and it’s essentially all demand side) is likely to boost spending over the short term.  So let’s talk about our own estimate and touch on the tax plan a bit more.

So I had estimated GDP growth at 2.0-2.5% for all of 2011 prior to the compromise – weak in the first half, possibly testing contraction with GDP prints around 1%, but accelerating in the second half.  Now with the tax compromise all but passed, we should see something closer to 3.0%-3.2%, assuming one of the many potential shocks out there doesn’t come jumping out from around a corner.  Also, austerity measures within state and local governments will offset private sector spending a bit so that’s another risk to this increased outlook.

But on the tax plan, let’s get a couple of things straight.  This is no supply-side agenda (I’ve heard many supply-siders rejoice that it is) , meaning it fails to boost growth in a more lasting manner and provide for the revenue shot the government desperately needs.

Look at what we have here.  There are no reductions in labor and capital income tax rates, merely the status quo (better than what looked to be increases a few months back, but no actual improvement).  The largest part of the plan comes by way of Keynesian-style rebate checks – demand-side stimulus, which dominated 2009 and 2010 stimulus and look what that failed to do for GDP and job growth. 

Further, the two percentage-point reduction in payroll taxes lasts only one year (and we’ll have to borrow more to fill the SS gap); and ditto for the 13-month extension to emergency unemployment benefits (and I thought the emergency was over, the economy was doing fine; why then do we need this temporary cut in payroll taxes, more French-like jobless benefits and additional QE from the Fed?). 

Finally, even the increased expensing allowance for business spending lasts only one year.  This is a plan I agree with, but for it to be supply-side (have a lasting incentivizing effect on production) it would have to be permanent (or as permanent as Washington can be). 

So let’s not fool ourselves here.  The payroll tax reduction is very likely to boost personal consumption, but as we’ve seen with every short-term type of stimulus in the history of economics it will be short-lived and most probably carry a payback effect that must then be dealt with when it reverts back. 

I must say I find the recent predilection among economists towards premature excitement rather entertaining to watch, particularly since on average they remain so negative during the typical expansion when excitement over the recovery phase is miles more warranted. 

So we are likely to get something closer to 3% growth next year due to the sudden boost to incomes via the payroll tax reduction holiday.  But I’ll remind everyone (not because I desire to continue harping on the negative – I wish it were not so – but because it’s important if one is to look out over the next 12-24 months rather than the here and now) that the normal recovery from deep recession enjoys 7% real GDP growth in the first year (this time was less than half that), followed by 4-5% in the second year.  These are rates that boost confidence and job growth.  Yet, we remain mired here at rates of growth much lower than normal even with massive stimulus – and the Fed’s unprecedented easing campaign certainly carries consequences on the other side; many of which we cannot know. 

Sign up to receive the Daily Insight and other Acropolis publications here.

Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900