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Wednesday, November 29, 2006

Wednesday's GDP

I flew back home yesterday, and the plane was delayed so I didn't get home until the wee hours of the morning. Not that I cared, because it so happened that I was seated next to a man who is in the same general line of business as I am, so we babbled onwards with great joy (proving that men can and do talk as much as women).

It was utterly fascinating, because we have both independently drawn similar conclusions about several aspects of the economy domestically and internationally. For example, both of us see a lot of opportunity out there, but both of us also think the average person doesn't have a way to invest in the really good opportunities, because few of the really innovative startups are willing to go the public company route. It's deadly, at least in the US. It stifles the company's ability to be productive.

My personal belief is that the big imbalance in the economy (globally, not just domestically) that keeps producing all of these bubbles is too much capital stymied from finding its best use. This is a problem which can easily be fixed using today's technology, because there is nothing really stopping a second market of private capital from developing except knowledge channels, and those are easy to create nowdays. The potential strengths in the economic system are not being exploited right now, but this could change in a few years and produce a new boom, at least domestically.

Today we got preliminary GDP for the third quarter (revised from the advance for the third quarter). Third quarter GDP was revised up sharply to 2.2% from the advance report. It's not as good as it looks, because too much of the durable goods rise went into inventories and because of the government component, but it's still a lot better than the advance report.

Table 1 in these reports shows the rate of change in major components. Private domestic investment was flat because of the big 18% drop in residential investment, but government investment and consumption increased 2.2%. (Defense was down, but non-defense was up 6.8%, and state and local increased 2.6%.) Exports of goods increased 9.4%, and the weakening dollar could help this trend in the fourth quarter. Imports of goods increased 6.9%, less than exports, which is an encouraging sign, although quite a negligible one given the overall gap between exports and imports (refer to Table 2's "Net . But the bottom line is that most of the GDP growth came from personal consumption (up 2.6%) and government spending (up 2.2%), which is not a good trend.

For those whose eyes glaze over when presented with numbers, the bottom line is that both private domestic investment and exports must increase, and right now we know that the decline in housing permits will continue to drag down private domestic investment. (See this from a mortgage broker in Orange County for perspective.) The larger builders have continued to build in order to unload current investments ASAP, so we have not seen the real impact from the residential debacle yet. It will show up very strongly in the first quarter of 2007.

Gross national product increased 1.9% in the third quarter, the third consecutive decrease. GNP was at 0.5 in the fourth quarter of 2005, but I believe that reflected the impact of the hurricanes, and it was followed by a 6.1% increase in the first quarter of 2006. Those quarters really should be averaged, and if you do so you see a declining trend that is significant. These are the GNP/GDP numbers by quarter:
4thQ 2002: 1.0/0.2;
1stQ 2003: 0.8/1.2; 2ndQ 2003: 4.1/3.5; 3rdQ 2003: 7.3/7.5; 4thQ 2003: 3.5/2.7;
1stQ 2004: 3.5/3.9; 2ndQ 2004: 2.9/4.0; 3rdQ 2004: 3.3/3.1; 4thQ 2004: 2.0/2.6;
1stQ 2005: 3.6/3.4; 2ndQ 2005: 3.0/3.3; 3rdQ 2005: 4.9/4.2; 4thQ 2005: 0.5/1.8;
1stQ 2006: 6.1/5.6; 3rdQ 2006: 2.3/2.6; 4thQ 2006: 1.9/2.2
The pattern of the weak fourth quarter has been pretty consistent (indicating the stimulating forces in our economy of the past few years, which were consumer spending and housing), so to me it is the first quarter of 2007 which will be predictive. It's hard to see how we can have a fourth quarter above 1.0%, though. This is all a gentle hint to review your stock holdings; we are approaching the danger period.

New home sales supported the idea that the residential real estate market has stabilized IF you compared October's numbers to the revised numbers from summer on contained in this release. However, if you compared October's numbers to the August release, it appears to still be declining, and I believe that is the correct comparison. The consistent downward revisions have been significant, and I don't think that will change in October. November's numbers should show some uptick in sales reflecting bargains, incentives and low mortgage rates, although I don't think it's going to make dent in months of supply. The prices in the new home sales report month to month mean nothing, because the rate of error is very high and the mix of new home sales shifts rapidly.

However, mortgage rates are coming down, and we should see some stimulus from that. It's not enough to make a difference in the areas with high prices, but it is chipping away at the affordability gap. The bottom for national real estate is not near, but as I peer over the cliff the rocks below seem to be somewhat closer, at least if mortgage rates can remain at this level. This is important, because there a few areas with good economies that may stay out of the real estate swamp if mortgage rates stay down and if their local economies continue to do relatively well. If they do, the recession will be less of a shock.

Until months of inventory starts declining, it's lunatic to talk of "stabilization" in the housing market.

Mama! Talking to another man about economics? You're making me jealous!
You would have enjoyed speaking to him very much. He's been travelling a lot lately, and his views on the economy in Asia, especially India, and Souuth Africa are strongly positive. Europe he thinks has structural problems.

When I wake up properly I'll write more about his thoughts, and his reasons.
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