4th quarter GDP numbers were released today and they stink (really no surprise.) Total market activity grew just 3.9% in 2011 – but only 1.7% when adjusted for inflation. Inflation, the cost of money, outpaced economic activity by posting a 2.1% increase in prices.
The Dow Jones Industrial Average leads GDP up during economic expansions and down during recessions. Since the last real recessionary bottom (end of year 2002), the Dow appears to be indicating an economic expansion as of the current time. See below.
Remember, the Dow’s goal is to indicate the market – Nominal GDP. During boom cycles, like the housing boom which occurred in the 2002-2007 years, the Dow will greatly outpace Nominal GDP. When investors and traders are scared of overvaluation the Dow will stay close to Nominal GDP. In any event, the Dow is indicating expansion here, however so slight, even though it doesn’t feel like one.
The difference between the straight green line (Nominal) and the dotted green line (Real) is the inflation gap. To put it into words, inflation is responsible for more than 2,000 Dow points during this time period. This proves once again that you need to beat the Dow in order to make money with investment, otherwise inflation will rob you blind.
Of course, the argument can be made that 2002 was not the “last” recessionary bottom (even though I think so) but instead the 4th quarter of 2009 was. 2009 ended with the clinical definition of recovery – two straight quarters of market expansion – following the market crash in 2008. But a two year GDP/Dow trend isn’t quite enough to get a good feel for “the market” condition. I believe at least five years of data is required for such an analysis. Below is that 5-year chart.
Here the Dow is indicating a recession in Real terms (adjusted for inflation.) This chart also suggests that the Dow will have to regain its all-time high to indicate economic expansion. (As an FYI, that all-time high of 14,100 occurred in October 2007 – one year before the 2008 crash.) I’d argue that this chart is a more accurate indication of “the market” condition.
And why not? The world economy is a mess. Just a few days ago the International Monetary Fund (IMF) warned of a European recession in 2012 that could turn into a “deeper downturn” should their governments not take aggressive action to curb their debt crisis. PS: That means dramatically cutting government spending.
But spending cuts alone will not get the job done. At the same time, Europe must adopt aggressive pro-growth fiscal policies to expand their markets and put their people back to work. Today Spain announced that their unemployment rate has escalated to 22%. Yikes!— almost 1 out of every 4 Spaniards is unemployed. How could they possibly pay back their debt with so many people not generating tax revenue?
There’s a major problem over there. And there’s no way to escape it.
Add that to more evidence that wholesale inflation is on a rapid rise here at home and what you have is one troubled market. Also in today’s news, consumer staple powerhouse Procter & Gamble reported a drop off in profit to the tune of 49% in the most recent quarter, citing among other things, higher commodity costs as the cause. It’s only a matter of time until producer price pressures reach consumers. And stocks won’t like that either.
In the coming days I will blog about asset allocation and adjust the action zones for 2012. Stay tuned…