When Rhetoric Doesn’t Match Reality: A Closer Look at the GDP Number
Friday’s GDP number has generated quite the mixed response from analysts. Two common trends however shed some important light on the true nature of the recovery from the credit crisis: business investment has rebounded robustly, while consumer demand remains tepid. Why is this important? Well if you watch Larry Kudlow and his cohorts everyday, he would have you believing that what is troubling about this recovery is the LACK of business investment caused by a hostility from Washington towards the business community at large. Meanwhile, the real stories continue to be the productivity gains following the financial crisis, and the continued deleveraging of the US consumer.
As the market was plunging during the second quarter, the volume of the rhetoric increased exponentially: business investment is the missing link, or so the story went. Not only was business investment the missing link, but the lack thereof was directly attributable to government policies. The overhang of potential regulator reforms with fin-reg, the oil drilling industry, and cap-and-trade, allegedly left businesses unwilling to invest. Steve Wynn went as far as suggesting that China’s politics and policies are better than the US. Realign the incentive system and lo and behold, all would be well. Or so the story goes.
In reality, things are not quite as they may seem. These policy arguments do not align with the underlying economic reality. As Barclay’s Capital observes:
“While strong gains in business investment, inventories and imports are supportive of a backdrop of improving domestic demand, the weak trajectory of consumer spending held back growth in the first half of 2010…. [emphasis from original]”
Contrary to the rhetoric, the true problem for the economy in the second quarter was not a lack of business investment, but rather, a lack of end demand. Business investment itself was rather strong. As Donald Marron points out:
“Business investment in equipment and software (E&S) grew at a 22% pace, thus adding about 1.4 percentage points to overall GDP growth….And business investment in new structures recorded its first gain in two years….
Despite solid growth in disposable incomes–up 4.4% adjusted for inflation–consumer spending grew at only a 1.6% pace.”
What it comes down to is that businesses will invest when and where it will lead to tangible gains. Incentive need not come from the government. Even in the harshest of regulatory environments (which is not present in the US), businesses will invest IF AND ONLY IF it will lead to a tangible change for the better in their bottom line. Without the opportunity for profit there is simply no reason to invest. The lack of opportunity clearly comes far more from the sluggish uptick in consumer spending than it does an unwillingness on the part of businesses to invest. Unless businesses can sell more of their products to consumers, there is simply little reason for them to invest in increasing their manufacturing capacity or in hiring new workers.
The point of this writeup is not to take issue with any particular policy position, but to focus investors on the real, subtle and emerging trends in this economic recovery. An underlying theme that has been lost amidst the financial crisis is the rapid technological advancement in technology, particularly with regard to Cloud Computing–the virtualization of access to technological infrastructure and software. It has been a consistent theme on this blog to point out reinvestment in the technological infrastructure. and have discussed this theme with particular attention given to EMC (NYSE: EMC), Intel (NASDAQ: INTC), and Microsoft (NASDAQ: MSFT).
Clearly the GDP report provides the context necessary to understand the impressive rally in Cloud Computing stocks like EMC, VMWare (NYSE: VMW) and NetApp (NASDAQ: NTAP) during the past quarter. Companies are willing to invest in such products because they generate tangible productivity gains and these productivity gains translate directly into improved earnings. We all know that lower costs have gone a long way to helping corporate bottom lines; however, it’s easy to attribute the full extent of these lower costs to elevated levels of unemployment. As is often the case, that is but one component of a much larger story. Innovation has been a major driving force behind the productivity gains that are leading to the improving earnings landscape in corporate America.
Disclosure: Long EMC and VMW