America’s growth collapsed in the first quarter of this year, it seems.
The latest revision to GDP showed that the US economy shrunk at an annual rate of 2.9% during the first three months of 2014.
That’s staggering. To give you some perspective, that drop alone is bigger than the entire recession of 2001, as James Mckintosh notes in the FT. It really is a dreadful figure.
What does it mean for us as investors?
Honestly? I couldn’t care less. And nor should you…
Why America’s woeful GDP data can be ignored
There are lots of ‘explainers’ out there this morning about why US GDP came in far worse than expected in the first quarter of the year.
Depending on the political bias of the pundit in question, they’ll either be trying to talk the bad news down, or hype it up.
But the slump largely boils down to the fact that the US had a terrible winter – remember all those pictures of the sea being frozen over? That ‘Arctic vortex’ put a stop to lots of activity, from consumption, to exporting, to construction. Hence the drop in GDP.
Will activity rebound in the second quarter? It certainly looks like it. The US might not be enjoying the most vigorous economic recovery ever, but it hasn’t tumbled back into a hole either, as that GDP data might suggest.
As Mckintosh notes, US corporate earnings for the first quarter were largely fine – no sign of a catastrophic collapse in activity there. And “unlike national statisticians, finance directors rarely restate profits”.
So this doesn’t look like something to get worked up about.
The Fed has more ammunition to keep rates lower for longer
However, there is an aspect of the terrible GDP figure that investors do need to consider. And that’s the impact on monetary policy.
Central bankers in the US and the UK are at a very tricky stage in the cycle. In Europe, the bias is still towards loosening monetary policy, by perhaps printing money. And in Japan, the central bank is also still pumping the economy full of printed money.
But in the US, they’re ‘tapering’ off the amount of money they print. And in the UK, all the talk is of when rates will rise. This is the hard bit for central banks.
You see, printing money is rather fun. Everyone likes you. Stocks go up, property prices go up, politicians are happy, and anyone who owns any sort of asset thinks that you’re on their side.
If you start raising rates, and put an end to rising prices, you’ll be accused of being a party pooper. But if you let things get too exuberant, you run the risk of encouraging people to take on too much risk, making the financial system vulnerable to small shocks. You also run the risk of allowing inflation (remember that?) to get a hold on the economy.
And if you wait until inflation is showing signs of rising strongly before you tighten, it’s too late. You’ll need to tighten much faster than perhaps the economy can stand if you want to crush inflation from the system.
Trouble is, it’s clear that neither Janet Yellen in the US, nor Mark Carney over here in the UK, feel too confident about raising rates.
Yellen dismissed a recent, relatively high reading for US inflation, as “noise”. But as analysts at Capital Economics noted, price rises were spread across plenty of sectors – there’s no reason to think of this as a one-off spike.
However, what this grim GDP figure does is give the Fed that bit more ammunition – if it needed it – to keep interest rates lower for longer.
The next big crisis will be about inflation, not deflation
There are few sure things in financial markets. But experience so far suggests that one thing you can rely on is that central banks will only tighten monetary policy when it’s too late. That’s why I’m expecting the next big crisis we face to be one of inflation, rather than deflation.
What does that mean for your wealth? Any prospect of inflation makes bonds unattractive. If you do want to hold bonds in your portfolio (and there’s an argument to have them there for diversification), the most sensible way to do it is through a ‘bond laddering’ strategy.
I’m not keen on US stocks at the moment – as a market, the US is just too expensive. Of course there are individual opportunities – my colleague Matthew Partridge looks at one very promising sector in the latest issue of MoneyWeek magazine, out tomorrow. (If you’re not already a subscriber, get your first four copies free here.)
But overall, I wouldn’t be keen to invest in an S&P 500 tracker for example.
The irritating thing about the US market is that where it leads, others tend to follow. So even markets that we like and view as relatively cheap – like Europe and Japan – would take a hit if the US corrects. However, timing any correction is almost impossible, so I’d just keep drip-feeding money into your favourite markets. That means if prices fall, it just means you get to pick up more stocks.
And keep hold of gold as your portfolio insurance. As it becomes clear that central bankers are falling behind the curve, demand for gold will pick up again.
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