Earlier this week, on Wednesday, the Durable Goods Orders number came in at -4.2%.
Durable Goods are defined as goods whose intended lifespan is three years or more. This report includes everything from washing machines to airplanes.
The Durable Goods report is considered an important leading indicator for the manufacturing sector.
So when Durable Goods Orders shrink by 4.2%, it’s not a good thing. In fact, such a negative reading can stop a bull market in its tracks.
That’s what happened last summer…
On July 27, 2011, Durable Goods number came in at -2.1%. It was dismal.
The S&P 500 had been flirting with 1,350 prior to that release. Nine trading days later, the S&P 500 had peeled off 237 points.
That’s a 17% drop in just trading nine days.
It was only the potential for more quantitative easing from the Fed that kept that decline from becoming a crash…
The Fed answered with Operation Twist on September 21, 2011.
Now, let’s fast-forward to this week’s data. Not only did Durable Goods come in far worse than expected (the consensus estimate was for a decline of -2.5%), but GDP for the first quarter came in much worse than expected, at 2.2%.
The stock market hasn’t started plunging on this, but investors are probably still asking themselves: What’s wrong with the U.S. economy?
What’s Wrong? Good Question…
Before we get to this question, let me start by saying you can never trust a headline number. You always have to read the fine print. And the details of first quarter GDP weren’t as bad as the headline.
First and foremost, personal consumption (spending) was up 3%. Exports were also up, though only slightly, and residential investment was up nearly 20%.
So why does the headline number look so weak?
Overall, government spending fell for the sixth straight quarter. I think we’d all agree that this is actually a good thing.
And if the U.S. economy can continue to expand and push the unemployment rate down at the same time as government spending shrinks… well, that’s the best possible outcome.
When you compare the U.S. solution for debt to Europe’s, you can only conclude that the U.S. has done a far better job at balancing growth with spending cuts.
So, what’s wrong with the U.S. economy?
It’s the same thing it has been: debt, housing and unemployment.
We’ve known for a while now that there’s only one cure for these ailments: time.
The Outlook for QE3
The stock market didn’t sell off in reaction to weak Durable Goods and GDP.
In fact, stocks rallied.
There should be no doubt that part of the reason for optimism is that the Fed has said it would do more to help if the economy weakens. And by “help” the Fed means more quantitative easing.
Personally, I don’t think the Fed will embark on QE3. There’s just too much risk of inflation.
What’s more, I think the Fed is better off showing some confidence in the U.S. economy, rather than reverting to more stimulus.
I’d love to hear Bernanke say the economy is doing better than expected at this stage of the recovery. (It won’t happen, of course.)
What Should You Invest in Now?
I expect most investors would be surprised to see it, but Real Estate Investment Trusts (REITs) have been among the strongest stocks so far this year — an impressive turnaround for a sector that was absolutely crushed by the financial crisis.
But the combination of large dividends and upside potential makes these stock very attractive, especially in the current low-growth environment.
In fact, Canadian REITs are at a five-year high as office vacancies have dropped to just 8.2%.
Even better, office property values are expected to rise between 10% and 20% in Canada this year.
You’d be smart to keep an eye on REITs in our neighbors to the north until the U.S. economy finds its footing once again.
Until next time,
Briton Ryle
Analyst, Wealth Daily
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