The Bureau of Economic Analysis is expected to say next week that the economy shrank in the first quarter, with real GDP falling at a seasonally adjusted annualised rate of around 1 per cent. And with industrial production having fallen in April, James Knightley at ING says hopes of a strong rebound "are starting to evaporate." Economists at the Atlanta Federal Reserve estimate that GDP will grow by only 0.7 per cent (annualised) in the second quarter, with business investment falling for a second successive quarter. This would increase fears that the US economy has fallen into secular stagnation.
This could be bad news not just for US equities but for UK ones too, because there's a strong correlation (of 0.58 since 1995) between annual changes in US industrial production and annual changes in the All-Share index; on average, one percentage point slower US growth has been associated with 2.1 percentage points lower returns on UK shares.
But other economists are pinning their hopes on a bounceback. Tom Porcelli at RBC points out that wage incomes have risen strongly so far this year and says he would be "extremely surprised" if we don’t see a sharp pick-up in consumer spending because of this. And Steven Englander at CitiFX adds that one reason for the fall in GDP in Q1 is that net exports fell. But this, he says, usually leads to stronger growth the following quarter as imports are sold to consumers or used to increase production. These hopes were boosted this week by official figures showing that housing starts rose sharply last month.
Others suspect that the economy hasn't been as weak as official figures show. Economists at the San Francisco Federal Reserve believe that the BEA under-records first quarter GDP growth because it fails to adjust properly for seasonal variations. They say: "There is a good chance that underlying economic growth so far this year was substantially stronger than reported." If this is so, reported GDP growth should increase later this year even if there’s no change in actual growth.
But there is a growing risk that stock markets are pricing in a recovery and so would be vulnerable if one does not materialise. Alan Higgins at Coutts warns: "US equities are expensive."
