"Kee" Points with Jim Kee, Ph.D.

GDP came in at 2.2% for the 1st quarter of 2012. This was below consensus of ~2.6% but well above some of the 1% numbers that had been bandied about in the press recently. By the way, in February the Wall Street Journal Forecasting Survey put 1st quarter U.S. GDP growth at 2.25%. So the actual number really only missed some of the recently upward revised estimates. As discussed in prior Kee Points, I felt a “miss” was highly probable because lower business investment spending this quarter would probably follow last year’s acceleration in the 2nd half (in anticipation of the expiring 100% expensing of capital purchases – it is now 50%, which is still a strong incentive). Another reason has to do with the fact that GDP exhibits seasonality, which means some quarters are regularly weaker than others, and historically the weakest quarter is the first. No doubt a lot of this has to do with accelerated spending and shopping going into the holiday season during the prior 4th quarter. Economic activity is “rescheduled” from the future to the present. This creates a flip-flop or see-saw pattern in the data, and it is one of the more interesting areas of macro-economics, in my opinion. Some call it “the economics of false prosperity.” These patterns can be caused by lots of things. For example, higher anticipated interest rates can cause accelerated borrowing in the present; higher future taxes can cause accelerated activity and income recognition in the present; an expected currency devaluation in the future can cause capital flight in the present, etc. Pioneer Econ/Psychologist George Katona, who developed the University of Michigan Consumer Sentiment Index (1940s), discussed this decades ago, and I have always found his work to be among the most useful of the “behavioral economics” crowd (as that field came to be known).


In Europe, Spain is again in the news as Standard & Poor’s downgraded its credit rating to BBB+ from A. Spain’s GDP also contracted in the 1st quarter by 0.3%, which indicates recession (because the prior quarter was negative as well). None of this was really a surprise to the market. Interest rates and credit market derivatives like Credit Default Swaps have been rising in Europe for several weeks, so markets have been keeping abreast of the slogging, back-and-forth political developments there. But global risk measures like the St. Louis Fed and Kansas City Fed financial risk indices have not risen appreciably. These market-based measures contain forward-looking data like LIBOR-OIS spreads and global bond market rates. In the extreme, a case can be made that these “price” (rather than quantity) data contain the collective knowledge of the market and are “smarter” than any single economist or analyst. While perhaps overstated, I’ve always been somewhat sympathetic to this view. And what markets are telling me is that Europe still has plenty of problems to work through, but that the global financial system is ok. We continue to monitor these European and global data points on an ongoing basis.


That’s all for today. If interested, I was given some questions by a Boston reporter this morning, and my very brief answers are given below.


Q: Problems persist in Europe and Asia. Is there substantive evidence that the world economy is improving?

A. The direction of the IMF’s recently increased GDP forecast is a pretty good indicator that on balance the outlook (what’s ahead, not behind) is more positive than negative globally.


Q: What is your evaluation of this earnings season?  Are stocks getting too expensive?

A. Over 300 of the S&P 500 companies have reported 1st quarter earnings, and 70% beat analysts’ estimates. Many of these estimates had recently been revised downwards, so this probably isn’t as great as it seems. But overall the earnings picture remains positive. You can’t really predict the market, but what I see this year is a reversal of the spike in the equity risk premium that peaked around the end of November. A normalization if you will. So I don’t see stocks as being particularly under or overvalued.


Q: Why does inflation feel higher than what is reported by the government?

A. What a great question. The “man on the street” view is always that inflation is higher. Sometimes that’s right, sometimes it’s not. I think it is because people tend to downplay (1) improvements in quality which make apples-to-apples comparisons over time of purchased items difficult, (2) substitution effects, or the fact that people rarely buy the same basket of goods when the prices of some of them rise but, rather, substitute towards cheaper alternatives, and (3) many large ticket consumer durable items have actually fallen in price (cars, flat screens, computers, cell-phones, etc.).


Q: Are you more concerned about inflation or deflation, going forward

A. Neither right now. Inflation is like a statistical process control chart that’s in check. Given the huge amount of excess reserves I’d tilt towards inflation if I had to choose, but policy (tax/regulation) uncertainty has to come down for that to happen – I mean before the demand for and supply of credit expands to an inflationary extent.