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

A little dry, but here goes: In the U.S., anemic growth continues. The third estimate of second quarter GDP was revised downward from 1.7 percent to 1.3 percent. That’s not great news, for as I’ve mentioned, GDP has a strong cyclical component, with first quarter GDP generally being the weakest (because of the spending hangover caused by 4th quarter holiday spending). So a decline from the first quarter to the second quarter should always be viewed with disappointment. Half of the revision was due to a decline in “inventory investment” which is expected to rebound somewhat in the third and fourth quarters (Wells Fargo Securities). That’s mostly because farm stockpiles which were down due to the Midwest drought (WSJ). On a more positive note, the Labor Department released preliminary data showing that employers added nearly 20 percent more jobs between March 2011 and March 2012 than initially thought. That would help explain weak, but ongoing, positive consumer spending growth.


Durable goods orders fell 13.2 percent in August, the largest monthly fall since January 2009 (Wells). Most of this was due to a decline in orders for transportation goods like civilian aircraft and motor vehicles. Defense orders also fell. But economists like to look at durable goods excluding transportation and defense, which leaves basically business capital goods orders. These were up slightly, 1.1 percent, though the outlook points to very weak spending on equipment and software during the third and fourth quarters. This is all consistent with the “holding pattern” that I expect will cause forward-looking decisions (like durable goods orders and hiring) to be delayed until after the U.S. elections. The data point to growth in the U.S., but not robust growth, so it wouldn’t take much of a shock to move the U.S. close to recession (but it would take a shock nevertheless). What are the most likely candidates for that? Well….


Number one, I would have to say, would be an oil price spike due to disruptions in the Middle East, particularly an Israeli strike on Iran. Eighty percent of Iran’s oil exports are handled through Iran’s oil-export terminal on Kharg Island, making it a likely target (particularly since 65 percent of Iran’s national budget is covered by oil exports – National Review). American and European economic sanctions are already crippling the Iranian economy, but Israeli Prime Minister Benjamin Netanyahu has argued that the sanctions are not deterring Iran’s efforts at building nuclear weapons (Reuters). There are strategists arguing that Israel has an incentive to strike prior to the U.S. elections (because U.S. support would be more likely then), but there are also strategists who feel that Iran’s nuclear research capabilities are exaggerated.


Number two would be a full “fiscal cliff effect” of tax increases and spending cuts. Most analysts expect some middle ground between no fiscal cliff (full extensions of everything) and full fiscal cliff (all tax increases and spending cuts fully effective), with credible GDP estimates being somewhere from no impact to negative 4 percent impact on GDP growth. According to Credit Suisse, the market has already priced in a “most likely” scenario of expiring payroll tax cuts (which they estimate would result in very low 1 percent GDP growth). They don’t know, of course, but that gives you an anchor or ballpark guess that’s fairly typical of what crosses my desk from Wall Street. And I’m pretty keen on focusing upon “what’s priced in?” It is always a difficult question to answer with any real precision, but it is the correct question to ask.


What should investors do? Running to cash is not recommended, as timing is impossible and that asset class has no return or inflation protection. Typically, those investors who don’t like this kind of macro uncertainty own a balanced portfolio that is hedged with safe bonds. If you have a balanced portfolio, you are already doing what you should do. A 100 percent equity portfolio is for those who are more comfortable taking a long range perspective. For example, a longer run perspective would certainly include the possibility of new energy supplies (tar sands, shale gas, etc) leading to lower energy prices and less dependence upon oil from the Middle East. That would hurt traditional oil exporters (Russia, OPEC, Latin America) by reducing exports and lowering export prices, and it would benefit net importers (e.g. U.S.) through lower prices and through profits from alternatives (La Jolla Economics).