GDP Growth Likely to Stagnate, Even if Fiscal Cliff is Avoided

By The Curmudgeon

Consumer debt rose to a record high in October as Americans used their credit cards more often and borrowed to attend school and buy cars, the Federal Reserve reported on December 7, 2012. Consumers increased their borrowing by $14.2 billion in October from September. Total borrowing rose to a record $2.75 trillion.

One would expect such borrowing to boost consumer spending. Not so. The increase in borrowing came in a month when Americans cut back on consumer spending by 0.2%, according to The Commerce Department. Part of that drop might be due to disruptions caused by Hurricane Sandy. Consumer spending accounts for approximately 70% of U.S. GDP.

It's noteworthy that although credit card use rose in October, it has fallen sharply since the 2008 credit crisis. Four years ago, Americans had $1.03 trillion in credit card debt. In October, that figure was 17 percent lower. During the same period, student loan debt rose. The category that includes auto and student loans is 22 percent higher than in July 2008. That reflects in part the decision by many Americans who have lost jobs to return to school to get training for new careers. If employment prospects were better, that wouldn't be happening.

And consumer sentiment has weakened. The Thomson Reuters/University of Michigan Index of Consumer Sentiment fell to 74.5 for December, a substantial drop from November’s promising 82.7. The median forecast from economists polled by Reuters was 82.4.

Meanwhile, consumers are not investing in equities or equity mutual funds. Part of the reason might be they're scared of the potential volatility caused by High Frequency Trading (see earlier article on that topic:

HFT 2.0: Wall Street Gyrations Negatively Impacts Main Street

The New York Times reported this week that High Frequency Traders are taking significant profits from traditional investors. HFT traders make an average profit of as much as $5.05 extra per contract, when they pair up with small traders buying and selling S&P500 futures-one of the most widely used financial contracts.

High-Speed Traders Profit at Expense of Ordinary Investors, a Study Says

At the same time overall consumer debt continues to climb, corporations have improved their balance sheet and are hoarding cash. The WSJ reported this week that U.S. companies were sitting atop a record pile of cash at the end of September. American nonfinancial corporations held $1.74 trillion in cash and other liquid assets at the end of the third quarter, the Federal Reserve reported on December 6th. That is $44 billion more than three months earlier and more than erases the prior quarter's slight decline.

Companies may no longer be adding to their cash reserves, but they aren't drawing them down either, said Howard Silverblatt, senior index analyst for S&P Dow Jones Indices. "Companies are not spending," Mr. Silverblatt said. "They're not sure of how the economy and how their specific business is going to be going over the next couple of years."

Conclusion: With consumers not spending and corporations not investing in new equipment, plants, or people we don't see how U.S. GDP can grow at more than 1 or 2 %- even if the fiscal cliff danger is averted. With corporate profits at a record high as a percentage of GDP (that's mostly due to cost cutting rather than top line growth, in our opinion), we don't think they will be higher in 2013. Where does that leave stock prices in the year ahead? That's an exercise for the reader of this article!

Till next time,

The Curmudgeon

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.