The economy grew faster in the third quarter than initially estimated, the Bureau of Economic Analysis reported today. Higher is better, although yesterday’s anxieties about the economic outlook continue to plague.
Arguably, those anxieties should have marginally lessened on the news that GDP rose by 2.2% during July through September, higher than the 1.6% initially estimated. The source of the upward revision was a combination of a downward estimate of imports and a hike in calculations of private inventory management and personal consumption expenditures.
That’s all well and good, but it doesn’t change the strategic issue of: what’s up for 2007? Indeed, the economy grew faster in the third quarter, but the 2.2% pace was still slower than the second quarter’s 2.6%, which in turn was much slower than the first quarter’s 5.6%.
The trend, to cut to the chase, remains intact: the economy’s slowing. To reiterate the obvious: how much it slows, for how long, and if it leads to an outright contraction are the great questions. Next year is likely to dispense an answer, and by this time in 2007 (if not sooner) we’ll all have something meatier to chew on in terms of a definitive answer. Getting from here to there, of course, is the challenge and the peril.
That issue, in fact, was front and center this morning at a press conference in New York, hosted by Deutsche Bank’s private wealth management division. Your editor was in attendance, and among the comments that caught our attention was the intention in the near term for “taking risk out of portfolios rather than putting it in.”
So said Ben Pace, Deutsche Bank’s U.S. chief investment officer. Among the potential trouble spots, he explained: the ongoing correction in the housing market. Yes, some have said the worst is behind us, he admitted. But Pace isn’t yet convinced, warning that there could yet be an impact on consumer spending from the deflating housing market.
Yesterday’s report on existing home sales for October offers a reason for staying wary, he pointed out. Although much attention (including ours) yesterday was given to the fact that the number of houses sold last month inched higher for the first time since February, the reason for the boost in units sold is less than encouraging. Pace noted the average price of homes sold was 3.5% lower in October vs. a year earlier. That’s the third straight year-over-year decline and the largest in the 38-year history of the data series. So, yes, lower prices tend to move product, but deciding if it’s not necessarily a thing to cheer about, at least not yet.
Another speaker, Klaus Martini, global chief investment officer for DB’s wealth management division, pointed to another factor that gives pause: low yield spreads. “If economic growth turns down,” he opined, “spreads will widen.” Given the low spreads of late, that risk has convinced Martini to steer clear of high-yield bonds completely in client asset allocations at the moment.
To be fair, Martini and Pace also spoke of the positives as they see it. That includes a bullish outlook on emerging markets and a prediction that inflation will remain contained. Considering the latter, Fed Chairman Bernanke yesterday said he too was still concerned about inflation. Meanwhile, the DB team today said inflation has been tamed, in part because of the disinflationary winds blowing from low-cost products from China and elsewhere. So while a rate hike or two may be coming early next year, the DB team sees Fed funds somewhere in the 4.50% neighborhood by the end of 2007, which would amount to a 75-basis-point cut from current levels.
Of course, the tricky part of projecting inflation may turn heavily on where U.S. economic productivity goes from here. For the moment, productivity appears to be slipping. That’s no trivial trend, since rising productivity of recent vintage has generally been considered one of the key factors putting a lid on inflation. As one journalist at the DB meeting reminded, productivity gains in the past have been largely a byproduct of large inputs of new technology. Will new technology inputs in the future suffice to keep productivity bubbling?
Questions, questions, questions, and all without fully satisfying answers at the moment. Perhaps then there’s no mystery as to why Deutsche Bank’s private wealth management team is focused on educating its high-net-worth clients about the merits of asset allocation strategies that go beyond the typical stocks/bonds/cash. Private equity, hedge funds, commodities, real estate, and so on are all the rage these days among forward-looking investors who think strategically. It’s a different world, the DB folk emphasized, and that requires thinking differently when it comes to designing portfolios. Perhaps that’s the only bit of advice that’s not subject to data revisions.