Today’s first guess at fourth-quarter GDP revealed what everyone already knew: the economy slowed sharply in the last three months of 2007 to a 0.6% annual pace in real (inflation-adjusted) terms, the Bureau of Economic Analysis reported. That’s a world or two below the third quarter’s 4.9% surge.
What’s the source of the downshift? Real estate–residential real estate, to be precise, as the table below shows. Spending on construction of new houses, apartment buildings and all the associated products and services took another hit in the fourth quarter, tumbling nearly 24%. Even worse, that follows a 20.5% tumble in the third quarter. In fact, you have to go back to the fourth quarter of 2005 to find a positive number in the residential real estate investment column in GDP reports. Since then, the sector’s been mired in red for each and every quarter and the toll has grown on the overall economy. The only difference this time: the 23.9% slump in housing investment in last year’s fourth quarter is the deepest yet for this cycle, and the mounting pressure is obvious via the weak economic growth generally.
The good news is that the pain is still largely contained to real estate, at least it was in the fourth quarter. That may or may not continue this year, but as we write consumer spending, while slower in 2007’s last three months relative to the previous quarter, still appears to be rising. Alas, the 2.0% rise in consumer spending is unimpressive relative to the past few years, but beggars can’t be choosy. With that in mind, we note that Joe Sixpack’s spending pace comfortably exceeded the economy’s growth rate as of late last year. Perhaps we should all be thankful for small (and increasingly precarious?) favors.
In fact, focusing on the durable goods component of consumer spending shows an even brighter profile in last year’s fourth quarter. As you can see from the table above, spending on big-ticket items remained fairly brisk, advancing 4.2%, down only slightly from 4.5% previously. But that’s tempered by the slowing in the consumer spending tied to nondurable goods and services.
And, of course, real estate woes continue to weigh heavily on this economy. For some time now the debate has rightly focused on whether the housing slump will infect the larger economy. The answer is clearly “yes,” as the fourth quarter numbers reveal. But the pain, so far, has been mild as measured in broad terms. And with Congress and the Federal Reserve moving heaven and Earth in an attempt to limit if not end the housing infection, perhaps there’s reason for hope.
The great unknown is whether the worst of the real estate woes are now past. There’s a case to be made on both sides of the debate. Indeed, economists seem to be all over the map. Of course, someone will be wrong, and perhaps by more than a little.
Risk, in short, still stalks the economy, the capital markets and investors. It’s tempting to think the danger has passed. The rising U.S. stock market of late looks especially confident that the all-clear bell has been rung. We don’t dismiss the possibility, but nor do we necessarily embrace the idea.
We are, however, inclined to nibble where the values look favorable among the major asset classes, which include REITs and junk bonds and, yes, U.S. stocks. But we don’t know if this is a bottom or just a bear-market head fake that will lead to even lower prices and more-enticing valuations. We’re always clueless about the future, of course, but that state of affairs is especially risky at this point. As such, our portfolio allocations to risk remain relatively low while our buying is opportunistic and limited.
We’re fully prepared that our cautious stance may come at an opportunity cost if bull markets sweep the globe once more. Nonetheless, risk management remains our foremost concern and for the time being we’re willing to forgo big gains in exchange for the possibility of finding even greater bargains later. It’s an imperfect world and so we’re fated to make what may be imperfect decisions.
Others will no doubt see the opportunities and risk horizons differently. Given the fluid climate of late, that’s no surprise. This much, at least, is clear: Each and every investor must decide if they’re more comfortable with a lesser expected return or a higher expected risk and then act accordingly.