Initial GDP tops expectations but the consumer is still dead

Initial reads on the Commerce Department's GDP report this morning pointed to the headline figure -- a 1.0 percent annualized sequential drop -- as a sign the recession is coming to an end. While it's certainly true that the number beat expectations, looking deeper into the report reveals a few disconcerting data points. For example, the first quarter of 2009 was revised even lower, from a -6.1 percent GDP contraction to -6.4 percent. Notably absent was any sort of consumer demand, and the slack was largely picked up by spending from various levels of government.

Personal consumption spending fell 1.2 percent in the quarter, and equipment and software spending (a proxy for business investment) dropped almost nine percent. Imports were down 15.1 percent, and exports were off nine percent -- a combination that added to U.S. GDP, even though that's not encouraging for America or its trade partners. Barry Ritholtz calculates that, without the "boost" provided by the import/export difference, "GDP would have been -2.38 percent" -- far worse than expected.

The import/export number should raise more eyebrows about what's happening with the Chinese economy, in particular. According to data from the US-China Business Council, the U.S. is by far the largest destination for China's exports, with about a 20 percent share. How China can overcome -- in a sustainable manner -- their largest trade partner buying so much less from the rest of the world is a mystery. The Shanghai Composite has almost doubled year-to-date, and plenty of company's have said their earnings prospects for the next year depend on Chinese demand. This is another call to be careful of industries or companies that rely on China's growth prospects, which I believe are much worse than consensus.

Off-setting the numerous negatives mentioned in the BEA report were "positive contributions from federal government spending and state and local government spending." Federal government spending was up 10.9 percent, including a 13.3 percent increase in national defense outlays. The defense complex has lagged the market -- Raytheon (RTN) has posted a gain in the last three months, but Lockheed Martin (LMT) and Northrop Grumman (NOC) are both lower -- and with those stocks around 9x forward earnings, maybe there is a trade to the long side in a market that looks overbought.

State and local governments also elevated GDP, posting a 2.4 percent rise in their expenditures. These are the same state and local governments, of course, which are facing budget deficits (48 of 50 states), plunging revenues, and higher borrowing costs on their debts. The California IOU situation is not likely to be the last high-profile situation of its kind, so whether their spending is really a positive should be questioned.

As an investor, I'm wary of reports that cite these GDP figures as a sign of material improvement to the economy. Things are still getting worse, they just aren't getting worse as quickly as before -- and that's mainly because of the ability of the U.S. government to borrow and spend liberally. That's not the stuff upon which solid foundations for a recovery are built in an era of deleveraging.

James Cullen edits and writes at He has no personal position in the stocks mentioned above.

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