Streetwise for Friday, May 10, 2019

If you want to determine where Wall Street could be headed, and in turn the direction of a company’s future performance, you need to analyze the economy first.

Now for many scrutinizing macroeconomic data is about as entertaining as having a tooth drilled. Therefore, I will try to make the following as easy on you as I can.

Let’s start with the quarterly performance of the nation’s gross domestic product (GDP), since it provides a summary of how the economy is doing. And while first-quarter GDP growth increased 3.2 percent from 2.2 percent in the prior quarter, I would not do a happy dance just yet. 

Why? Because there are a few cracks in the ice. However, let me preface the following by saying that I do not mean to imply in any way that the financial markets are headed for a major, or even a minor correction in the near term.

However, to select investments that will grow in value, it is necessary to understand the potential impact the nation’s economic climate might have on a company’s future.

For example, the GDP depicted an unusual composition of data, including weak consumer spending and outsized contributions from net trade and inventories. Therefore, going forward I would be looking for second quarter GDP growth of between 2.1 and 2.3 percent.

To understand why consider that manufacturing activity slowed more than expected in April, amid a sharp drop in orders. In addition, construction spending was lower in March, again suggesting a moderation in economic growth.

The Institute for Supply Management (ISM) reported that its index of national factory activity fell to a reading of 52.8 in April from 55.3 in March. Yes, a reading above 50 does indicate growth in the manufacturing sector, which accounts for about 12 percent of the economy, but the trend is wrong.

ISM’s sub-index for new orders fell 5.7 points to a reading of 51.7 last month as factories reported a decline in hiring. One measure of manufacturing employment fell to 52.4 from 57.5 in March. This suggests that manufacturing payrolls remained weak in April after falling for the first time since July 2017.

Meanwhile, the Commerce Department reported that construction spending decreased 0.9 percent March, with the data for February revised to show construction outlays rising 0.7 percent, instead of 1.0 percent as previously reported. Construction spending fell 0.8 percent on a year-over-year basis in March.

Consumer spending, which accounts for nearly 70 percent of GDP, slowed significantly in the second quarter, falling to a 1.2 percent increase from 2.5 percent the previous quarter. The pace of increased spending was less than half of the average 2.6 percent pace set in 2018. 

There was also a sharp decline in durable goods orders (goods designed to last 3 years or more), coming in at a negative 5.3 percent decline as compared to a positive 3.6 percent gain during the fourth quarter, while services fell to 2.0 percent as compared to 2.4 percent.

However, a rebound in discretionary spending, particularly on autos at the end of the quarter, bodes well for an acceleration in consumption in the second quarter.

The pace of business-investment increased only 2.7 percent from 5.4 percent rise the prior quarter, with equipment investment barely increasing in the quarter at a 0.2 percent growth rate, as compared to a 5.8 percent average increase during 2018.

Housing is an important part of GDP and residential investment declined for a fifth straight quarter, posting a growth rate of a negative 2.8 percent. This is something we have not seen since the Great Recession. 

Inventory accumulation continued into first quarter as inventories increased by $128.4 billion, which could have a negative effect on GDP going forward.

In summary. it appears to be that economic growth will likely feel the fading impact of fiscal stimulus. Therefore, you might want to look for companies whose performance is not tied directly to the size and direction of the nation’s economic cycles. I will try to delve more deeply into companies meeting this criterion in future columns.

Lauren Rudd is a financial writer and columnist. You can write to him at LVERudd@aol.com. Phone calls accepted between 9 AM and 3 PM at (941) 706-3449. For back columns please go to www.RuddReport.com.