The good news first. The economy grew by 6.5 percent in the second quarter, which was one of the best quarters in recent memory. The bad news: it was a big miss.
Economists were expecting an 8.4 percent rise, but the markets took it in stride. One explanation is that investors are well aware that the macroeconomic data is, at best, somewhat unreliable and prone to large revisions. It is not the government's fault. The pandemic and subsequent reopening of the economy has made gathering economic data difficult.
Another reason investors gave the miss a pass is that consumer spending, the biggest component of U.S. economic activity, exceeded expectations. A stronger than expected number supports the case that the economy is still in good shape. It was shrinking inventories, rather than a falloff in demand, that dented growth. Supply chain restraints and shortages were a substantial part of the drawdown in inventories.
The weaker GDP number is also one of those "bad news is good news" events, since it supports the Fed's argument that there is no need to tighten right now. This month's FOMC meeting, and Fed Chairman Jerome Powell's press conference, drove the point home that there would be no change in policy.
For the time being, Powell said, the Fed will be more focused on gaining jobs than in controlling a temporary spike in the inflation rate. Bond traders are guessing that at some point in the fall we can expect the central bank to begin tampering their bond purchases. Of course, the wild card will continue to be the spread of the Delta variant of the coronavirus.
On the political front, kudos are in order for those on both sides of the aisle. Senators from both parties finally arrived at a compromise on infrastructure spending. The 67-to-32 Senate vote, which included 17 Republicans in favor, cleared the way for passing the first infrastructure bill in years. President Biden deserves credit for his ability to lead (as well as to compromise). But investors should know that there is still a long way to go before this deal becomes law.
My own disappointment centers around the fact that this agreement only includes $550 billion in new federal spending spread over many years. It is not nearly enough, in my opinion, to repair and rebuild a nation's worth of roads, bridges, railroads, transit, water, and other necessary physical infrastructure programs.
For example, just repairing (or rebuilding) one century-old tunnel that connects New Jersey with Manhattan would cost $11.6 billion or more. How many more such bridges and tunnels are there across the country? If we compare the amount other nations spend on infrastructure, (think China for example) this bill is woefully inadequate. It almost guarantees that our nation will continue to slip lower on the economic scale, among most nations.
Fortunately, the Democrats are working on a $3.5 trillion budget blueprint that will provide additional spending on climate, health care, and education.
As this quarter's earnings season winds down, it is no surprise that the vast majority of companies beat estimates on both the top and bottom lines. It was to be expected, given easy comparisons and the surge in economic activity. Those earnings are what have propelled the averages to new highs.
Large cap, growth stocks have had a great run recently and seem to me to be a bit over-extended. Some of the FANG stocks experienced a bout of profit-taking this week as well. We will also have passed the Aug. 1 deadline on raising the debt ceiling, which should create some short-term angst among traders. It wouldn't surprise me if we see a mild pullback (3-5 percent) in the weeks ahead, so be prepared.
Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at email@example.com.
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