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How Good is the Rebound?

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Wednesday, June 25, 2014

The stock market today is unlikely to reverse Tuesday’s pullback following this morning’s soft economic data. The market wasn’t looking for much strength in this morning’s data about Q1 GDP and Durable Goods to begin with, but they came short of even those modest expectations.

The final look on Q1 GDP shows that the U.S. economy was in an even worst shape than many expected. Contrary to consensus expectations of Q1’s growth getting revised down to -2% from the prior -1% decline, the decline came in at -2.9%. Importantly, personal consumption expenditures or consumer spending was materially revised down to a growth of only +1% from the +3.1% growth at the second look. All components of consumer spending were revised down, but the revisions were notably severe on the services side – up +1.5% now vs. +4.3% in the second look. The investments side of the ledger didn’t see much change, with non-residential fixed investments down -1.2% in Q1 and investments in equipment down -2.8%.

The disappointment in the GDP report notwithstanding, it has little bearing on the current and coming quarters and is no more than record keeping. What the GDP report told us afresh is that Q1 was even weaker than what all of us expected. That said, such a weak reading in Q1 makes the arithmetic of higher GDP growth for this year all the more difficult to achieve. We knew that Q1 was weak.

This morning’s soft Durable Goods report didn’t provide much solace on the business capital spending front for the current period either. Just like the GDP report, the Durable Goods reading was expected to be on the weak side, but it came in even weaker – both at the ‘headline’ and ‘core’ levels. The overall hope in the market is that businesses will start ramping up their outlays this year on equipment, software and structures, which has been a missing pieced in this recovery thus far.

With record cash on their balance sheets, companies certainly have the wherewithal to spend more. But they have been hesitant to do that, citing weak demand in the market. They have instead been returning cash to their shareholders through dividends and share buybacks. Business spending on dividends and share buybacks reached an all-time record in 2014 Q1, surpassing the previous record set in the last quarter of 2007. Buybacks were the primary driver for the Q1 record, up 59% from the same period last year and 23% from the preceding quarter. All the major companies like Apple (AAPL - Free Report) , Cisco (CSCO - Free Report) , IBM (IBM - Free Report) and Exxon (XOM - Free Report) were big buyers of their own shares in Q1.

The stock market has largely brushed aside the weak Q1 data, focusing instead on the rebound in activity levels in the current period and expectations of even better growth down the road. While economic growth has no doubt bounced back Q2, the magnitude of the rebound may not be as impressive as the record levels of the broad stock market indexes would like us to believe. In other words, the stock market may have moved out of sync with economic and corporate realities.

Sheraz Mian

Director of Research

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