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Despite Much Pessimism, Slow Growth Persists

The Mideast is exploding in violence while Europe and China are in the throes of an economic slowdown. The top domestic story for months has been the U.S. fiscal cliff. Yet the fundamentals driving the economy remain fairly encouraging. Assuming political leaders can come to an agreement on averting the fiscal cliff — and they have little choice but to do that because the consequences would be devastating — the economic recovery remains slow, but good enough to propel corporate earnings higher. 

“This recovery is not fragile and it’s not risking stall-speed,” says Fritz Meyer, an independent economist. “We are three years into an economic recovery that has been persistent and steady. While it is subpar compared to previous recoveries, it’s good enough to continue to drive higher corporate earnings, which is the key driver of stock prices.” 

Economic Growth Factors. Economic growth is largely attributable to four key factors: consumption, investment, government spending, and net exports. When you examine these four components, the overall trend supports continued economic growth. The charts below show the respective contributions to GDP growth that each of these four factors have made since 1997.

Consumption. The U.S. economy grew by about 2% in 3Q2012, and 1.5 percentage points of that growth came from consumption. The rate of growth in consumption in recent months was about one-half of 1% lower than the historical norm. However, consumption is holding up and is not too far off from its long-term historical rate.

Government spending. Government spending surged in 3Q2012, largely from a jump in defense spending, a historically volatile category. Longer-term it’s hard to imagine that government spending won’t continue to grow more or less in line with the past, although in the near-term, state and local fiscal restraints will weigh on the aggregate government spending figures.

Investment. Gross private domestic investment includes construction—both residential and commercial — plus inventories held by corporations and other corporate spending. Here again, the picture does not portend a booming economy. But it’s untrue to say companies have not been investing. Yes, private investment stumbled in 3Q2012, but it has contributed just below 1% annually to the growth in the economy since the 2008 recession. Moreover, private investment fluctuates and an occasional dip amid a recovery is not unusual or alarming.

Net Exports. This key swing-factor in economic growth contracted in 3Q2012, but the subsequent release of third quarter trade figures suggests that net exports will be revised substantially higher, taking 3Q2012 growth closer to 3%, a good deal higher than the preliminary 2% that was reported. The substitution of domestic oil production for imported oil is a favorable development for the net exports contribution to GDP.

While pessimism abounds, the economic data shows an economy growing slowly and resulting in improved corporate earnings — a key driver of stock prices.

This article was written by a professional financial journalist for Legend Financial Advisors, Inc. and is not intendedas legal or investment advice.

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