Intelligent Investor

Why the economic data shows double standards

There is a wide gap between the optimistic data in official figures and the reality for many businesses. What's happening?

Interest rate cuts, promised US tax cuts, lots of politicians' hot air on both sides of the Pacific - none of it seems to be lifting the gloom which is spreading like a fog through the markets both here and in the United States.

The problem is that the signals which lead economists to their conclusions seem to many businessmen and consumers to be at odds with what they are seeing on the ground. For this reason Peter Costello and George Bush can stand up hand on heart and quite honestly point to data which does not spell doom and gloom.

Doing it tough

At the coalface it all looks a bit different and people are doing it tough. And it's not just small businessmen in Australia who are noticing it. In a recent interview the famed investor Warren Buffet was complaining of just this phenomenon.

He says that he has found no improvement in the US economy - at least not as reflected in the accounts of the wide range of companies his Berkshire Hathaway investment vehicle owns.

His statements fly in the face of US Government data indicating that the economy grew by 2% - a rate which was better than expected - in the first quarter. We know who we would rather trust.

Despite the government's figures, Buffet said that much of the economy had hit the wall 'in a major way'. 'I see no evidence the slowdown is not continuing,' he said.

So what is going on? Part of the problem is that raw data such as GDP growth figures are a pretty blunt instrument. They measure business activity across the board and so can mask very varied performances in individual businesses and industries.

Buffet's statements are illustrative. Berkshire Hathaway's businesses cover insurance, retail stores, newspapers and manufacturing. He famously has no technology investments. He says that the only industries which are not continuing to contract are the auto industry and housing.

Official figures

That would explain the discrepancy in official figures - which give no one except politicians comfort - and what is happening in the real world.

Much the same dynamic is at work here. The government's assistance to first-time home buyers may be stimulating construction and housing market growth, but it is an isolated and somewhat artificial phenomenon. In a practical setting, while it may save the businesses of some builders, it is of real use only for political debate in an election year.

The interest rate cuts may work in the long-run. Certainly the aggressive way the US Federal Reserve has been cutting rates has helped market sentiment. But the problem with interest rate cuts is that they take time to filter through the economy.

The recent rally on Wall Street and - to a lesser degree here - has been the result of optimism that the cuts will do their work in the future - not that they have done their work already.

The instrument of interest rates - one of the few left to macro-economic managers - is far from perfect in any event. No matter how cheap money is, it can't make businessmen invest if they are gloomy about prospects for the business climate.

If you are in any doubt of that look at the Japanese economy where interest rates have been set so low for so long, financiers are practically paying borrowers to take a loan, and yet the Japanese economy remains in the doldrums.

And that is what we fear is going to happen in the US and Australia. The stockmarket may have reacted well to interest rate cuts, but that optimism will wear thin when analysts and investors see little evidence of an upturn in corporate financial reports.

Sure, eventually they will have an effect, but not before further pain on the markets. That is in line with predictions - at least in the States, and what happens there has a big impact on how markets will react.

Analysts predict economic growth of only about 1% in the first half of this year rising to 2.5% in the last quarter.

If that is right, share prices could continue to languish for much of this year, only rising when there is clear evidence the real economy - and not just government figures - is improving.

Additional problem

In Australia we have the additional problem of it being an election year. And what an election year. With the parties already involved in a phony war, investors can expect little other than hype from them for months to come.

We can also expect more decisions like the Woodside/Shell rejection. Expediency in the electorate will take precedence over economic sense and this will be a further destabilising factor in the stockmarket.

If you take the long view of Warren Buffet, none of this matters too much. He has never cared about cycles. His horizon is so wide that a short-term blip means little. We are of the same opinion. While there is more work to do, structurally the Australian economy has never been in better shape. We should be able to ride the storm and recover faster than in the past.

It makes timing investments difficult in the short-term, but patience, and and eye for quality will win out in the end.


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