Midday Musings: Risky Business and the GDP Report

The government's preliminary report on fourth-quarter GDP today showed the economy grew by 1.4% last quarter, revised from 0.2% in the advance report and well ahead of consensus expectations for 0.9% growth.

The question now is: How will investors interpret the report?

One possibility is that they'll conclude fourth-quarter growth was artificially -- or at least temporarily -- induced by aggressive monetary policies and robust government spending after the Sept. 11 attacks, as well as by deep incentives from automakers.

Clearly, there is evidence to support this argument, which in turn supports the double-dip theory of (among others) Morgan Stanley's Stephen Roach. With a gain of 4.1%, personal consumption was the biggest contributor to GDP. Of that total, record vehicle sales accounted for about 70% of the increase. With a gain of 1.8%, government spending was the second leading contributor to fourth-quarter GDP. It was the biggest quarter for government spending since 1978.

A far more optimistic interpretation is that the recession ended in the fourth quarter, meaning the much-ballyhooed downturn of 2001 produced only one quarter of declining GDP. That, in turn, might prompt a revival of the New Era economic theory previously thought to have been debunked.

Leading indicators suggest "there's an end to recession now, with growth ahead with low inflation and good productivity numbers," said Lakshman Achuthan, managing director of the Economic Cycle Research Institute. Given that, "it's going to be hard for some forecasters to resist the 'return of the New Era' explanation," he said.

The ECRI does not share that view, and Achuthan was very clear that there's risk in it. "It's that kind of misinterpretation that encouraged some excesses that brought on the recession in the first place," he said. Still, "I don't see how that temptation can be resisted," he said.

Yesterday, Federal Reserve Chairman Alan Greenspan was unable to resist the temptation to at least give a nod to the New Era theories he has long championed.

In his congressional testimony, Greenspan discussed how "preliminary data suggest that productivity has held up very well of late, and history suggests that any depressing effect of rapid productivity growth on employment is only temporary."

The chairman also waxed longingly about how the availability of real-time information played a key role in ensuring "the imbalances that triggered the downturn and that could have prolonged this difficult period did not fester."

The Inventory Question

As with his Jan. 11 speech in San Francisco, Greenspan gave no airtime to the issue of how, if just-in-time inventory management is so wonderful, so many companies -- notably high-tech firms -- found themselves with so much excess inventory.

The answer is that if you believe in the idea of a New Era, "then the conclusion is the risk of a downturn is less. And when you believe that, it is rational to buy on dips and build excess capacity," Achuthan said. "Those kind of misperceptions of risk created excesses in stocks and capacity in the late 1990s."

The economist suggested a return of New Era thinking won't have the same result as in the late 1990s, "but it may engender or embolden some people to underestimate the risks" again.

That gets to the heart of this column's critique last night of the chairman. It also dovetails nicely with yesterday's musing about the potential for a "rediscovery" of tech stocks, even though the Nasdaq Composite was underperforming at midday today.

Even if you wholeheartedly disagree with the New Era theory, you have to admit that many people want and need to believe in it. From the traders' perspective, the key is that they're not going to wait for confirmation that the recovery in either the economy or tech spending is sustainable.

With the stars aligning for another tech-stock surge, prudent investors should either get on board or get out of the way.

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