Forget the Debt Ceiling Debate… Where’s the Economic Growth?

It is our contention at Hennion & Walsh that the market has essentially priced in the belief that an agreement on raising the current debt ceiling will happen.  It is just now a question of when the agreement will be finalized and what the length and terms of the finalized agreement will be.  Unfortunately, the finalization of the agreement may not be enough to avert further consideration of a downgrade to the U.S. AAA credit rating by the rating agencies.   Regardless, after this current debt crisis is behind us, investors, in our opinion, will return their focus to a stalling economic recovery that is facing multiple headwinds.  These headwinds include a stubbornly high unemployment rate, a disturbing trend of increasing jobless claims, elevated commodity prices, a lackluster residential real estate and increasing sovereign debt problems overseas and, as previously discussed, on our homeland.

We believe that the equity markets would have suffered more of a hit initially this morning when reports on U.S. Gross Domestic Product (GDP) growth came across the newswires, if not for the belief by many investors that the pending agreement in Washington on the debt ceiling debate will move the equity markets higher over the short-term by removing that particular area of uncertainty.  The most recent batch of economic reports showed that U.S. GDP experienced a lower than expected 1.3% annualized increase in the second quarter of 2011 (consensus forecast was 1.7%).  However, the downward revision to growth in the first quarter of 2011, to just 0.4% from the previous estimate of 1.9%, was even more disturbing.

Further, consumer spending, which accounts for approximately 70% of U.S. GDP, inched up by an annualized rate of just 0.1% during the 2nd quarter of 2011 – the weakest rate in two years – and consumer sentiment, not surprisingly, was also lower in July as reported by the University of Michigan. These reports provide further credence to our belief that that this economic recovery may be a longer, more drawn-out recovery than many market professionals, including the Federal Reserve, initially anticipated.

We recognize that the debt ceiling debate may make for interesting political theatre for some.  We also recognize that the spending and revenue issues underlying the debate need to be addressed sooner than later.  However, the heightened threat of stagflation*, now present in the system, is of paramount concern to us.

*Stagflation is a financial term often used to describe an environment where inflation (i.e. prices) is high and economic growth is low.  Periods of stagflation have historically been accompanied by high unemployment as well.