Stocks Inflate While Economy Deflates

February 4, 2013

Our 2013 investment outlook remains one of mild caution. 
-Regina Shafer, AVP of fixed-income investments, USAA 


Stocks shrugged off Wednesday's report that the U.S. economy contracted in the fourth quarter of 2012. The headline figure for real GDP declined slightly by 0.1% (measured quarter over quarter, at an annual rate), substantially weaker than the 1.1% growth expected by economists.

While the news appeared alarming at first, the underlying components were not as bleak. Government spending and inventory accumulation were large contributors to the negative surprise. The weak defense-spending figures may have been caused by anticipation of the large-scale defense cuts scheduled in "sequestration," as well as reduced military spending.

On the positive side of the report, personal consumption spending rose at a steady 2.2% rate (vs. 2.1% estimate). Business fixed investment rose at an 8.4% rate, indicating strength in consumer spending and capital investment, which points toward an underlying strength of the economy. The numbers continue to validate our view that the economy is growing at a below-trend rate while remaining above recessionary levels.

The labor market continues its slow healing process. The Labor Department reported that 157,000 jobs were added in January and revised upward December's estimated gain by 41,000 to 196,000. The unemployment rate ticked up 0.1 percentage point to 7.9%.

This week provided further confirmation of the rebound in housing as the S&P/Case-Shiller Composite Home Price Index increased 5.52% year over year. We continue to view housing as one of the primary tailwinds for the U.S. economy in 2013.

The U.S. Federal Reserve Board met this week and, as expected, maintained its stated policy to increase its balance sheet by $85 billion per month by purchasing Treasury bonds and mortgage securities. The Fed also reiterated its long-held policy of maintaining short-term interest rates near zero until the unemployment rate is meaningfully reduced. The Fed is clearly trying to encourage investors to take more risk by moving out of low-yielding short-term debt securities and into higher-risk investments such as corporate stocks and bonds.

Stocks powered to another five-year high, and the S&P 500 ended the week at 1,513, up 0.7%. U.S. Treasury bonds were sold off, with the yield on the 10-year rising 0.07 percentage points to close the week at 2.01%. Spot gold rose 0.5% to end the week at $1,667 per ounce.

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