Investors have been shaken up this summer over fears of the double dip recession. It’s been in the media, it’s the hot topic at work, and the market sure is trading like it could happen. After August effectively demolished the gains from June, we find the S&P 500 closing at the lows of the day, seemingly destined to retest the 1040 support again sooner rather than later.

The volatile swings, while appearing overdone at times, may not be completely unjustified though. Lately, economic data has been awful, and the Fed can’t seem to agree on the best policy action. Last Friday, Real GDP was revised down to a 1.6% annual rate in Q2 2010 from the 2.4% in the first estimate. This latest figure confirms the fear – The recovery is losing momentum. Many investors believe the slowdown will accelerate, which may push us back into a recession.

However, it is important to understand that the main reason behind the lower revision to GDP growth wasn’t the consumer heading back into the bunker but rather a wider trade gap. The gap between imports and exports rose to roughly $444.9 billion, which marks the highest level since 2008. Imports rose 32.4%, which was above its 28.8% estimate. Exports rose by 9.1% versus a 10.3% estimate. This means that net trade subtracted 3.37 points from growth, which is the most is has done in 63 years.

Despite all the doom and gloom surrounding the revision, many investors probably missed the fact that Friday’s GDP report actually offered some encouraging news moving forward.

First, real final sales to domestic purchasers, which doesn’t include net exports and inventories, was revised up to 4.4%, which is its highest level since Q1 2006. This exceeded the earlier estimate of 4.1%, and is suggesting that domestic demand has picked up. If this demand can be sustained, it is highly unlikely that the US will slump back into a recession.

On Monday it was announced that personal consumption expenditures (PCE) rose 0.4%, which met expectations. The good news is that spending on durable and nondurable goods actually rebounded for the first time in four months, and real PCE rose by 2.0%, marking its fourth straight increase. Analysts note that while real PCE continues to perform below its historical average, it is still in line with the recoveries of 1991 and 2001.

Looking back at that troubling import figure, another thing to keep in mind is that while the number is substantially high, it can be partially credited to a spike in consumption and a constantly evolving international trade scene. Since the mid 1990s we have seen a shift in the makeup of our imports. Traditionally, the US has always produced skill intensive goods, and imported the more labor intensive goods. Nowadays, we see the trend shifting towards being an importer of both. In our quest for lowest possible production costs, we export the skill-based portion of production (such as a computer microchips and computer assembly) to low-cost countries. The recipient country assembles the plastic around the computer, and then sends it back to the US (thus becoming in “import”). The imported computer is actually net-contractual to our GDP figure, as there is domestic production and consumption not being factored in due to businesses using the international trade market to strive for lower production costs.

To be sure, the state of the economy will continue to be the focal point of the stock market. But as members of the glass-is-half-full club when it comes to betting on the USA, we’d like to leave you with a quote from Stephen Stanley of Pierpoint Securities, who nicely summed up his view of the data right now with the following. Stanley said, “Once again, reports of the demise of this expansion have been greatly exaggerated. While the loud pessimists are busy yelling about the economy falling off of a cliff, the reality is more like slogging through the mud. To be sure, the reality still stinks, but it is a far cry from the worst case fears that have been built into the markets.”

 

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