The trade deficit numbers were released yesterday and, drum roll please, they were a little better than expected because of the recent pull back in oil prices. As I stated yesterday on CNBC, 40% of the trade deficit is oil which is priced in dollars, therefore a declining, or weakening dollar, will directly show up in the trade deficit numbers. Of course, this is not a revelation, all one has to do is look at a chart of the US Dollar as compared to the ebb and flow of the trade deficit and even an untrained eye can tell you there is a high degree of correlation between the two.
The trade deficit is a direct contributor to the economic equation:
GDP = C + I + G + (X-M)
Where: C = Consumption
I = Private Investment
G = Government Spending
X = Exports
M = Imports
The last part of the equation is what is relevant today. GDP has been declining over the last couple of quarters particularly due to the recent rise in the trade deficit but also combined with a decline in government spending and investment. The trade deficit numbers today, as imports declined relative to exports, will provide a positive contribution to the GDP equation. However, don’t get all excited about a strong bounce in the number as we will see negative contributions again from consumption, investment and government spending. More importantly the drag in imports was due to a large degree to the disruptions from the earthquake in Japan and the downward movement in oil prices. Data for May is already stacking up for quite a different picture.
Our current estimate is that the final estimate for 1st quarter GDP will be revised down to most likely between 1.5 and 1.7% growth with the 2nd quarter GDP coming in softer than expected as well.
As we stated yesterday, a weak dollar is not good for the economy in the near term or the long term. We need to focus on the things that will begin to reduce the drag on the economy and create a stronger dollar. This in turn will begin to assist in the strengthening of the economy.
How Does This Impact The Market?
This will continue to put pressure on the financial markets in the near term as declines in spending (both private and government) as well as consumption will continue to pressure on corporate profit margins. While the stock market is currently oversold, and should have a fairly strong bounce in the short term, the weakening economic environment will apply pressure to stocks that are priced for stronger economic growth. In turn this leads to a significant downside risk to portfolios that are heavily weighted in equities particularly if the Fed does not act to start bolstering the economy with another round of liquidity injections in some form.
As we continue to state….caution is advised.