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Factory Follies
New York: April 12, 2010
By John Stephenson

Lately, the stock market has been cheering a sharp rebound in US economic output and industrial productivity. While Wall Street trumpets market data that seems to suggest that output per worker is soaring and businesses are churning out products faster than anyone realized is possible—Main Street remains perplexed. After all, with official unemployment continuing to hover around 10 percent, is an economic miracle really taking place? No.

Increasingly, the strength of the American industrial rebound looks questionable. The latest gross domestic product (GDP) reports are case in point as they suggest that output per worker expanded at around 7 percent annualized rate over the last three quarters—a huge jump in productivity. Not only has output per worker soared, but hours worked—another important indicator of industrial activity—has remained stagnant. This suggests that the existing cadre of workers is producing more goods, but without increasing the length of their work week.

While sharp snapbacks in productivity are certainly possible after troughs in economic activity as semi-idle employees are put back to full use again, the size of this rebound boggles the imagination. In past cycles, there would be at least some growth in hours worked. This time round, layoffs are continuing, while GDP is surging ahead at a more than five percent annualized rate.

So what gives? It would appear that the GDP data may in fact be over-stating the strength of the US economic rebound. The GDP data is compiled using survey data, which encompasses samples of large businesses, but only partial reports from smaller firms. There is mounting evidence that the downturn in the US economy was particularly hard on smaller firms who have little access to the bond market and are reliant on bank loans for expansion. Banks have cut lending capacity and have not loosened historically tight lending standards, putting further pressure on smaller businesses.

Adding to the conundrum is the rapidly rising quantity of imports into the United States that are not yet being picked up in the official figures. As businesses continue to outsource to low-wage countries, some of the “foreign” productivity gains are actually being counted as “domestic” gains. The official data is based on shipments per hour worked, rather than the domestic value added, suggesting that some of the foreign content is not accurately being stripped out of the basket of US made goods.

The implication of all of this is that the strength of the American economic recovery has been vastly overstated, by as much as 1.5 percent. While a recovery is underway, it is not nearly as robust as the GDP figures have suggested. A slower growing American economy suggests that inflation and hence rate hikes are going to be a long time in coming.

Given that the US economy appears to be growing, albeit slower than many market watchers have predicted, then it may be appropriate for investors to reduce the “risk” trade and rotate into classically defensive areas that have lagged the market over the last twelve months.

In particular, investors should focus on defensive stocks that pay a healthy dividend. If US economic growth continues to remain sluggish, with little or no job creation, then investors will be well-served by dividend-paying companies. These stalwarts of the US economy pay investors while they wait for economic growth to rebound once more. Utility and telecommunications stocks appear to be the most attractively valued with many offering dividend yields in the six to seven percent range.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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