Last month, we wrote in the middle of a busy week for economic data. High yield bonds had sold off. A strong GDP report followed. Stock prices reacted favorably, and Treasury bonds lost value. After some initial volatility, the S&P 500 has continued to move upwards, but bond prices have improved, too.
Market participants have had a chance to look into the numbers. They can see that inventories accounted for 1.66% of the 4.0% increase in GDP. Without the increase in inventories, the remainder rose 2.3%, in line with the 2.2% of sluggish real GDP growth we have seen so far in this recovery. Second quarter GDP was up just 2.4% from a year earlier, even with the second quarter inventory surge.
Those of us who are looking for decisive evidence that the economy can sustain growth without robust fiscal and monetary assistance are still waiting. We would like to see growth in nominal wages and salaries. Wages and salaries tend to be spent quickly since they are largely earned by middle and lower income people who lack sizable asset reserves. Growth in that category dropped from 7.0% to 6.1% from the first quarter to the second. Average hourly earnings were up only 2.0% from a year ago. Real hourly wages fell to $10.28 per hour, about the same as $10.30 reached in April 2013, according to the Bureau of Labor Statistics.
With Quantitative Easing expected to unwind in October, equity investors now seem to be focusing on when the Fed will increase short-term interest rates. If economic growth does accelerate and labor markets improve, then the Fed may move early next year. In the meantime, though, it looks like growth will continue on its present 2.0% plus path with modest increases in the labor force. We believe the Fed will be cautious in raising rates.
Investors have other concerns, though. Unfortunately, the situation in Ukraine seems to be heating up. Argentina is flirting with another government bond default. The European markets have been weak, with Germany, France and Italy reporting disappointing numbers. Additionally, their proximity to the Middle East and dependence on Russian natural gas increase uncertainty. Talk of economic sanctions, which would reduce global trade, negatively affects consumer and business confidence.
Many economic strategists have been expecting long-term interest rates to rise. Considering what has been going on in the global economy, it is not surprising that interest on the 10 year US Treasury note has been falling.
John Hess 
Falgun Jariwala 
Managing Principal Managing Director
jhess@nsinvestors.com fjariwala@nsinvestors.com
www.nsinvestors.com www.nsinvestors.com
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