Can the Fed Turn this Mess Around?

The reporting of a weak U.S. gross domestic product (GDP) for the fourth quarter of 2007 on Thursday was not a surprise to me. Coming in at a dismal 0.6% rate, the fourth quarter reading was unchanged from the third quarter, but there is now added economic risk. Should the GDP reading in the first quarter of 2008 decline or be negative, then a weaker or negative GDP in the second quarter could point to a technical economic recession. Of course, things are already slow.

A key variable to monitor will be consumer confidence, which continues to be a key focal point for investors since consumer spending accounts for two-thirds of GDP. The Conference Board reported that consumer confidence in March came in at a soft 64.5,
well below the 73.0 estimate. It was also the lowest reading since a 61.4 reading in March 2003. The concern is that the weak consumer confidence will cause consumers to hold back on spending, especially on big-ticket items and housing, and this would negatively impact the economy heading into the second quarter.

The wildcard will be the effectiveness of the Federal Reserve to keep the economy afloat with its massive $162-billion economic stimulus program and efforts to provide liquidity to the economy in order to avert a recession and a collapse in the credit markets. The Fed cut its key Fed Funds rate by another 75 basis points to 2.25% at the recent FOMC meeting, but so far the economic picture continues to show downside risk. The Fed’s move is positive, but we are not sure that it will be enough to turn around the ailing U.S. economy and softening consumer spending.

If the economy continues to soften, we could see a decline in cyclical and small-cap stocks, as they are more vulnerable to a slowdown. Hang on, the ride could be bumpy.