According to recent data from the Bureau of Economic Analysis, the US economy contracted by 3.8% on a quarter-on-quarter annualised basis in 4Q 2008 (See Table 1). Though better than consensus expectations, it was the most severe slowdown since 1982 and shows the severity of deterioration in the world’s largest economy. In prior coverage, we had forecasted negative growth in 2Q and 3Q 2008, but actual growth was better than expected in 2Q 2008, possibly due to the tax rebates handed out in that period, which helped to delay the onset of a consumption decline. Despite this boost, consumption only contributed 0.87% to 2Q 08 GDP growth, and we have seen the fall in personal consumption take its toll on GDP in the second half of 2008. Table 1: GDP Components (Actual, Annualised quarter-on-quarter change) 2008-I 2008-II 2008-III 2008-IV Gross domestic product 0.9% 2.8% -0.5% -3.8% Personal consumption expenditures 0.9% 1.2% -3.8% -3.5% Gross private domestic investment -5.8% -11.5% 0.4% -12.3% Exports 5.1% 12.3% 3.0% -19.7% Imports -0.8% -7.3% -3.5% -15.7% Government consumption expenditures and gross investment 1.9% 3.9% 5.8% 1.9% Source: US Bureau of Economic Analysis Advance GDP figures showed that consumption contributed -2.47% to 4Q 2008 GDP. While net exports boosted GDP in the first 3 quarters of 2008, the strength of the US dollar in 4Q 2008 hurt demand for US goods. Despite the negative quarter-on-quarter annualized growths in the last two quarters of 2008, for the whole of 2008, the US economy grew 1.1% (based on adjusted figures). But we think that 2009 will mark a contraction in the US economy. Government spending contributed little (0.38%), but going forward, this may get a boost from the US$787 billion economic recovery plan which recently passed the scrutiny of both the House of Representatives and the Senate.

Chart 1: Consumption of durable goods and total spending Chart 2: Savings rate

Our US Growth forecasts for 2009

Given the poor conditions in the US housing and job market, we expect personal consumption to remain a detractor to growth in 2009. Consumption contracted 3.5% in annualised quarter-on-quarter terms in 4Q 2008 but given the poor December 2008 retail sales figures, we forecast a downward revision in the final GDP number which will drag down the final 4Q 2008 GDP figure to a 4.1% quarter-on-quarter annualised contraction.

While government spending plans are substantial, the actual impact will be long-drawn and small in comparison to actual GDP. We foresee a mild recovery (0.3% q-o-q annualised) in the US economy in 3Q 2009, led by increased investment by corporates taking advantage of cheaper credit to expand businesses, but we expect 2009 full year growth will still be a negative 1.4% year-on-year.

Unsustainable Consumer Habits

Strong US consumer spending in the past few years came together with an extremely low savings rate. This, in turn, was driven by a booming housing market which made consumers feel wealthy and more willing to spend most of their disposable income. In fact, the savings rate actually turned negative in 2005 (See Chart 2), meaning US consumers spent more than what they earned after paying their tax that year, either by drawing down on savings or by getting cash-outs from existing mortgages as home prices sky-rocketed.

The situation has changed now with home prices plunging and sentiment in the pits. The savings rate recently increased to 3.6% in December 2008, after remaining under 1% for most of 2005, 2006 and 2007. This suggests that any cash handouts received at this point may be saved rather than spent, which will not give rise to a significant rebound in household spending. A move towards higher savings is positive in the long-run as it will help to reduce uncomfortably high household debt levels, but this will mean more pain for the economy in the near-term.

We are likely to see an increasing US personal savings rate, which has been too low for far too long, and this will depress consumption going forward. Fears of unemployment and falling home prices will continue to weigh on consumer spending. Latest consumption data showed that consumer spending fell 1% in December 2008, the 6th straight month of decline. Going forward, it is likely that spending may not return as swiftly as many would hope, with many more jobs still likely to be cut in early 2009, and home prices still in limbo.  

US personal consumption is facing strong headwinds, and the current environment is not supportive of free-spending by the average US consumer. It will take time for this recessionary cycle to play out; for companies to be done with job cuts, for home prices to stop falling and for confidence to return.

A mild recovery in 3Q 2009, driven by domestic investment

Instead of the US consumer spending its way out of this downturn, there are suggestions that domestic investment may be the next driver of growth for the US economy. A low interest-rate environment is supportive of business spending. While corporate spreads remain wide, any increase in investor risk-appetite will see a narrowing of spreads which will help reduce the cost of borrowing for the corporate sector. We foresee this translating to cheaper expansionary plans which will boost domestic investment as early as 3Q 2009.

Moreover, we feel that US home prices may stabilise in the second half of 2009, as government stimulus and increasing investor interest in mortgage-backed securities will help lower mortgage costs, reviving the US housing market and providing a boost to residential domestic investment.

We feel that there is less downside risk for the US equity market after the huge correction in 2008, but it will take time for the economy to heal and for the market to reflect signs of a recovery. Based on our forecasts, we are looking at two more consecutive quarters of quarter-on-quarter declines in GDP (a total of 4 consecutive quarters of decline), after which we expect to see a mild recovery in 3Q 2009. While earnings are uncertain going into 2009, a price-to-book measure of the S&P 500 of 1.73X (as at 13 February 2009) means the US market is at its most attractive level in at least 14 years. We have a 4-star or “very attractive” rating on the US market, primarily on the basis of low current valuations in comparison to the historical levels.

A recovery for the US economy and stock market is inevitable, and the question is not whether a recovery will materialise, but rather, when it will happen.