Can the economic recovery continue?

There's plenty of room for optimism with today's new signs of growth.

By Anthony Mirhaydari Jan 29, 2010 2:26PM

MirhaydariInvestors were pleasantly surprised Friday morning by news that the U.S. economy expanded by a whopping 5.7% annual rate in the fourth quarter of 2009 -- the most since 2003. This was well ahead of the 4.5% consensus estimate and solidly beats the 2.2% growth managed in Q3. The turnaround is the largest in almost three decades.


The main driver of the performance was a slowdown in the rate at which businesses were drawing down their inventories. This area alone contributed 3.4% to overall growth in the quarter. Paul Ashworth at Capital Economics in London believes that inventory rebuilding will continue to boost GDP growth for two or three more quarters.


But what happens after that, especially as the stimulus spending out of Washington winds down later this year? The big question is: Can this rate of growth continue?




Ashworth notes that by filtering out the impact of inventories and external trade with other nations, a more accurate measure of the underlying strength of the domestic economy actually slowed in Q4. It dropped to 1.7% from 2.3% in Q3. You can see this represented in the chart above.


Still, there is plenty of room for optimism. The crack economists at the ISI Group in New York recently highlighted evidence that a solid, if not overly rapid, recovery remains on track here in the United States: Leading economic indicators continue to improve, earnings revisions remains positive, vehicle production is up, steel production is up, oil and gas drilling rig counts are up, and semiconductor equipment sales are up.


Exports are also improving, up 18.1% vs. a 10.5% rise in inports, thanks to the increased competitiveness of the U.S. dollar.


Moreover, the ISI Group's private survey of corporate confidence continues to improve; in fact, their survey of retailers moved to a new high this month, suggesting that consumer spending has bounced back.


The ISI Group notes that prior economic recoveries have either been fast or slow; with growth of either 3.5% or less or 6% or more.  What they are predicting is a recovery that isn't slow and isn't rapid: A middling economic recovery with growth 4.5% this year and 3.5% in 2011.


Moving forward, business spending is likely to be the main driver of growth. Consumer spending is responsible for a record 71% of the economy while capital expenditures by businesses make up only 9.5%. During the economic expansions of the mid-1990s and the mid-2000s, business spending swelled to upwards of 13% of GDP. We're already seeing early signs of this: Business investment expanded by 2.9% last quarter driven by a 13.3% rebound in spending on equipment and software.


The stocks that are poised to outperform includes those with the most exposure to this trend including the likes of Caterpillar (CAT), General Electric (GE), and United Technologies (UTX). Also included on the list are technology and software names like Oracle (ORCL).


Disclosure: The author does not own or control a position in any of the funds or companies mentioned. You can watch him trade during the day at Wall Street Survivor here.


Anthony Mirhaydari is a researcher for the Strategic Advantage investment newsletter. He can be contacted at Feel free to comment below.

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