The Big Picture

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7.2%!

Monday, November 03, 2003 | 04:08 PM

Drilling Down into the numbers
plus, a look at mutual fund inflows

The sizzling 7.2% GDP number was beyond nearly every estimate of growth for the quarter, including our own guess of 6.25-6.50%. Surprisingly, the market failed to react much on Thursday or Friday. Was the number fully baked into the cake, or is something else going on entirely?

We note at the outset that the large dose of economic adrenaline provided by tax cuts and credits were most certainly the source of the big GDP number for Q3. While there certainly will be some continuing impact from tax cuts and mortgage refinancings, the lion’s portion of the stimulus - tax rebates and refi cash outs - is now behind us, in our view. Indeed, Bridgewater Associates observed that the “Treasury sent out $13.7 billion in child tax-credit checks in July and August. Without the orgy of spending those billions unleashed, GDP growth in the quarter would have been 3.39%, a good performance,but hardly breathtaking.”

We agree, noting an additional dark lining to the silver GDP cloud: Autos, Home Construction, and Defense Spending were big contributors to last week’s monster GDP number. These sectors, unfortunately, are not where new job growth will be coming from. On the other hand, the service sector - which is the source of most new jobs - grew at only 1.8% - way below the past 10 year average of 2.6%, according to NDR. That is very significant, because the most new jobs in this economy are going to be created in the service sector.

We noted last week that the healthy increases we have seen in Money Supply (M2) were trailing off. That is worrisome, as M2 acts as fuel for the market. This week, we add to our list of concerns Mutual Fund Inflows. Early looks at the October fund flow data suggests that over $30 Billion dollars in new money flowed to U.S. domestic equity funds, the highest level of fund flows since the $35.5 Billion reported in February, 2000. (We do not expect similar carnage).

While we are cognizant that fund flow eventually gets put to work by fund managers - most of whom do not like to sit in cash - we also must note that big fund flows tend to mark the last leg up of a market move, and not the beginning. In addition to the aforementioned February 2000 flows, we note that when the Dow was recently at 7,500, most equity funds experienced net redemptions. Smart money trades opposite the fund flows at their extremes.

The trend remains up: tighten stops and the market will (eventually) take you out of your holdings at the right time.