If the Economy Is Improving, Why Are Investors Pricing in a Slowdown?

The Bureau of Economic Analysis (BEA) surprised even the most optimistic of economists when it reported the U.S. economy grew at an annual rate of four percent in the second quarter of 2014. 

On the surface, the number—four percent growth—sounds great. But how serious should we take that gross domestic product (GDP) figure? 

Firstly, I’d like to start by pointing out that the BEA often revises its GDP numbers down. We saw this happen in the first quarter. First, we saw the BEA say the U.S. economy grew by 0.1% in the first quarter, then after a couple of revisions, they said the economy actually contracted 2.9% in the quarter. 

I obviously expect the BEA to lower its initial second-quarter GDP numbers again. 

But here’s what really worries me… 

If the GDP data suggests the U.S. economy is growing, why are investors pricing in an economic slowdown? 

The chart below is of the 10-year U.S. Treasury, the so-called safe haven. Back in 2007 to 2009, investors ran to U.S. Treasuries as a safe haven. As the U.S. economy improved, the yields on the 10-year U.S. Treasury started to rise as interest rates rose with general optimism towards the economy. 

 

Chart courtesy of www.StockCharts.com 

But since the beginning of this year, yields on the 10-year U.S. notes yields have declined 18%. This is despite the fact the biggest buyer of these bonds, the Federal Reserve, has stepped away from buying these Treasuries as its quantitative easing program comes to an end. 

At the same time, we have the stock market finally starting to give in. So if the stock market is a leading indicator, and it is down four percent this year (measured by the Dow Jones Industrial Average), and the yield on 10-year U.S. Treasuries reflects a slowing economy, not a growing one, how could we have GDP growth of four percent? Doesn’t sound right to me. 

The U.S. economy is getting softer here in 2014, not stronger. 

This article If the Economy Is Improving, Why Are Investors Pricing in a Slowdown?

was originally posted at Profit Confidential