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As we enter October, short-term-investors are encouraged by the markets continued move upward and the shallow pullbacks which have accompanied this long rebound, implying little selling interest for now. Yet there is a feeling that things are not quite right.  Stocks are up. Bonds are up. Gold is up. Oil is up. Treasuries are stable. It’s rare that all of these asset classes move upward together. It’s enough to make a wise investor pause and consider why this anomaly exists and what it means.

To answer this question, I recently sat down with Dr. Senyo Adjibolosoo, a PhD in Econometrics and my MBA thesis sponsor at the Fermanian School of Business at PLNU. True to his credential in econometrics, Dr. Adjibolosoo was quick to explain why this economic anomaly was occurring. It’s a matter of the formula for gross domestic product (GDP), “C+ I+G+ (X-M)”, he said as he wrote the formula down on a napkin.


GDP = C + I + G + (X-M), where:

C=Consumer Activity I=Gross Investment Activity G=Government Spending

(X-M) = net exports

The U.S. government has only so many strategies by which to improve GDP. Famed economist Maynard Keynes was the first economist to recognize that a nation’s GDP is the result of the summation of economic variables which create a formula that can be manipulated to advance economic recovery during downturns.

As you can see from a review of the GDP formula, governments have four main variables with which to manipulate an economic recovery: 1.) consumer activity, 2.) investment activity, 3.) government spending, 4.) net exports. Take a moment to review the formula closely. Now ask yourself, if millions of people were counting on you, (insert name), to revive the U.S. economy, which two variables in the formula would you manipulate? Don’t be quick. It may cause thousands of people to lose their jobs, go bankrupt or fall prey to foreclosure. Not sure what to do? Here are two hints: 1.) Consumer activity is down for the count. 2.) Maynard Keynes hated government deficit spending unless it was driven from a forthcoming federal surplus. Okay, now which variables from the GDP formula are left to revive the economy?

If you chose investment activity and net exports, you are correct! You now know more about Keynesian economics than most people. Write your congressman. Tell a friend. Go to the head of the class. In order for the government to boost net exports, the dollar must decline. When the dollar declines against international currencies our manufactured products are cheaper, making them more attractive abroad and driving up export demand. As a result, (X-M), or exports minus imports, goes up. To boost investment activity, the government adds money to the banking system, lowers interest rates, and provides funding or stimulus spending for new infrastructure projects.

Clearly the government has been pushing all four variables: consumer activity, investment activity, government spending and net exports, in order to engineer a recovery. Investment activity, however, has been the most conspicuous part of the government’s push to help retirees and would-be retirees recover from severe losses taken in March. Consumer activity remains weak, although it is showing signs of improvement. Government spending is not spending so much as it is borrowing and net exports have seen improvement from a weaker dollar.

The government is expected to continue to support investment activity for some time. For example, most of the infrastructure spending in Obama’s stimulus plan, which falls under the category of investment activity, doesn’t hit the economy until 2010. As the economy rebounds, consumer activity should increase, supporting GDP. As the consumer strengthens, expect the Federal Reserve to tighten the money supply to combat inflationary pressures and strengthen the dollar. A stronger dollar will hurt net exports, but a stronger consumer and continued government support of investment activity should more than offset the reduction in export activity. Government spending and borrowing also looks here to stay as military spending continues in Iraq and Afghanistan, healthcare reform looms on the horizon, and programs similar to “Cash for Clunkers” or the first-time homebuyer tax credit are put in place. As recently as September 30, Obama has announced plans to spend $5 billion on medical research, medical supplies, and upgrading laboratory capacity (CNBC.com).

To put it in numbers, 2nd qtr GDP was revised upward on September 30, to -0.7%, beating consensus estimates. Recall that 1st qtr GDP was -6.4%, on an annual basis. According to Briefing.com analysts, the US is on track for positive GDP growth in the 3rd qtr. Even as positive momentum is returning, we continue to exercise caution as the market has rallied over 50% since March without a major correction and October tends to be a wild month in the stock market. Fortunately, we shouldn’t see anything as wild as last October!

I am currently accepting new clients. If you know anyone who needs the help of an experienced personal portfolio manager, please refer them to me. You can also give them a copy of this newsletter, and reference them to the “About Vaughn Woods” paragraph below.

Contact Us to learn more about working with Vaughn Woods Financial Group.

Best Regards,

Vaughn L. Woods, CFP®, M.B.A.

About Vaughn Woods: With over 25 years of experience, Vaughn Woods spends each day monitoring and managing client portfolios on a moment-to-moment basis. Recently recognized in Forbes Magazine, by Goldline Research, as a leading provider of wealth management, Vaughn Woods takes the unique approach of aligning the neuro-economic decision making needs of clients with the financial intimacy they desire. If you think a one-on-one relationship with a professional wealth manager is right for you or someone you know, than give us a call at 858-454-6900.

*Investors should be aware that there are risks inherent in all investments, such as fluctuations in investment principal. Past performance is not a guarantee of future results. Asset allocation cannot assure a profit nor protect against loss. Although the information has been gathered from sources believed to be reliable, it cannot be guaranteed. Views expressed in this newsletter may not reflect the views off Delta Equity Services Corp. The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. VW1/VWA0057. Fee paid to Goldline Research for administrative costs.

**Marketedge.com, Pershing NetExchange Pro, Bloomberg, Credit Suisse, Briefing.com
*** “Obama Unveils $5 Billion Plan to Create Health-Care Jobs”, 09/30/2009 cnbc.com