Turbulence

This was to be a busy week of U.S. economic news, but markets themselves grabbed the headlines.

Chinese stocks fell almost 9% in Shanghai overnight Tuesday. The Dow responded by dropping over 500 points as part of a world wide rout in share prices.

Among the economic news, there was plenty to make investors revise their expectations.

Alan Greenspan suggested there might be a recession in our future. (See below.)

GDP growth

The estimated growth of the U.S. economy was revised downward. The Commerce Department said GDP grew only 2.2 percent (that is a seasonally adjusted annual rate) far short of the 3.5 percent initially reported. That is one of the largest downward revisions in a long time. The main culprit was the estimate of inventory investment, although downward revisions of fixed business investment spending and consumer spending on durable goods and nondurable goods all contributed.

The fourth quarter saw a big inventory sell off. Although this pulled down estimated GDP growth by 1.35 percentage points (final sales grew 3.6 percent), a drop in inventories can be a good omen for future production. We must take a careful look at its composition.

New home sales dropped 16.6 percent in January.

The housing sector is continuing to worry investors. They are right to worry. The lenders who financed the run-up in house prices are now finding their capital strained. See Justin Lahart: "After Subprime: Lax Lending Lurks Elsewhere" and Robin Sidel And David Reilly, "No Worries: Banks Keeping Less Money in Reserve."


The fallout

Viewed from the vantage point of Thursday afternoon, investors seem to have taken Professor Greenspan’s advice. They are now a bit more risk adverse. Consequently stocks are a bit cheaper, government bonds a bit dearer, and high yield bonds’ yields are higher. And analysts are now a bit gun shy about saying the economy has nowhere to go but up.