The first estimate of U.S. Gross Domestic Product for the fourth quarter of 2008 shows the economy fell off a cliff in the aftermath of the Lehman Brothers failure in September. Real GDP declined at a 3.8% annual rate in the quarter, which is the worst performance since 1982. This is a rapid deceleration in economic activity following the third quarter GDP of -0.5%. But looking beyond the headline figure, this report is even weaker than the headline suggests. A big increase in inventories of over $6 billion makes the headline look better, when in fact real final sales, which excludes inventory changes, declined at a 5.1% annual rate.

Declines in business activity were broad-based. Consumer spending fell 3.5%, real business spending fell 19.1%, exports declined 19.7%, and imports were down 15.7%. Vehicle sales plunged at a 63% annual rate, accounting for over half the decline in GDP. Government spending, no surprise here, was the only category that rose. Deflationary pressures emerged, as the price index declined at a 4.6% annual rate, and excluding food and energy, prices rose at the slowest rate in nearly 50 years.

Stocks, of course, sold off on the weak GDP report, ensuring the worst January on record. The S&P 500 declined 8.57% in January and has given back half of the gains from the November 20th low. Before we break out the old saying, “As goes January, so goes the year”, remember that this theory is most accurate when the January performance was positive. Barron’s reports that of 22 January stock market declines over the past six decades, 11 led to further losses that averaged 14.1%, while the other 11 were followed by gains that averaged 9.2%.

This week the market will be focused on key economic reports and critical developments in Congress. Specifically, the December payroll employment report will be released Friday. Economists expect employment to shrink by 533,000 jobs and the unemployment rate to bump up to 7.5%. Also look for prior months’ employment figures to be revised lower, in keeping with the trend of recent months.

Finally, investors will closely watch the deliberations in the Senate with regard to the stimulus plan. The version passed by the House of Representatives last week offered little in the way of true economic stimulus, with much of the plan amounting to a large increase in existing entitlement programs and pork spending. An intense fight in the Senate is expected as members attempt to modify the bill. In addition, we will watch for developments on how the second half of the $700 billion TARP will be spent, including the potential creation of a “bad bank” to hold toxic bank assets.


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