This patient may need a defibrillator…

Today, the  non-partisan Congressional Budget Office (CBO),  published a report estimating that government stimulus raised real GDP (Gross Domestic Product) by anywhere from 1.7% to up to 4.5% in the second quarter of 2010.   The report is 20 pages long, but is worth a look.  Reuters put out a piece this afternoon that summarizes the report.

A revised Q2 GDP number will be released this coming Friday.  The consensus from economists polled by Reuters is that the economy grew in Q2 at a rate of 1.4%.  Piecing together this number with the CBO’s estimate of the stimulus’s impact leads to the uncomfortable realization that without government stimulus, the US economy contracted in the second quarter, pointing to evidence of a dreaded “double dip recession.”

While this outcome has surprised many market commentators (particularly those in the bullish camp), for almost a year now we have been skeptical that the US economy would come roaring out of our worst recession since the Great Depression, despite the injection of hundreds of billions of dollars in government stimulus.

In our 10 Themes for ’10 we published in January, our #6 theme was the following:

A cold year for growth: We expect the US economy will see almost negligible growth in 2010.  Margins will continue to contract for US businesses and profit growth will remain slim. The expiration of stimulus programs and slim prospects for their renewal in a mid-term election year will reduce aggregate demand.  Cost cutting and efficiency measures will continue to be necessary to offset top-line deterioration.

We believe the impact of the combined credit, real-estate and stock market crisis of 2007-2009 will take years to resolve.  Typically, recovery from such crises has impacted growth rates for 5-10 years as households rebuild savings. Unfavorable demographic trends (such as in Japan), can push growth even further into the future.

In our Q1 quarterly letter, published in April, we wrote the following:

Withdrawal of Economic Stimulus. The other major theme we expect to impact our economy over the rest of the year is the withdrawal of extraordinary fiscal and monetary stimulus programs put in place during the crisis. Various measures by the Fed, European and Asian central banks to provide liquidity support to banks and markets will be withdrawn over the course of the next several months.  Numerous stimulus programs across the world will also be removed over the course of this year, including bank loan fueled infrastructure spending in China.  As the global economy has these crutches removed, we will watch with great interest to see how severe the damage to core private enterprise has been.  We will also keenly track developments in trade agreements since various countries have enacted or are considering trade barriers and currency related moves to protect key industries and exporters.

As evidenced by the CBO report, it appears the damage to private enterprise has been fairly severe and far reaching.  Now that the crutch of government stimulus has been removed (with little likelihood of another round on the immediate horizon), our economy does not appear to be the picture of great health that some market commentators would have us believe.