Upbeat news on the US economy last Friday should have been a headline-grabbing event, but images of massive street protests in Egypt stole the show instead ... and sent the stock market reeling at the end of last week.

I’ll give you our take on the troubles in the Middle East in just a few minutes ... but first, let’s cover the positive economic news here at home ...

On Friday, the Commerce Department unveiled the latest data on US gross domestic product (GDP) for the fourth quarter of 2010, which shows our economy ended the year on a high note. Investors closely track GDP because it’s an all-inclusive scorecard of US economic activity ... revealing the big picture trends in consumer spending, business activity, exports and government spending.

One of our biggest concerns about the current recovery is that it was being driven mostly by government stimulus spending ... not to mention the Federal Reserve’s aggressively easy monetary policy.

In other words, many investors shared a valid concern: Was the expansion in 2009 and 2010 real organic growth ... or was it just an illusion ... an artificially-induced, temporary sugar high for the economy?

But last Friday’s report showed the US economy gaining upside momentum in all the right places — an encouraging sign ...

First, headline GDP growth checked in at a 3.2 percent annual rate in the fourth quarter of 2010. This was slightly below consensus forecasts of about 3.5 percent — but it’s a first estimate that’s likely to be revised higher.¹

This fourth quarter 2010 GDP report stands in sharp contrast to the dismal data we witnessed just a few quarters ago.

Recall that after a strong start to the recovery ... including robust GDP growth of 5 percent in the fourth quarter of 2009 ... the expansion appeared to be running out of steam early last year. In fact, GDP growth slowed sharply — from nearly 4 percent in the first quarter of 2010 — to just 1.7 percent in the second quarter ending June.²

Typically, when growth slows to 2 percent or less, the economy ends up sinking back into recession ... which is exactly why we were concerned about the potential for a double-dip last year. But as it turned out, growth indeed picked up again in the second half of 2010 — avoiding the dreaded double-dip scenario— and the economy is now clearly gaining momentum.

Second, personal consumption growth rose at a 4.4 percent annual rate — the fastest pace of consumer spending since 2006. Despite continued deleveraging on consumers’ personal balance sheets, and in spite of ongoing concern about home values, this shows that Mr. & Mrs. US Consumer appear to be alive and well after all.³

Third, consumption growth alone accounted for fully 95 percent of total economic output last quarter. Business investment (which grew 5.8 percent year-over-year) and strong growth in exports (up 8.5 percent annualized) were the other bright spots contributing to a solid report overall.⁴

Fourth, real final sales finally came through ... posting a huge annualized gain of 7.1 percent last quarter — the fastest pace since Ronald Reagan was in his first term as President. Final domestic sales growth (excluding exports) jumped at a healthy 3.4 percent yearly rate.⁵

As you’ll recall, another concern we’ve had about the economy’s recovery path last year was that real final sales growth in the domestic economy had been extremely anemic up to this point ... much slower than in previous recoveries. That’s because government deficit spending had been propping up growth ... and adding to our national debt burden in the process.

But we believe the latest data indicates — at long last — that genuine, organic growth appears to be taking the reins of this recovery away from government stimulus spending.

Although a single quarter does not make a trend, if this momentum continues, it will be a welcome sign of more broad-based and perhaps enduring growth ahead.

Market Psychology Another Key Factor

Needless to say, there are still risks that could derail the upside momentum in our economy ... or at least distract investors enough for markets to correct in the near term.

For instance, look at the impact political unrest in Egypt had on our markets last Friday in spite of the positive economic news. But, let’s add some perspective here too ...

In spite of the graphic videos of machete-wielding Egyptians roaming the streets of Cairo, Egypt’s economy is only about the size of Louisiana ... and we contend there is little risk that this event alone could negatively impact the US economy. But of course, you can’t discount the possibility of a larger contagion risk.⁶

Remember, recent political unrest started in Tunisia and then spread to Egypt — a far more strategically located and influential country in the Arab world. Although perhaps unlikely, a wider outbreak of political protests ... in say Saudi Arabia or Iran ... could trigger a major spike in crude oil prices.

Investor psychology is also a factor, which can have just as big an impact on stock prices in the short term, as economic fundamentals do in the long run.

Fundamentals like GDP, corporate sales and profit growth have the biggest long run influence over asset values, to be sure. But in the short term, markets can be driven more by the irrational emotions of fear and greed — with little regard for the underlying fundamentals.

Since stock markets were already at overbought levels in recent weeks, the events in Egypt offer a convenient excuse for a reversal. The selling last Friday gave way to a quick bounce back early this week, so this pullback was limited. But it’s also possible a more meaningful correction could happen. Only time will tell.

However, other asset classes that appear oversold, including gold and US Treasury bonds, actually benefited from the flight to safety last week, and could be poised to rally further if political unrest escalates.

Proactive Investors Should Remain Alert

One thing is clear to us, there appears to be definite rotation taking place right now in stock sectors, which is not unusual as the market pauses to prepare for its next move. The performance of some of last year’s favorite sectors, including consumer discretionary and basic materials stocks, have been slipping so far in 2011.

Discretionary stocks as a group are off 0.6 percent year-to-date (through 1/28/11) while materials are 1.3 percent lower. Meanwhile, the S&P 500 Index is up 1.8 percent over the same period. At the other end of the performance spectrum, energy (+5 percent), technology (+3.7 percent) and industrials (+3.5 percent) are leading the way higher. In our equity portfolios, we are happy to be currently overweight in these particular sectors, among others.⁷

The bottom line is, with continued volatility and markets undergoing a potential transition in leadership, this is a good time for proactive investors to carefully evaluate their current investment holdings.

At Banyan Partners, we’ve been making tactical shifts in our client portfolios in recent weeks as part of our opportunistic investment approach. Perhaps you should consider doing the same.

For instance, if you’ve been waiting for higher bond prices to reduce your long-term US Treasury holdings, we may soon witness the start of a short-term uptrend in this oversold market.

Also, you may be concerned about protecting gains in individual stocks or ETFs ... or perhaps you want to consider hedging against future risks.

Right now is a good time to have that conversation with a financial advisor.

Unexpected events can and will influence market prices in the short term, regardless of the fundamentals.

But as investors, we have to discipline ourselves to stay objective, no matter what’s in the headlines.

Don’t let headlines about political unrest in foreign countries distract you from what appears to be a genuine improvement in the long-term fundamentals of our economy.

Good investing,

Mike Burnick
Director of Client Communications
Banyan Partners, LLC

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¹ Ned Davis Research: Daily Economic Commentary, 1/28/11
² Bloomberg market data, 1/7/11
³ Ned Davis Research: Daily Economic Commentary, 1/28/11
⁴ Econoday: 2011 Economic Calendar, 1/28/11
⁵ Ned Davis Research: Daily Economic Commentary, 1/28/11
⁶ NPR.org: Planet Money Blog, 1/31/11
⁷ Bank of America Merrill Lynch: Market Analysis Comment, 1/31/11