US Economy
New data shows the U.S. economy contracted in the first
quarter of this year, keeping pace with shifting expectations but down sharply
from the prior already disappointing estimate. (Sharf, 2014)
Starting with data stateside, the U.S. economy contracted
for the first time in three years in Q1 2014 as output literally and
figuratively froze under a severe winter.
The slower pace of inventory
accumulation and a larger-than-estimated trade deficit helped push the numbers
to the worst performance since Q1 of 2011. Economists estimate severe weather
could have reduced GDP growth by as much as 1.5%. (Lam, 2014)
The northern and eastern U.S. experienced above-average
snowfall from December through February, keeping Americans closer to home and
hampering production as factories had difficulty obtaining materials on time.
March quarter US GDP was revised sharply lower on the back
of a significantly lower inventory investment.
The initial print of +0.1% (annualised) was revised down to -1.0%. However, all the signs are pointing to a
strong bounce back in growth in the second quarter of the year. The downward
revision to inventories accounted for the entire GDP revision. In total, inventories knocked 1.6 percentage
points off GDP in the quarter. The good
news is that much of the inventory adjustment we expected to play out this
year, and with that the drag on growth, has now already occurred.
The Bureau of Economic Analysis’ second estimate of real
gross domestic product showed output produced in the U.S. declined at an annual
rate of 1% in the first quarter of 2014. This is relative to fourth quarter
2013, when real GDP increased 2.6%.
That said, investors are not particularly worried as signs
of a rebound are pointing Q2 estimates to as high as +4% in Q2 of which I have personal reservations about. As
weather-related factors fade, inventories are expected to swing higher and
boost output in Q2. In addition, bullish jobs data also bolstered the case for
a rebounding economy as initial claims dropped 27,000 to a seasonally adjusted
300,000 last week. Initial claims, a measure of the underlying labor market
conditions, hit its lowest level since August 2007. And when you accumulate positive
existing home sales, recent manufacturing and inventories data, the numbers fit
to the overall picture of steadily improving market conditions and a recovering
economy.
Companies boosted stockpiles by $49 billion in the first
quarter, less than the $111.7 billion in the final three months of 2013.
Inventories subtracted the most from GDP since the fourth quarter of 2012.
Slower inventory accumulation may encourage factories to step up production
should demand accelerate.
Consumer purchases, which account for about 70 percent of
the economy, increased at a 3.1 percent annualized rate in the first quarter.
The gain, which added 2.1 percentage points to GDP, was more than the previous
estimate of 3 percent.
The increase reflected a stronger pace of spending on
services, including utilities as colder winter weather prompted Americans to
adjust their thermostats. Spending for health care picked up as the provisions
of the Affordable Care Act went into effect.
When it comes to forecasting near-term real GDP growth, there are parts of the economy that are easy
to follow and then there parts of it
that are tough. The easy parts (with lots
of timely information) are consumer spending, business investment, and home
building. And despite one of the worst
winters in multiple decades, this portion of the economy looks like it grew at
a solid 2.5% to 3% annual rate in the first quarter, right in-line with the
trend since the recession ended in mid-2009.
To get that kind of growth during this past brutal winter means the
underlying fundamentals of the economy are gathering strength. Now that banks
are more confident the Fed’s balance sheet isn’t going to shrink anytime soon,
the M2 money supply and commercial and industrial loans are both accelerating.
Meanwhile, the recovery in home building is still far from complete and low
business and consumer debt obligations mean plenty of room for growth in
purchases of big-ticket items
But is some of this optimism by economists on the second
quarter exaggerated?
As Zero Hedge has pointed out, if it wasn't for dramatically
increased healthcare spending due to the implementation of Obamacare, U.S. GDP
would have actually dropped at a 2 percent annual rate during the first quarter
of 2014.
BEA — a division of the Department of Commerce – will
release its third and final Q1 GDP estimate on June 25.
Second Quarter Rebound
Mike Jakeman, global analyst for The Economist Intelligence
Unit, noted that private consumption growth was revised up. This, he wrote,
“suggests that there is some real momentum behind consumer spending. Given that
households account for 70% of GDP, we remain confident that the economy will
bounce back strongly in the second quarter.”
RBS Economist Guy Berger also takes an optimistic view. He
pointed out in a note that much of the downward revision was due to inventories
which were built up at the end of 2013 and trade deficit.
Growth in key indicators such as employment, income, and
consumer spending have recently begun to improve from weather-affected levels
earlier in the year, according to Robert Niblock, the chief executive officer
at home-improvement retailer Lowe’s Cos., said recently.
Stock Market
Stock market punters are gambling on a strong rebound in GDP
in the second quarter to justify the recent extension of gains to new all-time
highs. The reality of the economic backdrop looks rather different.
Stock prices are high by historic multiples because the
outlook is supposed to be a breakout into a new era of high growth for the US
economy. We are now actually almost two-thirds through Q2 and the data at best
gives mixed signals about an economy bouncing along the bottom. For investors
the issue is how to square this near recession with a rampantly optimistic
stock market trading at record highs, albeit on lowish volumes crowded into a
few stocks.
The Fed
The Fed continues to taper at a pace of $10 billion per
month. Fed Chair, Janet Yellen, has stated that tapering is not on a set
course, although at this rate tapering will be complete by fall of 2014. In the
March FOMC meeting there was a change to forward guidance, removing the 6.5
percent unemployment target and shifting to more qualitative measurements.In
addition, in the March FOMC meeting, Yellen said that rates could be increased
as soon as six months after tapering ends. Markets reacted to the March FOMC
meeting by selling off and increasing volatility.
Domestic Economy
The U.S. economy continues to expand thanks to the consumer and
less fiscal drag.The consumer has benefited from rising home prices and equity
markets. The first quarter saw a pull back on personal consumption due to
extraordinarily cold weather in the Northeast.The rise in household net worth
boosted spending and overall sentiment. Household worth continues to hit
all-time highs.Most measures of the housing and employment markets confirm
improving trends; however, the pace of improvement is slower than we prefer.Inflation
continues to run well below the Fed’s target measure of 2 percent. (Silicon
Valley Asset Management, 2014)
Q1 spending activity pulled back due to extraordinary
weather conditions.
·
Consumers were less optimistic towards the end
of the quarter with consumer confidence falling to a four-month low.
·
Disposable incomes rose the most in February
since September 2013 at 2.1 percent year-over-year.
·
Consumer spending expanded by 3.3 percent in the
final quarter of 2013, the biggest increase in three years.
·
As the winter cold passes consumers will start
to feel positive again.
Housing
Total housing sales have suffered from recent uptick in
rates.
·
Housing starts have improved recently, but have
far to go given continued population growth. Starts are most important to the
overall economy due to associated purchases and economic transactions.
·
Home prices remain in an upward trend, but
momentum has paused recently. If employment continues to grow, look for housing
statistics to also continue moving upward.
·
The homeownership rate seems to be bottoming,
providing significant support for all aspects of the housing sector.
·
Home affordability has struggled in the recent
quarter. However, it would take a significant jump in mortgage rates to make
home ownership markedly less affordable.
·
Foreclosures continue to drop quickly as
resolutions to REO holdings are offered by alternative investors.
Inflation
·
Core PCE continues to be well below the Fed’s
target of 2 percent.
·
The Fed has acknowledged that inflation has been
running below its long-term objective.
·
Despite being on the tapering track, the Fed is
still open to accommodative monetary policy.
·
The Fed plans to monitor inflation developments
carefully in search of evidence that inflation will move towards its target.
Conclusion
The first quarter growth was "frozen" by the extreme winter experienced in the US.The slower pace of inventory accumulation and a larger-than-estimated trade deficit helped push the numbers to the worst performance approximately reducing GDP growth by as much as 1.5%. But despite one of the worst winters in multiple decades,Consumer spending expanded by 3.3 percent in the first quarter of 2014, the biggest increase in three years.To get that kind of growth during this past brutal winter means the underlying fundamentals of the economy are gathering strength.Given that households account for 70% of GDP, we can remain confident that the US economy will bounce back strongly in the second quarter.Home prices remain in an upward trend, but momentum has paused recently.Core Inflation continues to be well below the Fed’s target of 2 percent.Fed Chair, Janet Yellen, has stated that tapering is not on a set course, although at this rate tapering will be complete by fall of 2014. In the March FOMC meeting there was a change to forward guidance, removing the 6.5 percent unemployment target and shifting to more qualitative measurements.Some Economists have been bold enough to estimate a growth of +4 in Q2, But we at Economeka have a slightly more modest estimation of +2.5% for the second Quarter.
Bibliography
Lam, M. (2014, June 3). US Economy Retracts in Q1
but shows signs of Q2 Rebound | Economic Update. Retrieved June 11, 2014,
from Samuel Scott:
http://www.samuelscottfg.com/us-economy-retracts-in-q1-but-shows-signs-of-q2-rebound-economic-update
Sharf, S. (2014, May 29). U.S. GDP Dropped 1% In
The First Quarter 2014, Down From First Estimate. Retrieved June 11,
2014, from Forbes:
http://www.forbes.com/sites/samanthasharf/2014/05/29/u-s-gdp-dropped-1-in-the-first-quarter-2014-down-from-first-estimate/
Silicon Valley Asset Mangement. (2014). Quarterly
Analysis US Economy.
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