Orlando's Outlook: Grinding higher
Bottom line In its third and final revision for 2012's fourth quarter, the Commerce Department said Gross Domestic Product (GDP) grew 0.4%, a tick below consensus estimates but up from the previously estimated 0.1%. To be sure, this is the ultimate rear-view-mirror report, what with the first quarter of 2013 ending this Easter Sunday. But it’s still significant to note the fourth-quarter’s downward revision to consumer spending was more than offset by stronger business spending on structures and an improvement in net trade. More to the point, as we look out to the economic horizon, it appears this marginally positive fourth-quarter GDP report will likely serve as the trough of the current cycle, as we expect continued gradual improvement in employment, manufacturing, housing and autos over the course of the year, with Washington concerns beginning to fade from view. As a forward-looking discounting mechanism, the equity market has begun to absorb and process this positive shift in tone, resulting in what was the best first-quarter for stocks in 15 years.
GDP revised higher The fourth quarter, which was initially flashed at a negative 0.1%, was revised up to 0.1% last month and revised to a higher 0.4% today. While that still represents a sequential GDP decline from the third quarter’s 3.1% reading, the full year stays at 2.2% growth for 2012, versus 1.8% in 2011. Here’s what drove the revision:
- Consumer spending softens This was the weakest part of this morning’s report, with personal consumption expenditures, which account for 70% of GDP, revised down to 1.8% growth from a preliminary estimate of 2.1% in the fourth quarter. That compares with tepid consumer spending growth of 1.6% and 1.5%, respectively, in each of the third and second quarters.
- Business capex strengthens Real business fixed investment was revised up to a final 13.2% gain, compared with a preliminary 9.7% fourth-quarter gain and a flash increase of 8.4%. This compares with a 1.8% third-quarter decline. Business structure investment, such as factories and office buildings, is on a tear, surging by a revised final gain of 16.7%, versus a preliminary 5.8% bump in the fourth quarter and a 1.1% flash decline, all of which compares with no change in the third quarter. Business equipment and software spending rose by a revised final gain of 11.8% in the fourth quarter, versus a preliminary increase of 11.3%. These readings were both slightly weaker than the fourth-quarter’s flash gain of 12.4%, but they compare very favorably with a 2.6% third-quarter decline, which was the weakest reading in three years.
- Net trade improves Exports declined by a revised final 2.8% in the fourth quarter, versus a preliminary decline of 3.9% and a flash decline of 5.7%, compared with an increase of 1.9% in the third quarter. Imports were revised to a final decline of 4.2% in the fourth quarter, versus a preliminary decline of 4.5% and a flash drop of 3.2%, compared with a more modest 0.6% third-quarter decline. So the less-bad revision in exports versus imports resulted in a positive bump to GDP.
Aside from this positive GDP revision, there are several other indicators we monitor, which collectively suggest that economic growth could grind higher over the course of the year, and perhaps accelerate in the second half:
Leading Economic Indicators (LEI) The February LEI was recently flashed at a better-than-expected 0.5%, while January was revised up to an increase of 0.5% from a preliminary gain of 0.2%. This is the third consecutive solid monthly LEI increase, on the heels of a 0.4% increase in December and a flat reading in November. Given a normal three-to-six month lead time, that suggests that the pace of GDP growth could begin to accelerate to 2.0% of more in coming quarters. Highlights of the February report include interest-rate spreads, building permits, credit trends, and the length of the average workweek.
Manufacturing improves The national ISM index has steadily improved over the course of the past three months, from 49.5 in November to 54.2 in February, which implies a resumption of economic growth. To that point, nominal durable goods orders for February surged by 5.7%, compared with a decline of 3.8% in January. But the regional metrics remain mixed, with disappointing recent results in Chicago, Richmond and Kansas City, mitigating solid readings out of New York, Philadelphia and Dallas.
Housing and autos remain well positioned Although housing may have encountered a bit of a seasonal soft patch, we remain very confident that we are in perhaps the second year of a robust five- to-seven-year recovery. While the housing-market index—a key confidence indicator—dipped to 44 in March from 47 in December and January, it is still more than triple where it was when the housing market bottomed in September 2011. Mortgage rates and inventories are low, affordability is high, household formations and prices are rising, starts and permits have surged by 80% off of half-century lows, mortgage delinquencies and foreclosures are falling sharply, and new and existing home sales have accelerated. Likewise, autos are now up nearly 70% from the cycle trough in February 2009, sitting just under a four-year high at 15.33 million annualized units, with plenty of track left.
Employment strengthening The leading employment indicators suggest the labor market is improving. The smoother four-week moving average of initial weekly jobless claims fell to a five-year cycle low of 341,000 in March. The ADP report, a forward-looking proxy for private payroll growth, gained a surprisingly strong 198,000 jobs in February, with an average of 209,000 jobs per month over the past five months. And the household survey bounced to a gain of 170,000 in February from only 17,000 jobs in January. The only fly in the ointment is that the decline in the rate of unemployment from 10.0% to 7.7% over the past three years is largely due to a concurrent decline in the labor-force participation rate to a 33-year cycle low of 63.5%.
Consumer spending perks up After a tepid Christmas season and a decidedly weak January, retail sales in February enjoyed a healthy bounce. But is that rebound sustainable? Low-end consumers were hurt at the beginning of 2013 by the 2% increase in the Social Security payroll tax to 6.2%, the 18% increase in gasoline prices in January and February—which have since eased by 4%—and the delayed IRS tax refunds due to the late fiscal cliff deal on New Year’s Day. High-end consumers have been hurt by President Obama’s increase in the marginal tax rate and the phase-out of deductions and exemptions, although the recent rise in both real estate and equity prices have helped to ameliorate that sting. But consumer confidence, as measured by the Conference Board and the Michigan sentiment index, both fell sharply in March after strong February readings, which gives us pause on declaring the consumer healthy.
Moreover, our significant misgivings about dysfunctional fiscal policy in Washington have begun to fade in recent months:
- The fiscal cliff compromise on tax rates was completed on New Year’s Day, with the so-called Bush tax cuts locked into place for 99% of Americans.
- The automatic spending sequester was signed into law on March 1, with $85 billion in spending cuts through the end of the current fiscal year, with an additional $1.1 trillion in spending cuts coming over the next decade.
- The March 27 deadline for the “Continuing Resolution” to fund the federal government was also pushed back to the end of the current fiscal year on Sept. 30.
- The $16 trillion federal debt ceiling was temporarily suspended at year-end 2012 and Congress agreed to add about $500 billion to it into the second quarter, at which point Washington will review the state of its finances. But with the economy starting to improve and President Obama signing the Republicans’ tax and spending cuts into place, the thinking is that the federal budget deficit may be in slightly better shape by midyear.