Orlando's Outlook: Spring swoon
Bottom Line Just as the swallows magically return to the Mission San Juan Capistrano in California each March 19, it appears that for the third year in a row, the domestic economy is poised to revisit its typical “Spring Swoon.” In recent weeks, the labor market, consumer spending and confidence, the pace of inventory restocking, manufacturing—even housing and autos—have all softened, some noticeably.
To be sure, the most probable explanation for this year’s spring economic weakness is the relatively early Easter and cold March weather—compared with a later Easter and a much warmer March last year—issues that are sure to fade. But what’s different this year is that due to Washington’s unpopular fiscal policies, we introduced higher taxes and the spending sequester in the first quarter, and businesses and consumers need some time to digest the new rules. To that point, we absolutely believe that over time, this near-term economic chilling effect on business and consumer spending should ease, as economic growth should rebound in the second half of 2013. Moreover, with spring finally upon us, Hurricane Sandy should begin to shift from a headwind to an economic tail wind, due to rebuilding efforts in the Northeast.
Up until a week ago, however, investors were choosing to ignore this temporary economic soft patch, as they powered the S&P 500 to another in a series of new all-time record highs. But over the past seven trading days, large-cap stocks have fallen by about 4%—and by nearly 6% on the Russell 2000 small-cap index—providing investors with what we believe is an attractive re-entry point from oversold conditions.
Changes to our GDP outlook The fixed-income and equity investment professionals who comprise Federated’s Macro Economic policy committee met yesterday to address these aforementioned transitory issues, and we made the following adjustments to our estimates for Gross Domestic Product (GDP):
- On March 28, the Commerce Department issued its final fourth-quarter GDP revision, talking its -0.1% preliminary estimate up to its first revision at 0.1%, and then up to its final reading at 0.4%, largely due to stronger net exports and business spending, which more than offset weaker consumer spending. That leaves full-year 2012 GDP at 2.2%, versus 1.8% in 2011.
- Next Friday (April 26), the Commerce Department will flash its first quarter of 2013 GDP. Due to stronger economic trends in January and February—but cognizant of March weakness—we are raising our first-quarter GDP estimate from 1.7% to 2.4%, while the Blue Chip consensus estimate moves up from 2.0% to 2.9%.
- We expect that the Northeast will begin to rebuild from Sandy, but we are also concerned about the economic offset from weaker trends in consumer spending. So we are ticking down our second-quarter GDP growth estimate from 1.8% to 1.7%, while the consensus estimate falls from 2.2% to 1.8%.
- Manufacturing activity and inventory restocking should begin to recover during the second half, so we are keeping our third-quarter estimate unchanged at 2.3%, while the consensus estimate declines from 2.6% to 2.4%.
- We are also keeping our estimate for fourth-quarter GDP growth unchanged at 2.6%, while the consensus lowers its estimate from 2.8% to our 2.6%. Because both we and the consensus raised our first-quarter estimates for economic growth sharply, that increases our full-year 2013 GDP estimate from 1.8% to 1.9%, compared with the Blue Chip consensus, which is boosting its estimate from 1.9% to 2.1%. However, both sets of full-year GDP estimates remain well below 3.0% trend-line economic growth.
- We are initiating a more constructive full-year 2014 real GDP estimate of 2.7%, compared with the Blue Chip consensus, which is lowering its estimate by a tick to our 2.7%.
The Macro Policy Committee also made the following investment observations:
Employment weakens March’s results were surprisingly soft across the board, with nonfarm and private payrolls coming in less than half of what was expected, manufacturing going negative, and the household survey plunging by nearly 400,000 jobs from February. The ADP report, a forward-looking proxy for private payroll growth, gained only 158,000 jobs in March, versus a 201,000 average for the past six months under its new methodology. The rates of unemployment (U-3) and labor impairment (U-6) plunged to 7.6% and 13.8% in March, respectively, largely due to the labor-force participation rate, which hit a 34-year cycle low of 63.3% last month. This tells us that unemployment is falling for the wrong reasons, as discouraged workers are leaving the labor force in droves. The good news is that these poor results may be temporary, as initial weekly jobless claims—an important leading economic and employment indicator—have begun to normalize after an Easter-induced spike to 388,000 two weeks ago. Weekly claims for the week ended April 13—the survey week for the April labor report—came in at a constructive 352,000, so we may be primed for an employment rebound on Friday, May 3.
Retail sales and consumer confidence fall On the heels of a poor January and a healthy rebound in February, retail sales turned negative in March, largely due the early Easter and a cold March, but also because of the economic impact from Washington’s fiscal policy initiatives. The low-end consumer was hurt by the increase in the Social Security payroll tax, and the high-end consumer is feeling poorer after the increase in tax rates and the reduction of deductions and exemptions as part of the fiscal-cliff tax increase on New Year’s Day, partially offset by a positive wealth effect triggered by rising equity and real estate markets. Moreover, consumer confidence has been choppy over the past six months. The Conference Board’s consumer confidence index hit a four-year high of 73.1 in October 2012, but has since fallen back to 59.7 in March, while the Michigan consumer sentiment index hit a five-year high of 82.7 in November 2012, but has slipped to 72.3 in April. However, we’re expecting April retail sales to rebound from March’s poor base.
Manufacturing a mixed bag After three consecutive stronger months, the national ISM manufacturing index slipped back to 51.3 in March, which implies marginally positive economic growth. In addition, five of the seven important regional Fed indices we monitor have experienced a sequential decline. The net trade balance improved in February, and factory and durable-goods orders enjoyed their biggest gain in five months. But wholesale and business inventories were poor in February, as companies are de-stocking inventory in the face of softer end-market demand. Finally, industrial production was up slightly in March, and capacity utilization continues to grind higher.
Temporary pause in auto and housing strength After a powerful four-month rebound from Hurricane Sandy, auto sales consolidated at 15.22 million annualized units in March. But auto sales are still up 70% from the bottom of the cycle in February 2009, sitting just under a four-year high, and we believe that positive momentum will resume in coming months. The housing-market index, a key confidence indicator, has slipped from a six-year high of 47 in January to 42 in April, although it is still triple where it was in September 2011 when the housing market bottomed. We remain very positive on this sector, as starts have doubled to one million units off of half-century lows, household formations are rising, mortgage delinquencies and foreclosures are falling sharply, pricing continues to strengthen, interest rates are near record lows, affordability is near a record high, and new and existing home sales continue to improve, even during a seasonally soft part of the cycle.
The bar is low for first-quarter earnings The confessional season ended with a negative-to-positive pre-announcement ratio of five to one, the worst in 12 years, with expectations for essentially flattish revenue and profit results for S&P companies. We’re only 28% of the way through the first-quarter earnings season this past fortnight, but revenues are up 4% year-over-year, with one-third of companies beating consensus estimates. Earnings rose by 10% thus far, largely due to good results from the banks, which represent a 3% positive surprise, with 70% of companies beating consensus estimates. Not surprisingly, however, management guidance has been cautious due to poor economic visibility, with 85% guiding lower by an average of 1.6% below consensus.
Inflation remains benign On a year-over-year basis through March, core inflation is running at well-behaved levels of 1.7% and 1.9%, respectively, for the wholesale Producer Price Index (PPI) and the retail Consumer Price Index (CPI). The core Personal Consumption Expenditure (PCE) index—the Federal Reserve’s preferred measure of inflation—is running at a very benign 1.3% year-over-year through February, which remains well within the Fed’s 1.0% to 2.0% target range. The combination of subdued inflation and concerns about domestic and overseas economic growth prospects have sparked a rout in commodity prices, as gold and crude oil have plunged over the past few months.
Fed on hold We continue to believe that the combination of the Federal Reserve’s new trigger mechanisms, benign inflation prospects and slower global economic growth will keep central-bank policy makers at bay. Until unemployment comes down to at least 6.5% (from 7.6% in March) and so long as core PCE inflation does not exceed its 2.5% target (from 1.3% now), the Fed plans to keep its Zero Interest-Rate Policy (ZIRP) in place, probably into next year, at the earliest. But the Fed’s expansive “QE to Infinity” bond-buying program—in which the Fed is purchasing $85 billion of Treasury and agency mortgage-backed securities per month to keep interest rates low, help to spark a wealth effect in the equity and real estate markets, and offset the economic drag from Washington’s suboptimal fiscal policies—is a much more nuanced and qualitative decision, which we think the Fed will keep in place into the second half of this year, at the earliest, before beginning to taper.