Orlando's Outlook: Weather is first-quarter GDP speed bump
Bottom Line In light of the difficult winter weather across most of the country the past four months, perhaps the ideal academic background for an investment professional today is an undergraduate degree in finance, an MBA in economics and a Ph.D. in meteorology. Armed with this eclectic basket of degrees, we could then more effectively evaluate the potentially transitory impact of this severe winter on Gross Domestic Product (GDP) in last year’s fourth quarter and the current first quarter and how strong (or not) the ensuing bounce will be when the weather inevitably improves. Our base case is that the labor market, manufacturing and consumer spending are already showing signs of improvement, and we fully expect that housing and autos will rebound sharply once winter finally fades from view.
We reduced first-quarter GDP, but expect a sharp bounce The equity and fixed-income investment team that comprises Federated’s macroeconomic policy committee met on Wednesday to evaluate the brutal winter weather and its impact on our GDP forecasts:
- Largely due to severe December weather—whose economic impact was included in the fourth-quarter’s revised GDP calculation for the first time—the Commerce Department lowered its flash reading of 3.2% to 2.4%, which compares with a robust 4.1% in the third quarter. The final revision will be released on Thursday, March 27, but the full-year 2013 GDP is unlikely to change from its current 1.9%, versus 2.8% in 2012.
- Due to the deleterious economic impact of the severe winter weather, we are lowering our first-quarter 2014 GDP estimate from 3.4% to 2.5%, while the Blue Chip consensus has reduced its estimate from 2.5% to 2.2%.
- We think there’s enormous pent-up demand that will begin to manifest itself when the weather improves—particularly in autos and housing—so we are keeping our admittedly aggressive second-quarter 2014 GDP estimate unchanged at 3.6%, while the Blue Chip consensus is keeping its estimate unchanged at 2.8%.
- We’ve also left our third-quarter GDP estimate unchanged at 3.7%, while the consensus remains unchanged at 2.9%.
- We’ve left our fourth-quarter estimate unchanged at 3.7%, and the consensus estimate also remains untouched at 3.0%.
- As a result of the government’s downward revision for the fourth-quarter of 2013 and our own first-quarter estimate cut, the lowered base prompts us to reduce our full-year 2014 GDP estimate from 3.5% to 3.1%, while the Blue Chip consensus ticks its full-year estimate down from 2.8% to 2.7%.
Federated’s Macro Policy Committee also made the following investment observations:
Fourth-quarter revenues and earnings were pretty good Earnings season for the fourth quarter of 2013 was actually quite good, particularly against the backdrop of a record 8:1 negative-to-positive corporate earnings guidance during the preceding confessional season. Revenues were up about 2-3%, with more than half of the reporting companies surprising to the upside, while earnings per share were up 9-10%, with two-thirds surprising to the upside.
Corporate profit margins had expanded in last year’s third quarter, due to a revised 3.6% increase in productivity and a 2.0% decline in unit labor costs, with a steady trend-line 0.4% increase in the employment cost index (ECI). But fourth-quarter metrics were less favorable, with only a 1.8% increase in productivity, a muted 0.1% decline in unit labor costs and a 0.5% bump in ECI. So profitability trends may finally be peaking as the labor market improves. We fear that, due to a lack of visibility, corporate guidance may be overly conservative once again during the upcoming first-quarter earnings season.
Commodities pop, but core inflation remains benign Due to heightened geopolitical-risks in Russia and Ukraine, commodity prices have soared. Gold has surged by 17% thus far, from $1,180 per troy ounce at year end to $1,390 currently; crude (WTI) oil rose by 15% from $92 per 42-gallon barrel in mid-January to $105 in early March; and agricultural commodity prices have leapt, with corn up 21%, wheat up by 26%, and soybeans up by 17%.
But core inflation, which strips out the impact from volatile food and energy prices, has remained benign. On a year-over-year basis through February, the wholesale Producer Price Index (PPI) is running at a well-behaved core level of 1.1%, and the retail Consumer Price Index (CPI) is at 1.6% through January. The core Personal Consumption Expenditure (PCE) index—the Federal Reserve’s preferred measure of inflation—has been running at a very benign 1.1% year-over-year through January. It remains anchored at the very low end of the Fed’s 1.0% to 2.0% target range and well below its 2.5% inflation trigger to reverse its current Zero Interest-Rate Policy (ZIRP).
Benchmark 10-year Treasury yields, which had risen from 2.50% in October to 3.03% at year end, have been stuck in a relatively tight 2.60% to 2.80% trading range over the past few months. We continue to believe that yields could grind higher to about 3.50% to 3.75% over the course of 2014.
Fed’s taper plans remain on track The Federal Reserve’s $85 billion monthly Quantitative Easing (QE) program has already tapered twice since December, down to a monthly pace of $65 billion. We expect that the Fed’s new Chair, Janet Yellen, will stay on this unwinding path over the balance of this year so that it’s down to zero by year end. Dr. Yellen’s first Federal Open Market Committee (FOMC) meeting and press conference as Fed Chair will be next week on March 18-19, and markets will be no doubt be parsing her every word, with particular interest in her thoughts on the Fed’s employment threshold. At this point in time, we do not expect the Fed to begin to raise the federal funds rate before mid-2015 at the earliest.
Labor market starts to thaw in February The negative impact on employment due to weather—which decimated December and hurt January—began to fade in February. The labor report was stronger than expected last month with positive revisions, which suggests that the U.S. economy is beginning to heat up again. Nonfarm payrolls rose by 175,000 in February (versus 84,000 in December and 129,000 in January). Initial weekly jobless claims—another leading economic and employment indicator—have slipped to a three-month low of 315,000 for the week ended March 8, which suggests that this improvement in nonfarm payrolls should continue.
Unemployment (U-3) rose a tick to 6.7% in February, as formerly discouraged workers are becoming sufficiently confident in their job prospects that they are starting to look for work again. The labor-force participation rate held steady in February at 63.0%, which is just above the 36-year cycle low of 62.8% reported in December, and the labor impairment rate (U-6) slipped a tick to 12.6% in January.
Manufacturing rose by 6,000 jobs in each of January and February and 7,000 in December versus a powerful gain of 35,000 jobs in November, its strongest month since March 2012. Construction added 15,000 in February after a surprising gain of 50,000 jobs in January, which was a six-year cycle high. The volatile household survey added only 42,000 jobs in February versus 638,000 in January and 143,000 in December.
Unfortunately, the ADP report, which is a forward-looking proxy for private payroll growth, has softened over the past four months, with a below-consensus 139,000 jobs added in February, and downward revisions for each of the past three months, to 127,000 jobs in January, 191,000 in December and 245,000 in November. January and February 2014 was the weakest two-month reading since August/September 2012.
Autos and housing still impacted by winter’s chill After surging to an annualized 16.31-million unit level in November, which was a seven-year high, auto sales have languished for the past three months, falling by 6% in February to 15.27 million units, largely due to the inclement weather. This is temporary, as auto sales remain one of the economy’s true bright spots, with overall sales trends up by 70% from the cycle trough of 9.0 million total units in February 2009.
Brutal winter weather, lower inventories, rising prices, tighter credit and the back-up in mortgage rates over the past nine months have collectively had a temporarily negative impact on new- and existing-home sales, refinancing and pending sales. But we believe that housing will re-accelerate during this year’s peak selling season in spring 2014. Mortgage delinquencies and foreclosures continue to fall sharply, after peaking in 2010 at 10.06% and 4.64%, respectively, to 6.39% and 2.86%, respectively, in the fourth quarter of 2013.
February bounce from 'Bah, Humbug' The year 2013 was the worst Christmas for retail spending since 2009, with a downwardly revised gain of only 3.1% for November, December and January combined, which was only marginally better than the 3.0% increase for the same three months in 2009. But February enjoyed a nice rebound off of dreadful January levels, with particular strength in online shopping, which suggests that the winter’s deep freeze has created some pent-up demand for retail therapy. Consumer spending accounts for 70% of GDP, so continued strength in retail will help to fuel a bounce in GDP. The Michigan consumer sentiment index has rebounded from 73.2 in October to 81.6 in February, and the Conference Board’s consumer confidence index has bounced from 72.0 in November to 78.1 in February.
Manufacturing looks promising The national ISM manufacturing index fell from a strong “growth” reading of 57.0 in November to 51.3 in January, before rebounding to 53.2 in February. Factory orders turned negative in three of the last four months, but wholesale and business inventories have remained positive, which suggests that businesses are looking through the temporary weather problems to maintain inventory levels for when demand returns in the spring. While durable goods orders and cap goods shipments were weak in December and January due to the weather, the core durable goods orders ex-transports and cap goods orders ex-air surged in January by the most in eight months, suggesting that there is latent strength in the economy that we’ll see once the weather improves. So while manufacturing likely will hurt the upcoming first-quarter GDP report, we could see a nice bounce in the second quarter.