Orlando's Outlook: Weather pivot to boost GDP
Bottom Line There’s little question that challenging winter weather across three-quarters of the country from December through March negatively impacted economic growth during the fourth quarter of last year and the first quarter of 2014. While many share our point of view of expecting a nice rebound in this year’s second quarter, the bear case wonders aloud whether that bounce will continue into this year’s second half, due to the presumed absence of any longer-term economic growth catalysts. We disagree, and point to recent strong improvements in employment, manufacturing and the consumer as reasons for a sustainable economic rebound that could keep Gross Domestic Product (GDP) elevated above a trend-line 3% for the balance of the year.
Economic growth should start to bounce The fixed-income and equity investment professionals who comprise Federated’s macroeconomic policy committee met on Wednesday to evaluate the strength and pace of the economic recovery in the aftermath of this brutal winter:
- The Commerce Department revised its final reading for fourth-quarter GDP to 2.6% (down from the flash reading of 3.2%, but up from the revised 2.4%), which compares with a robust 4.1% in the third quarter of 2013. That leaves full-year 2013 GDP unchanged at 1.9% versus 2.8% in 2012.
- We are making an admittedly controversial call here, but we are choosing to leave our first-quarter 2014 GDP estimate unchanged at 2.5%, while the Blue Chip consensus has reduced its estimate from 2.2% to 1.7% (within a range of 1.0% to 2.4%), due to the effects of the extreme winter weather. There’s little doubt that we’ll be too optimistic when the Commerce Department releases its flash report on Wednesday, April 30, with a reading that will probably approximate 2.0%. But we also believe that the economy has taken a sharply positive U-turn in March, with much stronger-than-expected readings in consumer spending and manufacturing. As such, we expect the first-quarter’s two revisions (to be released May 29 and June 25) to demonstrate a strong upside bias.
- We continue to believe that there’s enormous pent-up demand that will begin to manifest itself when the weather improves, so we are keeping our second-quarter 2014 GDP estimate unchanged at 3.6%, while the Blue Chip consensus is raising its estimate from 2.8% to 3.0%, with a range of 2.4% to 3.7%.
- We’ve also left our third-quarter GDP estimate unchanged at 3.7%, while the consensus is increasing its estimate from 2.9% to 3.0% (within a range of 2.4% to 3.6%).
- Finally, we’ve decided to leave our fourth-quarter estimate unchanged at 3.7%, and the consensus estimate is rising from 3.0% to 3.1%, with a range of 2.3% to 3.8%.
- The Commerce Department’s modest upward revision for the fourth-quarter of 2013 raises the base and prompts us to tick up our full-year 2014 GDP estimate from 3.1% to 3.2%, while the Blue Chip consensus’ full-year estimate remains unchanged at 2.7% (within a 2.4% to 3.0% range).
Federated’s Macro Policy Committee also made the following investment observations:
Employment strengthening The brutal winter weather—which clearly hurt December and January employment results—has faded, and the labor report has strengthened considerably over the past two months, with more improvement expected in April. Nonfarm payrolls rose by an average of 195,000 new jobs in February and March (versus only 84,000 in December and 144,000 in January), and we’re expecting some 210,000 for April, to be released next Friday, May 2. The volatile household survey enjoyed a huge 476,000 job bounce in March, after a tepid gain of only 42,000 jobs in February.
The ADP report, an important leading indicator of private payroll growth, appears to have troughed with a weak gain of only 121,000 jobs in January, but it has strengthened with increases of 178,000 in February and 191,000 in March. Initial weekly unemployment claims—another important leading indicator—were sitting at 304,000 in the April survey week that ended on April 12, which is roughly a 7-year low.
Consumer on a roll After the weakest 3-month Christmas retail season since 2009, retail sales have surged in February and March. The first half of Christmas was hurt by Washington-related fiscal drag, and the back half of the Christmas season was hurt by the frigid winter. But with better weather and enormous pent-up demand, nominal retail sales surged by a stronger-than-expected 1.1% in March, which represented the largest month-over-month gain since September 2012, and February was revised up to a 0.7% headline increase, which was more than double its original print. Consumer spending accounts for 70% of GDP, so strongly positive “control” results (which feed directly into GDP) in February (up 0.4%) and particularly March (up 0.8%) will help to salvage first-quarter GDP results, and potentially set the stage for stronger consumer spending trends in the second quarter. In contrast, “control” results fell by (0.6%) in January.
Confidence improving To that point, we’re encouraged that the Michigan consumer sentiment index has rebounded from 73.2 in October to a 9-month high of 84.1 in April, while the Conference Board’s consumer confidence index has bounced from 72.0 in November to a 6-year high of 82.3 in March. The Leading Economic Indicators (LEI) plunged to breakeven in December from an increase of 0.9% in November, largely because of the severe winter weather. But we have started to see a strong bounce over the past three months, with gains of 0.2% in January, 0.5% in February and 0.8% in March. That sequential improvement suggests that second-quarter GDP should rebound from weak first quarter levels, with continued economic strength spilling into the third quarter.
Manufacturing bounce First, the national ISM manufacturing index has rebounded from a cycle low of 51.3 in January to 53.7 in March. Next, factory orders have similarly bounced from a negative (2.0%) in December and a negative (1.0%) in January to a positive 1.6% in February. Third, industrial production improved from a decline of (0.2%) in January to a gain of 0.7% in March, while February levels were revised up to a gain of 1.2% from a preliminary gain of 0.6%. Capacity utilization surged to 79.2 in March, its highest level since June 2008.
Finally, while durable and capital goods orders and shipments were weak in December and January due to the weather, we are starting to see a strong bounce. After declines of (5.3%) in December and (1.3%) in January, durable goods orders soared by 2.1% in February and by 2.6% in March; durable orders ex-transports rose by 2.0% in March, compared with a (1.8%) decline in December; cap goods orders nondefense ex-air leapt by 2.2% in March after falling by (1.1%) in February; and cap goods shipments nondefense ex-air—which feed directly into the first quarter 2014 GDP report—rose by 1.0% in March and by 0.7% in February, after a (1.4%) decline in January. So the manufacturing contribution to first-quarter GDP is clearly starting to strengthen.
Autos accelerate, but housing still stuck in the mud After rising in November to an annualized 7-year high of 16.31-million units, auto sales languished for the next three months, falling by 6% to 15.27 million units in February, largely due to the bad winter weather. But with better weather in March, auto sales rebounded by 7% to a new 7-year high at 16.33-million annualized units. In our view, autos remain one of the economy’s true bright spots, with overall sales now up by 81% from the cycle trough of 9.0 million total units in February 2009. While that pace of growth is clearly not sustainable, we do believe that auto sales can remain in a healthy 16.0-17.0 million annualized unit sales range for the next several years.
The only fly in the economic ointment has been housing as we have not, as yet, begun to see the strong spring bounce we had expected. Certainly brutal winter weather, lower inventories, rising prices, tighter bank credit and the 100-basis-point back-up in mortgage rates over the past year have had what we believe will prove to be a temporarily negative impact on new- and existing-home sales and refi’s. More recently, surprisingly big personal tax bills to the federal government likely impacted affordability and down payments. Bottom line, continued housing weakness will impair first-quarter GDP.
First-quarter revenues and earnings pretty good so far Earnings season for the first quarter of 2014 has been pretty good so far, particularly against the downbeat backdrop of consensus expectations for modest 2-3% year-over-year revenue growth and flattish to slightly-down earnings. We’re about halfway through earnings season and revenues are up about 4% year-over-year, with about 40% of the reporting companies surprising marginally to the upside, while earnings per share are also up by about 4%, although nearly 70% are surprising to the upside by about 5%. Corporate guidance has been conservative once again, due to limited visibility.
Georisk spikes commodities, but core inflation stays low Likely due to heightened geopolitical-risks surrounding the ongoing Russian/Ukraine situation, commodity prices have risen sharply so far this year. Gold and crude (WTI) oil have leapt by 10%—amid much volatility—to $1,300 per troy ounce and $100 per 42-gallon barrel, respectively. Key agricultural commodity prices for corn, wheat and soy have leapt by 25-30%.
But core inflation, which strips out the nominal increase from volatile food and energy prices, has remained relatively benign, although it has ticked up in recent months. On a year-over-year basis through March, the wholesale Producer Price Index (PPI) is running at a core level of 1.4% (up from a gain of 1.1% in February) and the retail Consumer Price Index (CPI) is at 1.7% through March (versus a gain of 1.6% in February). The core Personal Consumption Expenditure (PCE) index—the Federal Reserve’s preferred measure of inflation—remains at a very benign 1.1% year-over-year level through February, the very low end of the Fed’s 1.0% to 2.0% target range and well below its newly lowered 2.0% inflation trigger to reverse its current Zero Interest-Rate Policy (ZIRP).
Benchmark 10-year Treasury yields have been stuck in a relatively tight 2.60% to 2.80% trading range over the past few months. Yields could grind higher to about 3.50% to 3.75% over the course of 2014, particularly if the bond vigilantes’ lingering concerns about pipeline wage inflation reach fruition.
Fed’s pace on track The Federal Reserve’s $85 billion monthly Quantitative Easing (QE) program has already tapered thrice since December, down to a monthly pace of $55 billion. We continue to expect Fed Chair Janet Yellen to stay on this unwinding path over the balance of the year, such that she’s wound QE down to zero by year end. We do not expect the Fed to begin to raise the federal funds rate from its current zero to 25-basis-point range before mid-2015 at the earliest.