Orlando's Outlook: Separate the wheat from the chaff

04-20-2018

Bottom Line While there’s no shortage of noise, nonsense and general stupidity coming out of Washington on a variety of issues these days, underlying fundamental strength suggests that equities should rally over the course of April and May. True, net trade continues to deteriorate to its worst level in nearly a decade, inflation is rising and a brutal winter, delayed tax refunds and low savings rates prompted consumers to pull in their horns during January and February. But the Federal Reserve’s leadership and policy transition appears to be progressing smoothly. Moreover, many of the confidence metrics we monitor hit multi-decade cycle highs during the first quarter, perhaps fueled by President Trump’s December tax cuts. The labor market is healthy, despite March’s weather-impaired stumble, manufacturing trends remain solid, companies are restocking inventories and first-quarter corporate profits are the strongest in seven years, with earnings per share rising more than 26% on a year-over-year (y/y) basis thus far.

Trade war brewing, while consumers slow spending The trade deficit in February expanded for the sixth consecutive month to its widest level in nearly a decade at $57.6 billion, 30% higher than last August. The deterioration in net trade reduced an otherwise strong 2.9% fourth-quarter GDP by nearly 1.2 percentage points, sparking Trump’s tariff threats with our key global trading partners, including China, Mexico, Japan, Germany and Canada.

Retail sales in March rose by a relatively strong 0.6%, compared with three consecutive 0.1% nominal declines in December 2017 and January and February 2018. The personal savings rate had fallen to only 2.4% in December 2017 (its lowest level of the past year), down from 4.1% in February 2017. Consumers pared spending to boost the personal savings rate back up to 3.4% in February as they began to repair their balance sheets. We expected more robust levels of spending in “Mapril,” but the four nor’easters in March likely pushed some spending into April. Autos and housing are starting to emerge from their winter slumber.

Confidence is strong The Conference Board leading indicators and consumer confidence, the NFIB small business optimism, ISM manufacturing, and regional gauges in Dallas and Milwaukee all hit multi-decade cycle highs in February 2018. The ISM service index did the same in January, while Michigan consumer sentiment hit another record high in March. Elevated confidence contributed to the strongest y/y corporate earnings growth of 26% in the first quarter in seven years, and GDP has been growing at a sustainable 3% run rate for the past three quarters.

Adjustments to our GDP forecasts The fixed-income and equity investment professionals who comprise Federated’s macroeconomic policy committee met on Wednesday to discuss the trade picture and the temporary slowdown in consumer spending.

  • The Commerce Department revised up fourth-quarter GDP from 2.5% to a final gain of 2.9%, as consumer, business and government spending all rose, along with inventory rebuilding.
  • The brutal winter weather, the widening trade deficit and the temporary slowdown in consumer spending will hurt first-quarter economic growth. So we are reducing our first-quarter GDP estimate from 3.2% to 2.5%, while the Blue Chip consensus has reduced its estimate from 2.8% to 2.1% (within a range of 1.6% to 2.7%). The Bloomberg consensus has reduced its estimate to 2% and the Atlanta Fed reduced its GDPNow model from 2.5% to 2%. Commerce will flash first-quarter GDP next Friday, April 27.
  • We’re expecting some snapback in the second quarter, due to more seasonal weather and the tax refunds. Personal and corporate spending should improve due to Trump’s tax cuts, and we expect that the growing trade deficit will start to reverse in March. As a result, we are ticking up our second quarter of 2018 GDP estimate from 3.3% to 3.4%, while the Blue Chip consensus is raising its estimate from 2.9% to 3.1% (within a wide range of 2.5% to 3.8%).
  • We are keeping our third quarter of 2018 GDP estimate unchanged at 3.1%, while the Blue Chip consensus is raising its estimate up toward Federated’s, from 2.7% to 3% (within a range of 2.5% to 3.6%).
  • We are also keeping our fourth quarter of 2018 GDP estimate unchanged at 2.9%, while the Blue Chip consensus is increasing its estimate toward Federated’s again, from 2.6% to 2.8% (within a range of 2.4% to 3.3%).
  • Because of our first-quarter reduction, we are ticking our full-year 2018 GDP estimate down from 3.1% to 3%, while the Blue Chip consensus remains unchanged at 2.8% (within a range of 2.5% to 3%).
  • Our full-year 2019 GDP estimate remains unchanged at 3%, while the Blue Chip consensus is raising its estimate up toward Federated’s, from 2.4% to 2.6% (within a range of 2.1% to 3%).

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