Orlando's Outlook: Sandy, election outcome pare our outlook
Bottom Line The near-term economic drag from Hurricane Sandy and the heightened recession risk associated with Tuesday’s election results combine to cloud the prospects for Gross Domestic Product (GDP) for the next several quarters. While we are not issuing an explicit recession forecast at this time, we believe that we are right on the knife’s edge with marginally positive GDP growth, as we monitor developments closely.
With at least 100 people dead and damages of more than $50 billion—estimates for both are likely to climb higher—Sandy is already the nation’s second-worst storm ever, trailing only Katrina. We expect a negative hit to GDP from Sandy over the next two quarters, but then we should begin to enjoy some incremental economic stimulus come next spring, as the Northeast begins to rebuild. Likewise, with Tuesday’s status-quo presidential election results, and with the critical fiscal-cliff and debt-ceiling deadlines looming by year end, the odds of Washington intransigence sparking a recession have increased significantly. Even if we’re able to successfully avert a recession, however, the ongoing fiscal policy dysfunction in Washington, at a minimum, could potentially cast a pall over both business investment and consumer spending for the next several quarters.
Other than that, domestic economic fundamentals aren’t that bad. Consumer spending, which accounts for 70% of GDP, enjoyed a solid third-quarter Back-to-School (BTS) season, compared with dismal second-quarter results, as housing and auto sales remain strong. Manufacturing, which had been weak over the summer, has perked up over the past two months. While concerns about soft end-market demand in Europe and the emerging-markets (such as China, Brazil and India) continue, we believe that growth there now appears to be stabilizing. Moreover, the vertical summer spikes in food and energy prices have begun to reverse in recent months. Even third-quarter corporate revenues and profits have been OK, although forward guidance has been understandably cautious due to the lack of visibility.
Macro committee slashes fourth-quarter, 2013 GDP forecasts
The fixed-income and equity investment professionals who comprise Federated’s Macro Economic policy committee met this past Wednesday to discuss Hurricane Sandy and the election results, and their potential collective impact on economic growth, and we decided to sharply reduce our GDP estimates for the next five quarters.
- The Commerce Department recently flashed its third-quarter GDP at 2.0%, compared with the Blue Chip consensus estimate at 1.8%. But retail and auto sales, housing, manufacturing activity, inventory restocking and exports were all solid during September, so we believe that the government’s first revision on Nov. 29 will likely boost third–quarter GDP into the 2.5% to 3.0% range.
- But with Sandy likely chopping 0.5% from fourth-quarter GDP, with Europe and the emerging markets still slumping, and with a potential economic chilling effect on business and consumer spending due to the election results and the fiscal cliff and debt ceiling in Washington, then growth could be at risk. So we are cutting our estimate for fourth-quarter GDP growth from 1.8% to 0.9%, compared with a more modest reduction by the Blue Chip consensus growth estimate from 1.9% to 1.8%.
- That lowers our full-year 2012 GDP forecast from 2.2% to 2.1% (versus 1.8% growth in 2011), while the Blue Chip consensus estimate remains unchanged at 2.2%.
- Sandy will still be an economic drag during the first quarter of next year. In addition, while our base case continues to expect that Washington will successfully defuse the ticking fiscal-cliff time bomb, there’s clearly a risk to that forecast. Given the complete lack of visibility on this issue, businesses and consumers could very well remain on the sidelines indefinitely. As a result, we’re cutting our first-quarter 2013 GDP estimate from 1.1% growth to 0.5%, while the consensus estimate comes down from 1.8% to 1.7%.
- We expect that the fiscal-cliff and the debt-ceiling issues will be resolved by the end of the first quarter, and that the Northeast begins to rebuild from Sandy, in which case GDP growth will begin to ramp higher. But due to the lower base we’ve established, we still need to reduce our second-quarter GDP estimate from 1.7% growth to 1.3%, while the consensus estimate is reduced from 2.3% to 2.2%.
- We are taking our third-quarter estimate down from 2.1% growth to 1.5%, versus a reduction in the consensus estimate from 2.7% to 2.6%.
- We are cutting fourth-quarter GDP growth from 2.3% to 1.8%, versus an unchanged consensus estimate at 2.8%.
- That takes our full-year 2013 GDP estimate down from 1.7% to 1.2%, versus the Blue Chip consensus, which is cutting its estimate from 2.1% to 2.0%.
The Macro Policy Committee also made the following investment observations:
Third-quarter earnings season not as bad as expected We’re 90% of the way through the third-quarter revenue and earnings season, and results are just not as bad as the confessional season had us primed, with the ratio of downward-to-upward management guidance at a very poor four-to-one. Revenues are higher by 1.6% year over year, which is 0.8% below expectations, and only 29% of the companies have reported an upside surprise. Earnings, however, are down by 0.6% year-over-year, but that’s 3.6% above expectations, and 65% of the companies have surprised to the upside. This suggests to us that while revenue growth has been and will continue to be a challenge, profit margins have likely expanded, resulting in better bottom-line performance. In fact, third-quarter nonfarm productivity grew by a solid 1.9%, while unit labor costs actually declined by 0.1%.
Employment improving Nonfarm payrolls are starting to gain some modest positive momentum, rising by an average of 173,000 jobs in each of the past four months, compared with only 67,000 in the second quarter and a much stronger 226,000 average in the first quarter. The ADP report—an important leading indicator of private-sector job growth—added a relatively healthy 158,000 jobs in October, compared with a downwardly revised 114,000 in September. But ADP changed its methodology last month, increased the sample size, and switched outside partners (to Moody’s Analytics from Macroeconomic Advisers), so we probably need to give this data series a few months to establish itself. Construction, manufacturing and temporary help all turned positive last month, while the household survey remained strong. The unemployment rate, which at 7.9% is down from a peak of 10.0% in October 2009, has declined largely due to a 2% drop in the labor force participation rate, which has fallen to a 31-year cycle low of 63.5%. President Obama won reelection with the highest rate of unemployment since FDR in 1936.
Commodity price spike easing Due to the worst drought conditions in half a century, corn prices soared by 70% over the summer, while wheat and soybeans rose by 45-50%. But agricultural commodity prices have, in fact, pulled back by 5-10% over the past few months. Since the Iranian oil embargo on July 1, crude oil (West Texas Intermediate) soared by 30% to $101 per barrel, before retreating to $85 over the last two months. That has taken the national average price for a gallon of unleaded gasoline down by 10% from $3.87 to $3.45. So the sharp spike in nominal inflation we saw over the summer has started to recede, and core inflation is still running at relatively well-behaved levels of 2.3% and 2.0%, respectively, for the wholesale Producer Price Index (PPI) and the retail Consumer Price Index (CPI) on a year-over-year basis through September. The core Personal Consumption Expenditure (PCE) index, the Federal Reserve’s preferred measure of inflation, is still running at 1.7% year-over-year through September, which remains well within the Fed’s 1.0% to 2.0% target range.
Back-to-school bounce for consumer spending BTS spending enjoyed a nice sequential rebound in the third quarter, compared with negative retail sales for three consecutive months in April, May and June, the first time that’s happened since the financial crisis in 2008. Because consumer spending accounts for 70% of GDP, that swing accounted for much of the third-quarter’s GDP rebound, versus the negative impact that weak retail sales had on second-quarter economic growth. Ordinarily, that positive trend would hold up through the fourth quarter with a contribution from important Christmas sales, as BTS and holiday tend to be very highly correlated. But we’re understandably concerned about the impact that Hurricane Sandy and the election results may have on Christmas sales. Consumer confidence has strengthened through October, with Michigan sentiment at a five-year high at 84.9, while the Conference Board’s consumer confidence indicator is at a four-year high of 72.2. The Leading Economic Indicator (LEI) is at a seven-month high at 0.6%, and the housing-market index is at a seven-year high at 41.
Manufacturing perks up After posting readings just under 50 for three consecutive months through August, which implies economic contraction, the national ISM manufacturing index popped back over 50 into growth mode during September and October. True, the important regional Fed indices we monitor have been a mixed bag. But the September trade balance hit a two-year low, due to a record surge in exports, largely due to strong end-market demand in Latin America. Factory orders and wholesale inventories soared in September, while durable goods orders and industrial production and capacity utilization rebounded solidly from very weak August levels. Auto sales hit a four-year high in September at 14.9 million units, which is now up 65% from the bottom of the cycle in February 2009, although results were at least temporarily hit by Sandy over the last five days in October.