Follow the money
Bottom Line The Conference Board reported yesterday that its consumer confidence index plunged to a much weaker-than-expected 124.1 in March. The consensus expectation was for a modest increase to 132.5, which would have been in line with February’s 131.4. The equity market, however, correctly shrugged off the disappointing number. We think that a series of transitory issues negatively impacting first-quarter GDP and corporate earnings growth are beginning to fade from view. As a result, we expect second-quarter and second-half 2019 results to pivot sharply higher.
What are these transitory issues?
- Negative fourth-quarter wealth effect Stocks plunged 20% from Sept. 21 to Christmas Eve—with P/E multiples contracting from 18 to 14 times earnings—as investors priced in the near certainty of recession sparked by the fear of a Federal Reserve policy blunder. But stocks have since rebounded 20% (with P/Es expanding back to 16 times), nearly erasing the fourth-quarter correction.
- Worst Christmas in a decade Nominal retail sales declined 1.6% in December for their worst performance in a decade, while control results (which exclude autos, gas, building materials and food service) plunged 2.3% to a 19-year low. This was largely due to the negative wealth effect fueled by the declining stock market in the fourth quarter. But with the powerful first-quarter bounce in share prices, January nominal and control sales rose 0.2% and 1.1%, respectively.
- Brutal winter weather It was the snowiest winter ever on record in the Pacific Northwest, the polar vortex made it also the coldest in half a century in the Midwest and Northeast, and torrential rains resulted in massive flooding and mudslides throughout the country. While these likely curtailed first-quarter economic activity, spring has ushered in more seasonable weather, which should trigger a release of pent-up consumer and business demand.
- Government shutdown The partial closure of the federal government ended Jan. 25. Running 35 days, it likely cost the economy at least 0.5% in first-quarter GDP growth, according to the Council of Economic Advisers. That may have trimmed as much as a full percentage point off growth due to the multiplier effect.
- “Frugal February” When consumers get their holiday credit card bills, belt-tightening usually ensues in February to get budgets back on track for Easter spending (late this year on April 21). The personal savings rate recently spiked to a 3-year high of 7.6%, so we expect this amassed dry powder to be spent over the next month or so.
- February nonfarm payrolls plummet The labor market added only 20,000 jobs in February, the weakest level in 17 months. But most of the miss stemmed from the bad winter weather and the government shutdown. It was countered by positives, including a 20-year-low unemployment rate of 3.8% and a 10-year-high annual wage growth of 3.4%.
- Slower first-quarter GDP and EPS Third-quarter growth was 3.4%, but it slowed to 2.6% in the fourth quarter, a preliminary reading that consensus believes will be revised down to a final gain of 2.3% on Thursday. We think growth in the first quarter will decelerate further to about 1.7% before rebounding to 2.6% in the second. Corporate earnings soared about 25% in the first three quarters of 2018—the strongest pace in eight years—before pulling back to a 15% gain in the fourth. We are bracing for a modest first-quarter decline of 3-5% due to the temporary issues mentioned above before returning to positive territory in the last three quarters. 2019 could very well be capped by a double-digit year-over-year gain in the fourth quarter.
Leading indicators forecast the trend There is a strong positive historical correlation of some 70% between several of the leading confidence indicators we monitor and the lagging growth rate in the economy. The following metrics were all at multi-decade cycle highs in August, September and October 2018, consistent with above-trend growth through the third quarter. But they collectively fell off a cliff in November, December and January due to fears about a recession, a Fed policy error, the China trade deal, Brexit and the government shutdown. That prompted us to lower our fourth-quarter 2018 and first-quarter 2019 GDP growth estimates to 2% and 1.7%, respectively. But it appears these metrics have bottomed, suggesting a possible upturn in second-quarter growth.
- Conference Board’s Consumer Confidence Index surged to an 18-year cycle high of 137.9 in October 2018. January’s reading then tumbled to 121.7. February rebounded to 131.4, but March retreated to 124.1 (perhaps due to the aberrant February jobs report released March 8).
- Michigan Consumer Sentiment Index rose to a 14-year cycle high of 101.4 in March 2018, but plunged to 91.2 in January. The preliminary March 2019 reading soared to 97.8.
- National Federation of Independent Business small-business optimism index hit an all-time, 44-year record high of 108.8 in August 2018, but then declined sharply for five consecutive months to 101.2 in January 2019. February stabilized by rising slightly to 101.7
- Leading economic indicators increased sequentially for 25 consecutive months through September 2018’s 111.5, another in a series of all-time cycle highs (dating back 58 years). But the index has treaded water for the past five months, slipping to 111.3 in January before rising back up in February to match its cycle high.
- ISM non-manufacturing index leapt to a 13-year cycle high of 60.8 in September 2018, before falling to 56.7 in January. But it rebounded to 59.7 in February.
- ISM manufacturing index reached a 14-year high of 60.8 in August 2018, but dropped sharply to 54.2 in February.
- Housing Market Index builder-confidence metric After peaking at 68 in October 2018, it fell to 56 in December 2018, but bounced back to 62 in March.
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