It was a quiet week for the markets as earnings season started to wind down and the economic news was mixed. World data this week was slim. The U.S. market was little changed, Europe and Japan were a little weaker, and emerging markets ended their winning ways, falling 2%. A softer dollar may have helped commodities along this week; they were the best performer, gaining 1.5%.
The dollar fell this week as U.S. GDP growth not only disappointed, but also was lower than growth reported in Europe for the first quarter. Emerging markets also fared poorly because of worries over U.S. growth rates, as the United States is a prime market for emerging-markets exports. Surprisingly, despite a weaker-looking U.S. economy, U.S. interest rates on the 10-year bond moved up from 1.92% last Friday to 2.12% this week. I suppose it didn't help that after this week's monthly Federal Open Market Committee meeting, the U.S. Federal Reserve remained noncommittal about when it would raise interest rates. It is clearly not giving out any hints or help whatsoever, which I suppose the bond market finds quite annoying.
The U.S. GDP report of just 0.2% GDP growth in the first quarter was disappointing to everyone, as falling oil drilling activity ruined a report that was already expected to be hit hard by bad weather and West Coast port-related activities. Drilling activity pushed GDP growth down by about 0.8%, about the size of the negative surprise. Still, we wouldn't be too upset with a GDP report that shows four-quarter-over-four-quarter growth of over 3%. Seasonal factors and weather have really confounded economists and statisticians, who tend to favor the sequential quarter-over-quarter growth methodology.
In other economic news, auto sales came up a little short at 16.5 million annualized units versus expectations of 16.7 million units. That represents year-over-year growth of 4%-5%, a slowdown from over 10% in the early years of the recovery and 5.4% for all of 2014. More incentives, higher inventories, and longer loan lengths all suggest that the automotive economic engine is beginning to sputter. In better news, pending home sales continued to accelerate sharply, indicating that the housing market may be beginning to accelerate after a long pause that lasted for most of 2014 and early 2015.
GDP growth disappoints
We suspected that the first quarter would disappoint investors, but even we were disappointed. The sequential, annualized growth rate barely managed to stay in positive territory at a paltry 0.2% compared with consensus estimates of 1.1% just a week ago. And even that terrible growth rate was artificially inflated a bit by an unusually large contribution from inventory adjustments, which kept GDP growth from falling to a 0.5% loss.
That first-quarter U.S. GDP number needs some context, though. GDP growth was close to 5% in the second and third quarters of 2014 before falling back to 2.2% in the fourth quarter, and now a positive 0.2% in the first quarter. Weather and seasonal factors helped inflate those midyear 2014 data points and are now hurting the sequential comparisons in a big way. Our trusty year-over-year data, viewed on a first-quarter-to-first-quarter basis, looks much higher and more stable at around 3%. Even the rolling four-quarter GDP data (not shown) shows a growth rate of over 3%. Better weather this year versus last year has helped some of the year-over-year data, but I still believe the year-over-year GDP growth would be higher than 2.5% without the weather-related help, a slight improvement in the five-year trend of 2.0%-2.5% growth.
GDP component data shows consumer buying strike, collapsing exports, and large energy issues
The individual U.S. GDP component factors weren't too far off of consensus forecasts. Consumption growth was cut in half in a widely expected drop from 4.4% to just 1.9% growth between the fourth quarter and the first quarter. At almost 70% of GDP, that fall single-handedly took off 1.7% from the GDP growth rate (contribution from 3% to 1.3%). The rapid deterioration in consumption was widely expected. We have a fuller discussion of consumption data below, but the bottom line is that special factors and weather weighed on the short-term data and some, not all, of the rapid deterioration should be recovered in the second quarter.
The big surprise was the sharply worsening effect of the trade deficit. We expected the deficit to be modestly less painful in the first quarter than the fourth. Instead, the government is estimating that the net deficit took 1.0% off of the fourth quarter, and that jumped to 1.3% in the first quarter as the BEA believes imports will surge in March (not yet released), based on the port strike settlement. Hopefully, the trade gap growth will slow some in the months ahead as oil prices and competition stabilize, but not soon enough to help the second quarter.
Speaking of oil, the decline in oil structures (think oil rigs and associated piping) caused the business structure category to collapse. The business structures category, which is usually too small to move the GDP needle much, managed to take 0.8% off of the GDP calculation. With oil-related structures still declining, it may be another couple of quarters before this begins to stabilize, keeping a headwind in front of GDP growth.
Inventory growth may limit the GDP rebound this time around
Inventory growth, which was unexpected, contributed a positive 0.8% to the U.S. GDP calculation. This is the second quarter in a row inventories have been a help. That is somewhat unusual--good quarters usually follow bad quarters, and vice versa. In fact, though the sequential inventory numbers jump all over the place, inventories seldom make much of a difference over a year's time. With inventories relatively high, businesses will not need to ramp up production as quickly in the months ahead. This is bad news for the GDP bulls who believe that the economy could bounce back from first-quarter 2015 weakness, just like it did a year ago. Inventories were a huge detractor from the GDP calculation in the first quarter a year ago and an equally massive help in the second quarter. This year, inventories helped the first quarter and are likely to hurt the second quarter, maybe by a lot. No 5% growth in the second quarter this time around, in my opinion.
For the curious, in 2014 the weather was so awful over such a wide area, both production and retail sales were equally lousy. So when sales got better, manufacturers had to step up their game. Southern and Midwestern hubs of the U.S. manufacturing sector were spared most of the really intense weather in 2015, so factories remained open and production continued to do OK, but not great. However, the weather was still bad enough to limit consumer shopping, and inventories continued to build. Those higher inventories will put even more pressure on manufacturers in future months.
Our 2015 GDP growth forecast remains 2.0%-2.5%
I am guessing that the recent first-quarter U.S. GDP report will probably pull down the consensus forecast for 2015 closer to our long-standing growth rate of 2.0%-2.5%. We are making no change to our forecast range. Second-quarter growth is likely to rebound some, perhaps to 3%, and settle into a 2.5%-3.0% growth rate in the back half of 2014. The consumer, housing, and some moderation in the import/export situation will be the key drivers of second-half growth.
Monthly personal income and spending converge, at last
According to the GDP report, consumption overall did poorly in the first quarter. However, things started looking at least a little better in March. One of the great mysteries of the recent year has been very strong income and total wage growth and more muted growth in consumption. This is particularly true of the sequential, month-to-month data and quarterly data, but the trends are still visible even in the year-over-year data. Usually U.S. consumers spend most of their income growth in short order.
The month-to-month data since November was looking particularly out of whack, as shown above. From December through February incomes surged (better employment growth, hourly wage growth, and low inflation). Meanwhile, consumption barely budged over that time frame. Annualized consumption for December through February grew just under 1% on an annualized basis, while incomes soared almost 7% over that same three-month period. The difference seemed particularly unusual because of accelerating job growth and falling gasoline prices. Our thesis has been that poor weather, high utility bills, and higher rents as well as skepticism concerning the durability of falling gasoline prices all hurt consumption data. We also believed that some of the employment gains may have been merely shifted around to different times of the year, befuddling some of the employment and income calculations.
However, the March report on incomes and spending finally showed the month-to-month data beginning to converge as consumption grew at an above-trend level of 0.3% while incomes were off 0.2%. Spending likely rebounded with better weather while incomes were negatively affected by slower employment growth and higher inflation.
The year-over-year data, which is probably benefiting at least a little from an even more severe winter in 2014, shows a much less volatile, if perhaps slightly elevated growth rate in both income and consumption. In any case, consumption is still running considerably behind income and wage growth.
Income outlook uncertain, spending looks set to improve
Continued improvement in the income growth category will be very dependent on a rebound in April and May employment and hourly wage growth. My guess is that we are likely to get decent hourly wage growth (
Wal-Mart's WMT big minimum wage increase kicked in as of April 1) or better employment growth, but probably not both. On the consumption side, better weather, lower utility bills, and higher but still reasonable gas prices should keep consumption rates growing.
The potential offset to all of the consumption good news is that consumers in oil-dependent states could continue to pull in their horns. That's one of the reasons I believe consumption growth slipped so suddenly. Oil-related issues cinched spending instantaneously once the layoffs began, while consumers benefiting from lower gasoline prices spend their gasoline-related largesse more slowly. Further good news is that the savings rate remains elevated, providing future firepower for spending increases even if the employment outlook dims some.
Auto sales losing some of their oomph
While auto manufacturers were trumpeting good April numbers, I believe the auto recovery is looking a little long in the tooth. We estimate the BEA auto sales for April were about 16.5 million units, which would mark a 4% annual increase. The graph below shows pretty clearly that auto sales growth has slowed dramatically from the heady days of 10%-plus growth annually from 2010 to 2012. Notice how the blue sales line has gone flat after years of angling up sharply.
There's good and bad news embedded in that slowing growth trend. First, while unit growth has slowed quite dramatically (from a peak of over 13% to just 5% for the first four months of 2015), U.S. automakers are still pleased. More profitable and U.S.-manufactured pickup trucks are doing well even as plain autos, which face more foreign competition, continue to be soft. Ford F noted its popular and redesigned F150 pickup now sells for over $42,000, up more than $3,000 from a year ago. However, the dark side of strong pickup and SUV sales is that we assume a meaningful part of that growth is from oil patch states. So far, the slowing purchases in oil states aren't turning up in the overall numbers.
However, not all the news was good, and sounds suspiciously like we are nearing some type of top. Auto loans continue to stretch out, with new auto loans made in April averaging 67.8 months, the longest average length in history. Some loan programs now stretch to 84 months (seven years) and beyond. Incentives, while not at the go-go levels of the turn of the century (the last time sales were over 17 million on a sustained basis), also were on the rise in April, especially at the Big Three. Also worrisome was the fact that inventories are beginning to build, especially in the small-car sector. According to Edmund's, subcompact inventories were at 98 days and compact cars at 78 days, both above longer-term levels.
Putting it all together, auto sales, often a leader of consumer sentiment, are still moving ahead but at a slower pace as the industry seems to be reaching a saturation point, at least in terms of units. A collapse certainly does not appear to be imminent, but no boom, either. This in turn will keep a lid on consumption growth, unless sales break out of current levels.
Pending home sales point to better housing activity
Pending home sales were up 1.1% month to month in March, marking a third consecutive monthly increase. Year over year, pending home sales increased 11.1% and averaged over three months, the metric further accelerated to 10.5%. On that basis the pending home sales growth bottomed a year ago when pending homes' three-month average year-over-year growth was bleeding with an 8.4% rate of decline. Since then, we've seen a series of consecutive improvements, dramatically shifting the picture for the existing-home market, which tends to follow pending home sales by one to three months.
Late last year, when growth was just emerging from a long slump, we expected pendings to get better, but not even in our more bullish scenario would we have thought the pace of the increases would accelerate so quickly. Better pending home sales signify that the previously lethargic existing-home sales growth should continue to pick up steam.
Case-Shiller confirms the faster pace of home price increases
Case-Shiller confirmed what both the Federal Housing Finance Agency and CoreLogic CLGX have already suggested. The pace of home price increases continued to pick up rather significantly. The 20-City Case-Shiller Index increased 0.9% in February, marking a seventh straight month of monthly increases. Year over year, the growth stood at 5.0% compared with 4.5% in January. CoreLogic reports March sales, along with an April estimate next week, and we will be on the lookout for any signs of further acceleration in home price increases. We are hopeful that year-over-year price growth will not cross the 6% threshold, as this would be detrimental to housing affordability and potentially to the health of the housing recovery in general.
ISM purchasing manager data stops going down, at last
The overall ISM Purchasing Manager Index, a great leading indicator of manufacturing activity, was flat in April at 51.5, after falling for five consecutive months, as shown in the far right column below. That has been a great leading indicator of industrial production. At a reading of 51.5, the metric shows that more businesses are seeing an increase in activity versus a decline. Still, the number, at least on the surface, disappointed analysts who expected a weather- and port-related bounce to 52.2.
That said, the April report was a bit stronger than it looked. New orders--the most leading part of the index--increased from 51.8 to 53.5, and current production moved from 53.8 to 56. Exports and imports also showed nice increases, though these are not used in calculating the composite index.
ISM sector data showed that manufacturing improvement broadened out substantially in April, even as the composite index remained unchanged. In April, 15 of 18 sectors showed growth versus just 10 in March. This broadening-out phenomenon is usually a very positive trend.
On the bad news front, inventories contracted. This was probably necessary given the inventory growth shown in the GDP report (which stops in March, a month sooner than the ISM report). Employment also dipped below 50 to 48.3, which equals the lowest level since the recovery began. This will not be good news for next Friday's employment report.
Employment data and trade on tap next week
The key question next week is, was the March data report a statistical data fluke or the start of something more ominous? Recall that the March data showed jobs only increased by 124,000 versus its 12-month average of over 260,000 jobs. In addition there were some revisions to prior months that reduced the rate of job growth. The low growth rate and the revisions brought the GDP growth rate and employment more into line.
Given that initial unemployment claims have remained low and some weather-related bounces, I suspect that the April employment report will rebound to something closer to its annual average of 260,000 jobs. However, the bad ISM read on manufacturing employment and continued issues in the oil patch are likely to keep a lid on the improvement. My guess is that employment grows by 200,000-250,000 with a single-point estimate of 225,000. A report of anything much less than 200,000 new jobs would likely panic the markets. Also, it will be very interesting to see how the Wal-Mart minimum wage edict flows through the hourly wage data, which had already shown some signs of acceleration. Economists are looking for a 0.3% increase in the hourly wage (3.6% annualized), above the 0.2% reading registered in March.
Trade report expected to show a huge increase in March
Trade was a huge detractor from the GDP report for the first quarter. Part of that was a huge assumption by the BEA concerning the March export and import of goods. The government appears to assume that the nominal trade deficit went back up to $45 billion in March from $35 billion the prior month. A lot of economists are hoping they were wrong. The consensus forecast is for a trade deficit of $43 billion. Unfortunately, the monthly trend in the data and a continued strong dollar (well, until this week's disappointing GDP report) suggest that the trade deficit is likely to be a large detractor from the GDP calculation in the second quarter.
