Economic Commentary
Daniel Laufenberg, Ph.D.

Also See our Special Report: Health Care Legislation:
Essay No.1 - Costs
Essay No.2 - Revenue
Essay No.3 - Budget Deficits

Numerous economic data series are released between the publication dates of the Laufenberg Economic Quarterly (LEQ). Therefore, this page is designed to provide commentary on the more recent data and their implications for the economic outlook.

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More evidence of a strong finish
(December 22, 2011)

More recent data continue to support the view that the U.S. economy is much stronger in the second half of the year, especially the fourth quarter, than it was in the first half. Recall that real gross domestic product (GDP), the most comprehensive measure of economic performance, grew a scant 0.8 percent at an annual rate in the first half of 2011, which I have argued was the result of several strong but temporary headwinds. Based on more recent data, it looks as if the first-half headwinds were temporary. According to the Bureau of Economic Analysis (BEA), real GDP grew 1.8 percent at an annual rate in the third quarter, which is up from the 1.3 percent pace in the second quarter and the 0.4 percent pace in the first quarter but down from the preliminary third-quarter estimate of 2.0 percent reported a month ago. However, as noted before, real final sales growth, which is real GDP less the change in inventories and a measure of domestic final demand, grew 3.2 percent in the third quarter. This is twice the pace in the second quarter and four times the average pace for the first half. In other words, the underlying strength of the U.S. economy in the third quarter was much stronger than the headline statistic alone suggests.

In the final estimate of third-quarter real GDP, the bulk of the downward revision to real growth was in the services component of personal consumption expenditures. There are several aspects of this revision that merits discussion. First, spending on services by consumers in the current recovery has lagged service spending in each of the two prior recoveries by a considerable margin. In other words, even prior to the downward revision in the third quarter, consumer expenditures on services were disappointing.

Second, recall that we have argued on several occasions in the past that since most U.S. payroll jobs are in services, any meaningful acceleration in job growth will not occur until service spending improves. Real consumer spending on services increased 1.9 percent at an annual rate in the third quarter, equaling the pace in the preceding quarter. Although this is considerably slower than the 2.9 percent gain estimated earlier, it still is fast enough to suggest moderate job growth. That is precisely what we have had.

Third, the downward revision to consumer spending on services was mostly spending on health care. This is consistent with the anecdotal evidence that I have gathered from friends and family in the medical profession, who noted that business was slow in the third quarter and early in the fourth quarter. However, the hospital staffers tell me that their business picked up dramatically in the last several weeks. The implication is that health care spending in the fourth quarter may turn out to be surprisingly robust, with most of it coming in December. Moreover, this suggests a solid starting point for consumer spending on services in the first quarter of 2012.

The bottom line is that, despite the downward revision to real GDP in the third quarter to 1.8 percent from 2.0 percent, real GDP in the fourth quarter is still on track to register a very solid gain. Indeed, fourth-quarter real GDP growth is now expected to be even stronger than shown in the November LEQ; that is, 4.0 percent versus 3.4 percent (see Table 1).

table 1
I noted in the November LEQ that real GDP growth would average something around 3.0 percent for the second half of the year, up from the 0.8 percent average pace for the first half. Of course, that projection was made following the BEA’s advance estimate that third-quarter real GDP grew 2.5 percent at an annual rate published in late October. Unfortunately, the BEA has revised its estimate of third-quarter real GDP downward in each of the two revisions since. In late November, the estimate was revised downward to 2.0 percent and more recently it was revised downward again to 1.8 percent. As such, real GDP growth averaging 3.0 percent for the second half of 2011 seems like a real stretch. However, recent gains in retail sales, a rebound in industrial output, an improving housing market, and the drop in the unemployment rate, along with the drop in business inventories and the very strong gain in real final sales in the previous quarter, suggest that real GDP growth of 4.0 percent in the fourth quarter is a strong possibility.

As shown in Table 1, the bulk of the difference between the November forecast of 3.4 percent and the current estimate of 4.0 percent in the fourth-quarter real GDP growth comes from two items, fewer imports and more inventory accumulation. The revisions to these two items alone have added nearly 0.7 percentage point to my estimate of fourth-quarter real GDP growth, more than enough to offset slightly less robust business fixed investment.

That being said, nothing in the recent data would cause me to change my forecast for all of 2012. I continue to expect growth to be solid and inflation to remain relatively benign. Obviously there are several risks to my 2012 forecast, including a more severe and longer recession in the eurozone than currently anticipated, a more protectionist trade policy, a misguided shift in budget policy, or an overly zealous financial regulatory policy. My forecast assumes that the eurozone will experience a recession but it will be mild because Germany will not participate. Trade problems will arise but they will be settled without enacting more restrictive trade provisions. Budget problems will be addressed but in a more realistic manner and with a longer-term perspective (common sense eventually will prevail). And bank regulation will finally be written and it will not be as onerous as many fear. Credit markets will continue to function, but banks will increasingly become less important once again. The reason is that financial innovation most likely will occur outside of the commercial banking industry. With the last financial crisis still haunting us, it will take bankers a while to convince regulators that any new activity is something they should be allowed to do. Once permission is given, which it frequently is, banks once again will end up holding the “proverbial bag.” It is amazing how some things never change. period

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For the current economic forecast, as well as other analysis and commentary, please visit the Stonebridge Capital Advisors website.

Dlaufenberg@stonebridgecap.com

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The views expressed here reflect the views of Daniel Laufenberg as of the date referenced. These views may change as economic fundamentals and market conditions change. This commentary is provided as a general source of information only and is not intended to provide investment advice for individual investor circumstances. Past performance does not guarantee future results.


2011 Commentary

More evidence of a strong finish
-- December 22, 2011

Finishing Strong
-- October 14, 2011

Living in interesting times
-- September 8, 2011

A not so pleasant surprise!
-- September 2, 2011

Surprise!
-- August 16, 2011

Debt ceiling politics
-- July 25, 2011

Q2 growth: Another disappointment likely
-- July 14, 2011

Interpreting the ISM manufacturing index and the employment situation report for May
-- June 4, 2011

A slower start to 2011 than anticipated earlier
-- April 14, 2011

Is the dollar's status as the reserve currency at risk?
-- March 21, 2011

More trouble in the Middle East
-- February 26, 2011

Searching for the next debt crisis
-- January 13, 2011

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