Economic Commentary
Daniel Laufenberg, Ph.D.

Numerous economic data series are released between the publication dates of the Laufenberg Economic Quarterly (LEQ). These commentaries are designed to provide insight on the more recent data and their implications for the economic outlook.

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Q2 growth: Another disappointment likely
(July 14, 2011)

Recall that real gross domestic product (real GDP) grew a mere 1.9 percent at an annual rate in the first quarter, which was well below what I expected earlier in the year. Unfortunately, real GDP growth appears to be on track to disappoint me once again in the second quarter. I had expected the growth rate to accelerate to an annual rate in excess of 3.0 percent in the second quarter, which now seems unlikely in the wake of the recent economic data.

There are two ways to measure output—demand and supply. On the demand side, output is measured by summing the various components of expenditures, including personal consumption expenditures, private nonresidential fixed investment, residential investment, government spending, net exports, and the change in business inventories. Most economists focus on demand when they attempt to estimate or forecast output. In fact, at the moment, the sources of my disappointment in the second-quarter real GDP appear to be on the demand side of the ledger, especially personal consumption expenditures (consumer spending) and residential investment (housing). Both are going to come up well short of earlier expectations.

Real consumer spending through May, which is the most recent data available, is on track to increase a scant 0.5 percent at an annual rate in the second quarter, well below the 4.0 percent pace I was expecting earlier. Consumer spending in June would have to be off the charts to get close to my earlier forecast. Based on the limited consumer data reported so far, including light motor-vehicle sales, chain-store sales and heating degree days in June, a gain in consumer spending is possible but an outlier is very unlikely. In particular, light motor-vehicle sales of only 12.1 million units at a seasonally adjusted annual rate in the second quarter (11.4 million in June), which was down from 13.0 million units in the first quarter, do not bode well for consumer spending on durable goods last quarter.

On the other hand, chain-store sales were much better than expected, suggesting that consumer spending on nondurable goods improved markedly. This conclusion is reinforced by the decline in the average price of gasoline last month, which means that overall inflation most likely will not deflate spending like it did in April and May.

Also, spending on services may have improved a bit in June, as the number of total degree days last month were above the total number of the degree days in May. This means that consumers probably spent more on utilities in June than in May, which is part of consumer spending on services. My best estimate at the moment is that consumer spending increased about 1.0 percent at an annual rate in the second quarter, which is better than the 0.5 percent already in the data but well below the 4.0 percent gain I was expecting a couple of months ago.

Housing is the other source of disappointment in the second quarter. For the first two months of the second quarter, housing starts have averaged 550 thousand units at an annual rate, which is even lower than the anemic 582 thousand average starts in the first quarter. My forecast of a few months ago was expecting housing starts, and in turn residential investment, to show a small improvement in the second quarter. Obviously, there is very little chance of that happening now. But even with this disappointment, residential investment is so depressed that even a sizable decline in the second quarter most likely will have very little negative impact on overall real GDP growth.

My assessment of housing is that the long-anticipated improvement has been delayed and not derailed. As such, I remain convinced that housing starts must recover at some point, based on the ongoing changes in demographics and the expectation that the jobs market will improve. I continue to expect the recovery to begin this year.

The other components of demand are less likely to be surprising, even though some could be disappointing. For example, real government spending, which detracted 1.2 percentage points from growth in the first quarter, is expected to detract less than a half of a percentage point from growth in the second quarter. In addition, net exports, which contributed slightly to growth in the first quarter, are expected to contribute considerably more in the second quarter. Finally, business fixed investment, as well as business investment in inventories, should contribute more than a half of a percentage point each to real GDP growth in the second quarter. Hence, if we add up all of the components of demand, it looks as if second-quarter real GDP growth will be about 2.3 percent at an annual rate. At the moment, the consensus is expecting a growth rate below 2.0 percent.

From the supply side of the ledger, real output growth in the second quarter looks to be in line with, or somewhat better than, the growth rate suggested on the demand side. Output from the supply side of the national product accounts is essentially the sum of total hours worked and labor productivity. In other words, the more hours worked, the more output produced, or the more productive labor is when working, the more output produced. This relationship is shown in Chart 1, which plots the quarterly percent change in hours worked and the quarterly percent change in real GDP since 1965, both at annual rates. For the most part, the two lines track reasonably well but are not exactly the same. The difference between the percent change in output and the percent change in hours worked is the percent change in labor productivity.

In the second quarter, based on the employment data reported through June, total hours worked in the nonfarm sector of the economy increased 2.8 percent at an annual rate. The implication is that if labor productivity was unchanged in the nonfarm business sector last quarter, then total output must have increased 2.8 percent as well. The problem with this measure is that we do not observe labor productivity directly. Productivity is derived from the difference between real output and hours worked; that is, if the change in output cannot be explained by the change in hours worked, then it must be a change in productivity that explains the difference. In the second quarter, the 2.8 percent gain in hours worked do not guarantee that output grew 2.8 percent, but it does suggest that real GDP growth of 2.8 percent is not as far-fetched as many economic forecasters may claim at the moment.

Chart 1 Total Hours Worked Index

The bottom line is that real GDP growth in the second quarter probably will not be as robust as I expected earlier but neither will it as weak as the consensus now expects. Moreover, I continue to expect a reacceleration of real GDP growth in the third quarter because of more favorable household and corporate balance sheets, budget resolutions at all levels of government, the mildly positive momentum at the end of the second quarter, the anticipated rebound in motor vehicle production, the increase likelihood that housing cannot go much lower, and the expectation that the jobs necessary to re-energize the expansion to a more robust pace will emerge. 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

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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