Economic Commentary
Daniel Laufenberg, Ph.D.

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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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A good finish to 2011 but still not good enough
(January 27, 2012)

The Commerce Department’s Bureau of Economic Analysis reported this morning that real gross domestic product (GDP) grew 2.8 percent at an annual rate in the fourth quarter of 2011, which was well below my estimate of 4.0 percent in my December Commentary. This is the advance estimate, which means that it does not include December data for inventories or foreign trade. However, there is nothing to suggest that the December data, when reported, will alter the outcome in a meaningful way. According to the release, the increase in real GDP in the fourth quarter reflected positive contributions from private inventory accumulation, personal consumption expenditures (PCE), residential fixed investment, and nonresidential fixed investment that were partly offset by negative contributions from federal defense spending and state and local government spending. Net exports essentially were flat in the fourth quarter. As a result, real final sales, which are defined as GDP less the contribution from the change in inventories and are often represented as a measure of final demand for goods and services, increased a scant 0.8 percent at an annual rate in the fourth quarter, well below my estimate of 3.4 percent in my December Commentary.

This is the fourth consecutive quarter that real GDP growth fell short of my estimate. For that reason, it is imperative that I assess why. The forecast miss in the first half of the 2011 could be explained by the events around earthquakes, flooding and budget deficits. As such, it was reasonable to expect that these headwinds would subside as the year went on. In some ways they did not, but it was primarily because of the weather again. For example, flooding in Indonesia disrupted global supply chains again, just as they were starting to recover from the problems in Japan earlier in the year. But probably more importantly for U.S. real GDP growth in the fourth quarter, the winter has been extremely mild.

The weather is too often used as a scapegoat for bad forecasts, so I understand why many of you might resent my pointing a finger at the weather here. But in this case, I think I really do have a case. First, real PCE on services increased a mere 0.2 percent at an annual rate in the fourth quarter, whereas real PCE on goods jumped 5.7 percent. Clearly, weaker-than-expected service spending was the reason PCE did not perform as well as expected. When the weather is unusually mild, they do not spend as much on utilities as the seasonal factors allow, creating a meaningful headwind for seasonally adjusted spending on services. This is supported by the industrial production data released by the Federal Reserve Board, which estimated that utility output declined a whopping 10.5 percent at an annual rate in the fourth quarter. Of course, if consumers do not have to spend on utilities, that means they have the wherewithal to spend on other things, which may explain why spending on goods did as well as it did in the fourth quarter. However, the other aspect of a mild winter and a lack of snow in many northern regions of the country is that PCE on winter recreational activities, such as snowmobiling, skiing, ice fishing, and snowboarding, and many of the higher frequency, shorter trips away from home to do these things, are curtailed dramatically. The bottom line is that PCE on services added far less than expected to fourth - quarter real GDP growth—0.1 of a percentage point rather than 0.9 of a percentage point.

Second, my December forecast was that real government spending would be flat in the fourth quarter. It fell 4.6 percent at an annual rate. The bulk of the miss was due to the much larger-than-expected plunge in federal defense spending—down 12.5 percent at an annual rate, which alone detracted 0.7 of a percentage point from real GDP growth—and a larger than expected drop in state and local government spending—down 2.6 percent, which detracted another 0.3 of a percentage point from real growth. The decline in defense spending was a miss that was not weather related—I simply guessed wrong on defense spending in the fourth quarter. On the other hand, the miss in state and local spending could be somewhat weather related. One of the major expenses of many state and local governments during the winter is snow removal. Indeed, the usually mild winter and the lack of snow has been a blessing for local budgets. However, the seasonal effect can quickly move in the other direction if the winter weather simply returns to something closer to average.

The declines in federal defense spending and state and local spending were offset slightly by a 4.2 percent gain in federal nondefense spending, which contributed about 0.1 of a percentage point to growth. On balance, real government spending detracted a whopping 0.9 of a percentage point from growth. The bad news is that the negative contribution from state and local government spending, combined with the shortfall in PCE on services, can explain the discrepancy between the advance estimate of real GDP growth in the fourth quarter and my December estimate. The good news is that most of the shortfall could be due to seasonal factors, which cancel out over time. This means that eventually, the shortfall in the fourth quarter will be offset in large part by excesses later.

Of course, an unusually mild winter generally is temporarily helpful for construction on a seasonally adjusted basis, especially housing. It should be no surprise then that residential fixed investment in the fourth quarter made its largest contribution to real GDP growth—0.2 of a percentage point—since the second quarter of 2010. Any further gains in new home construction will have to overcome the seasonal effect, which could actually be a headwind in the first half of 2012.

Finally, another miss in my December forecast was nonresidential fixed investment, which increased 1.7 percent at an annual rate in the fourth quarter rather than the 9.5 percent gain that I was expecting. The miss was widespread across both structures and equipment and software spending. In particular, I expected business investment in structures to be up slightly rather than down 7.2 percent (mild weather was no help here) and I expected business investment in equipment and software to climb at a double digit pace again in the fourth quarter rather than only 5.2 percent. However, given the more recent data of a solid gain in December orders of nondefense capital goods excluding aircraft, it looks as if business spending will accelerate in the first quarter. And given the weaker - than - expected gain in the fourth quarter, there is more room for such spending to accelerate.

On balance, despite the consecutive misses in real GDP growth over the four quarters of 2011, I continue to expect real growth to rebound to at least a 3.0 percent pace in 2012, with the bulk of the improvement coming in the first half of the year. But even if it turns out that I’m too optimistic on the pace of growth again this year, I doubt very much that the miss will be as large as it was last year. Of course, this assumes no unusually severe weather in the forecast for developed countries as well as for major developing countries. I have enough problems trying to forecast the U.S. economy without trying to forecast the weather as well, even though there are times when the weather really does matter. Stay tuned. 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.


2012 Commentary

A good finish to 2011 but still not good enough
-- January 27, 2012

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

2010 Commentary

What's going on?
-- October 15, 2010

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