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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Assessing the recent weak economic data
(June 8, 2012)

Recent U.S. economic data have come up short of consensus expectations, culminating with the May employment data released last week. Once again, the shortfalls in the data have caused renewed anxiety among investors about the survival of the current expansion, triggering a pronounced flight away from risk. As such, stock prices fell and bond prices climbed. The question now being raised is whether the data will continue to support this “risk-off” trade or is a turnaround in the cards. I suspect that it is the former rather than the latter, but I also must admit that the economy has not generated the growth in real output or jobs that I expected by this point in the business cycle. Moreover, it is imperative that the Federal Reserve not engage in another round of quantitative easing. I contend that they have overstayed their accommodative policy stance already, which in turn has contributed to the current U.S. economic malaise.

First-quarter GDP

Real gross domestic product (GDP) growth for the first quarter was revised downward to a disappointing 1.9 percent annual rate from the initial estimate of 2.2 percent. The interesting aspect of this downward revision was that the components of real growth were actually somewhat more encouraging. In particular, real final sales, which represents final demand, were revised slightly higher to show a gain of 1.7 percent at an annual rate versus the earlier estimate of 1.6 percent, despite an even larger drag on growth from the government sector and a slightly smaller contribution to growth from the consumer sector in the revised data. Government consumption expenditures and gross investment detracted 0.8 of a percentage point from real GDP growth in the first quarter compared with the original estimate of a 0.6 percent drag. In addition, personal consumption expenditures added 1.9 percentage points to real GDP growth in the first quarter, down a bit from the 2.0 percentage points initially. The difference was that nonresidential fixed investment added 0.2 of a percentage point rather than detracting 0.2 of a percentage point, representing a net gain of 0.4 of a percentage point in revised data.

Given that real final sales growth was a tad stronger but overall real GDP growth was a bit weaker, the change in business inventories contributed less to overall GDP growth in the revised data. Originally the change in inventories was estimated to have added 0.6 of a percentage point to real growth in the first quarter, but was revised to show a contribution of only 0.2 of a percentage point. The implication is that there is now more room for inventories to add to growth over the remainder of the year. Whether this occurs in the current quarter is unclear. The Institute of Supply Management (ISM) reported that inventories at manufacturers were declining in May at an even faster pace that in April, while inventories at nonmanufacturers were too high in May, except for retailers who thought their inventories were too low. Recall that the change in inventories cannot sustain expansions or contractions but it can add or detract substantially from real growth in any one quarter.

ISM and industrial production

With regard to the ISM report on manufacturing, there was considerable anxiety about the composite index (PMI) slipping to 53.5 in May from 54.8 in April. The implication is that the manufacturing sector, and in turn the overall U.S. economy, slowed in May. Although the pace may have slowed a bit, it probably was not as severe as the response suggested. A reading above 50 percent indicates that the manufacturing economy is generally expanding; below 50 percent indicates that it is generally contracting. As shown in Chart 1, the index remains above 50, while the percent change in industrial production from a year ago hovers around a gain of 5.0 percent. There is nothing in this chart to suggest that the U.S. economy is heading into a recession in the near term.

chart 1

A PMI in excess of 42.6 percent, over a period of time, generally indicates an expansion of the overall economy. Therefore, the May PMI indicates growth for the 36th consecutive month in the overall economy, as well as expansion in the manufacturing sector for the 34th consecutive month. According to the ISM, "The past relationship between the PMI and the overall economy indicates that the average PMI for January through May (53.6 percent) corresponds to a 3.7 percent increase in real gross domestic product (GDP). In addition, if the PMI for May (53.5 percent) is annualized, it also corresponds to a 3.7 percent increase in real GDP annually." Obviously, real GDP did not grow as fast in the first quarter of 2012 as the PMI suggests, which means that the PMI could slip even further and still be consistent with real GDP growth of 3.0 percent.

Unemployment—insurance claims vs. rate

To get a more timely impression of labor market conditions, many market participants rely on weekly initial unemployment insurance claims. However, the problem with weekly data is that it tends to be noisy and too often misinterpreted. I contend that the recent reading on claims represents just such an occasion. For example, initial unemployment insurance claims edged up for the month of May, causing commentators to turn negative on the outlook. This negativity was reinforced by the weaker than expected May employment report, which showed that the unemployment rate ticked up to 8.2 percent from 8.1 percent a month earlier. Two things come to mind. First, the headlines from the May employment report were clearly disappointing. Second, as shown in Chart 2, a longer-term perspective of the claims data suggests that the unemployment rate is on a downward trajectory and will continue in that direction for some time, despite the recent uptick in claims.

Chart 2

As a result, I continue to expect the unemployment rate to trend lower over the next year and a half at least, regardless of what the Federal Reserve decides to do. However, whether it continues to fall beyond my forecast horizon does depend on what the Fed does. Any additional quantitative easing (purchases of longer-term debt by the Fed) will deliver very small short-run benefits but create some very serious longer-term problems. I wrote a piece after the first QE program by the Fed suggesting that it was a bad idea in large part because it appeared to be doing it for the wrong reason. At the time, I warned that we would become addicted to QEs; that is, every time the market went down, Wall Street would expect the Fed to come to its rescue. The Fed has to stop bailing out fiscal policymakers, speculators and traders; it is creating a serious moral hazard problem.

Consumer spending

This is just a short note on real personal consumption expenditures (PCE) in April. According to the Bureau of Economic Analysis, the level of real consumer spending in April was already 2.1 percent at an annual rate above the first-quarter average. In other words, if real consumer spending is flat in May and June, then real PCE for the second quarter still would register a gain of 2.1 percent. Given that inflation most likely was benign in May and likely to continue that way in June, real PCE likely will look as good as the current dollar estimates imply. I remain constructive on consumer spending in the current quarter. For more on this, see the “Consumers to the rescue” section of the May 2012 issue of the Quarterly.

On balance, I remain optimistic that the U.S. economy will perform better than the consensus; both the old consensus as well as the new downward revised consensus. Consumer spending, which represents over 70 percent of GDP, will be the key to this above consensus outlook. In addition, housing will continue to improve (albeit gradually), business fixed investment will be okay (albeit slower), and the government sector will stop being a drag on growth. Net exports are expected to be a slight drag on growth, as imports are likely to expand faster than exports. This should not be a surprise given the economic troubles elsewhere and the expected strength in consumer spending. After all, most consumer products are imported, whereas the bulk of our exports are capital goods. 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

Assessing the recent weak economic data
-- June 8, 2012

Consensus too pessimistic about everything
-- April 16, 2012

Risks to the forecast
-- March 7, 2012

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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