Economic Commentary
Daniel Laufenberg, Ph.D.

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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Growth gyrations continue
(January 28, 2013)

After registering an upwardly revised growth rate of 3.1 percent in the third quarter, it looks as
if U.S. real gross domestic product (real GDP) will be reported on Jan. 30 to have slowed
considerably in the fourth quarter. Interestingly, this gyration in real output growth is in large
part due to temporary swings in the change in business inventories and government spending.
For example, in the third quarter, real final sales grew 2.4 percent at an annual rate, even though real consumer spending grew a mere 1.6 percent and business fixed investment actually
declined 1.8 percent. Clearly, other components of final sales, including a 3.9 percent jump in
real government expenditures as well as a 13.5 percent jump in residential investment, did
much better in the third quarter. Moreover, despite a much - anticipated, drought - related
decline in farm inventories, the gain in nonfarm business inventories was far more than enough
to offset it. As a result, business inventories contributed a solid 0.75 percentage point to real
GDP in the third quarter.

In other words, much of the better - than - expected gain in third - quarter real GDP was most likely temporary and destined to be reversed to some degree in the fourth quarter. And that seems to be what happened. The surprise is that real final sales growth (real GDP less the change in business inventories) most likely was very similar in both quarters—increasing at a 2.4 percent pace in the third quarter and something close to that again in the fourth quarter but for very different reasons.

The most obvious difference will be in the government spending component of GDP. In the
third quarter, federal defense spending surged 12.5 percent at an annual rate, which was a key
factor behind the government sector’s surprisingly large contribution to third - quarter real GDP
growth. In this regard, shipments of defense capital equipment, which help estimate the
defense spending component of real GDP, were up somewhat on average through the first two
months of the fourth quarter (most recent data available) from the third quarter. Assuming no
substantial drop in defense shipments in December, federal defense spending could register a
surprising gain in the fourth quarter. However, other government expenditures, including
nondefense federal spending as well as state and local spending, are expected to be a drag on
growth. This is based on large part by further cuts in government employment in the fourth
quarter, as well as declines in public construction spending in October and November (the most
recent data available).

Another difference is business fixed investment, which was a drag on real GDP in the third
quarter, but is expected to contribute a bit in the fourth quarter. This is based on shipments of
nondefense capital goods, which are up substantially through the first two months of the fourth
quarter. Although it is still early and subject to revisions, it looks as if business spending on
equipment was solid in the fourth quarter despite concerns about the fiscal cliff. In addition,
real personal consumption expenditures, which were somewhat anemic in the third quarter,
appear to be stronger in the fourth quarter. After all, the average level of real consumer
expenditures for October and November were already up 2.0 percent at an annual rate from the
third quarter. Also, light vehicle sales, retail sales, and the NAPM services index all suggest
that consumer spending may have increased further in December. The bottom line is that
consumer spending is likely to add more to real GDP growth in the fourth quarter than it did in
the third quarter.

With all the good news about final sales, the bulk of the growth problem in the fourth quarter
most likely will come from the change in inventories. That is, after adding nearly 0.8 percentage
point in the third quarter, inventories are expected to detract over a percentage point in the
fourth quarter. This will reflect the combination of another decline in farm inventories and a
substantial slowdown in inventory accumulation by nonfarm businesses.

In the first quarter of 2013, the gyrations are expected to continue. That is, the change in
business inventories is unlikely to detract from growth again in the current quarter. First, the
Bureau of Economic Analysis will assume that the weather returns to normal and therefore the
seasonally adjusted farm output will return to normal as well. This should provide a mild
boost to farm inventories in the first quarter as well. Second, business inventories are far from
excessive at the moment. Indeed, if anything, it could be argued that nonfarm business
inventories are still lean by historical standards. If there is one business decision that might be
influenced by the uncertainty about fiscal policy, it could be the decision to hold only those
inventories that are considered essential. Once the level of anxiety about fiscal policy is eased,
businesses may be willing to hold inventories more in line with shipment/sales growth.

The key will be whether real final sales growth can be sustained in 2013. For the most part, I
expect that it will, but it too will experience gyrations. On the one hand, ongoing concerns
about policy risk, both here and abroad, could be a drag on U.S. economic growth from time to
time in 2013, even though I doubt it will not be enough to pull the overall economy into a
recession. On the other hand, consumers, which still represent more than 70 percent of the
economy, are expected to be in a position to contribute markedly to real GDP growth in 2013.
The primary drivers of this outcome will be more jobs, more income, higher home prices, still
low interest rates, and relatively stable consumer prices for most of the year. 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.


2013 Commentary

Growth gyrations continue
-- January 28, 2013

2012 Commentary

Optimism, not irrational exuberance
-- October 15, 2012

Disappointing but far from disasterous
-- July 31, 2012

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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