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CNB Economic Comments June 30
July 2, 2014
“A Mid-Year Review of the U.S. Economy”
At year end 2013, I was hoping for slightly better Gross Domestic Product (GDP) growth in 2014, but was uncertain whether business or consumers would provide the spark. The recent release of first quarter GDP gave me the same sinking feeling I’ve become accustomed to receiving from my golf game. U.S. GDP actually fell 2.9% in the first quarter of 2014, the worst showing since the Great Recession. Consumer spending had a small gain, business spending had a large contraction, net exports went negative, and government spending, while stronger, still contracted. It’s pretty hard to blame it all on the lousy winter weather, but no one wants to use the “recession” word right now. This expansion is five years old this month, just about average for the post World War II period, but substantially less than the 1991-2001 and 2001-2007 expansions… and the Fed money machine continues, but at a slower pace.
The June estimate of GDP growth for 2014 done by the Federal Open Market Committee (FOMC) recognized the reversal. FOMC members dropped their 2014 GDP growth estimate from 2.8%-3% to a 2.1%-2.3% range… and the FOMC is known to be a bit enthusiastic in their forecasts. So what’s happening out there?
A look at personal income and spending thus far in 2014 gives a pretty clear indication of a still cautious consumer. Disposable personal income has risen moderately in each month of 2014 after dipping in December 2013. Personal spending fell in January, had decent increases in February and March, was flat in April, and advanced a paltry .2% in May. There’s a definite lack of uniformity between consumer income and spending being displayed here.
Retail sales figures for the past year also reflect an indecisive consumer. While motor vehicle sales have had solid double digit growth in the past year, most other categories have had sub-par growth. Total retail and food sales have advanced 4.3% since May 2013, but are up only 2.8% without auto sales. Annualized growth in consumer stalwarts like electronics, grocery stores, restaurants, and clothing has been abysmal. However, there was good growth in building materials, non-store retailers, and furniture. Consumer spending for the past year has been spotty, and needs to recover… soon.
Let’s not forget this year’s 800 pound gorilla – home sales. Both new and existing home sales had shown slow growth in 2014 until May, when both reported good numbers. Existing homes still haven’t returned to the over 5 million annualized units that were seen last year, but inventories and prices are firming. Foreclosures and short sales are dropping as a percentage of sales, which is another indication of a strengthening market. New home sales topped the 500,000 annualized unit level in May for the first time since 2008. Median prices are up about 5% from year ago levels, while inventories are beginning to shrink. Everything here indicates a better second half.
I believe the second half of 2014 could see substantially (3%+) growth in consumer spending for four reasons. First, the employment situation will continue to slowly improve. While there remains concern over wage level growth, one factor that can’t be ignored is the pace of job growth. It has averaged over 231,000 per month since February, the best 4 month average since December 2001 – March 2012, and there have been 2.4 million jobs created in the past year. Unemployment continues to improve, with 1.5 million fewer long term unemployed (15+ weeks) than at this time last year. These numbers will help to stimulate better retail sales. Secondly, the Debt Service Ratio (household debt payments dividend by disposable income) as measured by the Federal Reserve Bank is at its lowest level since the measurements began in 1980. It has fallen 25% since the extravagant days of 2005-2007. Simply put, consumers have reigned in debt and have more disposable income available for new purchases than at any time in memory. Perhaps that’s why outstanding consumer credit has begun to expand at such a rapid pace (10.2% in April versus 6.6% in the entire first quarter of 2014). And credit card debt rose 12.3% in April after a miserable 1.9% increase in the first quarter. Thirdly, the two major consumer confidence polls both show consumers have recovered fairly well from the Great Recession. These surveys have recovered dramatically from 2009 bottoms, but do remain 20-25% below all-time records set during the mid-2000’s boom. While these polls have been relatively flat for the past year, the most recent surveys suggest an uptick in consumer feelings about business conditions and job and income prospects. A breakout above the mid 80’s levels of both indices would suggest better consumer spending. Finally, I just can’t ignore the ongoing increases in home and stock prices. Of course the Fed’s “easy money” policy has been the fuel, but the FOMC continues to back away from its asset purchases. Stepping in has been the banking system. As measured by the Fed, bank loans and leases are increasing at more than 8% annualized in 2014, almost four times the rate of increase in 2013 (2.2%). This transfer of credit availability will support ongoing growth.
Business spending in early 2014 fell almost 12% from fourth quarter 2013 levels, as inventories plummeted, and equipment and structure spending went negative. There were huge disruptions that were weather related in most categories of industrial production, holding growth below normal levels for the first five month of 2014. Anecdotal information from the Fed’s “Beige Book” suggests that most business categories are coming back on track. However, I’m a little concerned that U.S. productivity is falling off, seeming to indicate a working force that is getting a bit tired. Productivity fell 3.2 % in the first quarter of this year as output dropped and labor costs rose. Durable goods orders from U.S. manufacturers had a good three month run stopped in May. Most of the decline was in aircraft and defense spending, the usual culprits of volatility. Surveys of business leaders suggest that business confidence is resuming, but my hopes for a big year in business spending are fading faster by the minute. With the global economy continuing to lag, and China’s “new growth norm” about half of past years the net export picture isn’t looking very good either. So it’s easy to see the corporate picture as having a long way to recover to moderate growth for the whole year.
It appears that inflation as measured by the Consumer Price Index (CPI) and Producer Price Index (PPI) is displaying a bit of an increase due to food, energy and related costs. With both indices around the 2% level, the FOMC will have to keep its eye on those numbers. Some writers are already calling for interest rate hikes by mid-2015. Without some spectacular growth in the second half of 2014, that seems highly unlikely to me.
So I’m lowering my estimate of GDP growth for the year to +1.8% to +2.0%, and the economy will need three pretty good quarters to get there. Inflation as measured by the CPI could increase just a bit, to around 1.8% to 2.0%. Unemployment levels have already surpassed my hopes, and should be around 6% by year end. I see no reason to change my short term interest rate (Federal Funds at .25%). Reaching .95%-1.05% on a 3 year CD probably won’t happen, even though bank lending has accelerated. Look for 3 year CDs to be in the .80%-.90% range by year end.
Stock prices have seemed little concerned with the less than stellar performance of the economy. I had suggested that prices could rise in the 10% range for 2014, and thus far the NASDAQ and the Standard and Poor’s 500 are right on track (as are a number of world indices that some readers follow). It seems the stock markets remain the favored repositories of much of the investment cash since most shorter bonds have negative real returns. With stock prices above historical price /earnings ratios, investors are going to have to be a bit careful in the second half of 2014.