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CNB Weekly Economic Commentary: Year in Review & 2013 Preview

December 28, 2012
To: Everyone
From: Gregory S. MacKay, Senior Vice President & Chief Economist
Date: 12/28/2012


The Year in Review:

Is it just me, or did the economy in 2012 seemingly zig-zag more often than a lost minivan on I-4 looking for the entrance to Disney World? The flood of economic data presented seemed to paint a picture of an economy that couldn’t figure out which way is up. But let’s be clear about one thing right up front: The U.S. economy is in an expansion, not a recovery, and has been so since the fourth quarter of 2011 when inflation adjusted annualized GDP surpassed all prior quarters. “Expansion” sure sounds a lot nicer than “recovery”. When the final numbers are in, the U.S. economy will have grown over 2% in 2012… not robust, but better than a majority of developed countries.

Last year I talked about six factors that would contribute to U.S. economic growth:

1) Consumer spending rose at an unadjusted 3.4% annualized rate from the third quarter of 2011 to the third quarter of 2012, a bit slower than I hoped for. Considering a pre-inflationary increase in disposable income of just over 3% for the past four quarters, consumers did well. They suffered a “soft patch” in spending in May and June similar to 2011, as rising gasoline prices led some writers to suggest inflation was on the rise. Consumer Confidence figures also bounced about a bit in mid-year, but are recovering nicely as yearend 2012 approaches.

2) I expected the jobs situation to continue and pick up some steam. November 2012’s national unemployment rate of 7.7% is one full percentage point below November 2011, which in turn was down 1.1% from November 2010. The rate is better than I projected, but concern remains. Bureau of Labor Statistics data can seem to be contradictory sometimes. While the participation rate (labor force divided by civilian non-institutional population) remains stagnant, jobs and new people seeking work is growing, but discouraged workers remains high. The simple fact is that 1.8 million jobs have been generated thus far in 2012, with monthly gains ranging from 45,000 to 275,000. More improvement is needed here.

3) Inflation adjusted annualized business spending increased over 11% from third quarter 2011 to third quarter 2012, led by a huge surge in inventories, strong growth in housing, and good equipment and software purchasing. The dark cloud here is that equipment spending fell in the latest quarter, and inventories probably won’t continue to grow at the current pace, but it’s been a good year for business.

4) Bank Lending increased just under 4% from November 2011 to November 2012. However, there was noticeable slowing in November 2012, as some caution was being exhibited by corporate America and the “fiscal cliff” began to loom. Housing was a nice surprise in 2012. I was concerned about tight credit, tight appraisals, and an overhang of unsold homes. Existing home sales in November 2012 went over the 5 million level (annualized) for the first time since 2007. The increase was 14.5% over the prior November, and inventories of just over 2 million were down 22.5% from year ago levels. The November 2012 median price of $180,600 is up 10% year-over-year, and is at 2003-2004 levels. New housing starts and permits are soaring, and new home sales hit a two year high in November. The declining existing home inventory (almost 2 million units less than in 2007) has been noted by builders. The housing expansion is real.

5) Total government spending (annualized) actually fell from the third quarter of 2011 to the third quarter of 2012. That’s right – fell. Regardless of all the election year rhetoric about who was spending what, total government spending actually fell .5% for that period. The bad news is that federal spending has risen steadily since the beginning of 2012, while state and local cuts continue.

6) Inflation just wasn’t an issue. While gasoline prices jumped earlier in the year, there was some concern noted that inflation could ratchet through the economy. It just hasn’t happened, as both the CPI and PPI are well within Fed targets.


A Preview of 2013:

Any discussion of 2013 has to include the 800 pound gorilla out there. As of this writing (December 28), the President and Congress have returned from a holiday, and there has been little news from either political party. Since you’ll be reading this after Hanukkah or Christmas I can ask: Did anyone out there tell their kids or grandchildren “no” to any one thing requested this holiday season… just one thing? Good for you… now can you teach the people in Congress the same concept? That’s the heart and soul of this “fiscal cliff”. There are somewhere between $600-$750 billion of tax cuts and spending programs about to expire… and we have a debt ceiling ready to burst, too… and to top it off, milk prices are about to double. Everyone in America benefits from one or more of these tax breaks or programs. While we citizens seem to agree that our deficits can’t continue to grow, Congress can’t decide who to say “no” to. Now the world isn’t going to end January 1 even if no action is taken. But I sense that all of us voters know all the presents under the tree can’t be ours, and we’re willing to compromise. Sure, we’ll all grind our teeth a bit, but down deep we all know that some combination of tax increases and program cuts is going to happen. So how do we get this message through to Washington? There may be some solution by the time you read this that could take one or more of the flowing forms:

1) If the deadlock stays and no compromise or alternative passes, the spending cuts and tax increases are expected to draw over $1 trillion out of the economy and put us into a recession in 2013. That is shameful.

2) Since the various tax increases and program changes ratchet in over time, Congress can sit on its hands for a month or so to see who hollers the loudest, then act. That is cowardly.

3) Simply extend the current programs and try to deal with them in 6 months to a year. That is indefensible.

4) Hopefully, our politicians will have returned after their holiday and will find compromise on some items of difference. Making some headway will mollify the securities markets, which will in turn make all of us civilians more comfortable. Please, anything by year end, and then some serious statesmanship as we go into 2013.

So, on to my view of 2013. With the expansion now 3½ years old, some people are asking me how soon before the next recession? According to the National Bureau of Economic Research, since World War II there have been 11 economic cycles, with the average trough to peak of 58.4 months. The economy bottomed in June 2009, so we’ve got a good year and a half left in the average expansion… and I think it could be a lot more. To give my views some perspective, my projections are based on some fiscal compromises developing very soon (Social Security tax increase, partial reduction of discretionary spending, partial increase in income tax rates, some loophole closing, partial unemployment insurance extension) and continued Federal Reserve Bank support.

While economists often debate which style of economic thought should prevail, I’ll offer up a slightly different view for today. The Chinese have a wonderful philosophy called “Yin and Yang”, some of which tenets merit inspection from an economic standpoint. Yin and Yang are opposites, yet cannot exist without each other. Levels of Yin and Yang continuously change, and when out of balance can adversely affect each other. Now substitute fiscal and monetary policy for Yin and Yang and see my drift. I’ve championed the Fed and the Federal Open Market Committee (FOMC) for some time as the primary reason the Great Recession wasn’t even worse. Congress did provide fiscal relief with Troubled Asset Relief Program (TARP) and the American Recovery and Reinvestment Act (ARRA). However, the huge amount of liquidity continuing to be provided by the Fed trumped the efforts of Congress. Yet both types of stimulus have proven to be necessary to dig out of the recession. The FOMC just recently changed its advisory on monetary tightening to give us actual inflation and unemployment targets rather than a calendar date for policy changes. I believe this absolute transparency is necessary as it signals the Fed’s determination to support the expansion. The Fed is going to keep all monetary guns blazing through 2013 and longer. Congress has to get back in the game. Fiscal cliff versus easy money.

I believe that the first quarter of 2013 will be somewhat adversely affected by our bickering Congress. Consumers have been holding up fairly well in late 2012, as holiday spirit and sales generally mask any unease. But the rumblings about tax increases are out there. The biggest fear is of the unknown, and individual tax increases for the average American family of $3,000 to $10,000 are being bandied about. That’s a big bite in most budgets. But after a poor first quarter, I think consumer spending should be slightly better than this year. The savings rate is still high, debt deleveraging has given many some breathing room, and stock and home prices are increasing again. Look for consumer spending to grow around 1.7% adjusted for inflation.

Without some fiscal help, which is highly unlikely, it seems that job growth will muddle along, but at a slightly better pace than this year. As with consumer spending, the first quarter looks weak, as corporations are holding back on hiring plans until Congress sorts itself out. The new housing mini-boom beginning could greatly aid the jobs numbers. Thus business spending, the all star for 2012, is highly unlikely to reach the same levels of 2012. With inventories to work off, and uncertain tax legislation, I’ll offer that business spending, even with a better new housing market, is going to detract from GDP growth in 2013.

Government spending will fall slightly in 2013, more from continued retraction at state and local levels than from federal cut backs. No, I don’t see the 10% reduction in federal discretionary spending becoming a reality, but a more moderate compromise will begin to peel back Federal spending. Look for government spending to be relatively neutral to GDP.

The export-import situation will not be much of a factor. With many industrialized countries in a no growth/slight recession mode, we won’t get a big export improvement, nor should energy costs spike our import costs.

I hesitate to even mention inflation. There is little wage pressure in this country, more than adequate room for expansion in our manufacturing capacity, no commodity shortages, no productivity pressures and plenty of job seekers out there. Only a global social geo-political or weather related crisis could upset economic conditions enough to put a short term inflation scare into our economy.

So with a weak first quarter, then better consumer spending, and neutral government and export/import factors, I see 2013 as follows:

GDP (total year 2013) +1.8% to +2.0%
CPI (total year 2013) +1.9% to +2.1%
Unemployment Rate (12/2013) 7.1% to 7.5%
Federal Funds Rate (12/2013) .15% to .25%
3 Year Certificate of Deposit (12/2013) .75%

Financial Markets:

U.S. stock prices here had a great 2012, partly due to the ongoing expansion, partly due to unrealistic bond yields, and partly due to a slowing global economic picture. European markets had a nice second half of 2012 as the European Central Bank (ECB) issued a “Fed-like” statement that it would “do whatever it takes” to save Europe. Further monetary easing is necessary there.

The year 2013 will be challenging to investors early, due to the “fiscal cliff”. Again, believing in a realistic compromise, slightly lower GDP, no inflation, continued Fed pressures on interest rates, and ongoing slow global growth leads me to think that U.S. stocks should have a fairly good 2013. Early resolution of the fiscal cliff could yield stock price increases approaching double digits.