Volume 59 | Number 5
GDP rose an anemic 1.8% in the first quarter, and nominal GDP rose just 3.7% following a soft 3.5% annualized gain in the fourth quarter of 2010. Despite the hype, there appears to be very little weather effect in the numbers. Construction spending was very soft for both the non-residential and residential sectors, but that came off unexpectedly strong growth in the fourth quarter. The main culprit appears to be far weaker than expected spending on defense and state and local government. Meanwhile, business equipment spending and exports remained the mainstays of the recovery, with annualized growth rates of 11.5% and 5.0% respectively. The consumer benefited from the $2,000 social security tax reduction; with robust 6.9% annualized growth in disposable income generating 6.6% annualized nominal growth in spending. Rising gasoline prices ate most of the benefit, with real consumer spending up a more modest 2.7%. While we, like other forecasters, see a rebound in construction and government spending in the second quarter, the consensus is still for just 3.8% real GDP growth in the second quarter – leaving growth in the first half at 2.8%, exactly the pace seen in both the first and second half of 2010. Tough to see why there will be any acceleration in the second half of 2010 with QE2 ending and fiscal policy tightening.
The Federal Reserve appears to have one of the most optimistic forecasts for growth in the remainder of 2011 and 2012 – and is likely to be steadily disappointed as in the fourth quarter of 2010 and the first quarter of 2011. The FOMC lowered their 2011 fourth quarter to fourth quarter forecast from 3.4%-3.9% to 3.1%-3.3%. Given the 1.8% growth in the first quarter, real GDP growth would have to average 3.7% for the rest of the year to meet the Fed’s average forecast – or basically fulfill the mid-range of their earlier forecast. The Fed also barely lowered it 2012 forecast from 3.5%-4.4% to 3.5%-4.2%, dropping the average just 0.1% to 3.85%. Note that the US economy has only turned in five quarters with growth of 3.7% or more in the past ten years. Two of those were due to stimulus packages and the other three were followed by growth of less than 2%. To believe in seven straight quarter of such growth after seven stimulus assisted quarters which averaged just 2.8% appears folly. After all, the cyclical peak in real GDP and real final sales has been falling for the past fifty years. How will the Fed justify tightening policy when they are consistently missing their own growth forecast? Or is that the point?
That Profits Thing Again
Every quarter when we get GDP we remind ourselves and our readers that the key lead indicator in a capitalist economy is the growth rate in profits. We estimate profits after the initial report on GDP because the Commerce Department does not publish a figure until the second report. However, with some reasonable assumptions on business interest and the statistical discrepancy (the difference between output of product and reported income) we can get a best guess. For the first quarter of 2011, it appears that profits are declining at a -4.8% annual rate. Now, we must confess that last quarter our initial estimate was also negative, but the Commerce Department slashed the statistical discrepancy by $50 billion in their final report on fourth quarter GDP, producing a 16% annualized growth rate in domestic corporate profits. Perhaps that could happen again, but the statistical discrepancy now is the lowest since the recession began. Another rule of thumb is that profits grow at roughly ten times the difference between nominal GDP (cash register receipts) and compensation, which accounts for over 70% of outlays. In the first quarter, nominal GDP rose 3.7% and total compensation rose at a faster 3.9% annual rate. In the corporate sector, compensation rose even faster at 4.6%, reflecting the surge in first quarter bonuses. No matter how you look at it, corporate profits appear to be slowing – if not declining – in the first quarter.
That clouds the potential for faster growth in the second half of the year as businesses have been fast to cut costs to protect profits in the current cycle. The recent surge in initial claims for unemployment show that firms are reacting quickly to Japanese supply chain disruptions. This was the third straight week with claims over 400,000 – and the average of the three at 416,000 was substantially higher than the 390,000 four week average three weeks ago. Again, state data over the past two weeks (they lag by one week) make it clear that Japan is the primary culprit. There has been almost no increase in claims in the Northeast (New England and the Mid-Atlantic states) in the past two weeks compared to the previous four. The rise has been 9%-17% everywhere else over the same period. Heaviest hit have been Alabama, Kentucky, Ohio, Indiana, Missouri and Texas. All are states with large auto operations, especially those states where Toyota is a key employer. As Toyota says it will not be back to normal before year end, we see no reason for a strong rebound any time soon.
Now corporate profits normally peak as a share of GDP roughly six quarters ahead of the start of a recession, so we expect continued growth in 2011 and early 2012 – but no better than 3% on average and slowing as the expansion ages. We are clearly far less optimistic than the Fed, which has the unemployment rate at 7% by the end of 2012 with real GDP growth averaging near 4%. Indeed, we are unsure how the US could grow at 4% without imparting even more growth to the Chinese juggernaut, which is already driving energy and other commodity prices higher. Indeed, we are more worried that China is making a policy mistake as it tries to throttle off inflation. Copper, long known as the metal with the PhD in economics, peaked in February and has been fading since. It looks much worse in euros. Indeed, in euros, copper correctly marked the peak of the US housing boom in early 2006. Today, it may be marking the peak of the Chinese construction boom. With the locomotive slowing, the rest of the train is far more likely to slow than speed up. Bottom line, we remain very worried about what happens when the downturn ultimately comes, as in our view we will still have a roughly 8% unemployment rate and a 8% of GDP budget deficit and interest rates near zero. My main question is not how will our upcoming election change the economic outlook for the US, but can we make it to the election before a new crisis is upon us?