Volume 61, Number 7
A deluge of economic data came out this week, and most of it was shaded to the optimistic side reinforcing the view that real GDP growth will top 3% in the third quarter and maybe in the fourth quarter as well. The question now is whether after a soft start to the year this is merely catch-up or is the economy about to break out into sustained above trend growth? From our point of view, the details in the data suggest that the recent success has been a rebound from the Japanese earthquake supply chain disruptions. After a rebuilding of inventories in the fourth quarter, the economy still needs a source of momentum to generate steady above trend growth. We don’t see policy conditions as conducive to ongoing optimism. Barring a huge surprise, the Congressional super-committee appears ready to do the minimum. Both parties seem to agree to let the election – still twelve months away – decide the future direction of the country. The sequester does not take hold until January 1, 2013 and so the politicians see no true deadline for negotiation or compromise. Whether they let the 2% payroll deduction holiday roll off on January 1, 2012 is the first test of their resolve. All this may be fine for politicians and their brinksmanship, but for corporate America it means another year of muddle through. A wide swath of industries will be affected by either the sequester, the loss of the payroll deduction, or any of the many outcomes that the election could produce. Now is not the time for bold, expansive action by business. Rather it is still a period to husband ones resources and hunker down until better information is available. This is unlikely to lead to a double dip, but it puts expansion on hold as well.
Blood from a Stone
One of the key reasons for optimism recently is the surge in retail sales over the past three months, lifting consumer spending – which represents 70% of US GDP. Retail spending rose a robust 0.5% in October, after a strong 1.1% in September. Over the past three months, average retail sales have risen at a 6.5% annual rate compared to the prior three month average. This has happened at the same time that income has been stagnating, as weak employment and wage gains have limited wage growth to 2.7% over the same period (based on the McVean income proxy). Our friends at the Liscio Report indicate that the divergence between wages and sales is supported by state tax data, which show sales tax collections running ahead of withheld income taxes. We have noted in earlier letters that declining interest obligations have opened up some room for spending in excess of income – but the main reason for the improvement appears to be the rebound in the equity market and a surge in spending on big ticket and interest sensitive items. Durable goods and gasoline have had much wider swings during this recovery than nondurable goods ex energy. This is consistent with swings in consumer confidence, access to credit, and the equities market. Bottom line, we do not think trees grow to the sky, and the recent strength in retail sales is likely to be reined in during coming months as restocking of autos and electronics after the Japanese quake ends. The introduction of the iPhone 4S alone appears to have been a major boost in electronics spending, which soared 3.7% in October alone. Again, we do not expect a double dip, but the 5.2% growth in nondurable ex-energy sales appears to be a more reliable indicator of the sustainable trend in consumer spending.
One Word, Plastics
Industrial production in manufacturing rose a solid 0.5% in October, after a pair of 0.3% increases in the two previous months. The three month average for industrial production has risen from the prior three months at a 4.5% annual rate. As in retail sales, this strength is primarily a rebound in autos and other durable goods sectors after the Japanese earthquake. Normally, we look at three core industries – fabricated metal products, chemicals & plastics, and electrical machinery – to determine the underlying direction of the economy as they historically have the highest correlation with GDP because they are so widely used. However, since the quake, fabricated metal products has boomed as US auto makers gained share and electrical machinery has cratered as supply chain problems hit the domestic industry. Meanwhile, plastics have seen a slowing growth rate in contrast to the headline industrial production numbers. Though less clear than the retail sales data, we interpret this to mean that the surge is not stimulating a broader expansion in industrial activity. We expect that the economy will settle back into a muddle through mode during the first half of 2012 as it reacts to the political malaise.
Claims are Coincident
Initial claims for unemployment fell to 388,000 this week, bringing the four week average under 400,000 for the first time in seven months. As with our earlier indicators, the improvement in claims look more like a return to pre-quake levels than the start of something new. Employment is typically a coincident indicator of economic growth, though the report on initial claims is the earliest and most frequent indicator of job growth. State data seasonally adjusted by McVean Trading confirms the downtrend in nationally reported initial claims, even though state claims data is reported with a one week lag.