Recap: The U.S. economy grew at a 0.2% annual rate in the first quarter. It was the worst economic performance in a year, with evidence of a slowing international trade sector and anemic business investment. A sharp deceleration in hiring in March also ended a year long stretch of heady job creation, raising concerns about broader economic growth amid mounting evidence of a slowdown. Closely watched indicators of consumer spending, capital investment and manufacturing output have all slumped in recent months. A strong dollar has restrained U.S. exports and could continue to drag down broader growth. Much of the recent sluggishness may be chalked up to harsh winter weather across much of the eastern U.S., but the signs of weakness don’t end there. The spending boost from cheaper gasoline appeared to have faded or at least not materialized yet. Low oil prices have led to oil-field layoffs.
Despite these poor numbers, the weakness in consumer spending can be chalked up to weather related effects since underlying economic fundamentals remained on solid ground. Monthly employment figures have averaged 275,000 jobs a month over the last twelve-months – its strongest pace in 15 years – while the unemployment rate has steadily edged lower. Helping to accelerate employment gains have been the number of job openings that have reached new cyclical highs with each passing month. Moreover, as employment opportunities have become increasingly plentiful, the number of people leaving positions for new opportunities has also hit new post-recession highs, highlighting the impact that improving labor market conditions have had on overall sentiment.
This confidence has manifested in consumers, as evidenced by the Conference Board’s Consumer Confidence index, which surged to 101.3 in March before dropping slightly in April. This rise in consumer confidence alongside gains to household income appeared to have filtered through to vehicle sales in April.
Housing data has also started to show signs of a spring thaw. Pending home sales have increased while mortgage applications have also turned decisively higher in recent months. And while housing construction data has remained soft so far this year, building permits – a leading indicator for housing starts – has continued to point to a pick-up in building activity in the months ahead. Putting all of these factors together makes a solid case for an uptick in economic growth over the remaining three quarters of 2015.
GDP: Real GDP grew by just 0.2% (annualized) in the first quarter of 2015. The downturn in economic growth reflected a number of one-off factors. Harsh winter weather had its impact on consumer spending as well as the delivery of equipment and inputs to production. Second, the West Coast dock workers’ strike disrupted supply chains and again altered the strength of consumer spending and production. Third, the one-time shock of lower oil prices influenced the pace of business investment for equipment and structures as well as energy sector hiring and, ultimately, corporate profits. More lasting has been the impact of the rising dollar, which continued to weigh on net-exports and likely will do so in the quarters ahead.
Going forward, economic activity is expected to pick up in the second quarter as the adverse impact of temporary factors, such as poor weather and the West coast port disruptions subside.
Retail Sales: Retail sales rose 0.9% (month-over-month) in March. Gains were broad-based, with 9 out of 13 sub-components rising in the month. Besides autos, sales of building materials and garden equipment also delivered sizable gains. After rising in February, sales at gas stations fell 0.6%. Reflecting declining prices, sales at gas stations have fallen for 9 out of the past 10 months.
Following three consecutive monthly declines, consumers staged a comeback in March, with both headline and, more importantly, core numbers posting gains. Given the rebound in March, consumer spending should continue to rise in the months ahead, supported by robust real income growth, high consumer confidence and improved household balance sheets.
ISM manufacturing index: The combination of harsh winter weather, the West Coast port stoppage, plunging oil prices and the soaring dollar has proven to be a devastating mix for the nation’s factories. The Institute for Supply Management (ISM) manufacturing index fell by 1.4 points to 51.5 in March, marking the slowest pace of expansion since May 2013. Eight out of the index’s ten subcomponents edged lower in the month. The backlog of orders, employment, exports and imports led the declines. New orders and inventory also retreated with inventories falling more than the new orders. The spread between the two—which tends to be a leading indicator of future activity—has widened ever so slightly, increasing from 0.0 to 0.3 points.
This is the fifth decline in the ISM manufacturing index in as many months. While the index still remains above the 50-point threshold, which corresponds to expanding manufacturing activity, ongoing declines suggest that the pace of expansion has continued to taper. However, the steady rise in real disposable income growth in the United States—supported by robust job growth and low inflation—will induce higher spending in the month’s ahead, providing support to American manufacturers.
ISM non-manufacturing index: The ISM non-manufacturing index edged slightly lower in March to 56.5. However, as the value remained well above 50, it is in the expansion zone and indicates moderate economic growth. There was an increase in new orders and backlogs and the employment index. Prices paid rose for the first time in three months, suggesting some firming in inflation.
The modest decline in the non-manufacturing index over the past few months indicates that the manufacturing sector has taken the brunt of the dollar’s appreciation and port-related disruptions, while the service sector has been affected much less.
Inflation: Underlying U.S. inflation appeared to be firming despite slower economic growth, a potentially reassuring sign for the Federal Reserve as it weighs when to start raising interest rates. U.S. consumer prices increased for the second consecutive month in March after falling through much of the winter. The CPI increased 0.2% in March from a month earlier that matched the increase the previous month, which was the biggest rise since June.
The overall price gauge has trended downward since last summer when oil prices began to tumble. But the momentum appears to have shifted. Stabilizing energy prices have helped recent headline inflation measures move higher. This shift is expected to continue in the coming months as the early effects of low oil prices wane further. On the other hand, the core prices, excluding the volatile food and energy categories – have climbed 1.8% over the past year, reflecting higher costs for housing and medical care.
Small Business Optimism index: The NFIB’s small business optimism index unexpectedly declined in March, falling by 2.8 points to 95.2. All 10 of the major sub-components recorded declines in the month, with the largest deterioration coming from the percent of firms expecting the economy to improve and current job openings. The net percent of surveyed firms expecting to increase employment make new capital outlays and boost inventories over the next several months all recorded sizeable declines
The pullback in the percent of firms planning to hire is particularly discouraging, especially coming on the heels of last month’s weak payrolls report. Given the forward-looking nature of this subcomponent, the decline in March suggests that there may be more than lagged weather effects weighing on last month’s slowdown in employment.
Going forward, the overall economic backdrop should remain favorable for small and medium sized businesses. This is because of favorable accessibility to credit, a low interest rate environment and low commodity prices. These factors should provide a boost to overall household income and, in turn, support future sales growth.
US Dollar: For most of 2015, the dollar continued to rise rapidly. According to the Wall Street Journal SJ Dollar Index, the U.S. currency strengthened 12% against rivals in 2014, and gained more than 8% through the end of April. But the dollar’s rally has faltered in recent weeks. Despite the recent pullback, we still expect the dollar to appreciate as the U.S. economy maintains a faster growth rate than that of Europe and Japan though the rate of ascent should slow. The euro and yen will continue to struggle under powerful monetary easing measures, ranging from low – and even negative – interest rates to massive government asset purchase programs.
Trade: The U.S. deficit in trade in goods and services surged from $35.9 billion in February to $51.4 billion in March. Both exports (0.9% M/M) and imports (7.7%) rose in the month, with far greater movement in the latter. March’s sharp decline in the deficit was impacted by the port disruptions on the West Coast. However, there were also other reasons for lackluster export growth. Specifically, slow growth in some of the country’s major trading partners and the appreciation of the dollar, which rose more than 15 percent on a trade-weighted basis between the end of June 2014 and mid-March 2015.
In terms of the second quarter, this trade number starts the economy on a very poor footing. Even with a large upward turn in monthly indicators, second quarter real GDP growth could come in at a relatively subdued level, which would mean a weaker first half of the year than in 2014.
Fed: The Fed has attributed the economy’s sharp first-quarter slowdown to transitory factors, in effect signaling an increase in short-term interest rates remains on the table; although the timing has become more uncertain. The Fed now needs time to make sure its expectation of a rebound proves correct after a spate of soft economic data. The chances of a rate increase by midyear have diminished.
The Fed sees the risks to the economic outlook as balanced—an important sign that they aren’t at this point alarmed about the first-quarter slowdown. They believe that conditions are ripe for consumer spending to pick up in the months ahead, in part because employment, incomes and confidence have risen and falling gasoline prices have boosted household purchasing power.
International: So far, the European Central Bank’s quantitative easing program appears to have been successful at shoring up confidence and boosting economic activity in the Eurozone. Much of the impetus has been related to the sharply lower euro, which has declined over 20% in the past year. The lower currency has boosted exports. With imports unchanged, this has left the trade surplus higher for the single-currency area. Industrial production also surprised to the upside in March. The lower euro has helped inflation, which has remained slightly negative on a year-over-year basis as a result of lower energy costs, but appears to be turning the corner in light of stronger core measures.
The rest of the global economy is still adjusting to a new, more challenging, economic scenario created by the continuous slowdown in growth of the Chinese economy and by the recent collapse of the price of crude oil. The economies that are suffering most are those that have relied heavily on exports of commodities to China and the rest of the global economy. Those economies will now need to rely more on their domestic consumer markets to do the heavy lifting as external markets will remain constrained for some time. However, this is easier said than done, as many of these economies also relied on the revenues generated by this growth in exports to fund domestic demand.
But not all of the developing countries will be able to easily adapt to this new environment. Those countries that are linked more to the U.S. economy will continue to see relatively strong economic growth but those that relied more on the rest of the global economy will continue to lag behind. At the same time some of these countries put forward policies that were good in times of prosperity but that today are called into question. Perhaps the case of Brazil and its industrial policy is the most vivid example of policies gone awry with the scandal unearthed over the past several months regarding payments for projects contracted by Petrobras.
Outlook: The U.S. economy has been gathering steam, with evidence mounting that it will bounce back up in the second quarter. Auto sales rebounded strongly in recent months, after being depressed by weather in January and February; the housing market has shown signs of a spring thaw; and consumers have remained confident. The job market took a bit of a breather in March, but one months’ weak jobs tally needs to be put in the context of months of very solid hiring and a very harsh winter. Strength in the U.S. labor market will underpin the best pace of consumer spending in a decade in 2015.
Real disposable income should to rise in 2015 with gains reflecting the fundamentals of better job and compensation growth along with lower inflation. Meanwhile, continued gains in household wealth via financial assets and real estate should also support stronger consumer spending, as will easier standards for obtaining consumer credit.
Equipment and structure spending will bear the brunt of the decline in energy and other commodity prices. The slowdown in equipment and structure spending will reflect reduced investment in the mining and energy sectors. However, we do not project this weakness into a national slump as business credit continues to ease and other industries are in stronger positions to increase capital outlays.
Housing starts and residential investment should continue to improve over the course of the year. In addition, government spending continues to exhibit a turnaround after three years of negative impacts on growth.
Net exports are also in a turnaround situation—but this time there is flip from positive to negative. Both income and price effects have been negative. Weaker income effects reflect the sluggish global economic outlook for key trading partners. The price effect reflects the rise in the U.S. dollar exchange value. Add to these the fact that American consumers will boost imports, and the net effect is a negative impact on net exports and GDP growth.
Year-over-year inflation will continue to rise in the year ahead. The base effect of lower energy prices in 2014 will begin to drive up reported year-over-year numbers later this year. The FOMC will likely begin to lift the federal funds rate in the third quarter and we expect that the long-end of the Treasury yield curve will rise, but only partially, in response to a higher funds rate. However, we also anticipate that the credit cycle is ahead of the economic cycle, and decision makers need to be vigilant that investment decisions reflect the rising cost/declining quality of credit going forward. Corporate profit growth should overcome the energy hit and resume its 4%-5% pace for 2015. Finally, US dollar strength should persist over the remainder of 2015.
Sources: The Conference Board, NFIB, Wall Street Journal, Department of Commerce, Department of Labor, Institute for Supply Management
Robert Henderson is the President of Lansdowne Wealth Management, an independent, fee-only advisory firm in Mystic, CT. His firm specializes in financial planning and investment management for retirement, with a special focus on the particular needs of women that are divorced or widowed. He is an Accredited Asset Management Specialist and a Certified Divorce Financial Analyst. Mr. Henderson can be reached at 860-245-5078 or firstname.lastname@example.org. You can also view his personal finance blog,The Retirement Workshop at http://lwmwealth.com/blog and the firm’s website at http://www.lwmwealth.com.
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