FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
July 12, 2011
IN THIS ISSUE:
1. Latest Economic Reports – A Little Good News, But…
2. June Unemployment Report Was Dismal
3. The Optimists’ Case for the Economy
4. Debt Ceiling Debate Revisited
Economic news over the last few months has for the most part been disappointing or downright negative, although we have seen a couple of bright spots in the last week or so. Even the Commerce Department’s final estimate of 1Q GDP, which rose from a 1.8% annual rate to 1.9%, was disappointing. As a result, many economists have been dialing back their forecasts for the 2Q and the second half of this year.
Still, there are some forecasters that believe the 2Q was the worst of this year’s economic slowdown, and that the second half of this year could surprise on the upside, at least modestly. Whether accurate or not, I will summarize the basis for this more positive outlook in the pages that follow.
But first we’ll look at the latest economic reports including last Friday’s surprising unemployment report. Following that, we’ll look at the latest forecasts from Blue Chip Economic Indicators, a monthly survey of 50 leading economists.
Next we will revisit the debt ceiling debate once again. President Obama is adamant about raising taxes on those families making over $250,000 and individuals making over $200,000 a year. Plus he wants to eliminate numerous tax deductions including the home mortgage interest deduction. Never mind that the economic recovery is stalling and the housing market is still in the dumps – raise taxes anyway.
Republicans are resisting Obama’s push to raise taxes in return for spending cuts, so both sides remain far apart as this is written. Fortunately or unfortunately, time is quickly running out ahead of the August 2 deadline. I still predict that some kind of deal will get done, but I will not be surprised if people on both sides of the political aisle are unhappy with the outcome.
Finally, my liberal readers gave me an earful last week for suggesting that President Obama shares some of the blame, along with former President George W. Bush, for the current weak economic recovery. In the eyes of those who e-mailed to chastise me, it’s all Bush’s fault and Obama is doing the best he can with the awful situation he inherited. Yeah, right! If you would like to weigh in, you can e-mail me at firstname.lastname@example.org. I would love to hear from you!
Latest Economic Reports – A Little Good News, But…
On June 24, the Commerce Department released its final estimate of 1Q GDP at 1.9% (annual rate), up only fractionally from its previous estimate of 1.8%. Now all eyes are focused on the just ended 2Q numbers which we won’t see until late this month. As noted above, most economists are downgrading their forecasts for 2Q GDP growth.
For example, just two months ago Goldman Sachs projected that the economy would grow at a 4% annual rate in the 2Q. But in late June the company revised that number down to no more than 2% growth. Macroeconomic Advisers, a well-known research firm, projected 3.5% growth for the 2Q back in April but recently revised its estimate down to just 2.1%.
Both of these firms, well respected in their analysis, have cut their forecasts for the second half of the year as well. Shortly thereafter, the Federal Reserve downgraded its projections for the full year to under 3% growth, down from its earlier estimate of 3.9%.
Fortunately, not all of the economic news has been bad over the last few weeks. The Index of Leading Economic Indicators (LEI) rose a solid 0.8% in May following a decline of 0.4% in April. The LEI actually bottomed in early 2009 and has increased sharply since then suggesting a much stronger recovery than we have seen. This is not the first time the LEI has been off the mark.
In another encouraging report, the ISM manufacturing index rose to 55.3 in June, up from 53.5 in May. Orders for durable goods rose 1.9% in May, but that increase failed to offset the 2.7% decline in April. Retail sales fell 0.2% in May after rising 0.3% in April.
On the housing front, there was some mildly encouraging news. Pending home sales rose 8.2% in May but even that did not fully offset the decline of 11.3% in April. Sales of existing homes fell to 4.81 million in May, down from 5.0 million in April. New home sales were also slightly lower in May.
The main problem with the disappointing economic recovery continues to be sagging consumer confidence and spending. The Consumer Confidence Index fell more than expected in June to 58.5, down from 61.7 in May.
A New York Times/CBS News poll taken on June 30 found that 39% of Americans believe the economy is on a downward path. Almost 30% believe the economy is in a “permanent decline.” Only 57% believe the economy will improve over time, down from 68% last October.
As long as consumer confidence remains in the tank, the economic recovery is going to disappoint, since consumer spending accounts for apprx. 70% of GDP.
June Unemployment Report Was Dismal
The Labor Department reported last Friday that the official unemployment rate for June rose to 9.2%, the highest level since last September. This was above the pre-report consensus and was the third consecutive monthly increase in the rate. Worse yet, the report noted that only 18,000 new jobs were created in June, whereas the advance expectation was for more than 100,000 new jobs.
The official number of Americans unemployed rose to 14.1 million in June, but that number does not include 6.3 million people who have been unemployed for 27 weeks or longer and are no longer counted as unemployed. Another 8.6 million Americans are working part-time because their hours were cut back or they cannot find full-time employment. If we add in those Americans, the true unemployment rate is above 16%.
Making matters worse, the June unemployment report revised the May numbers as well. The 54,000 new jobs number reported for May was scaled back to only 25,000. The June unemployment report was disappointing in virtually all aspects. It remains to be seen how this will impact negotiations on increasing the debt ceiling (more on this below).
Blue Chip Economic Indicators Survey
The Blue Chip Economic Indicators (BCEI) is a monthly survey of 50 leading economists and forecasters. The survey results below were gathered in the first week of July and reflect the economy in June. The survey results were gathered before last Friday’s disappointing unemployment report. The latest BCEI report begins as follows:
“The consensus outlook for U.S. economic growth deteriorated further over the past month as our panelists reacted to a steady stream of weaker-than-expected high frequency data. Some of the economy’s underperformance in recent months is un-doubtedly attributable to temporary factors, but underlying momentum also appears to have softened, reinforcing the notion that recoveries following a significant financial crisis are usually modest and bumpy.”
For all of 2011, the average forecast for GDP growth is 2.8%, down from 3.2% just a month ago. For the 2Q the estimate is 2.6%, followed by 3.3% in the 3Q and 3.4% in the 4Q. GDP is expected to grow by 3.0% in the first half of 2012 followed by 3.2% in the second half. Interesting note: 80% of the forecasters believe that gasoline prices have peaked for this cycle.
As for inflation, the average estimate for CPI came in at 3.0% for all of 2011. As for consumer spending, the average estimate for personal consumption expenditures came in at a 2.7% increase over 2010 levels. Both of these averages were unchanged from a month earlier.
The forecasters surveyed by BCEI are mostly mainstream economists and therefore tend to err on the positive side.
The Optimists’ Case for the Economy
As noted earlier, most economists and market analysts continue to dial back their forecasts for the 2Q and the second half of the year. However, there still are some optimists out there, and I will summarize their general outlook below.
The optimists typically begin their analysis by noting that economic recoveries following financial crises tend to be slow and bumpy with setbacks along the way. This was one of the main points of the popular 2008 book, This Time is Different, by Carmen Reinhart and Kenneth Rogoff. I would not disagree with the premise that recoveries following financial crises tend to be slower than those following more typical recessions.
Had it not been for the financial crisis, most forecasters agree that the US economy should have grown by 5-6% or more in 2010 and 2011, and the unemployment rate would be significantly lower than it is today. With this historical perspective in place, most economic optimists then point out several potential reasons to be hopeful that the economy will perform at least modestly better in the second half of this year.
Typically, they start with the case for lower gasoline prices. As we all know, gas prices spiked almost $1 per gallon in the first three months of this year. Prices have since fallen around 30-40 cents, depending on where you live. Based on gasoline futures market prices, gas prices should continue to drift lower through the end of this year if historical trends are an indication.
But as we all know, there is so much unrest in the Middle East and Libya that we should not assume that gas prices will follow historical patterns this year. Venezuela which provides apprx. 10% of US oil imports threatened to cut off US shipments in May. Any number of things could cause prices to spike higher at any time.
Another area the optimists point to is the fact that Japan’s exports of automobiles and auto parts will return to pre-earthquake levels by the end of this summer. US auto production fell almost 8% in April and May, so as supply chain problems are reduced this should help boost the economy.
Another encouraging point is that bank lending has finally turned up again after falling off a cliff during the recession and financial crisis. The optimists expect this trend to continue higher through the end of the year and in 2012. I would tend to agree, assuming the economy doesn’t fall back into recession. Also, the Fed reported recently that bank lending standards are slowly beginning to relax.
The optimists also point to the fact that there is a lot of pent-up consumer and business demand out there. So-called “cyclical spending” expressed as a percent of GDP remains depressed, but the trend has turned higher in such areas as consumer durable goods, business equipment and software and inventories.
The optimists argue that at some point, people are going to “start buying stuff” even if the recovery remains tepid and the unemployment rate remains high. To an extent, they have a point. Take auto sales for example. In May, auto sales were 11.8 million, which is about three million less than what it takes to keep up with population growth. Housing starts so far this year are about half of what is needed to keep up with population growth.
Assuming that consumers do start ‘buying stuff’ eventually, many US households are in their best financial shape in several years. The ratio of household debt to disposable income declined from apprx. 123% in early 2007 to 106% in the 1Q of 2011. While 106% is still high by historical standards, the downward trend is expected to continue. The ratio of consumer credit (credit cards, auto loans, student loans, etc.) to GDP is back to where it was in the mid-1990s.
The point is, many households are now in a financial position to buy stuff – if they are so inclined – and that is the key. Currently, they are not so inclined, generally speaking, because consumer confidence is falling. It remains to be seen when that trend changes direction.
Next, the optimists always assume that the stock markets will continue to rise. While the stock market has almost doubled since the recession low in early 2009, there is no assurance that the bull market will continue to run. Likewise, the optimists assume that interest rates will remain low going forward, yet bond yields have risen since mid-June. The optimists generally attribute the latest spike in interest rates to the squabble over the debt ceiling and expect rates to fall as soon as the debt limit is increased (more on this below).
There are some prominent forecasters in the optimists’ camp, including The Bank Credit Analyst. Many point to the fact that the US economy has a long history of surprising on the upside. Yet, could it be that there are no more economic rabbits to pull out of the hat, what with trillion-dollar budget deficits and our exploding national debt? Yes it could.
Debt Ceiling Debate Revisited
As this is written the Republicans, Democrats and President Obama remain in a stalemate over raising the US debt ceiling. The president is pushing a deal that would (in theory) reduce federal spending by $4 trillion over 10-12 years, but would also raise taxes by $1 trillion starting January 1, 2013. I have included an excellent column on all the new tax increases Obama has already won and his latest proposals in SPECIAL ARTICLES below – you need to read this!
The Republicans are thus far standing firm that they will not vote for any debt ceiling deal that includes income tax increases, which are now referred to as “revenue enhancers” (see column on this topic in SPECIAL ARTICLES below). The Republicans know that many of the spending cuts promised over the next decade will never materialize. The Democrats and President Obama also know this, which is why they are holding their noses and going along with it.
The president and leaders of Congress have had several face-to-face meetings in the White House as this is written, and it remains to be seen what will happen in the days just ahead. We are told that a deal must be struck by July 22 at the latest to allow time for both houses of Congress to vote on it and the president sign it prior to the August 2 deadline. Yet both sides have their heels dug in.
President Obama cites polls that show a majority of Americans are in favor of tax increases on “millionaires and billionaires” as Obama calls them, when in reality he is talking about families making over $250,000 and individuals making over $200,000. He also wants tax increases on oil companies and hedge fund managers, among others. Republicans, on the other hand, know it could be political suicide for them next November if they vote for a debt ceiling increase that includes a $1 trillion tax increase.
It remains to be seen who blinks first in this dangerous game of chicken. At this point, I wouldn’t bet on it, one way or the other. The supposed July 22 deadline noted above is a week from this Friday. The August 2 supposed drop-dead date is only three weeks from today. If this issue is not resolved by then and a default occurs, I would NOT want to be long stocks or bonds!
Liberal Readers Give Me an Earful!
In last week’s E-Letter, I discussed reasons why this economic recovery is so tepid and provided you data showing that this is the weakest recovery since WWII, if not of all time. I concluded: In my view, both President Bush and President Obama share the blame.
I got dozens of e-mails from angry liberals criticizing me for suggesting that Obama has had anything to do with the weak economic recovery. Basically, their position was that Bush caused all of this, and Obama is doing the very best he can with the economy he inherited.
Because we have a lot of new readers, let me restate the following. Although I am not a member of any political party, I am a serious conservative on most issues political and otherwise. I believe, for example, in lower taxes and smaller government. As demonstrated in my May 10 E-Letter, I am just as apt to criticize the Republicans as I am the Democrats.
I do believe that President Obama is a left-wing ideologue who believes in wealth redistribution via higher income taxes on families making over $250,000 and individuals making over $200,000 a year – for starters. The national debt has increased by over $5 trillion since he took office. For these reasons and others, I oppose the president and his policies.
I also happen to believe that politics can affect our investment returns and even the markets’ direction from time to time. That is another reason why I occasionally tackle political issues and will continue to do so.
As always, I appreciate your comments (positive or negative) and suggestions. Feel free to send me e-mail at email@example.com.
Very best regards,
Gary D. Halbert
Obama’s Taxes Upon Taxes Upon… (very good)
In Fiscal Skirmish, Code Words Provide Cover for Politicians
How We Balanced the Budget Last Time