FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
March 4, 2014

1. 4Q GDP Revised Lower, Not Surprisingly

2. US Consumer Confidence Fell in February

3. Housing & Manufacturing Took a Hit in January

4. President to Downsize Military, Smallest Army in 75 Years

Overview

Late last year, President Obama predicted that 2014 would see “breakout growth” in the US economy. His optimism was not completely unwarranted since the economy grew by a healthy 4.1% (annual rate) in the 3Q of last year, driven largely by an unexpected surge in inventory rebuilding. Then in late January, the Commerce Department reported that the economy grew by a better than expected 3.2% in the 4Q.

A 4.1% jump in GDP in the 3Q followed by an above-trend 3.2% in the 4Q gave some forecasters, including President Obama, reason to predict that our anemic economy might finally be out of the doldrums. That was until last Friday’s second estimate of 4Q GDP, which was revised significantly lower to only 2.4%. That’s our lead topic for today, along with a look at some other recent economic reports that raise cause for concern.

Finally, we will look at some professional analysis of President Obama’s plans to significantly downsize our military in the next few years. If Obama and defense secretary Chuck Hagel get their way, the Army will be reduced to its lowest level in 75 years. Hopefully, Congress will stand up for our military, but in any event, you need to know what this president wants to do. Be sure to read the latest military intelligence analysis from LIGNET which appears later on.

4Q GDP Revised Lower, Not Surprisingly

Last Friday, the Commerce Department released its second estimate of 4Q GDP which was revised significantly lower. The “advance” estimate in late January showed the economy growing at a respectable rate of 3.2% (annual rate) following 3Q growth of 4.1%. However, in the second estimate, the government reported growth of only 2.4% in the final quarter of last year. GDP growth for all of 2013 was only a revised 1.9% according to the Commerce Dept.

While most analysts expected a downward revision from the initial estimate of 3.2%, Friday’s report showing growth of only 2.4% was below the pre-report consensus. Initially analysts blamed the weaker than expected GDP number on unusually bad weather late last year. But a closer look at the data shows that the weakness was not entirely the result of bad weather.

Specifically, consumer spending did not rise as much as initially reported in the 4Q, and exports were also adjusted lower as foreign demand for US goods was not as strong as previously thought. Thus, the latest downward revision to 4Q GDP diminished hopes for an early-2014 “breakout” in economic growth.

Last Friday’s report showed that consumer spending – which accounts for apprx. 70% of GDP – rose only 2.6% in the 4Q, well below the initial estimate of 3.2%. This further confirms that the significant buildup in companies’ inventories in the 3Q of last year was the big driver of GDP growth in the second half of last year. The drawdown of those inventories is expected to weigh on reported growth in the first three months of this year.

Consumer spending in the 1Q appears to be weakening. Already, the government has reported a slight drop in retail sales for January. Most analysts attribute the slowdown to the harsh weather and numerous snowstorms in January. But that is only part of the story.

Other recent economic gauges, alongside the downgraded GDP growth, have flashed warning signs. Measures of consumer spending, job creation, factory output and the housing market have come in well below expectations. While heavy winter storms and frigid weather in many parts of the country may have depressed or delayed some activity, the poor numbers are raising concerns about the underlying strength of the economy.

In the wake of last Friday’s disappointing GDP report, many economists have been revising their forecasts for 1Q growth downward. Given that the drawdown in inventories will be a drag on growth this quarter, many forecasters now believe that 1Q GDP growth will be less than 2%.

Perhaps that explains why President Obama is no longer predicting “breakout growth” in the economy this year.

US Consumer Confidence Fell in February

The Conference Board reported last Tuesday that its widely-followed Consumer Confidence Index fell to 78.1 in February from 80.7 initially reported for January and well below the pre-report consensus for a slight uptick to 80.8. Making matters worse, the Conference Board also revised its January estimate down to only 79.4.

[Note that in the chart above it appears that the Consumer Confidence Index went up last month; however, there is a small decline at the very end that is obstructed by the red arrow.]

Consumer expectations for economic activity over the next six months also dropped sharply to 75.7 from a revised 80.8 in January, originally reported at 81.8. However, not all the news in the report was bad. The Board’s Present Situation Index, a gauge of consumers’ assessment of current economic conditions, increased to 81.7 from a revised 77.3 in January.

The Conference Board explains that the split in these two indicators suggests that consumers believe the economy has improved, but they do not foresee it gaining considerable momentum in the months ahead.

While the consumer sector makes up apprx. 70% of the economy, households haven't been increasing their spending by much during this harsh winter. As noted above, January retail sales fell, and weekly store reports show shoppers didn’t spend much in the first three weeks of February.

Within the Board’s confidence survey, views on the current labor market were mixed in late February. Over 32% said jobs are still “hard to get” while only 13% said they expect the number of new jobs to increase just ahead. Over 20% said they expect fewer jobs just ahead.

Housing & Manufacturing Took a Hit in January

The severe weather in January took a toll on the housing sector. Housing starts and building permits both declined in January, and sales of existing homes also fell sharply. However, new home sales actually increased by about 40,000 units in January to the highest level since July 2008. No one is exactly sure why since the pre-report consensus called for a decline. Monthly new home sales figures are often quite volatile, so January’s numbers could be revised downward in coming months.

Sales of existing homes fell 5.1% in January, the lowest since July 2012. While most analysts blamed the decline on the severe weather in January, data from the National Association of Realtors showed that sales fell in all four regions of the country, including the West where weather was not a factor.

Meanwhile, mortgage applications to buy a home fell in late February to the lowest level in nearly two decades, according to a weekly survey from the Mortgage Bankers Association. The report is a clear sign of weakness in buyer demand heading into the usually busy spring housing season.

Higher interest rates have pushed home refinances way down from their boom levels, causing many banks to fire employees. Applications to refinance homes were expected to rise this year, but they are now down over 15% from a year ago.

On the manufacturing front, there was a significant decline in the ISM Index which plunged from 56.5 in December to 51.3 in January. The consensus called for only a modest decrease to 56.0, so the large decline in January was unexpected. Any number above 50 indicates that manufacturing is expanding, but a reading of only 51.3 suggests very little growth.

US manufacturing grew at a substantially slower pace in January as new order growth plunged by the most in 33 years, driving overall factory activity to an eight-month low. The January reading marked a second straight month of slowing growth from November’s recent peak reading of 57 – which had been the highest since April 2011. This suggests that the economy may be losing some of the momentum it had enjoyed in the second half of 2013.

The biggest red flag in the ISM report for January was the huge drop in the forward-looking new orders index, which fell to 51.2 from 64.4 in December. That 13.2-point drop was the largest monthly decline in that key component since December 1980.

Clearly, the US economy is slowing down, not breaking out as President Obama suggested late last year. How much more the economy will slow down remains to be seen.

President to Downsize Military, Smallest Army in 75 Years

President Obama’s federal budget proposal for FY2015 is being delivered to Congress today. While all of the details are not yet known, it is clear that the president wants to reduce our military significantly. The following analysis of the planned defense cuts comes from LIGNET.

The Langley Intelligence Group Network (LIGNET.com) is a Washington, DC-based service providing global intelligence and forecasting from former CIA, US intelligence and national security officers, drawing on an international network of experts and sources. Like Stratfor, LIGNET is highly respected around the world. I am a paid subscriber and highly recommend it.

QUOTE:

US Hollows Out Defense Budget, Asks NATO to Take Up Slack

Summary

Defense Secretary Chuck Hagel’s austere vision of U.S. defense spending priorities, if approved by Congress, would slash the military to the size it was before the 9/11 attacks, rendering the United States far less capable of handling two wars at once. Few are praising the plan, which appears to assume that increased European defense spending will cover NATO’s growing security gap.

The Obama administration’s budget proposal would mean fewer soldiers, sailors, airplanes and ships and perhaps only two Army brigade combat teams able to deploy at any given time, a major reduction in readiness. The Pentagon proposal thus assumes a new era of security priorities while offering little reassurance to a world bristling with armed conflict and fraught with geopolitical hazard.

Background

Under Chuck Hagel, the Pentagon plans to cut the size of the “active-duty military by 13 percent and the reserves by 5 percent in the coming years,” the Wall Street Journal reported Wednesday.

The Foreign Policy Initiative (FPI), a Washington think tank, warned that this is the third year of “forced cuts.” The proposed fiscal 2015 defense budget will total $496 billion, or $45 billion less than what President Barack Obama requested last April. This could reduce the level of U.S. defense spending to just 2.8 percent of gross domestic product – comparable to the level of spending before the Sept. 11, 2001, terrorist attacks on the United States.

At the beginning of the week, the defense secretary made public comments to preview the budget proposal that Obama sent to Congress on Tuesday. “You might say it’s a defining budget because it starts to reset, reshape . . . rebalance, and refine our enterprise for the future.”

More platitudes emerged later when Hagel traveled to Virginia to deliver speeches at Fort Eustis and Langley Air Force Base. “We had to make tough choices,” he told soldiers there. “We have had to prioritize like we have never had to prioritize in your career.”

Hagel continued, “After Iraq and Afghanistan, we are no longer sizing the military to conduct long and large stability operations.”

Under the current plan, the Army will go from 520,000 active-duty soldiers to perhaps as few as 444,000, a level not seen since before World War II. The Marine Corps will drop to 182,000 and its amphibious combat vehicle program will be canceled.

Twenty-two Navy cruisers will be “temporarily mothballed,” according to FPI. The Air Force will lose some of its tactical squadrons and will have fewer Reaper drones at its disposal. The U-2 spy plane and the A-10 Warthog attack aircraft also will go away.

Hagel traveled to Brussels on Wednesday to showcase his budget to NATO defense ministers. The secretary defended his budget as a plan that maintains America’s “global reach” and “technological superiority.”

Hagel explained that “to protect these priorities, we have chosen to reduce our troop strength and force structure. So adjustments in the U.S. defense budget cannot become an excuse for further cuts in European defense spending.”

Analysis

One mantra Chuck Hagel keeps repeating is “prioritization.” While it is beneficial to emphasize national security priorities, the world is a more dangerous place today than it was when Obama began his first term in 2009. There are so many security hot spots throughout the world, it is impossible to prioritize them all.

Syria’s civil war is spilling over into Lebanon and Iraq. Syrian President Bashar al-Assad still controls vast stocks of chemical weapons and he is suspected of using them against his own people. Iraq is fighting a Sunni extremist insurgency. The future of Afghanistan is enigmatic. Egypt is on a path to a military dictatorship. Iran has the infrastructure to create its own nuclear device.

Al-Qaeda affiliates are operating from Pakistan and Afghanistan to Yemen and across the Islamic Maghreb. No media outlet covering Hagel’s recent remarks mentioned the Sept. 11, 2012, attack on the U.S. diplomatic mission in Benghazi, Libya.

Meanwhile, the rest of the world is broadening its strategic priorities and expanding its military might.

• China is spending more on defense across the board with impressive modernization efforts and next-generation major end items for its army, air force, navy, ballistic missile forces and military space program. All of these branches are getting a host of upgrades. China’s maritime strategy is to have a blue-water navy and at least one carrier strike group. It is fielding new stealth jet fighters and improving its space war capabilities.
• North Korea has a nuclear arsenal and a volatile young leader in Kim Jong Un. U.S. intelligence estimates predict the regime will soon be able to fit nuclear warheads onto its ballistic missiles.
• Russian President Vladimir Putin ordered his military to intervene in Georgia in 2008 and he may soon do so again[already has] in Ukraine. Putin also has engineered a defense modernization program during the Obama era.

Despite these ominous signs, Hagel is touting his new cost-cutting program as “the first time in 13 years we will be presenting a budget to Congress that is not a war-footing budget.” The Obama administration seems to believe that if the United States does not use force, other countries will follow his lead and also refrain from using force…

As the Heritage Foundation states in its 2014 Defense Reform Handbook, “From day one, the Obama administration has neglected the imperative to modernize the country’s defense forces, underplayed the amount of forces needed for the national defense and failed to implement any serious reform agenda.”

...Hagel explained his defense budget by quoting World War II secretary of war Henry Stimson, who said that Americans “must act in the world as it is, and not in the world as we wish it were.” In making the case for a smaller, technologically superior U.S. military, Hagel presumes that the rest of the world is not likely to maintain massive increases in defense spending.

It seems clear, however Congress eventually acts, that U.S. defense spending is unlikely to return to the levels it reached during the past decade. Yet it is not true, as many in the Obama administration believe, that the “United States has stepped over a threshold into a new era of peace.”

END QUOTE

In closing, one might get the impression from LIGNET’s analysis that the Pentagon actually wants to reduce its forces. Nothing could be further from the truth. It is President Obama who wants our military downsized. Hopefully, Congress will stop him.

Best regards,  

Gary D. Halbert

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