Despite a recent series of positive economic data in the first quarter of 2013, the U.S. economic recovery is still in progress, with significant headwinds that need to be addressed. The data has not been consistent, nor are other conditions supportive enough, to be able to conclude that there will be solid & significant economic growth above last year. However, the positive economic, manufacturing, and housing numbers, had all been released around the same time, which has likely boosted short term optimism in the financial/economic community and the media.
My view is contrary to the recent economic forecasts, that have been very quick to conclude a rebound, garnered from data over such a small interval of time. We can hardly call a win streak of one, a streak or vote of confidence. I expect a period of low growth to continue in the U.S. (and globally) for 2013 and likely into at least the first half of 2014. If I ignore the technical levels, I still consider the U.S. (and most of the world to have never emerged from the recession which started in 2008). It would not be unexpected that another technical recession occur in the U.S. (and globally) later in the year.
There are a few main challenges likely to keep growth low and create a difficult environment for the U.S. economy:
• Unemployment – It is still persistently high. Massive corporate layoffs continue (CITI, JP Morgan, Motorola Mobility, AstraZeneca, Boeing, etc.). Consumer spending remains low, restricting demand & economic growth.
• Real estate – It is recovering, but mortgage lending is slowing.
• GDP/growth – Outlook remains low. Productivity & exports are issues.
• Federal Reserve & QE – The Fed helped to stimulate economic growth, and QE is keeping the market happy. But the economy will not be able to grow much further via the Fed’s policy and monetary tools.
• U.S. debt level – The country’s debt level is increasing, and the debt ceiling is being reached again. This limits fiscal spending and results in budget cuts/constraints. Ultimately, overall growth will be restricted, and in some area will contract.
• Sequester & $85 bln in spending cuts – This will impact the economy negatively, but the exact impact is not concrete. It most likely impact GDP/growth and jobs negatively.
Recent reports indicate that household wealth in the U.S. climbed in the fourth quarter of 2012 to the highest level in five years. Gains in home prices prices was said to be the largest factor that was “helping repair family finances”. Increases to home prices do not reduce the debt burden on households, nor does it increase the spending power of the consumer. However, increases in household earnings would reduce household debt burdens. This can only come from a sustained expansion in jobs.
The January 2013 seasonally adjusted unemployment rate in the US edged up to 7.9%. This isn’t a very surprising number, nor is it much of a change from the levels seen in previous months. The U.S. economy has done a good job to reduce unemployment down from the high-mid 9% crisis levels of 2009-2010, but has had difficultly reducing it below 7.8%. In February 2013, the unemployment rate edged lower to 7.7% which helped contribute to the recent optimism. It’s still too early to tell if this lower level can be sustained. The current unemployment level is still too high, especially when compared to the few years prior to 2008 (4-6% range) [See http://data.bls.gov/timeseries/LNS14000000/]. The jobs lost in the manufacturing and finance sectors during the crisis, have yet to be replaced.
As we step through the first few months of 2013, we still find major corporations are in layoff mode. Although the layoffs have not been as frequent or as numerous compared to those at the beginning of last year, the numbers are still significant. Announcements in workforce reductions as an indicator of unemployment and the economy in general, is one of many indicators that I have used over the years. It is something one can observe without complicated work and statistics. In 2012, it proved to be a very good gauge/predictor again. Growth of corporations mean growth in jobs & the economy. Inversely, large cutback programs mean a large reduction in jobs and a likely contraction in the economy. High unemployment reduces government revenues and increases spending burdens, which lead to larger deficits and higher levels of debt. Elevated levels of unemployment also mean lower domestic consumer spending & demand. This is why the biggest factor affecting the health of the U.S. economy is jobs.
On 3/19/2013 , the Department of Commerce indicated that February starts at building sites for homes increased 0.8% to a 917,000 unit annual rate. Starts for single family units (roughly two thirds of the total) rose 0.5%, the highest level since June 2008. Home construction permits increased to a 946,000 unit rate, which was also the fastest since June 2008.
Real estate in the U.S. has picked up somewhat in the first quarter of the year, but is still nowhere near pre-crisis levels. Data for U.S. housing starts can also be volatile and often the government makes large revisions to the numbers. Home-builder sentiment in March declined to the lowest level in five months, over concerns with rising costs and supply chain issues. It is unrealistic to expect activity and demand to return to those levels just within the next few years. I suspect it will take closer to 10 years or longer. A recover in real estate would also require Americans to feel confident enough with their employment situation and finances to purchase new homes.
GDP / Growth / Prices
According to the Commerce Department, real gross domestic product (goods & services produced by labor & property) increased at an annual rate of 0.1% (relatively flat) in the fourth quarter of 2012. This was the lowest level since 2009, and was a surprise for many economists. The sudden drop is primarily due to a decrease in national defense spending and slower inventory growth of private businesses. Defense dropped 22.0% in the fourth quarter of 2012, compared with a 12.9% increase in the third quarter. Inventory increased by $12.0 billion in the fourth quarter, compared to $60.3 billion in the third, and $41.4 billion in the second. However, GDP numbers across quarters have not been very consistent.
The Consumer Price Index for all items less food & energy increased 0.3% in January 2013, after increasing 0.1% in November and December. This was the largest increase in several months. However, throughout 2012 the index has changed consistently between 0.2% and 0.1%
The productivity of U.S. workers decreased in the fourth quarter of 2012 by 1.9%, the most in four years. The decrease was primarily due to increased labor costs (hours & workers). However, productivity numbers have not been consistent over quarters. The annual productivity of 0.7% in 2012 was little changed from 0.6% in 2011. 2009 and 2010 saw productivity at 2.9% and 3.1% respectively, while 2008 was at 0.6%.
The Federal Reserve
The Federal Reserve’s monetary policy has been highly accommodation during the past few years. It has reduced the Federal Open Market Committee’s (FOMC’s) target for the federal funds rate, which is the interest rate on overnight loans between banks. This has helped to stimulate lending shortly after the onset of the financial crisis. However, the rate has been close to zero since December 2008, and the Fed was forced to use alternative policy tools.
One tool has been in providing “forward guidance” on the FOMC’s anticipated decisions for the federal funds rate. “The December post meeting statement indicated that the current exceptionally low range for the federal funds rate ‘will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent.’ ”
The other tool, which is more unconventional has been to purchase a predetermined amount of (longer-term debt) securities on a large scale. This is known as quantitative easing or QE. On 9/13/2012 the Committee announced its third round of quantitative easing. For the third round (QE3) the Fed committed to purchasing additional agency mortgage-backed securities at a pace of $40 billion per month, as well as to continue extending the average maturity of its holdings of securities through the end of 2012. It also stated that it would maintain its policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities, back into agency mortgage-backed securities. The actions together were expected to increase the Committee’s holdings of longer-term securities by approximately $85 billion per month through the end of 2012. The open ended nature of QE3 gave rise to the name QE Infinity.
On 12/12/2012 the Committee stated that it would purchase longer-term Treasury securities at an initial pace of $45 billion per month beginning in January 2013. The Fed intends to maintain its existing policy of reinvesting principal payments from its holdings of agency debt and securities, and resume rolling over maturing Treasury securities at auction. The FOMC indicated that it will continue these purchases until it observes a substantial improvement in the outlook for the labor market.
The Federal Reserve’s actions alone have effectively kept longer-term interest rates low, which has largely been responsible for starting the recovery in the housing market. It has also resulted in increased sales & production of automobiles and durable goods. Together, this has propped up consumer sentiment and domestic spending. However, how much more the economy can be stimulated by the Federal Reserve’s policy tools, remains the largest concern. Economic growth must also be supported in the long term by the nation’s fiscal policy, through Congress and the Administration. Fed chairman, Ben Bernanke, also acknowledges the Committee’s limitations: “Although monetary policy is working to promote a more robust recovery, it cannot carry the entire burden of ensuring a speedier return to economic health. The economy’s performance both over the near term and in the longer run will depend importantly on the course of fiscal policy.”
U.S. Debt & Sequester
The debt situation in the U.S. continues to worsen. In 2012, there was a spike and steady increase in the statutory debt limit level, to its current level above the limit in 2013. On February 4, 2013, the President signed legislation suspending the debt limit until May 18, 2013. As a result, the debt limit does not apply for the period from February 4, 2013 through to May 18, 2013. The total amount of U.S. public debt outstanding is $16.759 trillion as of 3/26/2013. The debt numbers below show that U.S. debt accelerated since the onset of the financial crisis:
• 1/2/2007 = 8,678,229,324,205.41
• 1/2/2008 = 9,210,587,444,062.47
• 1/2/2009 = 10,627,961,295,930.67
• 1/4/2010 = 12,290,238,158,257.13
• 1/4/2011 = 14,014,049,043,294.41
• 1/2/2012 = 15,226,217,488,652.33
• 1/2/2013 = 16,431,219,143,696.53
• 3/26/2013 = 16,759,063,744,572.46
The continued tug of war in the U.S. over fiscal policy & spending will continue to intensify as the debt ceiling date approaches. However, the likelihood that the U.S. actually defaults on its debt obligations are close to being non-existent. More importantly the impact will be on spending & budget restraints, which will adversely affect the country’s economic growth.
On March 1, 2013, the U.S. sequestration came into effect, where $85 billion in automatic federal budget cuts will be made across areas of government fiscal spending (includes defense & non-defense). The sequester was passed as part of the Budget Control Act of 2011 (BCA), as a mechanism to compel Congress to act on deficit reduction, with a total reduction of $1.2 trillion ($109 billion each year) from 2013 to 2021. The sequestration requires reductions of :
• 7.8% in non-exempt defense discretionary funding
• 5.0% in non-exempt non-defense discretionary funding
• 2.0 to Medicare
• 5.1% to other non-exempt non-defense mandatory programs
• 7.9% to non-exempt defense mandatory programs
The precise impact on the economy is unknown. However, it covers spending across a very wide range of defense & non-defense areas of the government, from the Senate, Supreme Court, Food & Drug Administration, U.S. Patent & Trademark Office, Department of Defense, Office of Elementary & Secondary Education, Centers for Disease Control & Prevention, to the Department of Homeland Security. Reductions in spending will likely result in direct job cuts across government agencies. Reductions in grants, contracts, R&D, and funding, will also likely result in job cuts in private industry (indirectly).
Factors Affecting Outlook
There are a few inter-related items that would cause my outlook to change. The key is corporate expansion, which would in turn create jobs. This would occur if there was an increase in demand domestically, or from global trading partners. Domestic demand would require significant job growth in the U.S. in order to increase consumer spending, If we observe steadily increasing rates of employment, sustained over a period of many months, then the outlook would change. In order for this to occur fiscal policy needs to be supportive towards business growth. The latter (global demand), would require Europe’s debt troubles to stabilize, but also for the Euro Zone nations to see growth. Nations in the EZ are still challenged with austerity and burdening debt loads that threaten their financial system.
Note To Investors:
The economy and markets do not necessarily move in unison. Historically, markets react earlier (either positive or negative) as we have seen many times before. For function-centric and value investors, the economic/macro trends tend not to influence our investment decisions. However, knowledge of the macro-economic trends can be useful for determining upcoming conditions that create opportunities or headwinds, on a broad basis or for a specific business, industry, or sector. Knowledge gives the investor an edge.
Thanks & Happy Investing! — The Investment Blogger © 2013