US Perspectives: No QE3 for Now

After a very volatile week in the markets, indicators remained consistent, and no third round of easing appears to be looming.

Robert Johnson, CFA 16.08.2011
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I find it hard to believe as I write this that the S&P 500 is down a mere 2% for the week after S&P downgrade of U.S. government debt. And with all the stunning up-and-down days, we ended the week with a fairly typical weekly rate of change in stock market prices. U.S. Government bonds were one of the best-performing assets last week, seemingly thumbing their noses at S&P. While psychologically devastating, the downgrade didn't change much from a practical standpoint. I'm hopeful this will prove to be another "Y2K" moment--a wildly anticipated and prepared-for calamity turning out to be a nonevent. Furthermore, the downgrade didn't provide investors with any news that wasn't already blatantly obvious to investors and consumers alike.

 

Fed Vows to Hold Rates--No QE3 for Now

Thank goodness the Fed didn't give in to the market and implement QE3, which I think would have proved ruinous by continuing to buoy commodities and financial markets at the expense of consumers. They did offer to try to keep current low rates through mid-2013, ending debate on what they meant by an "extended period of time." The Fed also reduced its outlook for the economy.

 

But as I said in last column, now is not the time to give up on this economy. The healthy--if not necessarily robust--data continue pouring in. After the week before last week's positive jobs report, we added a nice monthly retail sales report for July last week along with another improvement in the initial unemployment claims report. Weekly retail sales held up well, even in the face of awful market headlines. Positive earnings continued last week too, as results from Cisco and certain retailers, especially at the high end, helped lift the market. Gasoline prices are dropping as well; the national average price of gasoline fell back to $3.62 from its May high of $3.99 with a slight upward detour in July. Coming with some cooler weather and discount prices, the back-to-school season could be better than expected for consumers.

 

Consumers Not Giving Up the Ghost Yet

After the positive batch of same-store retail sales for July, I wasn't surprised that the more comprehensive government retail sales report showed a very healthy growth rate for July at the same time that May and June numbers were also revised upward. Between June and July total sales grew 0.5% (6% annualized), while sales compared to a year ago were up a healthy 8%. Even excluding auto sales, which many correctly guessed would help the report, sales grew at the same 0.5% rate. Gasoline sales, aided by higher prices, also helped the overall growth rate by over 0.1%.

 

Because of the annual changes in the retail sales calendar of promotions, massive seasonality factors, and weather issues, I prefer to look at retail sales on a year-over-year basis. I also like to look at a three-month moving average rather than just one month's worth of data that can be subject to a lot of the special factors mentioned above. I also exclude autos (an earlier monthly report is the feeder report used to compile GDP reports) and gasoline (volatile prices that get adjusted out in the final inflation adjusted GDP report). On this basis it's hard to claim consumers are running for the hills just yet.

 

Retail Sales Ex-Autos and Gas

 

% Change

Jan 2011

5.7

Feb 2011

5.5

Mar 2011

5.5

Apr 2011

5.2

May 2011

5.4

Jun 2011

5.7

Jul 2011

6.2

Year-On-Year Sales, 3-month Moving Average
Source: Census Bureau

 

By category, things were relatively consistent; most categories grew at about the 0.5% average for the month. Gasoline stations, electronics stores, and miscellaneous did better than the average, while sporting goods, books, and the hobby category declined, as did building materials. I suspect the demise of Borders and the rise of e-book readers like the Kindle will continue to hurt the books category. Building materials were coming off a double-digit, weather-induced swing the previous month. Only the restaurant figures, showing a 0.1% decline, were at all disturbing. I'd expected a small gain based on warm weather in July, which tends to favor restaurants. Apparently higher gas prices trumped warm weather again. Based on strong grocery store sales and weak restaurant sales, I suspect consumers opted to eat in this month. Nevertheless, it's disappointing to see slowing restaurant sales, because that's a decent forecaster of short-term consumer confidence and employment (no job, no quick run to Mickey D's for lunch). With gas prices backing off again in August and weather staying hot, maybe restaurant sales will look better in August.

 

Despite Market Volatility, Weekly Sales Still Look Good

The really short-term (weekly) and volatile International Council of Shopping Center data softened just a touch but still looked positive, not far off previous levels and above the 2011 average of 3.0%.

 

Weekly Retail Sales

 

Year-Over-Year Growth Rate (%)

25 Jun 2011

3.0

2 Jul 2011

3.5

9 Jul 2011

5.5

16 Jul 2011

4.5

23 Jul 2011

4.2

30 Jul 2011

4.0

6 Aug 2011

3.6

Source: Internal Council of Shopping Centers

 

I usually prefer to look at this set of data on a four-week moving average basis to wipe out weird weather or promotions or even changing dates for sales tax holidays. The four-week moving average data look even better than the results above. However, I wanted to pinpoint what happened the week where all hell broke loose in the financial markets. As the table above shows, consumers didn't panic as much as Wall Street.

 

The Trade Deficit Jumps to a Recovery High on Falling Exports

The June trade report was not good news; the deficit increased to $53.1 billion as exports fell 2.3%, but exports fell at a much slower rate of 0.8%. The export figures were broadly lower across categories and countries. It is also not clear that the surge of Japanese imports that I'd expected was behind the slow drop in imports. As many countries tighten credit and raise rates in an attempt to reduce rampant inflation, it is not surprising that exports have softened a bit. The other bad news was that exports for June were lower than estimated in the first version of the GDP report for the second quarter. That points to another reduction in the already meager report of 1.4% growth in the second quarter. Though higher retail sales reported last week may offset part of the problem, it appears GDP growth could be reduced to as low as 1% at the next revision due later this month.

 

Initial Unemployment Claims Continue Their Downward Trajectory

In positive news, initial unemployment gains dipped to under 400,000, cheering an otherwise gloomy market on Thursday. Claims came in at 395,000, down from 402,000 the prior week. Even the less-volatile four-week moving average dipped to 405,000. I welcome the improvement and expect the recent fall from 478,000 in late April to 395,000 currently will have a positive effect on the August jobs report. That said, I worry that this number could click upward as several announced layoffs become actual pink slips. I suspect many Borders-related layoffs and many announced layoffs in the financial services and drug industries have yet to flow through the numbers. The most recent upward spike and subsequent decline are most likely related to the Japanese automakers in the U.S. drastically adjusting their production due to supply chain disruptions.

 

Consumer Durable and Exports Dominate Economic Recovery as Inventory Gains Fade

For the past two weeks I've been promising my quarterly chart of major contributors to GDP growth that I update every quarter. Even after the inclusion of the dismal second-quarter data and numerous revisions, the conclusions are basically unchanged from the previous quarter. The new data and revisions do show economic growth came even more narrowly from consumer durable goods and exports. The data also depicted a recession that was worse than previously thought. Though a lot of analysts made a big deal about these revisions, it appears the only drastic change was to the inventory account. Even there, the gains were shifted to the beginning of the recovery and away from the most recent quarters. In fact, a smaller inventory build explains the reduction in the first-quarter 2011 GDP estimate from 1.9% to that market-rocking revision of 1.3%.

 

Consumer Durable and Exports Dominate Economic Recovery as Inventory Gains Fade

 

2009

2010

2011

Whole Recovery

2Q

3Q*

4Q

1Q

2Q

3Q

4Q

1Q

2Q

Consumer Goods

-0.5

1.7

0.1

1.5

0.9

1.1

1.9

1.1

-0.3

2.1

Consumer Services

-0.8

0.0

0.2

0.5

1.2

0.8

0.6

0.4

0.4

1.0

Business Structures

-1.4

-0.7

-1.1

-0.8

0.2

0.1

0.3

-0.4

0.2

-0.5

Equip & Software

-0.3

0.4

0.7

1.3

1.5

0.9

0.6

0.6

0.4

1.8

Residential Construct

-0.6

0.4

-0.1

-0.4

0.5

-0.8

0.1

-0.1

0.1

-0.1

Inventory

-0.6

0.2

3.9

3.1

0.8

0.9

-1.8

0.3

0.2

1.8

Exports

0.0

1.5

2.5

0.9

1.2

1.2

1.0

1.0

0.8

2.6

Imports

2.2

-2.1

-2.4

-1.8

-3.1

-1.9

0.4

-1.4

-0.2

-3.2

Government

1.2

0.3

-0.2

-0.3

0.8

0.2

-0.6

-1.2

-0.2

-0.3

Others

 

 

 

 

 

 

-0.1

 

 

-0.2

Total GDP Growth (Annualized)

-0.7

1.7

3.8

3.9

3.8

2.5

2.3

0.4

1.3

N/A

Total Recovery GDP Growth

 

 

 

 

 

 

 

 

 

5.0

*Recovery Begins
Shaded Boxes are two best categories for the period
Source: Bureau of Economic Analysis, Morningstar Calculations

 

The far left column tells the story of this whole recovery after completing two years. Consumer goods and exports have been contributors this recovery, each contributing over 2%. Meanwhile, both residential and business construction continue to detract from GDP growth. Normally construction is one of the largest contributors to a recovery, but this time it's contributed zilch. Business spending on equipment and software has been helpful to the cause, but given huge cash balances and the depth of the decline before the recession, it is surprising the contribution wasn't even higher. Inventories provide their typical early burst before inventory growth rates began to collapse. Government, usually not a detractor, has also hurt this recovery. What's not clear is whether the first-quarter negative contribution was an anomaly (a lot of that decline was due to a decrease in defense spending) or a precursor of more bad things to come.

 

Autos, Gasoline Lead to Second-Quarter Consumption Disaster

The other key question the table raises is the apparent collapse of consumer goods spending in the second quarter of 2011. The drop is almost entirely due to falling gasoline sales (a really good thing, in my mind) and the tsunami-induced fall-off in auto sales. Adjusting for these factors, consumer spending doesn't look like it's gone cliff-diving. Consumer spending was still anemic but not terribly different between the first and second quarters.

 

Exports Good but Slowing Some

Another concern: Exports have been a key part of this recovery, and they have been slowing down a bit. Though the export news was pretty good for the second quarter, June was by far the worst month of the quarter. Faltering economies in Europe certainly haven't helped. Still, I am hopeful that a bigger contribution from Boeing in the second half, as the 787 and the new 747 go out the door to foreign customers, will keep exports growing. Strong exports of agricultural products could be a big help too, even as sales of mining and construction equipment slow.

 

Industrial Production Should Buoy Enthusiasm This Week

The highlight of this week's economic data should be a relatively strong industrial production report. A combination of strong utility growth (due mostly to warmer weather) and a return to healthier auto production should boost industrial production growth to 0.9% or more after a disappointing 0.2% growth rate in June. These statistics, laid on top of last week's initial claims report and retail data and previous week's employment report should begin to convince market participants that we are not dipping into an immediate recession. A couple of regional purchasing managers' reports are due this week that might shed more light on the manufacturing sector. Lately these reports have been quite volatile and not particularly indicative of the much more important national report. Nevertheless, with the national PMI dipping precariously to a no-growth reading for July, these regional reports (Empire State on Monday and Philly Fed on Friday) will probably take on more significance than they deserve.

 

Inflation Report Likely to Jump Again

June's inflation report (as measured by the Consumer Price Index) looked exceptionally good, with inflation dropping 0.2% because of falling energy prices. Those energy prices ticked back up again, causing the consensus forecast for inflation in July to jump to 0.4%. Elevated car prices and some food price increases won't help the CPI right now either. I suspect those auto prices will come down as the renewed production of Japanese cars finally reaches dealer showrooms. Energy prices are already back on their way down too. None of this will come in time to help the July report though, which could look pretty bleak to consumers.

 

Housing Data Due

Though no longer market-moving, a lot of housing data will arrive this week including builder sentiment, housing starts, and existing home sales. Starts are expected to come off their unexpected jump in June and fall back to an anemic 600,000 units on an annualized rate basis for July. Existing homes, on the other hand, should rebound from disappointing June numbers and improved pending home sales. Consensus is for existing home sales to approach a 5 million home rate. I think we could do better than that gain, which amounts to just 5%. There were also rumors that the National Association of Realtors would provide revised numbers for the recession years based on an internal review. I'll take those revised numbers as they come (or if they come), and I suspect those changes will result in declines in estimated sales in 2008-09. The revisions could make for some nasty headlines, but changing old data isn't very likely to change the here and now. We are still mired in the worst real estate recession since World War II. 


This is an edited version. The article originated from Robert Johnson’s column at Morningstar.com.


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Robert Johnson, CFA  Robert Johnson, CFA, is director of economic analysis with Morningstar.

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