Is The US Economy Overheating?
Last weeks release of third quarter GDP gave further evidence that the economy has been stimulated beyond anything healthy. The fact that the Federal Reserve continues to sit on its hands provides proof that it knows this growth is not healthy. If the economy was able to grow at 7.2% due to underlying economic strength interest rates would be allowed to rise. The current impetus to economic growth stems from the fact that money is cheap. The constant demand for borrowing, especially from consumers, is proof that current interest rates do not reflect the true market price.
Economic growth was widespread according to the third quarter GDP report. Personal consumption was up 6.6%, private investment increased 9.3%, led of course by a 20.4% jump in residential, and exports rose 9.3%. Surprisingly, the government sector was only up 1.3% in the third quarter after contributing almost half of the growth in the second quarter. Also notable was the $35.8 billion decline in inventories. This decline combined with the $17.6 billion decline in the second quarter has almost completely reduced the inventory build that happened from the second quarter 2002 to the first quarter of 2003. Depleted inventories will have to be replenished and could spur additionally economic activity as manufacturers increase production to replenish inventory. This GDP report will also embolden business leaders by showing them that the fabled second half recovery actually does exist. This in turn will likely influence business decisions. Unfortunately, this economy is being propped up by low interest rates. We expect that the economy will slow when interest rates increase. Unfortunately, this will cause new capital investments that seemed viable under a growing economy to be uneconomic and will lead to another "bust."
The manufacturing sector has been showing signs of recovery for several months and according to the October manufacturing ISM survey the strength continues. The survey increased 3.3 points to 57.0, which was the fourth consecutive month above fifty. It was also the highest level since January 2000. The strength was widespread as the imports and customer inventories were the only components that dropped. Imports were still 57.3, well above the 50 level that indicates expansion. Inventories, customer inventories, and employment were the only components below 50. While indicating contraction, employment was 47.7, which was the highest level since December 2002. The real strength in the survey came from production and new orders. Production jumped 5.3 points to 62.6, the highest since July 1997. New orders were even stronger at 64.3, 3.9 points ahead of September. This was the highest since 1994. Every component except for inventories, imports, and prices were at the highest level this year. Prices rose 2.5 points in October and have been over 50 for 20 months.
As strong as the manufacturing sector appears, the service sector of the economy is even stronger. October's non-manufacturing ISM rose 1.4 points to 64.7, erasing most of last month's decline. While a few more components declined in October, only one component, inventory, was below 50. New orders had the biggest increase. It jumped 4.5 points, reversing more than half of September's 7.7 point loss. Perhaps more important was that employment surged 3.8 points, rising above the magic 50 threshold for the first time since February 2001.
Vehicle sales in October came in at a 15.6 million unit rate. This was not only lower than analysts were forecasting but was under 16 million for only the fourth time since September 1998 and the first time since February this year. Analysts pointed out that some of the weakness is due to the "hangover" from very strong August sales and a reduction of incentives due to the introduction of the 2004 models. For the automakers sake, the weakness due to a reduction of incentives needs to be short lived. Automakers have to wean buyers off high incentives. The introduction of the 2004 models could be their change to try and end the high incentives. But, the automakers are talking about gaining market share. This inevitable will lead to the continuation of incentives. But even with the high incentives for the past couple years, the Japanese automakers have been able to take market share from the Big Three. Incentives will have to remain high just to stem the market share losses. Maybe there will be some blockbuster new vehicle introduced this year. Ford's new F-150 came to market with a lot of pomp and circumstance, but according to a local dealer it is being offered with 2.9% financing and "Ford owner loyalty" discounts of $1,000. This compares to zero-percent financing or $3,500 rebate for 2003 models. The focus on market share is reminiscent of the late 1990s when telecom and technology companies focused on market share with the idea that profitability will come later.
Beazer Homes announced earnings today along with Toll Brothers. Instead of rambling on about record this and record that, I'll just say results were impressive. Toll Brothers revenue jumped 29% to $849 million with a $2.64 billon backlog. Beazer Homes increased revenue by 15% to $1 billion and its backlog is $1.6 billion, up 27% from last year. While only comprised of three stocks, the S&P Homebuilding Index is up 90% this year. It does not include either of the two mentioned. Toll Brothers is up 99.4% with Beazer lagging. It is only up 75.4%. Both have a short interest that is more than 10% of the float.
With employment the current focus of the market, Friday's release of the Non-farm payrolls tally is the most anticipated economic report. The job-cut report form Challenger, Gray and Christmas dumped a little cold water on what is expected to be the first monthly back-to-back increase in jobs. According to the outplacement firms report, layoff announcements jumped by 95,368 to 171,874. Due to a similar spike last October, the number of announced layoffs is less than last October. It is interesting to note how the composition of the announced layoffs is much different. Last year, the job cuts were dominated by high-tech related industries. Telecom 33,801, Computer 17,843, Transportation 14,842, Aerospace/Defense 14,064, and Financial 13,904 comprised the top five industries. The industries that announced the most job cuts in October 2003 included: Automotive 28,363, Retail 21,169, Telecom 21,030, Industrial Goods 17,484, and Consumer Goods 12,077. Last year, the industries that reported the most job cuts were those that were performing poorly. Ironically, or perhaps very concerning, is the fact several of the industries planning to shed workers now are those that have been areas of growth in the economy, namely Automotive, Retail and Consumer Goods.
The Semiconductor Industry Association came out with its forecasts for the next couple years. It projects growth of 15.8% in 2003 to $163 billion and sales reaching $195 billion in 2004. Furthermore the industry is forecasting sales in 2006 to approach $220 billion. Just think this is just over a 1% compound average growth rate from the peek in 2000 when sales were $204 billion. Why investors give these forecasts merit is a surprise. Just two years ago the industry was forecasting $283 billion in sales in 2004. Again the industry now expects 19.6% growth in 2004 resulting in sales of $195 billion, or almost one-third less than previous forecasts.