Is Economic Growth Weakening?
Economic data has started to indicate that economic growth has stalled. Economists have been quick to highlight the weaker data as proof that the Federal Reserve will have to pause soon. While recent data has been weaker, it should be expected following the strong growth the economy exhibited in the first quarter. While we expect the economy to weaken, and weaken dramatically, it seems premature to forecast that it is currently underway.
On Wednesday, the Commerce Department reported that durable goods orders dropped 4.8% in April and excluding transportation, orders dropped 1.1%. Economists expected orders to drop by only 0.5% and to have increased 0.5% excluding transportation. Part of the weakness can be attributed to very strong orders in March. In fact, the already strong order growth was revised higher, 6.6% from 6.1%. While this is a rapid deceleration from March order growth, the year-over-year change in durable orders was a healthy 7.5%. Perhaps one reason for the decline in orders was the 22.7% increase in unfilled orders (non-seasonally adjusted, 11.8% adjusted). This was the largest increase in unfilled orders for at least two years and could indicate that manufacturers are operating at capacity. The average increase in unfilled orders over the past two years has been 10.4%, so the increase was more than twice the historical increase. In fact, unfilled orders have been steadily increasing over the past year.
The early indications reveal that the manufacturing sector has not significantly rebounded. Last week, the Philadelphia Fed survey rose 1.2 points to 14.4. Economists were expecting it to decline to 12.5. The survey was actually much weaker than the headline indicates. Six of the nine components fell. New orders fell 9.5 points to 2.7, the second lowest level since mid-2003. Prices paid soared 26.3 points to 55.2, while prices received dropped 4.9 points to 10.3. Additionally, the Richmond Fed survey fell 17 points to 1 in May. Almost all components fell. New orders fell 20 points to two and new orders dropped 18 points to three. It was interesting that while the number of employees fell along with the work week, wages remained unchanged. It is important to remember that both these are diffusion indexes with zero delineating between growth and contraction. There has been several times over the past two years that these diffusion indexes have declined to near zero after periods of strong growth only to rebound after a few months.
On Thursday, the Commerce Department will release the revised GDP report for the first quarter. The advanced report indicated first quarter GDP increased 4.8%. Economists expect growth will be revised to 5.8%. Economists also forecast that growth has started decelerating during the current quarter. Of the 83 economists surveyed by Bloomberg, the median forecasted GDP growth rate for the second quarter is 3.5%. Growth is forecasted to decelerate more in the second half of the year, down to 3.0% for both the third and fourth quarters. This represents slower growth than was anticipated at the beginning of they year. First quarter growth was substantially stronger than initial estimates, and economists presume that economic activity was simply front-end loaded as estimates for the full year remain unchanged from the beginning of the year at 3.4%.
Consumer confidence as measured by the ABC News/Washington Post weekly poll dropped to the lowest level since the first week of last November. After reaching -6 in mid-April, it has dropped to -19. All three components have dropped over the past month, with buying climate falling to -36, only one point away from the almost eleven-year low set last October. Higher gasoline prices are likely pressuring consumers' attitudes. Given the drop in consumer confidence and higher energy prices, retail sales have remained healthy. The ICSC forecasts that retail sales will advance 3.0% - 3.5% in May. Granted, this is a deceleration from the 4.7% increase in April, but it is near the average increase over the past two years.
New home sales rose 4.9% in April to an annualized rate of 1.198 million units. Most of the gain was due to the revision of March sales lower. March new home sales were initially reported at a 1.213 million unit pace. This was revised down 5.9% to 1.142 million. Sales were strongest in the Northeast (up 8.2%) and the South (up 7.8%). Sales weakened in the Midwest, falling 1%. The median price rose 0.9% compared to last year, the lowest gain since December 2003. The number of new homes for sale rose, but the higher activity pushed the months supply down to 5.8 from 6.0 last month.
After the close on Wednesday, The Ryland Group, announced that second-quarter home sales were running 35% below last years pace. Given the weaker sales results, the company lowered earnings per share guidance for the full year to $8.50 to $9.00. This was lower than current estimates of $9.40 and lower than he $9.14 earned last year. It will also be the first decline in yearly earnings since 1995. Earlier in the week, Toll Brothers reported second quarter earnings this week that were slightly better than estimates. The builder of luxury homes reported that revenues increased 14%, but were lower than analysts' estimates. Additionally, gross margin was 190 basis points lower than last year. Similar to a few other builders, Toll Brothers also wrote down $12 million worth of land inventory, $8mm was in the Detroit area. Over the previous four years, Toll Brothers wrote down a cumulative $24 million. Lastly, the company lowered guidance by about 2% for the full year to $4.69 - $5.16 per share. This compares to earnings of $4.90 in 2005.
Last week, we mentioned that stagflation will likely become the next buzzword. Over the weekend, Bloomberg published a story quoting Allen Sinai, president of Decision Economics, who said that Bernanke is challenged with "a mild dose of stagflation." It seems that there are a lot of economists that keep forecasting that the economy will weaken. On Monday, Deutsche Bank issued a note that concluded, "the economy will feel soft in Q2, and going forward it will have to deal with the lagged effects of past monetary policy actions." There does not seem to be much evidence, aside from the housing sector, that higher rates have caused any moderation in economic activity. Economists have been trained that there is a lag in monetary policy, but when it has been telegraphed so everyone knows that monetary tightening will be done in baby-steps, everyone is able to adjust. While economic growth is decelerating from the rapid pace of the first quarter, it remains a stretch to describe the economy as weakening. We do expect the economy to weaken and would not be surprised if the economy weakened dramatically when it does. However, it seems premature to say the economy is weakening at this point.