1Q GDP Was High Quality (If Not High Growth)
Though the market wasn't thrilled with Friday's GDP report, there was a lot to like in the first-quarter numbers.
Housing data led the economic data parade this week with a trifecta of good news: housing prices, new home sales, and pending home sales.
The economy has had a very hard time moving housing metrics up across different reports, so this week's good news was particularly welcome. The housing data was finally good enough to make the second positive contribution in a row to real quarterly GDP growth.
Overall inflation-adjusted GDP growth, at 2.2%, was a lot better than most people dreamed possible a couple of months ago, but as analysts raced to up their forecasts (and stay ahead of competitors), expectations got a little ahead of themselves. (Just a week ago the consensus was 2.3%, but by Friday's actual report, expectations had crept up to 2.7%.) That forecast would have proved very close to correct if government defense spending hadn't fallen by 12%. And while residential construction was a nice plus to the GDP, business-related construction spending nearly offset that highly positive report, hurting the GDP report by a lot more than expected. On the other hand, the consumer came through yet again with an astounding 2.9% increase in spending, far greater than expectations.
So while doomsters highlighted the fact that overall GDP real growth slowed between the fourth quarter (3.0%) and the first quarter (2.2%) (typical headline: Recovery Stalls Again), the reality is that consumption was up a lot, and the inventory contribution was much smaller than in the fourth quarter. In other words, the quality of the report was high. I have continually warned that the fourth quarter was helped by inventory rebuilding, especially in the tsunami-plagued auto industry, and favorable weather. The report did nothing to persuade me that the economy is booming or that it is falling apart. The economy seems to be on track for 2.0%-2.5% growth in 2012 and 2013.
The Fed open market statement turned out to be a non-event this time around, with renewed commitment to low rates through 2014. There was nothing in the report to suggest that the Fed was taking any more easing off the table (that is, QE3) but no immediate indications of easing, either. Luckily, the market was happy with the somewhat ambivalent report.
Corporate earnings also piled in this week, with many firms performing better than expected. Apple (AAPL), which had so worried the Street for the previous two weeks, had an explosively positive quarter, managing to shock even the most bullish analysts. News on the housing front was also excellent, with D.R. Horton (DHI) putting up another set of great numbers. However, there were more European-related earnings problems reported this quarter, but most were not really catastrophic. Kellogg (K), which blamed falling sales in Europe for a more dour outlook, was one exception to the generally neutral effect of a slowing European market. Starbucks (SBUX) results out of Europe were also disappointing, and that did manage to set back this recent highflier.
Unfortunately, not everything came up roses this week. Durable goods orders were weaker than anticipated. Volatile aircraft and auto orders have led to booms and busts in this index over the last six months, rendering the report virtually useless. But even I would be hard pressed to say that manufacturing is driving the recovery at this point. Given that the auto industry is likely to stall out a little this summer (due to some unusually large and early model changeovers), manufacturing reports of all stripes are likely to remain under pressure. Manufacturing data out of Europe and China was even worse. Unfortunately, there was more bad news: initial unemployment claims, on the surface, looked a little elevated again, largely because of seasonal factors. Year-to-year, claims are still down in the 8%-10% range. No need to panic just yet.
Goldilocks' GDP Growth: Not Too Hot and Not Too Cold
Although the market wasn't thrilled with the 2.2% real GDP growth rate, there was a lot to like in the first-quarter report. The strongest part of the report was consumers, who somehow managed to increase their spending at a 2.9% annual rate in the first quarter. While autos and other durable goods drove a large portion of the improvement, the larger service sector managed a bigger contribution and a higher growth rate than in the previous quarter.
The other large positive surprise was that exports had their best quarter in more than four quarters despite a general slowing in most world economies. While I have always been in the camp that said a slowing world economy might not make a big difference to the U.S. GDP growth rate, I didn't expect its contribution to GDP growth to actually increase.
While my readers won't be surprised, it was reassuring to see housing making its second quarterly contribution to the GDP in a row. Housing contributed 0.4% to GDP growth, following a 0.3% increase in the fourth quarter.
The last piece of good news in the report is also a potential seed for worry. Autos (including consumer, business, government, and inventory) contributed an almost unprecedented 1.1% to GDP growth, or almost half of net growth. The bad news is that a large number will prove nearly impossible to sustain in the months ahead. That is especially true as one large manufacturer is building inventory in front of a long model changeover process this summer. But our auto analyst Dave Whiston points out that most luxury manufacturers can't keep up with demand and Honda (HMC) has yet to be able to match supply and demand in the aftermath of the tsunami.
On the negative side of the report, spending on business structures showed a sharp decline and all but wiped out the gains in the residential building market. The number doesn't seem to match up with the architectural building index (an important leading indicator of the construction industry), which has been at or above the 50% level over the past five months. Also, while construction employment overall hasn't been robust, it certainly seems to indicate that the construction industry is growing and not shrinking, as the GDP report seems to suggest.
Business spending on equipment and software was soft as well, coming perilously close to puncturing the zero line. Even though the European crisis hasn't managed to scare consumers, it appears that businesses have pulled in their horns, at least for now. Government spending was a larger outright detractor, reducing GDP by a shocking 0.6%. Though the source of weakness keeps shifting, government spending registered its sixth straight decline (well, one quarter was flat). This time the proximate cause was a drop in federal government defense spending. State and local government spending almost made it back to the zero mark.
Housing Prices, an End to the Decline
This month both the Case Shiller 20 City Index and the Federal Housing Finance Administration Report registered sequential gains in seasonally adjusted prices (0.1% and 0.3%, respectively). More importantly, the FHFA report also broke into the black on a year-over-year basis (up 0.4%), the first time that has happened since the July 2006 period to July 2007 period. Even using my preferred three-month average approach, the improvement has been steady and dramatic, though not quite back to zero, as shown in the chart below.
Pricing Stabilizing at Last
The prognosis for further improvement is excellent. The media, including even the Wall Street Journal, is now talking of selective bidding wars in some markets. With mortgage rates back down, affordability back at record levels, and inventories in several markets near historic lows, further price increases would seem to be in the cards. It will also help that prices last spring were relatively weak, making for easier comparisons in the months ahead.
If You Looked Hard Enough, You Could Find Bad Things to Say About Case Shiller
However, my wish from last week's column was not fulfilled. Here is the dreaded headline I was hoping to avoid that was at the top of the official Case Shiller release:
Nine Cities and Both Composites Hit New Lows in February 2012
Unfortunately, it appears S&P's headline writer woke up on the wrong side of the bed and focused on the sequential, non-seasonally adjusted data that was down 0.8%. But February is usually a horrible month for home prices, hence the need for a meaningful upward seasonal adjustment factor. To focus on the seasonally adjusted number seems at least a little unfair. However, even they will admit that the year-over-year decline has been getting smaller with each passing month. Given the strength in the FHFA data (which is not a three-month average), it is just a matter of time until the Case Shiller Indexes break into the black.
Pending Home Sales Have a Great Month
Pending home sales are often a good indicator of future existing home sales, so I was very pleased to see a 12.8% year-to-year increase and a sequential monthly increase of 4.1% (monthly, not annualized). Again, even looking at three-month average data, the positive trend is well in place.
Improved pricing discussed above should mean that these pending contracts are less likely to fall apart because of appraisal issues. More tightly written contracts that favor sellers (no inspection clauses, more cash offers, and fewer mortgage contingencies) should also mean more pending sales become final sales.
All the recent positive news on inventories, pricing, and sales seems to indicate that the glut of foreclosures expected in light of the recent robo-signing scandal settlement have yet to materialize. Anecdotally, Jim Ryan, who follows the mortgage insurance industry for Morningstar, says that he has heard that some banks are bending over backward to avoid flooding the market with foreclosures. Since the settlement, there seems to be a greater willingness by banks to accept short sales and modifications instead of taking the sure and massive losses that go hand-in-hand with the foreclosure process. It is too early to declare victory on this front, but it is good to see at least some positive first steps.
Manufacturing Not a Key to My Forecast, But…
Manufacturing news this week was lackluster at best. With strong U.S. consumer growth as shown in this week's GDP report, I believe manufacturing could eventually ramp up again later this year to match supply and demand. At this point of the recovery, manufacturing is not the key driver it was (and almost always is) at the beginning of the recovery. Adam Fleck, an associate director on our industrials team, summed up the manufacturing news this week as follows:
Durable goods orders fell sequentially in March, leading to the slowest year-over-year growth since January 2010. This week the U.S. Census Bureau reported that seasonally adjusted new orders of durable goods fell 4.3% in March from February, and climbed at just a 2.7% clip from a year ago. Even excluding volatile aircraft and defense orders did not substantially brighten the picture, as this metric managed an only slightly better 3.9% year-over-year growth rate. That said, the monthly readings have proven erratic in the past, and examining the three-month rolling average of non-defense, non-aircraft capital goods' year-over-year growth tells a more measured story. Here, growth fell to 7.1%, from 7.7% in the prior month. While March's reading certainly does not inspire enthusiasm, we think it is too early to write off the manufacturing economy.
The European flash manufacturing PMI fell again in April, to a 34-month low. The Markit Flash Eurozone Manufacturing Purchasing Managers' Index--an early reading on next week's final PMI--fell to 46 in April from 47.7 in March. This metric was almost a three-year low. The authors noted that prospects remain dim, as companies also sharply cut head count to reduce capacity. Input price inflation fell to a three-month low, suggesting that government participants may have some room for growth-spurring action, but the authors also noted that the overall numbers seemed to indicate a continued double-dip recession in the geography.
China's flash manufacturing PMI ticked up in April, but still suggests near-term contraction. April's HSBC flash China manufacturing PMI posted a 49.1 reading, up from 48.3 in March but still below the 50 level that indicates positive growth expectations. The report's authors believe the improved metric suggests that government easing has started to work, and that concerns of a sharp growth slowdown are overblown. Still, demand growth remained low (new orders continuing to contract), indicating further monetary and fiscal policy alterations.
The Flood of Data Continues
Next week the personal spending and income report, the ISM purchasing managers reports, auto sales, retail sales, and employment are all due. This Friday's GDP report took some of the thrill out of the usually exciting personal spending and income report. Consumption is expected to grow a robust 0.4% (though the doom-and-gloom crowd is likely to get excited because it is down from the unsustainable 0.8% level of February). Incomes are expected to be up a more modest 0.3%, but that event seems a little high based on the quarterly numbers in the GDP report. Also, expect the obligatory whining about a falling savings rate. Spending by high-income individuals, huge auto sales, and renewed auto loans are all helping out spending even in the face of relatively stagnant income growth.
A lot of eyes will be on Friday's employment report to see if the sharp slowdown in March was a fluke or the start of a major decline. So far, the market is betting on the fluke angle and expecting private payroll growth to move from a measly 120,000 in March to 165,000 in April. That's still below the couple of 200,000-plus numbers that we saw at the beginning of the year. For the full year I am still expecting growth to average 195,000 new private-sector jobs per month.
Manufacturing data from the ISM is expected to fall from 53.4 to 53.0. Autos and Boeing (BA) are probably still a big help, but waning exports can't help but hurt. The overseas PMI numbers discussed above certainly don't give me a warm fuzzy feeling on this one.
Speaking of auto sales, the expectation is for sales to be flat at the 14.4 million annualized unit level for April, which is the same as the March number. Reports from dealers, especially luxury dealers, suggest yet another good month. However, weather and seasonal adjustment factors will be less of a help than in February and March.
Robert Johnson, CFA does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.