Economic Growth Around the Corner

The economic data released this week, including the GDP report, the Case-Shiller price indexes, and initial unemployment claims are all supportive of 2%-3% GDP growth in each of the next two quarters, and continued growth well into 2010.

My growth expectations are above consensus levels but still well below the 5%-plus growth level typically experienced after a deep recession. An end to inventory destocking, a housing industry that is no longer in decline, and a return to more normal auto demand make me more bullish than most, but I'm still concerned about shaky consumer balance sheets and poor consumer confidence.

The GDP report was consistent with an economy in the bottoming process. At negative 1%, the June-quarter results were better than both my expectations (negative 2% to negative 3%) and the market consensus (negative 1.5%). The number was also substantially better than the previous quarter when the decline exceeded 6%. Sharply improved government spending (due mostly to defense spending, not yet the stimulus) and a huge decrease in the rate of decline in investment spending were the primary reasons for improvement, along with better-than-expected exports. The inventory draw-down in the quarter was the largest on record at about $150 billion, negatively affecting GDP by almost 1%. In other words, if inventories had just stayed the same as in the previous quarter, total GDP would basically have been flat.

Although embedded in previously released economic data, it still was a little surprising to see that the consumer-spending portion of GDP was down almost 1% after having been a small positive in the first quarter. The strong reception to the Cash for Clunkers program, the stimulus plan, and a more neutral weather pattern (abnormally cool weather affected clothing and energy sales in the June quarter) give me some confidence that the spending number will improve in the September quarter. However, if jobs statistics worsen dramatically and consumer confidence remains in the dumps, I could be proven wrong.

The biggest surprise this week was the immediate success of the Cash for Clunkers program. This federal program offers up to $4,500 to new car buyers who were trading in used cars with substandard fuel efficiency. In less than one week, it appears the entire budget of $1 billion (or 220,000 cars at the $4,500 maximum) was exhausted. As of Friday afternoon, the U.S. House of Representatives had approved an additional $2 billion of funding with the Senate potentially taking up the bill next week. Passed or not, I believe that the quick sell-out was indicative of the pent-up demand for autos. For some time I have believed that auto sales were below the normal replacement rates and that eventually sales would return to more normal rates. This program provided a great jump-start. There is even some anecdotal evidence that consumers who failed to qualify for the program still bought new cars. It seems that the program was instrumental in getting people off the fence.

Case-Shiller housing prices, released Monday, were also a bright spot for the economy this week. For the first time in almost three years, housing prices showed a very small sequential increase, although still down by a high-teens percentage on a year-over-year basis. If current trends continue, housing prices could be flat on a year-over-year basis by later this fall. An improvement of this magnitude could substantially brighten consumer confidence and even provide the wherewithal to make additional expenditures.

As I warned last week, initial unemployment claims this week crept up to 584,000 from 559,000 on a seasonally adjusted basis. A dramatic shift in the seasonal adjustment factor has had a negative effect on reported claims for the last two weeks after aiding results three weeks ago. Smoothing everything out with a four-week moving average, claims fell from 567,250 to 559,000. On Friday of next week, the jobs reports will be out for the entire month of July, which should give everyone a better feel about where the economy is. I am anticipating only a modest improvement in the number of job losses from the previous month.

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