Outlook for the Economy
Can the U.S. prosper in a faltering world economy?
Quarter-End Insights
- The U.S. is less dependent on exports than almost any other country, so a general slowing in the world economy would not drastically affect the U.S. economy, though S&P 500 companies that have substantial overseas exposure are another story.
- The real cause of the global slowing hasn't been European contagion, but intentional government policies to curb inflation. Most countries are in the process of reversing those policies, most notably China and Brazil.
- Year-over-year data paint a relatively stable picture of the U.S. economy, as consumers have spent steadily while corporations have been more panicky.
For the last year, I have been relatively bullish on the U.S. economy, primarily because the U.S. consumer continued to spend at a relatively constant rate. Although a Japanese Tsunami, two gasoline price spikes, and unseasonably warm weather have caused some ups and downs in the broader U.S. economy, I believe the underlying growth rate, when adjusted for inflation, has been an unsatisfying but exceptionally stable 2% for the past two years
My general forecast has been for more of the same, 2% to 2.5% inflation-adjusted growth for both 2012 and 2013. For the record, the U.S. economy has averaged 2.7% growth since 1973, so the current shortfall from trend is not catastrophic, either. Looking ahead, I expect more of U.S. economic growth to come from the housing industry, even as exports and inventory growth both slow. Lower commodity prices, including both food and oil-based products, will also provide a considerable boost to the long-suffering U.S. consumer. My forecast is for year-over-year inflation to slow to the low end of a 2.0-2.5% range by the end of 2012.
Worries Over Export Growth
A recent and steady drumbeat of bad news from overseas has a lot of economists worried about the U.S. recovery. Some of those concerns have merit given that exports are a lot more important to the U.S. than in any other time in the last 50 years. Furthermore exports were a major contributor to GDP growth early in the recovery.
However, I believe some of those fears are misplaced. The fact is, the U.S. is less dependent on exports than almost any other country, according to data from 2010. Looking at just the 10 largest economies, only Brazil exported less as a percentage of GDP than the U.S.
Nevertheless, Export Shrinkage Was a Major Contributor to the Last Recession
That said, slowing exports did play a meaningful role in the most recent recession, accounting for as much as 40% of the decline in U.S. GDP. However, I believe that the recession of 2008 and 2009 was a special situation. The sharp decline was a result of a failed banking system that could not provide the necessary trade finance to enable trade.
In the economic meltdown of 2008 and 2009, U.S. exports fell about 20% before adjusting for deflation (the fall was a less drastic 14% after adjusting for deflation). The bulk of the decline occurred in the third and fourth quarters of 2008, when trade financing was nearly impossible to obtain. The sharp decline was related more to the availability of credit than the lack of need or desire for U.S. products. When the credit crisis ended, exports rebounded quickly. And while many observers speak of export-driven growth, a lot of the improvement was merely that recovery from the drastic credit crisis. Exports today are 14% of GDP, not meaningfully different than the 13.4% of GDP that they represented in 2008 before the collapse began.
Slow Exports Will Hurt the S&P More Than the U.S. Economy
My conclusion from the data is that a general slowing in the world economy would not drastically affect the U.S. However, another complete meltdown of the banking system, which no one can rule out categorically, could indeed have a major impact on U.S. growth.
S&P 500 companies that have substantial overseas exposure are another story. In June The Wall Street Journal published a report from S&P that broke down foreign sales by sector for the S&P 500. (Keep in mind that these figures include only companies providing geographic breakdowns; many companies do not do so.)
Stock Prices Adjusting to Slower World Economy, Relative Tranquility in U.S.
Based on the slowing world economy, and a relatively stronger U.S. economy, it is really no surprise that the stocks of U.S. industries with lower overseas exposures--such as utilities, communications, and health-care stocks--were among the best performers in the second quarter. The relative U.S. strength shows up in country data, too, as U.S. indexes were down just 5% near the end of the second quarter, while both European and emerging-markets indexes were down 10%-15% for the quarter.
Emerging-Market Slowdown Could End Quickly
The good news is that outside of Europe, other non-U.S. economies are likely to see some improving growth rates, maybe as soon as the second half of 2012. An awful lot of the slowing we have seen worldwide was self-induced. Inflation rates in many nations, especially food inflation, were approaching near-disastrous levels. In emerging markets, inflation is not merely an inconvenience but a catastrophe for the poor, who already spend a massive portion of their incomes on food. Out-of-control inflation also raised the specter of political unrest.
In reaction to higher prices, governments around the world have mounted a year-long effort to reduce inflation by boosting reserve requirements, raising interest rates, and tightening lending standards. Those policies have worked, perhaps a bit too well. Indeed inflation has slowed in most cases. But those very same policies, by definition, have also brought down growth rates.
So while many pundits have conjured up elaborate theories about a worldwide slowing based on a European contagion, the real cause of the global slowing is intentional government policies. Most countries are in the process of reversing those policies, most notably China and Brazil, both of which have recently cut rates. Unfortunately, lower rates take a while to have an effect. In the interim, European woes won't help countries that export a lot to the European Union.
Fears of U.S. Slowdown Overblown
Meanwhile, fears of a slowing U.S. economy appear to be overblown. While it's impossible to argue that U.S. growth is accelerating, it's also hard to say there is any real slowing, either. Weather and antiquated seasonal adjustment factors made the U.S. economy look stronger than it was this winter. Now that weather has returned to more normal levels and seasonal adjustments turn from a tailwind to a headwind, growth looks weaker than it actually is.
Even before some of the weaker data came in, Ben Bernanke gave a big, public speech cautioning that weather had helped a number of economic statistics, especially the employment data, which was growing inexplicably faster than total GDP growth. We were all warned.
Year-Over-Year Data Paint a Relatively Stable Picture of the U.S. Economy
My guess is, based on weekly retail sales data, the strength of the U.S. economy never budged from its core central tendency of 2.0%-2.5% growth. In fact, year-over-year growth in a lot of statistics (which are less affected by the messed-up seasonal adjustment factors) shows a relatively steady economy. Those same statistics (including retail sales, industrial production, and employment) do look soft if one simply compares the data with the prior month. However, I caution that looking at data this way tends to badly confuse statistical noise and random monthly events with real changes in economic trends.
Look Beyond the Short-Term Numbers to Determine the Strength of the U.S. Economy
When trying to decide whether to use the month-to-month data or the year-to-year data, consider this: Why would housing prices turn up and housing starts increase to 40% above their recession lows if the U.S. economy is falling apart? Or why would auto sales, one of the leading beacons in the recovery, accelerate sharply in 2012 if the end was near? Housing and auto sales are big-ticket purchases that consumers, even U.S. consumers, don't take lightly.
Consumers Steady Even as Corporations Are Acting Panicky
It feels really odd to write this, but my biggest economic fear is that S&P 500 companies hit the panic button. One would think that consumers who are reading all the terrible headlines would be the ones panicking. Instead employment data and capital spending data would suggest that it is corporations that are pulling the reins. Meanwhile, consumers continue to spend. And falling prices should give them even more buying power in the months ahead.
Our Analysts Remain Cautious, but See Some Positive Signs
Our analyst teams remained relatively cautious this quarter, though there are at least some glimmers of hope in the individual sector reports. A number of the reports noted that input prices were beginning to decline, which could potentially help profit margins later this year. Falling gasoline prices were also cited by our consumer analyst as helping stimulate demand in the months ahead. Unfortunately, low commodity prices were not good news for many of our basic material companies, which are suffering from lower prices for their goods even as costs of production remain relatively high.
One commodity that has shown some recent strength is lumber, which may be a reflection of renewed growth in the housing market. Our industrial sector outlook also contains a bullish case for even more growth in the auto industry, a stalwart of this economic recovery.
Commentaries on the effects of the world economy were more muted than I expected. The industrials and tech teams seemed the most concerned about Europe, but even in those reports, no one is claiming a train wreck. A slowing China seems to be affecting commodity demand and prices more than anything else. However, a lot of the industry reports did mention the recent Chinese rate cuts and the potential for a relatively quick turnaround in that economy.
I am not sure if it is entirely a positive trend, but there are some early signs that health-care spending might not totally consume the U.S. economy after all. Our health-care commentary notes that consumers have been forced to pick up more of their own health-care tab (higher deductibles, copays, etc.), making employees more sensitive to the no-longer-hidden cost of consumption and slowing health-care demand over the past few years. We are less sure whether this is just a recession-related phenomenon or a permanent trend. In addition, although a lot has been written about the horrible effects on pharmaceutical corporations of expiring drug patents, the positive effects on consumer wallets are seldom mentioned, even when drugstores and pharmaceutical companies take it on the chin as blockbuster drugs such as Lipitor move to the generic market.
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