Still Bullish (But Not Too Bullish)

This week, markets got excited by the U.S. Federal Reserve's potential delay of tapering bond and mortgage purchase programs. The Fed chairman and a number of Fed governors went to great pains to stress that cutbacks in bond purchases will be economic-data driven, and the short-term rates would remain low indefinitely. This week's softer tone follows the release of minutes for its mid-June meeting, which suggested a lot of disagreement, with several governors lobbying for a quick end to bond purchases.

As the result of this week's Fed jawboning, U.S. equities are nearly back to their spring highs while the 10-year U.S. Treasury bond, at 2.6%, remains far closer to its daily high of 2.8% than the 1.6% level of just this last May. Emerging markets also remain under extreme pressure, with the MSCI Emerging Markets Index still down a rather surprising 12% year to date, even as the U.S.-based S&P 500 was up almost 18% over the same period through July 12.

Second-Quarter GDP Growth Prospects Take a Hit
While there wasn't much U.S. news to report, based on a weak inventory report, it now appears possible that second-quarter GDP growth will be less than 1% compared with the not-so-wonderful 1.8% of the first quarter. Additionally, the global news was even worse with the IMF marking down worldwide growth rates yet again.

Rumors abounded on Friday that next week's second-quarter GDP release for China also will be disappointing. There is further talk that full-year Chinese GDP growth could fall to near 7%, down from 10%-12% several years ago and expectations of 8%-plus growth late last year.

In other bad news this week, producer prices were up more than expected, while both crude oil and gasoline made big moves up--never good news for consumers--based on continuing problems in the Middle East.

In a rare bit of good news this week was the U.S. budget deficit for both the month of June and the nine months ending in June. The move to a sub-4% of GDP deficit for fiscal year 2013, which is almost over, now appears to be a chip shot from here as May's disappointing report was reversed in June. However, even this piece of economic news comes with a dark side, which is, lower government spending that will also weigh on the U.S. GDP report.

I Remain an Economic Bull, Just Not an Economic Rocket Ship Recovery Kind of Guy
Although I am often accused of turning bearish, my U.S. GDP growth outlook for 2013 and 2014 remain relatively unchanged at 2.0% and 2.5%, respectively. It's just that the others around me keep changing their views around, which places my estimates either above or below consensus in a regular, alternating pattern. The Fed (with an estimate of 2.3%-2.6%) and the Obama administration (2.4%) and a number of pundits remain well above my estimates. Meanwhile, the IMF and the Congressional Budget Office are estimating U.S. growth at 1.7% and 1.4%, respectively. With first-half growth now likely to come in well below 2%, to get to a 2% growth rate will require at least one quarter of close to 3% growth to get even a 2% full-year growth rate.

The Extreme Economic Bulls Make Some Good Points, but Not Good Enough
The bulls, including the Fed, think we can do it based on an accelerating housing market, less drag from government spending and some overseas improvement. Unfortunately, the real estate market has already been quite helpful and is too small and improving too slowly to lift the economy more than a couple of tenths from the 0.3% it contributed in the first quarter.

The bullish case for government spending is that government spending subtracted 0.9% from first-quarter GDP growth, meaning the private sector grew at very acceptable 2.7% but combined the economy grew at a measly 1.8%. Now even if the government sector just gets back to no net growth, overall GDP growth would be back to close to 3.0% in a heartbeat. I am far less optimistic about government, given the lackluster spending data the Treasury Department released on Thursday, combined with sequestration effects. Even at the state and local government level, things are not all well. Municipal bond market turmoil and pension requirements and continued austerity pushes are all offsetting the increase in tax collections that have some economists so excited.

Finally, I believe that the international situation is still getting worse, not better, with the possible exception of Japan and the United Kingdom. Chinese leaders seem generally less enamored with growth for growth's sake and more likely to let the economic chips fall where they may than providing more knee-jerk stimulus plans. More growth seems to just create more inflation, which doesn't do wonders for the popularity of current leaders. A slowing China, a not so wonderful U.S. economy, and a suddenly more competitive Japan is not great news for Germany's export-dependent economy, either, which is about the only decent performer in Europe, at the moment.

World Unrest Rising Uncomfortably
On more anecdotal level, economic unrest around the world is rising, which is never a good thing, either. Even beyond the very unsettled situation in Egypt, even normally calm Brazil has seen its share of riots, and riot activity in Turkey has picked up in 2013. So even as markets seem to dance with every Fed whisper, the dimmer world situation goes largely unnoticed, perhaps with the exception of an unwanted and unneeded increase in oil prices and softer prices for emerging-market debt and equities.

IMF Reduces Its Economic Growth Forecast Again
Until the last year or so, I hadn't paid a lot of attention to the various world economic growth rates as the U.S. isn't terribly dependent on exports. However, over the last six months I have noticed that the International Monetary Fund has had to twice reduce its long-term growth rate as a whole and for individual countries. This week, world growth forecasts for 2013 were reduced by 0.2%, to 3.1%. Japan (new economic policies, lower valued currency), the U.K., and Canada were the only countries that avoided a growth downgrade of some sort. Russia, South Africa, Mexico, and Brazil sustained the biggest downgrades.

Frankly, at negative 0.6%, the rate for Europe still looks too high, especially with export market activity probably moving against Germany. I still believe that Europe will see its economy shrink between 1% and 2% for all of 2013. I think the numbers for China and Brazil look a little high as well.

Commodity Bull Market: Game Over?
Perhaps even more telling were the commodity price forecasts the IMF put forth:

Though a war or drought could change things in a hurry, it appears that the back of the major commodity boom has been definitively broken. The commodity situation is another good news/bad news story. It is generally good news for consumers everywhere but bad news for commodity-producing economies (think Western Canada, Russia, South Africa, Brazil, Australia, and OPEC) and companies serving commodity producers.

Weaker Growth Hits Emerging Markets' Stocks Hard
So far, a more favorable and stable economy has generally had a positive effect on the U.S. equities while sinking a lot of emerging economy stock markets and most bond markets. The U.S. outperformance is breathtaking and not something that most people expected just six months ago.

China, Retail Sales, Consumer Price Index, Industrial Production, and Housing Data All Due Next Week
By far the retail sales report will be the most important release next week, given that the consumer drives 70% or so of the U.S. economy. However, rising gasoline prices and soaring auto sales will provide a highly positive tailwind for the headline numbers. Retail sales are expected to jump a remarkable 0.9% (almost 11% annualized). Even the ex-autos rate is expected to jump 0.5% (6% annualized). The International Council of Shopping Centers data for June (released this Thursday) was up 4.1% year over year, its best performance since January, and that bodes well for the official government release on Monday. As usual, I will be parsing the report carefully to eliminate autos (which were undoubtedly red-hot in June) and gasoline, and reviewing the averages year over year to gain a clear picture of reality.

CPI: The Best of the Good News May Be Behind Us
With higher producer prices released on Friday, expectations for next week's CPI reading have been creeping up. Expectations are for all consumer prices to move up a combined 0.3%, one of its highest readings in several months. Unfortunately, a higher inflation rate will dull some of the positive effects of the better than expected employment and wages report last week. However, beyond energy, I am not expecting many other large upward category spikes. Unfortunately, oil prices are on the move again and likely to remain high due to the shaky situation in Egypt. As Fed chairman Ben Bernanke has indicated, we may have seen the best of the CPI inflation news for the year.

Housing Data--Will Starts Get Better?
Both builder sentiment (expected to be flat) and the housing starts and permits reports are due next week. Starts are expected to be up sharply from 914,000 to 951,000 units after May's unexpected swoon. Still, without some healthy revisions at midyear, starts are likely to remain below the 1-million rate for the first half (920,000, using consensus estimates). That means to get over the 1-million rate for the full year, which we all thought was a chip shot, starts have to approach 1.1 million units in the second half, which still looks relatively optimistic. The June start report has a lot of moving pieces that make it nearly impossible to project, so anything could happen. (Apartment units are especially volatile.) Permit growth, which usually helps predict starts, looked terrible last month, but new home sales spiked because of houses purchased but not yet started. On the positive side, slightly higher inventories and a rush to purchase homes before rates moved even higher could aid the June report.

Industrial Production Projected to Remain Lackluster
Overall industrial production is expected to grow just 0.1% following an increase in May. That seems conservative; however, utility demand will weigh on those results. Autos and airliners should remain relative stand-outs with weak world markets depressing chemicals and paper. Falling inventories and respectable if not ebullient retail data should mean better days ahead for manufacturing. Therefore, I am not fretting about the report for June, even if it looks a little soft.

Second-Quarter GDP Report Due from China
As I mentioned earlier, China is set to release its GDP growth rate for the June quarter next week, and expectations are not high. After growing at a disappointing 7.7% rate in the first quarter, the rate is expected to drop even further in the second quarter, to 7.5%. The Chinese reports get a lot of attention because China also drives a lot of commodity-oriented economies, as well as nearby neighbors'. The interest is probably justified as China represents the world's second-largest economy, behind only the United States.