Decreased Oil and Gas Imports Keep Trade Deficit in Line

With a thin economic news flow and earnings season coming to an end, the market basically treaded water for the week, with small caps continuing to be the one weak spot. The S&P 500, European indexes, and even emerging markets were virtually unchanged on the week. Bond rates were slightly lower at 2.62% on the 10-year U.S. Treasury bond versus the 2.7% range last week. My colleague David Sekera, Morningstar's director of corporate bond strategy, says that it's been quite awhile since rates have remained in such a small range for this long.

The trade report was the only one of consequence this week, and it was little changed and in line with expectations. Home price growth slowed, but not as much as I would have suspected. Weekly and monthly chain store data finally appeared to have made an important turn as better weather and better employment data have led to more spending. Federal budget data indicated that the federal budget deficit continued to decline. Surprisingly, tax collection did not do as well as employment data, suggesting that one of the two series is likely to be restated at some point.

Overall, the earnings season is turning out better than many had anticipated when the quarter began. With 454 of the S&P 500 companies reporting, FactSet is indicating year-over-year growth is expected to be 2.2% in the first quarter versus a 1.3% forecast decline as of March 31, when the quarter ended. Earnings surprises in general have been running higher than average. That's even with the rather dismal impact of worse-than-expected weather issues. Negative guidance was down sharply from last quarter as well.

Next Revision to First-Quarter GDP Could Indicate That U.S. Economy Contracted
A worse-than-estimated trade deficit for March and a disappointing construction report both raise the possibility that the economy contracted as much as 1% in the first quarter. Changing retail and inventory data could offset some of that pain, but avoiding an outright decline in GDP will be difficult. Originally, first-quarter GDP growth was reported as a positive 0.1%.

I am not worried, as consumption and employment data indicate a stronger underlying growth rate. Lately, GDP in isolation hasn't been a great indicator for much of anything. Data so far for April suggests that growth of 3% or more is possible in the second quarter, offsetting the sting of a disappointing first quarter. The trade report for April, released on Tuesday, is the primary reason for all the new thinking on the first quarter. That report is detailed below.

Trade Deficit Looks a Little Better, but Worse Than Government Estimated
Overall, the trade deficit narrowed to $40.4 billion in March from $41.9 million in February. The number was little different from the monthly $39.5 billion average trade deficit for all of 2013. That's unusual in a recovery, as more economic activity around the world generally boosts imports and exports equally. Since imports are almost 50% larger than exports in dollars, the trade deficit almost always goes up during a recovery.

Additional oil and gas production and shipments explain why the trade deficit has held steady or even improved over the past couple of years, despite an improving economy. Petroleum represents about 5% of all U.S. exports, which is up modestly over the past few years while petroleum-related imports have fallen 4 percentage points, from 14% to 10%, over the past three years in real terms. I also believe that the trade deficit in the first quarter was one of the indicators hit hard by the weather. Bad weather meant lower oil production, difficulties in moving the product to port, and higher domestic demand, limiting exports. This could mean that trade data will look substantially better in the second quarter as exports resume. 

The nonpetroleum-related categories showed the more typical pattern of higher import growth than export growth. The data also seem to be saying that world trade is picking up at least a little, with the most recent data above its 12-month moving average.

Airliners, Autos, Capital Goods Lead Export Parade
Looking at single-month data for March, not adjusted for inflation, total exports of goods and services were up 2.0% while imports were up a more modest 1.1%, which explains why the trade deficit shrank for the single month. Big-export categories outside of oil-related items include jetliners, automobiles, industrial machinery, and food products.

The by-country data was interesting as the deficit with China fell while the deficit with Europe expanded meaningfully. This reflects the fact that growth in China is slowing even as Europe's economic recovery continues and growth rates accelerate. In terms of major trading areas, Europe continues to be the largest, representing about 2.8% of U.S. GDP. China is considerably less at 1.1%, which is well below both Canada and Mexico as individual countries.

Home Price Growth Slows Some, but not as Much as Expected
The  CoreLogic home price data for March showed that the annual rate of home price growth has finally begun to slow meaningfully. Single-month, year-over-year home price increases have dropped from a high of 11.8% growth in October to 9.2%, using the estimated data from CoreLogic (based on pending home sale reports) for April. The slowing trend is even evident in the more stable three-month moving average data, as shown below.

Obviously, the monthly data this spring is showing far less-dramatic increases than a year ago when buyers were racing to beat interest rate increases. Still, the monthly increases for March and April look bigger than I might have guessed. That means without a slowdown soon, home price increases for the full year may exceed my 5%-6% forecast. Unfortunately, higher prices and higher mortgage rates may serve to keep a lid on the housing market in the months ahead.

Federal Budget Deficit Progress Slows a Little in April
The deficit improvement for the first seven months of the fiscal year continues to look great. For the first seven months of fiscal-year 2014, the deficit has declined by a whopping $187 billion, or by about 38%. Tax receipts are up dramatically because of law changes and tax increases while spending is down, but not quite as drastically. If the deficit were to remain exactly the same as last year for the last five months of the year, the total deficit for fiscal year 2014 would be $493 billion, which would be very close to the official CBO estimate of $492 billion, or about 2.8% of GDP.

The monthly data for April was OK, but not as good as I hoped. Overall, the numbers weren't that much different from what I guessed, as revenue growth seems to be slowing and spending isn't accelerating as much as many believed. Tax receipts for April, the biggest tax collection month of the year, were only up 2%, just barely outpacing inflation. That doesn't even include the fact that employment was up 1.7%, suggesting that total tax receipt growth should have been up something closer to 4%.

CBO believes there was more shifting in the timing of asset sales and bonuses from 2013 to 2012 than previously believed, which is reducing the tax take this year. A more ominous possibility is that the Labor Department has overestimated employment growth and when trued up with payroll tax data, the employment reports may need to be adjusted downward.

However, spending has been lackluster, too, even after the October budget deal that theoretically was supposed to allow for more spending. Expenditures in April were up just 2%, about the same as it was for the first six months of the year. Medicaid, Social Security, and Medicare are the only major spending categories showing any meaningful growth while most categories are flat, and some are even down (unemployment payments and defense).

Weekly Shopping Center Data Finally Showing Signs of Life
Mall retailers have had a tough go of it over the past year as  Amazon (AMZN) continues to pressure sales and consumers shift their buying patterns to more auto- and service-oriented categories.

While the trend below is not pretty, at least some of the really nasty numbers this winter are slowly beginning to reverse. Maybe some warm weather and Mother's Day shopping will help improve next week's data, too. The five-week moving average is now above 2% growth for the first time since January. The monthly data for April (which is calculated differently from the weekly data and includes different stores) looked great, and the combined March/April growth rate was 4.5%, well above trend.

I do caution that this monthly survey doesn't count for much anymore as the number of participating chains has dropped from over 30 to less than a dozen. Still, there are clearly signs of life in the malls after all. We will get a better and more comprehensive read on retail sales with the government's official report due next week.

Data Releases Pick up Again Next Week, Especially on Thursday
Next week the Consumer Price Index, Retail Sales, Industrial Production, Home Builder Sentiment, and Housing Starts and Permits will all be released. And that is just the major releases.

What the economy really needs is to see the housing data make an upturn after dismal winter results. Great permits and better weather should finally point to a builders' sentiment reading above 50, after staying below that mark for two consecutive months. Starts and permits should also look better. Housing starts are expected to increase to 990,000 units in April after a lackluster reading of 946,000 units in March. I will also be closely watching the mix between single and multifamily homes, which has tilted toward less stimulating multifamily homes lately.

Will the Retail Sales Report Confirm Recent Data?
Retail sales have had a few great months, but much of that has been outside of conventional retailers. In April, it appears conventional retailers picked up a lot steam, but autos and building material are likely to offset some of those gains. Overall retail sales are expected to increase 0.3% in April following an auto-inflated and weather-related increase of 1.1% in March. Again I will be watching the year-over-year data more closely, and that hasn't really begun to rally much, yet.

Inflation: Another Month of Increases?
Given rising gasoline and food prices, I think forecasts of 0.2% CPI growth for April versus March may prove low. Worse, the year-over-year data for a single month may skate close to 2% after being as low as 1.1% earlier. There are a few temporary factors boosting inflation, but I still think that we may have seen the lows for the year. I will also be watching health-care price inflation closely, especially now that demand is beginning to pick up. Auto inflation could prove interesting too, and may shed some light on how much auto dealers are discounting their cars.

Industrial Production Got Its Weather Bounce in March; April Data Could Be Down
Given less utility usage and poor employment growth in the manufacturing sector, no one is expecting good news for industrial production for the month of April. Overall, the consensus is for just 0.2% growth in industrial production following 0.7% growth in March. However, I have seen a number of forecasters indicating that IP could actually be down. I will be watching the auto production numbers particularly closely as production had gotten out of line with actual sales. It will also be interesting to see if the manufacturing improvement will be as broad-based as it was in March.