Data Confirms The Summer Swoon As We End 2Q 2011

Over the last few weeks a number of economists have have cut their domestic growth expectations following a string of weaker than expected data. Well, the notion of slower growth is more or less official now as the Federal Reserve downgraded its projections for U.S. economic growth and unemployment this past Wednesday.

The Fed now sees the U.S. economy expanding by 2.9 per cent in 2011 vs. its April forecast that called for 3.3 per cent growth and its January forecast of 3.9 per cent growth this year. In addition to the negative revision to it’s 2011 forecast, the Fed also reduced it’s growth outlook for 2012 3.7 per cent or slightly less vs. the prior projection of better than 4.0 per cent growth in 2012.
Despite those revisions downward, those forecasts off a rosier out look than some others, including that from the International Monetary Fund, even though Mr. Bernanke described the reductions in the Fed’s economic growth forecasts as “fairly significant.”

More disconcerting is that the Fed doesn’t “have a precise read on why this slower pace of growth is persisting” according to Mr. Bernanke. With already two cuts to the Fed’s forecast and no resolution as yet to the Federal debt ceiling and deficit as well looming issues in Europe, one has to consider that economic growth this year could be closer to the 2.5 per cent that the IMF is forecasting for the U.S. in both 2011 and 2012.
I say that in part because the Fed is tracking to finish its $600 billion program of debt buying later this month.  As with several other programs implemented to put the economy on growth trajectory over the last few quarters – housing tax credits, cash for clunker and such – the question that needs to be asked is whether or not these programs addressed the structural nature of the problem?
The short answer is no because none of those programs laid the ground work for sustainable growth that would ripple across the domestic economy, foster real job growth and get consumers spending. If anything, those programs pulled what demand there was forward by several months.
In terms of growth and job creation, many tend to look at weekly jobless claims and the monthly employment report, however there are indicators, such as capacity utilization, that suggest robust hiring is likely to be put off near term. While capacity utilization levels have improved from the 2008-2009 low according to The Federal Reserve Board, the May 2011 reading of 76.7 remains well below the 1972-2010 average of 80.4. In more plain language, there is enough slack that companies are not feeling the pressure to hire more workers because their current staff can keep up with demand. In the past, when capacity utilization is well above 80 per cent companies added new plants and new workers.
As it relates to spending, yes consumers have been hit by higher gas and food prices, but digging through the sea of data we find consumers have been up to something else as well – improving their balance sheets. The Fed’s household debt service ratio, (DSR), a quarterly estimate of the ratio of debt payments to disposable personal income, has fallen to a recent low of 11.51 in 1Q 2011 from the recent peak of 13.95 in 2Q 2007. Moreover, since that peak the DSR has moved steadily down over the last 13 quarters. To put some perspective around that 1Q 2011 DSR figure, it is the lowest level since 2Q 1995 when the reading hit 11.47. While the DSR shows that consumers have been getting their houses in order, getting them to spend – we are a consumer driven economy – will hinge on a better job outlook.
Many will point to the $800 billion cash on the balance sheets of the S&P 500 companies and wonder why they are not hiring. As I mentioned above, jobs are added as companies face a favourable demand equation, but also companies are not likely to hire when staring uncertainty in the proverbial face – Will the Fed undertake another round of stimulus? How fast will the economy grow? Will tax rates move higher as a result of debt ceiling and deficit reduction conversations? And so on.
Summer swoon indeed.
The Week Ahead
Most if not all investor eyes will be watching a number of things this week:

  • Greece. While news this morning suggests that France is moving closer toward backing a plan that would roll over its holdings of Greek debt, the real question is whether or not current discussions, austerity measures included, amount to nothing more than a band aid for the short term and simply kick the debt restructuring can just further down the road…
  • Economic data a plenty this week. Already this morning, we’ve received further indications that inflation persists and incomes remains under pressure as Personal Spending and PCE Prices for May both missed expectations – spending was weaker than expected while PCE prices were higher than expected. The bulk of the data will be in the second half of the week when we’ll get June perspectives on sentiment and manufacturing via the Chicago PMI, Michigan Sentiment Index and the ISM Index. Following last week’s report that Durable Orders rebounded in May from a negative April, I’ll be watching manufacturing related data this week to see if that rise in orders is confirmed or not.
  • Getting ready for earnings. With less than a week to go in 2Q 2011, investors – institutional and individual alike – will be getting ready for the barrage of earnings that will kick off not too long after the July 4 holiday weekend. Between now and July 11, I’ll be watching for earnings pre-announcements; my view is that a number of sectors and companies will have to update their forecasts to reflect the softer than previously expected economic landscape compared to when they last updated their guidance in April. Before that however, several companies including Nike (NKE), Family Dollar (FDO), KB Homes (KBH), Monsanto (MON), Constellation Brands (STZ), and Smith & Wesson (SWHC) among others will report their respective quarters this week.

Stay tuned and have a great 4th of July.

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