Trouble on Horizon

06/21/2010 12:36 pm EST


John Mauldin

Chairman, Mauldin Economics

John Mauldin, editor of Thoughts from the Frontline, warns that second-half growth could disappoint as stimulus and restocking fade.    

The question before the jury is a simple one, but the answer is complex. Is the US in a "V"-shaped recovery? Are we returning to the old normal? A great deal hinges on the answer, and this week we look at some of the evidence before us.

The consensus for growth in the last half of the year is around 3%, with some forecasts even higher. That would be a good number, but the usual number coming out of a recession would be over 4% and approaching 5%, so even the optimists are forecasting a weaker than usual recovery.

But there are some positive signs. Withholding taxes at the state level are starting to show year-over-year growth, albeit from low levels; let's take growth where we can find it.

New and existing home sales are up, but that appears to be largely related to the ending of the government buying subsidy. The tax break pulled forward people who were planning on buying within the next year or so, and without that stimulus...? Mortgage applications for new purchases are now at a 13-year low, and that is with mortgage rates below 5%!

"Chain store sales grew 2.6% in May, better than in April but consistent with the view that spending growth has moderated since the first quarter. Sales were limited by the shift in Memorial Day and adverse weather, particularly in the West. Fundamentals remain too weak to support consistent strong sales growth." (

And that last sentence seems to sum up most of the positive data points: the fundamentals are too weak to support robust growth.

We had massive stimulus applied to the economy in 2009 and through the first half of this year. That stimulus is now beginning to fade. Besides keeping us out a major deflationary recession or even depression, it was supposed to get us to a place where consumer spending and GDP growth would become organic and not need further stimulus packages.

So the question becomes, what happens when the stimulus goes away in the latter half of the year? Have we gotten the economy to the point where it can grow on its own? To answer that let's take a look at some leading indicators.

First, let's take a peek at data from the Economic Cycle Research Institute (ECRI). The leading economic indicator, which led the recovery by about four months, fell in April and is now at a 47-week low. It is not signaling a recession (yet) but it does suggest that growth in the latter half of the year will be in the range of 1-1.5%. That is not enough to cut into the unemployment numbers in any meaningful fashion. (Economists generally think that GDP growth in the range of 3.5% is needed to really create job growth.)

And now let me introduce you to a new economic metric from the Consumer Metrics Institute. They track consumer discretionary spending on a daily basis. Their Consumer Metrics Institute Growth Index, which is the composite of a number of sub-indices, seems to lead GDP growth by about 4-5 months. Look at this chart showing the index and GDP growth for the past four years.

Compliments of Thoughts from the Frontline.
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Wow. A negative 2% in the quarter starting next month? How can that be? Let's look at what caused the recent growth.

First-quarter GDP was revised down to 3% [recently] by the BEA (Bureau of Economic Analysis). But buried in that release was an upward revision to inventories, which accounted for over half of that 3%. At some point inventories become balanced and no longer grow.

And that may already be happening. The [latest] ISM number came in somewhat above consensus at a quite robust 59.7. But when you look at the inventory sub-component, you find a different picture. It was slightly negative in April and dropped another 3.8 in May to be down to 45.6. This is a drop in that index of 9.7 points in just two months (anything north of 50 shows growth and below 50 suggests no growth or actual retreat).

Increases in inventory count as a plus when you are figuring GDP. If inventories are not growing, that figures to be a drag on second-quarter GDP.

And a significant part of the growth in the past three quarters came from transfer payments from the government (AKA stimulus), which are going away. The money received by state and local governments, which allowed them to keep employees on the job, is now being taken off the table; and the stories of state and local governments having to cut back are everywhere.

I have my doubts about negative GDP growth of 2% in the third quarter, but a much slower GDP than the consensus 3% seems quite possible.

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