2011’s Second Half Looks Pretty Good
08/01/2011 8:30 am EST
There are a lot of mixed messages in the numbers, but there’s reason to be optimistic about the second half of the year, observes Robert Johnson of Morningstar StockInvestor.
The economy clearly hit a soft spot in the second quarter, as a wide range of indicators—including industrial production, retail sales, purchasing manager surveys, and auto sales—all registered disappointing results.
The disappointing data are a combination of reversible special situations (Japanese supply chain issues, unseasonably cool weather, and high gasoline prices) and poor fundamentals (diminishing real hourly wage growth, accelerating government layoffs).
Forecast: Real GDP Growth for 2011
Despite poor economic news over the past month, I am sticking with my recently reduced GDP growth forecast of 2.5% to 3% for 2011. While some fundamental economic issues remain, there is some evidence that this spring’s unique problems are beginning to diminish and may even aid real GDP growth in the second half of the year.
Inflation for the year is still likely to be around 3%, although that rate is clearly moderating now.
I still think monthly private-sector employment growth of 200,000 (or about 2% annualized) remains a real possibility. Given a combination of labor force dropouts and these better employment numbers, I still believe the unemployment rate can fall below 8.5% by the end of this year.
Japanese Situation Hits Manufacturing
The impacts of the Japanese earthquake were badly underestimated by economists.
Toyota’s (TM) unit production in the US fell from 111,000 in February to a mere 31,000 units in May. (The latest week of production in mid-June indicated the monthly run rate has now increased to just over 90,000 units.)
The situation in Japan itself was even worse, where total industry sales fell from 731,829 in April 2010 to 292,000 units in April 2011. Given that many of the parts and commodities that go into Japanese cars come from around the world, it’s not surprising global manufacturing data are falling in unison.
Thankfully, those numbers are just about to reverse themselves. Though harder to define, there were supply-chain issues in other industries too, including electronics.
The quake’s effects extended well beyond manufacturing; the Japanese issues raised US inflation, cut consumer spending, and certainly didn’t help the employment situation. Car prices are up more than 1% for two months running. Ford (F) raised prices three times this year, and incentives are at a nine-year low.
High prices and lack of supply cut consumer spending on autos, which depressed the most comprehensive measure of US retail sales for May. In fact, retail sales for May declined for the first time in 11 months.
Excluding auto sales, consumers continued to increase their spending during the month. While direct auto-manufacturing employment hasn’t decreased much, I suspect many suppliers had to make cuts that turned up in the employment data.
NEXT: What Indicators Should We Be Watching?|pagebreak|
What Indicators Should We Be Watching?
The market remains exceptionally reactive to each and every piece of economic news. As market participants shift from one side of the boat to the other on an hour-by-hour, indicator-by-indicator basis, what’s an investor to do?
I will continue to focus on the consumer and the metrics that drive the consumer; manufacturing only amplifies what is happening in the consumer world with a lag. Manufacturing isn’t going to grow without consumers here or abroad buying goods.
Manufacturers don’t produce things just for the fun of it. Furthermore, manufacturing data are hopelessly distorted by production impairments at Japanese plants in the US and Japan.
Housing data get plenty of attention, too, but that is too small to move the economic needle—new homes account for a mere 1% or so of GDP. Even home prices are not terribly relevant unless prices move into freefall, as US banks are now in a much stronger capital position, and consumers have been weaned from the concept of using their homes as cash machines.
Given all this, I am focusing on what consumers are spending, what’s happening to consumer incomes, and what’s happening to inflation.
Consumer spending has clearly held up better than anyone expected in the face of higher gas prices. Incomes have begun improving on a non-inflation-adjusted basis, but most of those gains have been eaten up by inflation. The good news is that inflation appears to have peaked in the short run; the rate of increase has declined for two months in a row.
Real wages have indeed slowed in recent months, which explains some of the economic softness. Given that consumers represent over 70% of the economy, and that consumer incomes come primarily from wages, the hourly wage data can provide important clues about consumer spending capabilities.
Real hourly wages began slowing in February, and moved into negative territory in May, when computed on a three-month moving average basis. Real hourly wage growth is calculated by taking wage growth and adjusting for the effects of inflation.
Non-inflation-adjusted hourly wages before inflation have been stuck in a very narrow range of 2% to 2.3% for over a year; meanwhile, inflation has moved from about 1.1% to 2.2%, putting consumers behind the 8-ball.
Now, if those nominal numbers stay in the same range, and inflation drops well under 2% in the months ahead, consumers could come out back on top again. Time will tell.
Consumer spending hasn’t been as weak as one might have suspected, above 5% annualized growth in recent months once backing out auto and gasoline sales. Stock market gains and lower payroll taxes have helped offset the slowing of real hourly wage growth. Year-over-year growth in consumer spending, excluding autos (affected by Japanese issues) and gasoline (volatile prices, lower usage is a good thing for the economy), has been remarkably stable.
Healing Should Continue, but Slowly
The economy is still close enough to the edge that we have the capability of scaring ourselves into another recession. Another bad geopolitical event combined with old-fashioned panic could sink this recovery.
As bad as the numbers will look over the next month or two, there are hopeful signs down the road, especially on the inflation front.
Longer term, I am convinced that decent productivity growth, favorable demographics, and a sustained real estate recovery beginning in 2012 could drive the economy forward for some time—if the politicians don’t mess it up (think eurozone politicians dealing with Greece or US legislators and the impending debt ceiling battle).