U.S. ECONOMY AT A STANDSTILL IN Q1, AND LIKELY TO TRUDGE ALONG INDEFINITELY AT NO MORE THAN 2% GROWTH

The initial estimate of first quarter GDP shows the economy at a standstill but the Fed, markets and most economists are still brimming with optimism about what lies ahead for the rest of the year. Today’s release showing a 0.1% gain in GDP over the first quarter of 2013 as compared to the disappointing 2.6% gain in the fourth quarter is largely being dismissed as a “wacky” number, with commentators quick to remind how bad the winter was. The bad weather excuse, however, has about as much credibility as “the dog ate my homework”. There are numerous reasons to doubt that the rest of the year will be as good as is being assumed, starting with the miserable record of forecasting that we saw last year from the Fed and economists, and ending with the lackluster earnings reports and persistently weak tone of the forward guidance we have been getting from companies in recent days. These corporate results have analysts busy trimming their Q2 estimates after already having slashed those for Q1.

And while the U.S. equity market as a whole has remained buoyant, probably for lack of any better investment alternatives, money managers have been fleeing anything that appears to be the least bit risky adopting a defensive posture that suggests they are not all that enthusiastic about economic prospects.

The gap between what appears to be the economic reality of sluggish growth at about a 2% to 2 ¼% annual pace for as far as the eye can see, and the average economist projection of 2.7% for 2014 as a whole, which means well in excess of 3% in the second half, is as wide as anytime in recent memory. Most disconcerting, is a feeling that the Fed is so hell bent to be done with QE by the end of the year that they are becoming cheerleaders for the economy, feeding us such happy talk as “growth has picked up recently” and “household spending appears to be rising more quickly.”   

It is true that consumers were the brightest spot in the otherwise uniformly somber Q1 picture as they braved the snow to push their inflation-adjusted spending up 3.0%, almost as good as Q4’s 3.3%, helped in large part by an acceleration in government social welfare benefits and a drop in tax payments. But when we look closely at the increase in personal consumption expenditures we see that the largest part consisted of utility bills and Obamacare sign ups, and they had to trim their saving rate back a bit to do that much. The only other reason that the GDP estimate was not negative in Q1 is that the federal government managed to increase its spending by 0.7%, mainly in the Defense Dept., after the sequester chopped spending by 12.8% in Q4.

Housing was the biggest worry in Q1, because the anticipated vigorous recovery of housing construction after the Spring thaw is at the core of much of the optimism about the 2014 outlook. Although housing looked set to take off last Spring, sales and new construction stumbled last year as mortgage rates moved up from record lows. Data that has surfaced in recent weeks suggest that it will take more than the start of the Spring home-buying season to get the market moving again.

Sales of both new and existing homes look set to stay at relatively low levels in the near term. The difficulty that buyers are having qualifying for credit under the much higher standards now in effect seems to be the greatest problem, but rising building costs and higher home prices are also bringing affordability into question. The big shock came when new-home sales fell 14.5 percent in March, while at the same time sales of expensive homes with jumbo mortgages (over about $650,000) rose by 7.8% and the first sale of an individual residence for over $200 million was recorded.
 

Meanwhile the ISM and Markit purchasing manager surveys for April that give perhaps the best overall reading of how the economy is shaping up, indicate that the US economy while stepping up from the January and February weather influenced lows, is not exactly entering the 2nd quarter with a full head of steam. Mostly, they show an economy trudging along at a monotonously steady annual pace of about 2%, with the jobs market showing little or no significant signs of improvement. The Markit surveys that are relatively new even point to non-farm payroll growth sliding to around 100,000 per month in sharp contrast to expectations that Friday’s April jobs report will top 200,000. In the services sector that encompasses about 80% of the economy, there are worrying signs for future momentum. Levels of outstanding business fell, and firms’ optimism about the year ahead have also waned in sharp contrast to the views of most economists and important policymakers as well.

After the earnings season ends in a couple of weeks and markets finish digesting the results, all eyes will turn to the economic outlook for the rest of the year. Ukraine has largely been dismissed as a slow motion event with both Europe and the U.S. careful not to impose the kind of sanctions that could rock the global economy. If the economic outlook disappoints, as seems likely, we could see more of the same risk aversion by money managers, with a lot of choppy market action, more sideways than upward moving, but not necessarily precluding the market from continuing to grind slowly upward in a relatively calm if not exuberant atmosphere, with 10 year Treasury yields remaining under 3%, and more and more discussion of how the Fed will ever be able to raise interest rates to so-called.”normal” levels.