MAKING CENTS — Steady as She Goes
On average, since World War II, we have had recessions every six-and-a-half years. The current economic expansion is rapidly approaching its six-year anniversary, and I know a few folks who are getting a little nervous.
Contrary to popular belief, the likelihood of entering a recession does not depend on the age of the expansion. However, there are other issues.
In this recovery, average growth in the first quarter of the year has been well below the average of the other three quarters.
There’s a Pattern
Economic activity has strong seasonal patterns related to various events such as the weather, the school year and holiday-related shopping. Estimates of Gross Domestic Product (GDP) are adjusted for seasonal differences; or rather, their components are adjusted (usually by the agency providing the source data).
By design, seasonally adjusted data should not display signs of seasonal variation (that is, there should be no residual seasonality).
So, while first quarter GDP growth in recent years has been lower, the real question is whether or not that truly is significant.
Economists at the Fed’s Board of Governors say no. Economists at the San Francisco Fed say yes, and properly adjusted, GDP growth for 1Q15 would have been 1.8 percent, rather than the 0.2 percent reported in the advance estimate. Yet, any statistician can tell you, five observations are not enough on which to base any meaningful analysis.
In other words, nobody knows. Post-recession seasonal patterns may have changed.
Patterns Change
The housing collapse and mortgage debt overhang could have led to permanent changes in spending habits. Financial deleveraging may have led to longer-term distortions in the credit system.
We won’t know for sure until a lot more time has passed. The government does alter the seasonal adjustment over time. However, seasonal adjustment problems will balance out over the course of the year. One can simply look at year-over-year changes.
Groundhog Day
I rather like how the Wells Fargo Economics Group puts it: This recovery has been reminiscent of the movie “Groundhog Day.”
Economic growth seems destined to replay the story from prior years, with a weak first quarter followed by a rebound in the spring and summer. Recall in 2014, real GDP declined at a 2.1 percent annual rate in Q1 before rebounding at a 4.6 percent pace in the second quarter and finishing the year up 2.4 percent.
The economy seems to be sticking to the script so far this year. A mix of temporary shocks, including the harsh winter weather in the Northeast and the West Coast ports stoppage, combined with a couple of more lasting shifts like the slide in oil prices and abrupt strengthening in the dollar, have been a drag on growth.
These four factors took a big bite out of growth in the first quarter by holding back construction, consumer spending and manufacturing activity.
The current environment is somewhat reminiscent of the 1980s, when the economy endured a series of rolling recessions throughout parts of the economy, but still continued to post solid overall gains.
The setbacks facing the economy today seem a little less formidable than they did back then, but growth is also a little less robust. The important point to note is that beneath the quarterly gyrations in real GDP growth are some pretty meaningful shifts in what is driving growth.
For example, consumer spending should post stronger gains in the coming months. So far, the drop in gas prices has had only a limited effect on outlays.
Real personal consumption grew at just a 1.9 percent pace in the first quarter. This reflects the fact that consumers tend to respond less to temporary windfalls in purchasing power than they do permanent shifts.
So, while lower gasoline prices are clearly welcome, spending would likely perk up more if income growth were to accelerate in a lasting and meaningful way. Most of the lift from lower gas prices, however, has been for smaller discretionary purchases such as dining out and movies.
Interesting Interest Rates
Another driving force includes interest rates. Several fiscal policy pundits are looking for the Federal Reserve to bump up short-term rates by one-quarter of a percentage point in September, before taking a wait-and-see approach to raising them further.
Despite a 5.5 percent unemployment rate, Fed Chair Janet Yellen still sees slack in the labor market, noting there are more dangers associated with raising interest rates too quickly than with not quickly enough. She’ll be sure to evaluate the impact of the September increase before moving on.
Odds are another increase wouldn’t come until the Fed’s meeting in December (skipping over the October meeting) and perhaps not until January.
Housing highs
Another driving force comes from the housing sector. Homebuilders ratcheted up construction in April to a level not seen since November 2007. Total starts increased 20.2 percent from March to a seasonally adjusted annual rate of 1.135 million.
The increase was also broader than it has been in recent years, with a 16.7 percent jump in single-family starts to an annual pace of 733,000, the highest since January 2008, and a multi-family increase of 27.2 percent to an annual rate of 402,000.
Some of the higher numbers were due to particularly cold and snowy weather in February and March. But the increases, particularly in the single-family market, are also indicative of continued market healing.
As the single-family market expands in the months ahead, the median size of newly built single-family homes is expected to recede. However, during the first quarter of 2015, a typical new home size hit a record high of 2,521 square feet. Median new home size fell over the course of 2014, but rebounded at the start of 2015 with the temporary decline in home construction volume.
Red Flags
As I said in many talks this past spring, there are few red flags from an economic viewpoint that were going to keep us from having a good spring season. Indeed, for the most part that has played out nicely, with the exception of heavy rains in certain parts of the country on some very key weekends. One of these areas has been my home state of Texas where rainfall records have been shattered. I know, right? Rain in Texas, go figure.
However, that did not seem to hinder the home improvement market as The Home Depot reported sales of $20.9 billion for the first quarter of fiscal 2015, a 6.1 percent increase from the first quarter of fiscal 2014. Comparable store sales for the first quarter of fiscal 2015 were positive 6.1 percent, and comp sales for U.S. stores were positive 7.1 percent.
Lowe’s Companies Inc. reported net earnings of $673 million for the quarter ending May 1, 2015, a 7.8 percent increase over the same period a year ago. Sales for the first quarter increased 5.4 percent to $14.1 billion from $13.4 billion in the first quarter of 2014, and comparable sales for the quarter increased 5.2 percent.
Walmart reported revenue of $114 billion, down 0.1 percent from the same quarter a year ago. While first-quarter earnings fell short of Wall Street expectations, it is important to remember that the $1 billion increase in their employee wages announced earlier in the spring, as well as a stronger dollar, had a dampening effect on their profits in the short run.
Second quarter earnings should be even better for all three of the mega-retailers, and inside sources indicate lawn and garden activity has been “better than expected.”
The healthy gains in residential remodeling activity estimated for the first part of 2015 are expected to decelerate in the third quarter, but then gain a little more traction by the end of the year, according to the Leading Indicator of Remodeling Activity (LIRA) reported by the Remodeling Futures Program at the Joint Center for Housing Studies of Harvard University. The LIRA projects annual spending for home improvements will increase about 3 percent in 2015.
So with that little bit of overview of how things stand at the moment, all that’s left to say is to keep the momentum up; steady as she goes!
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