GDP Report Shows the Economy is Stalling
FORECASTS & TRENDS E-LETTER
IN THIS ISSUE:
1. 2Q GDP Report Was Much Worse Than Expected
2. Fed “Beige Book” Confirms Economic Slowdown
3. Is a Double-Dip Recession Now Inevitable?
4. Is The Debt Ceiling Fiasco Finally Settled?
I had not been looking forward to writing today’s E-Letter on the very day that the government was set to default on its debt, according to Treasury Secretary Geithner. Plus, I like to know what I’m going to write about well ahead of my Tuesday deadlines. I was actually getting a little nervous over the weekend as the House and Senate remained deadlocked.
Yet a compromise deal was reached on Sunday night that most Democrats and Republicans could agree to for increasing the debt ceiling and avoiding a default on our national debt. The House of Representatives voted to approve the debt ceiling deal late on Monday, and the Senate passed it today by a comfortable margin. I’ll have more to say about the debt ceiling issue later on in this E-Letter.
But first, we have to focus on last Friday’s GDP report which was much more negative than expected. GDP growth was only 1.3% in the 2Q, well below the pre-report consensus. Not only that, the Commerce Department revised the 1Q and 4Q 2010 GDP numbers significantly lower. In addition to the GDP report, we will review some other economic reports of late and some disappointing polls from Rasmussen regarding consumer and investor confidence, or lack thereof.
Next, I will review the findings of the Fed’s Beige Book economic survey that came out last week, which also confirmed that the economic recovery is stalling. Also, we ponder whether the Fed is considering a third round of quantitative easing (QE3). After last Friday’s GDP report, the answer may be yes, unfortunately. Let’s get started.
2Q GDP Report Was Much Worse Than Expected
Last Friday’s report on the economy was about as bad as it gets. In the 2Q, US Gross Domestic Product rose only 1.3% (annual rate) as compared to the pre-report consensus of 1.8%. Of the 85 economists surveyed by Bloomberg ahead of the report, some expected 2Q growth as high as 2.9%. So, while this first “advance” estimate will be revised two more times, the report clearly was a big disappointment.
While the GDP report for the 2Q was a surprise, other details of the report were even more negative. The Commerce Department also revised its estimate of 1Q growth down from 1.9% to only 0.4% (annual rate). I know of no forecasters that expected such a significant downward revision to 1Q GDP. So we had almost no growth at all in the 1Q.
The Commerce Dept. noted that the disappointing 1.3% growth in the 2Q was largely due to negative contributions from state and local government spending and imports. And that’s not all. The Commerce Dept. also revised the 4Q 2010 GDP number from 3.1% down to 2.3%.
Making matters worse, the report noted that personal consumption expenditures increased only 0.1% in the 2Q, down from 2.1% in the 1Q. Here again, I know of no forecasters that expected such anemic consumer spending in the 2Q.It is clear that consumers have pulled back in light of high gasoline prices, continued high unemployment, fears about the European debt crisis and our own debt ceiling drama.
While the Consumer Confidence Index ticked up slightly in July, it remains near the lowest levels of the past two years. The Rasmussen Consumer Index, which measures the economic confidence on a daily basis, found last week that only 13% of adult consumers say the US economy is getting better, and 64% say it's getting worse. At the beginning of the year, 30% said economic conditions in the country were getting better, and only 45% said they were getting worse.
The similarly depressed Rasmussen Investor Index on Friday found that only 16% of investors think U.S. economic conditions are getting better, while 64% say they are getting worse. At the beginning of 2011, investors were about evenly divided, with 36% saying economic conditions were improving and 39% saying they were getting worse.
Given these findings from Rasmussen, it is no wonder that consumer spending was flat (0.1%) in the 2Q. Consumer spending makes up apprx. 70% of GDP and based on the latest GDP report, there is no reason for it to accelerate significantly in the second half of this year. Expect economists to downgrade their second half forecasts accordingly just ahead.
Friday’s GDP report also noted that orders for durable goods fell 4.4% in the 2Q as compared to an increase of 11.7% in the 1Q. Orders for non-durable goods increased only 0.1% in the 2Q as compared to 1.6% in the 1Q. Almost everything in the latest GDP report was disappointing.
An exception was that the price index for gross domestic purchases, which measures prices paid by US residents, increased 3.2% in the 2Q, compared with an increase of 4.0% in the 1Q. Still, 3.2% is well above the Fed’s target rate for inflation, but at least it moved lower in the 2Q. Excluding food and energy prices, the price index for gross domestic purchases increased 2.6% in the 2Q, compared with an increase of 2.4% in the 1Q.
Finally, the ISM manufacturing index for July was a shocker yesterday. The widely-followed index plunged from 55.3 in June to 50.9 in July, the lowest level in two years. The pre-report consensus was for a number around 54, so the stock markets fell sharply just after its release. If the ISM Index falls below 50, which could happen next month, that is another signal that the economy is falling back into recession.
Fed “Beige Book” Confirms Economic Slowdown
Eight times each year the Fed releases its so-called “Beige Book” which summarizes economic conditions in its 12 member districts across the country. The latest report was released last Wednesday, and it confirmed that economic growth is decelerating, especially in six of its districts along the Atlantic seaboard, Minneapolis and Dallas. Overall, eight of the 12 districts reported that economic conditions were slowing.
The latest report on July 27 was worse than the previous report on June 8. In the June Beige Book, only four of the 12 districts reported that economic growth was decelerating. Seven districts reported that growth was steady, and one district reported that growth improved. So, the July Beige Book confirmed what we already knew, that the economic recovery is stalling.
Given the very disappointing GDP report on Friday and the latest Fed Beige Book, the question that is increasingly bubbling up is whether or not the Fed will feel compelled to launch another round of “quantitative easing,” or QE3. Fed Chairman Bernanke has stated in recent speeches that all options remain open, and he has hinted that QE3 could be enacted if it looks like the economy is rolling over into a double-dip recession.
The next Fed Open Market Committee (FOMC) meeting will be held on Tuesday, August 9. The FOMC sets monetary policy. You can bet that the financial markets will be tuned in for that meeting, especially given the latest troubling economic reports.
There is little doubt that the subject of QE3 will be discussed at this upcoming meeting. Most Fed watchers believe that Bernanke will have trouble getting a majority of the FOMC members to agree to QE3. But that could change in light of the latest very disappointing economic reports. Thus, it will be very important to read the policy statement that the FOMC releases late in the day on August 9.
Some, including PIMCO’s Bill Gross, have speculated that Bernanke will likely leak or announce that QE3 is coming at the annual Fed Economic Policy Symposium late this month in Jackson Hole, Wyoming. You may recall that Bernanke signaled that QE2 was coming at this same symposium last year. We’ll see.
Some pundits have claimed that the Fed has already begun QE3 without announcing it formally. However, if you read the minutes from the last FOMC meeting on June 21-22, the only mention of additional “monetary stimulus” (QE3) was in the context of a much worse economy in coming months. There was no decision to begin QE3; in fact, some FOMC participants suggested that the Fed should start unwinding QE1 and QE2 to head off rising inflation. No decision was made on that either.
What some observers may mistake for QE3 is the fact that the Fed continues its policy of reinvesting proceeds from the securities it owns in Treasuries. For example, as mortgage-backed securities mature, the Fed uses those proceeds to buy Treasuries. The Fed has done this ever since QE1 began. That is not the equivalent of QE3.
Is a Double-Dip Recession Now Inevitable?
The National Bureau of Economic Research, the arbiter of recessions, says that the Great Recession began in December 2007 and lasted until June 2009. Since then, we’ve officially been in a recovery, but in many parts of the country it hasn’t felt like one. In the wake of last Friday’s gloomy GDP report, we’re hearing a lot more talk of a double-dip.
In June 2009, the supposed end of the recession, the unemployment rate was 9.4%. Two years of ‘recovery’ later, it’s still at 9.2% and over 14 million Americans are out of work, with over a third jobless for a year or longer. Home prices have plunged 50% in some parts of the country, and many believe there may be another 10% or more to go.
The working theory among most economists is that it would take another significant shock to send the economy into a second recession later this year or next year. Wall Street Journal columnist Justin Lahart succinctly addressed this line of thinking recently as follows:
“For those fretting that a string of disappointing U.S. economic data presage a double dip in the recession, there is good news and bad news. The good news: It would probably take a significant shock to knock the economy off course, even in its weakened state. The bad news: In the current environment there are plenty of potential shocks to worry about.” [Emphasis added, GDH.]
I couldn’t agree more! I am getting more and more worried about a second recession, or something even worse, in the next year or two. I’ll share more about these concerns in the weeks ahead.
Most discussions about a double-dip recession this time around usually harken back to the recession of 1980 followed by a second one in 1981-82. Most clients and readers will remember that President Carter appointed Paul Volcker as Chairman of the Federal Reserve in August 1979 when inflation was raging out of control, with the mandate of bringing inflation down.
Inflation hit a peak of 13.5% in 1981. In response, Volcker hiked the Fed Funds rate to 20%, and the prime rate hit 21.5% by June 1981. The most severe recession since the Great Depression unfolded during this period. Yet by 1983, the US inflation rate had plunged to 3.2%.
Our situation today is quite different. The recession of 2007-2009 was actually worse than the recession of 1981-82 in that we also had a severe credit crisis. The Consumer Price Index has risen by 3.5% over the last year but does not appear to be headed significantly higher since consumers continue to deleverage.
This trend of deleveraging is a deflationary force which has allowed the Fed to keep short-term interest rates at historic lows without risking runaway inflation. The Fed will have to raise rates at some point, of course, but most forecasters don’t expect that to happen until the economy is on stronger footing.
Given that inflation is not out of control and the Fed is not likely to ratchet interest rates up anytime soon, conditions do not seem ripe for a double-dip recession. Yet the latest GDP numbers argue that we are coming dangerously close. Economists have taken to calling this a “growth recession,” a period when GDP is positive but very modest, and unemployment remains quite high.
All of this brings us back to the question of whether there will be another “shock” or surprise that makes consumers pull back on spending even more, thus pushing the economy into a double-dip recession. As Justin Lahart suggests above, there are plenty of potential shocks to worry about!
At the top of my list is the European debt crisis which is getting worse, not better, by the day. I will have more on that subject in the weeks ahead. Not far behind is the possibility that the US could lose its AAA credit rating. While I doubt that the much maligned credit agencies will do it right now, all hell will break loose all over the world if US debt is downgraded to AA.
Is The Debt Ceiling Fiasco Finally Settled?
As I have predicted for the last several weeks, lawmakers reached a compromise to raise the US debt ceiling late on Sunday night. The House of Representatives voted to approve it late on Monday, and the Senate passed it by a comfortable margin today. Details of the compromise plan are still sketchy, but here is what we think we know as this is written. In a word, the deal is UGLY!
The last-minute debt ceiling deal that would keep the country out of default would supposedly reduce federal budget deficits by an estimated $2.4 trillion over a decade. Whether the deal might also avert a first-ever credit downgrade for the United States is not clear, since ratings agency Standard & Poor's indicated it was looking for a credible, bipartisan plan that had at least $4 trillion of debt reduction.
As described by congressional leaders, the new debt ceiling plan includes no tax increases and no entitlement reform measures up front, although theoretically it leaves the door open to both (more on this below). The plan would raise the debt ceiling immediately by $400 billion, and then by another $500 billion by December of this year when yet another debt ceiling debate will almost certainly unfold.
If the agreed upon spending cuts for this year are enacted, the debt ceiling would be increased by another $1.2 trillion to $1.5 trillion. All told, the debt ceiling increase of $2.1 trillion to $2.4 trillion should cover the Treasury’s borrowing needs until 2013. In that regard, President Obama got what he wanted – the debt ceiling increase should get us past the November 2012 elections.
As for the supposed spending cuts, the plan would immediately cap domestic and defense spending, resulting in cuts of $917 billion or more over 10 years. A second larger round of deficit reduction would be proposed by a special bipartisan Joint Committee of Congress. Just what we need – yet another committee!
The “Special Committee” supposedly has until Thanksgiving to come up with its spending cut proposals and those recommendations would be approved by an up-or-down vote, supposedly without amendment, by both houses of Congress by December 23. If the Special Committee deadlocks or comes up with less than $1.2 trillion in cuts, or if Congress votes down the committee's proposals, the debt ceiling will supposedly be raised by $1.2 trillion automatically.
[Editor’s Note: You will note that I have used the word “supposedly” in this discussion repeatedly because there is no way to know what will really happen. Washington has a long history of voting for spending cuts over long periods of time that never actually happened. In most cases, the spending cuts were merely reductions in the rate of spending increases.]
As noted above, the initial debt ceiling package that was passed in the House yesterday does not include any immediate tax increases or cuts to entitlement programs; however, the Special Committee does have the power to “reform” taxes (ie – raise taxes) and impose entitlement changes if necessary. The point is, the Special Committee will have enormous power.
Next, we move to the so-called “trigger.” If the Committee deadlocks or fails to come up with at least $1.2 trillion in debt reduction, then the trigger comes into play. The trigger would supposedly force automatic across-the-board spending cuts in the federal budget. Specifically, as much as $1.2 trillion in across-the-board cuts would kick in – evenly divided between defense and non-defense spending. If this were to occur, a 50% cut in the Pentagon budget could happen and would decimate our national defense. I can’t imagine that happening, but it is a part of the debt ceiling deal. 0:00/ 4:09 Obama maps out debt deal
“Across-the-board spending cuts” apparently does not include Social Security, Medicaid, veterans' benefits and pensions, food stamps and Supplemental Security Income. While Medicare would not be exempt, the plan would restrict cuts to no more than 2% of the program's cost. And the cuts that occur would not affect Medicare benefits, nor would they increase seniors’ costs, according to the White House fact sheet. Healthcare providers would bear these cuts, not Medicare recipients.
The bottom line is that the debt ceiling plan that was passed yesterday by the House does NOTHING to reform entitlement programs. They will not be touched in any material way. Thus, the federal government will continue to run huge deficits.
To add insult to injury, the across-the-board spending cuts could supposedly be avoided altogether if instead both chambers of Congress pass a Balanced Budget Amendment to the Constitution and send it to the states for ratification before the end of the year. In short, the debt ceiling deal leaves Washington plenty of options for not cutting spending. What else is new?
History will show that this largest-ever debt ceiling increase occurred on President Obama’s watch, even though he never presented a real plan to do so. His massive spending and trillion-dollar deficits over the last two years got us to this point. As noted above, the debt ceiling deal – assuming it passes the Senate today – is UGLY!
Even with the spending cuts, our national debt will still rise by at least $7 trillion over the next 10 years, instead of the $10 trillion currently projected by the CBO, and that is based on some very rosy economic assumptions that may not pan out. So our national debt will still explode, just at a supposedly slower rate.
Then there is still the question of whether the spending cuts in the years ahead will actually be enacted by future Congresses that may vote to eliminate them. Yes, there is the so-called “trigger” that would supposedly force the spending cuts outlined in the latest debt ceiling deal. But that trigger, which could decimate our national defense, can also be revoked by a future Congress.
The bottom line is that our national debt will continue to skyrocket. It seems inevitable that our AAA credit rating will be downgraded to AA, if not now, then at some point in the not-too-distant future. As noted above, such a downgrade would most likely create chaos in the financial markets worldwide.
All of this just creates more uncertainty and potential danger, and the stock markets are reacting accordingly. Individual investors are bailing out of US stock mutual funds and heading for the safety of taxable bonds and cash in droves. And who can question them?
Sometimes, cash is the best place to be. Actually, I have advocated having a cash option for years. Almost all of the professional “active” money managers I recommend will go to cash from time to time to avoid bear markets, even though Wall Street swears that timing the market is impossible. Well, we have proven otherwise for over 15 years at Halbert Wealth Management!
With a worldwide debt crisis upon us, maybe it’s time you consider the active management programs I recommend that can move to cash or hedge long positions, especially if all or most of your investments are in “buy-and-hold” strategies that are virtually guaranteed to lose big in bear markets. I’ll talk more about the benefits of going to cash in the weeks ahead.
To learn more about the actively managed strategies I recommend – where I have the bulk of my net worth invested – you can:
On a final note, some readers are reluctant to invest with us because they live in some other part of the country than Texas. Frankly, that is not a problem. We have clients in almost every state in the nation, and we have never met most of them in person. Don’t let the fact that you live somewhere else keep you from participating in these risk-averse active strategies.
Wishing you profits,
Gary D. Halbert
Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.