US GDP Forecasts: Mainstream Economists Will Be Wrong Again
You can’t fault positive thinking, but in economic and investment terms realistic expectations are the most valuable.
Back in January, I estimated that 2014 US GDP would be ~2.2%, far below Consensus which was thinking 3%+. Consensus has caught up and is now predicting 2.2% (down from 2.5% in May).
Turning to 2015, Consensus is again pie-in-the-sky hopeful at 3%.
Sluggish Inflation Today, Sluggish Inflation Tomorrow
The traditional and conventional view is that inflation drives economic growth by forcing producers to buy today before prices get more expensive. Inventory stockpiling boosts the economy.
Looking around, is there inflation and are producers stockpiling? The answer to both is a whopping no.
Some amount of wage inflation is creeping in as minimum wages grow and as labor continues to tighten. Businesses will sometimes bump prices opportunistically. Paul Krugman recently pointed out something that is actually useful and relevant to the 21st century economy. He said businesses that are local and don’t face competitive pressures are raising prices, like airlines and restaurants.
However most producers do face competition and they are not raising prices. Producer Price Inflation (PPI) for goods has been negative two months in a row. On a year-over-year basis, PPI is up a tepid 1.6%. What little inflation we’ve seen comes from food price hikes in the face of drought.
Low inflation has been the trend for over a year, stemming from less pressure to raise prices because margin pressures have eased in the face of low energy prices (thank you cheaper oil) and a stronger dollar. The strong dollar is lowering inflation expectations since the US has emerged at the cleanest shirt in the global economy.
Global Oversupply: The Real Reasons for Low Inflation
Producers are struggling for pricing power. The economy may be on better feet than at any time since the recession ended, but there is still a major supply glut. Chinese supply has overwhelmed demand, leading producers like Alcoa to close factories and steel makers to walk away from purchases. Many commodity prices are in free fall. So much for the super-cycle in commodities.
Manufacturing Capacity Utilization is a great way to evaluate slack on the production side of life. The Federal Reserve Board measures capacity utilization by considering how much production is possible and sustainable and how much is actually being utilized. It considers available labor and equipment, among other things.
Supply constraints point to inflationary pressures as well as demand trends. Buyers bid up prices when supplies are tight.
The good news is that capacity utilization is at a cyclical high, indicating solid demand and some price strength.
The bad news is that capacity utilization remains below the peaks of the previous cycles. We are almost four months into the sixth year of recovery and still lagging the previous cycle.
This business cycle is continuing for a while and with it capacity will get tighter, which is good for producers. Although the primary reason for higher capacity utilization is that producers are expanding slower than the pace of demand growth.
This undermines the entire conventional expectation that inventory stockpiling should be happening – right now – and pulling GDP up with it. Listen to earnings calls and you’ll hear producers in the supply-chain complaining that their customers’ inventories are too lean.
It’s not true that inventories are lean, though. They are leaner than the 1990s but right about where they were in the previous cycle and higher than ever this cycle. Business inventory-to-sales are actually rising.
If anything, inventories have grown too much. They have grown while sales have been flat. Some form of inventory cutbacks is likely in the 4Q as businesses right-size their capital.
The key point in all of this? Producers have sufficient capacity to meet end-user demand, which itself looks likely to soften a bit. Against this background, prices are not likely to rise much and growth will probably weaken a bit.
Semiconductor Sales: The Crystal Ball for 2015 Growth
Consider semiconductor equipment spending. Everything being manufactured either includes semiconductor chips or uses machines that require semiconductor chips. As such, expansion in production of any kind automatically translates into more semiconductor chips.
Semiconductor sales today are tomorrow’s industrial production. Right now, semiconductor producers are looking out and expecting minimal increase in demand.
Look at semiconductor factory expansion. While they are spending more on re-tooling capacity expansion is barely above 0%, about the same as this year.
Semiconductor makers are migrating to a new technology and that’s causing massive spending. Despite significant growth in the auto and mobility (smartphone) spaces as well as general global demand for stuff, semiconductor companies see no reason to greatly expand supply.
All that follows other fundamental data points. Consumer spending is steady but relatively mild. Most new jobs in 2013 and 2014 have gone to secretaries and bartenders. Retailers expect organic growth only, and without Y/Y increases.
With demand cruising along at organic levels (low single digits), of course producers will expand cautiously.
Fed Actions Will Slow Growth
Retailers and producers are positioning for low growth in 2015. Earlier this year there was talk about an escape velocity, meaning weather had caused some near-term sluggishness from which the economy was poised to surge and get back to some higher level of growth.
This idea of some mean reversion to higher growth made no sense. Growth is mild because demand is mild. US consumers spend what they earn, and no more. The wage picture doesn’t reflect a surge. Global demand is slowing. Producers expect prolonged subdued demand and are keeping a lid on expansion plans.
Into a low-growth environment, now add in rate hikes. David Shulman, Senior Economist at UCLA’s Anderson School, recently reflected the consensus view when he said that rates will go up for good reasons; because of a strong economy.
That’s not exactly true. One could argue that a stronger economy is what’s enabling both the end of QE and the reduction in treasury borrowing. The absence of pressure to keep rates low is far from being the presence of pressure to boost rates.
It’s an important distinction. If the economy is actually poised to slow and real interest rates rise, GDP will drop fast.
Household Wealth Will be Hit
The first blow will be felt in the housing market. Housing has already entered a slower stage. July home sales fell 4.3% Y/Y. During the most recent earnings calls, homebuilders reported a drop in unit sales and banks aren’t stepping in to chase the marginal buyer and create some type of escape velocity. Wells Fargo CEO John Stumpf recently said, regarding loans to low-income borrowers and poor credit holders, “We’re just not going to make those loans.”
Prices will come under some pressure as inventory grows. More owners are above water and can sell. Into this slower growth market, add higher mortgage rates.
Beyond the housing market, the stock market won’t like the impact of higher rates on leverage. A hit to stock prices is a hit to household wealth, contributing to further slowdown in spending.
We are likely entering a period of disinflation where prices don’t rise. That’s great for consumers; not so great for producers.
Prologue to Recession
Without inflation and pricing power, without growth in demand, companies stop hiring and start firing. A rate hike hastens the advent of a recession.
Right now, jobless claims are at 14-year lows. That’s actually a sign that a recession is coming within 12 months because once claims hit bottom, they can only rise. A rise in claims is the turn in the wheel for the economic cycle as it begins to slow and then contract.
So take economic indicators, conventional wisdom and consensus estimates with a grain of salt. Realistic expectations are far more valuable than overly positive ones.