Thursday, May 29, 2014 - First Quarter GDP and Extreme Weather

First Quarter GDP and Extreme Weather

by Sinclair Noe

DOW + 65 = 16,698
SPX + 10 = 1920
NAS + 22 = 4247
10 YR YLD + .01 = 2.44%
OIL + .79 = 103.51
GOLD – 2.70 = 1256.90
SILV + .02 = 19.14

The economy was worse than expected in the first quarter. The first estimate of first quarter gross domestic product showed 0.1% growth. Today, we got the second estimate and it showed 1.0% contraction. We figured the second estimate would show contraction but most estimates were calling for just 0.1% to 0.6% contraction. The newly revised estimate incorporates additional economic data released in recent weeks. Higher-than-expected imports and slower-than-expected inventory growth dragged the economy into negative territory.

US based corporations posted slightly lower, after tax, seasonally adjusted, first quarter profits of $1.88 trillion for the quarter, down from $1.905 trillion in the fourth quarter; but those numbers were not adjusted for inventory valuation and capital consumption adjustments; we know corporations are still holding bloated inventories. A big buildup in private inventories boosted economic growth in the third quarter of 2013, but left a hangover that weighed on growth in the first quarter of 2014. Inventories subtracted 1.62 percentage points from GDP growth, compared with an initial estimate of 0.57 percentage point subtracted from growth.

Business investment declined at a 1.6% pace, revised from an initially estimated decline at a 2.1% pace. Spending on structures fell at a 7.5% pace and spending on equipment fell at a 3.1% rate. Investments in intellectual property, like research and development, rose at a 5.1% pace.

Consumer spending grew at a 3.1% pace in the first quarter, revised up from an initial estimate of growth at a 3% pace. Spending on services, like health care and household heating, grew at a 4.3% pace while spending on physical goods rose at a more modest 0.7% pace.

The housing market was a drag in the first quarter and the revisions didn’t create much change; residential fixed investment contracted at a 5% pace, a little better than the original estimate of a 5.7% decline, and that subtracted 0.16% from GDP.

Exports fell at a 6% pace in the first three months of the year, not as bad as the initial estimate of 7.6%, but imports, which are subtracted from the GDP calculation, rose at a 0.7% pace, compared with the initial estimate that they declined at a 1.4% pace. Net exports subtracted 0.95 percentage point from GDP growth.

Total government spending subtracted 0.15 percentage point from GDP for the quarter, compared with an initial estimate of 0.09 percentage point subtracted from growth. Federal spending added to GDP, state and local government spending subtracted slightly from GDP.

So, it was a nasty GDP revision but don’t worry, be happy because it was weather related and the winter storms and polar vortexes have passed; gray skies have cleared up, put on a happy face. One headline today tries to tell us: “Why the GDP Drop Is Good for the US Economic Outlook”; the thinking is that there is pent-up demand; consumers and businesses will brush off their cabin fever and rush out to buy and sell. Another headline tries to maintain perspective by reminding us that: “The US Economy Had a Hiccup, Not a Heart Attack”; which is almost a valid point; this wasn’t a heart attack, but it wasn’t a hiccup either. That article says, “This isn’t a recession or even the beginning of a recession though.” True, but this is how recessions start, with economic contraction, but this isn’t a recession.

The economy changes slowly, even though economic numbers jump up and down, and the numbers can be tricky. For example, in October 2008, the numbers on the economy showed GDP had dropped 0.3%, not nearly as bad as today’s number. Back in 2008, Lehman Brothers collapsed and the politicians said we faced a global financial meltdown.

Back in May 2007, the markets looked a lot like they do today, very low volatility, troubling signs for housing stocks, and a stock sector rotation that suggested the bull market was long in the tooth. That bull market ran for 5 more months. Whether investors knew it or not, they were incurring a large risk for only a few percent reward.

The numbers don’t always reflect the scene on the street. Maybe they do, but more than likely, this is not the start of a new recession. This is how recessions start and the strange part is how most economists are just glossing over this as if it were nothing but a hiccup, when it actually represents billions of dollars; one percent of a $17 trillion dollar economy; some hiccup.

The blame is squarely placed on the weather without acknowledging that the weather is undergoing massive change, not just the polar vortex of winter, but let’s look at the wildfires of spring, and the drought of summer. The “weather effect” is not likely a one and done. The United States is currently engulfed in one of the worst droughts in recent memory. More than 30% of the country experienced at least moderate drought as of last week's data. In seven states drought conditions were so severe that each had more than half of its land area in severe drought. Severe drought is characterized by crop loss, frequent water shortages, and mandatory water use restrictions.

While large portions of the seven states suffer from severe drought, in some parts of these states drought conditions are even worse. In six of the seven states with the highest levels of drought, more than 30% of each state was in extreme drought as of last week, a more severe level of drought characterized by major crop and pasture losses, as well as widespread water shortages. Additionally, in California and Oklahoma, 25% and 30% of the states, respectively, suffered from exceptional drought, the highest severity classification. Under exceptional drought, crop and pasture loss is widespread, and shortages of well and reservoir water can lead to water emergencies.

Drought has had a major impact on important crops such as winter wheat. Just 29% of the entire US wheat crop is rated good to excellent; very poor to poor ratings are 78% in Oklahoma, 67% in Texas and 59% in Kansas. And even though much of Texas received rain in the past week, it may be a case of too little, too late. With the crop now heading out, there's not much hope for any recovery as we move deeper into the season. That likely means higher prices for your daily bread. Pasture land across the West is in generally poor shape; that likely means higher beef prices, which you’ve probably already noticed.

In the Southwest, concerns are less-focused on agriculture and more on reservoir levels. In Arizona, reservoir levels were just two-thirds of their usual average. In New Mexico, reservoir stores were only slightly more than half of their normal levels. And Nevada is the worst of all, with reservoir levels about one-third of normal.

The situation in California may well be the most problematic of any state. The entire state is suffering from severe drought, and 75% of all land area was under extreme drought. Restrictions on agricultural water use has forced many California farmers to leave fields fallow. At the current usage rate, California has less than two years of water remaining. And we know California is responsible for about half the nation’s fruit and vegetable supply.

This past February, US food prices jumped 0.4% — the largest one-month increase since September 2011. Then they jumped another 0.4% in March. Then another 0.4% in April. Fruit and vegetable prices rose even faster, at a 0.7% clip in April. The US Department of Agriculture says the California drought doesn’t seem to have affected vegetable prices so far this year and the agency isn’t predicting a catastrophic spike in food prices just yet. The USDA projects that food price inflation will be between 2.5% and 3.5% in 2014. That's higher than the rise last year, but it's in line with the long-term average of 2.8%.

There are a couple of reasons why we might not get hit in the wallet this year: farmers are shifting water use from some crops to others, cutting back on some crops, like corn and alfalfa that might be available from other places. This strategy is tricky; for example, California dairy farms depend on alfalfa for feed; if they have to import feed, it could increase dairy prices in the short term. Also, farmers are pumping groundwater. The problem is the aquifers are being depleted, even sinking in some cases, and losing their original capacity. In the short term, we adapt; but if the drought continues, next year could be a bear.

Commodity markets already have weathered record cold in the US that sent natural-gas futures to five-year highs and severe drought in Brazil that has nearly doubled coffee prices. Now meteorologists are predicting even more abnormal weather, thanks to the return of El Nino, a rapid and prolonged warming of the tropical Pacific Ocean, which disrupts normal weather patterns and would exacerbate the extreme climatic events already affecting many markets this year. Meteorological agencies say there is a 60% to 70% chance of El Nino occurring by the end of 2014, and a more than 50% chance it will arrive earlier, by this summer.

It's a significant event in commodities markets because El Nino affects weather patterns virtually everywhere. Past occurrences brought dry weather to West Africa, damaging the region's cocoa crop, and wet weather to Brazil, delaying the coffee and sugar harvests. India typically sees less rain in its monsoon during an El Nino year, which can mean smaller grain and cotton crops. In the US, El Niño could bring much needed rain to the southwest and California. If it comes.

But El Nino is not necessarily good news for commodity prices on a global scale; it tends to help soybean crops but harm corn, wheat and rice crops. And also remember that El Nino refers to an extreme weather event. When El Nino hit in 1997 it claimed an estimated 2,100 lives and caused $33 billion damage to properties.

No matter which way you look, the forecast calls for extreme weather, and that means the first quarter GDP wasn’t just a hiccup.

Thursday, August 29, 2013 - Pre-Labor Day GDP

Pre-Labor Day GDP

by Sinclair Noe

DOW + 16 = 14,841
SPX + 3 = 1638
NAS + 26 = 3620
10 YR YLD - .01 = 2.76%
OIL – 1.30 = 108.80
GOLD – 10.60 = 1408.20
SILV - .52 = 23.97

No new war yet. The British parliament voted against military action in Syria. Britain was considered a key ally in any US-led coalition. PM David Cameron said the government would respect the decision of parliament which means that Britain will not take part in military strikes against Syria.

Initial claims for state unemployment benefits slipped 6,000 to a seasonally adjusted 331,000. Claims for the prior week were revised to show 1,000 more applications received than previously reported. So, modest strengthening in the labor market. Next week, we'll get the monthly jobs report.

Meanwhile, the US economy accelerated more quickly than expected in the second quarter thanks to an increase in exports. Gross domestic product grew at a 2.5 percent annual rate, according to revised estimates, up from the initial guess of 1.7% growth. The second quarter’s growth rate followed gains of 0.1 percent in the fourth quarter and 1.1 percent in the first three months of this year.

The trade deficit in the second quarter was smaller than previously estimated, reflecting the biggest gain in exports in more than two years.  Gross domestic income, which reflects all the money earned by consumers, businesses and government agencies climbed at a 2.5 percent annualized rate in the second quarter, matching the gain in GDP. Corporate spending grew at a 9.9 percent annualized rate, exceeding the 9 percent gain previously reported. This reflected a $62.6 billion gain in stockpiles that was larger than first estimated. Investment in housing accounted for nearly a fifth of the economy's growth during the period. However, other reports have suggested that housing began to look more shaky toward the end of the quarter. Expectations that the Fed could reduce bond buying as early as next month have driven mortgage rates sharply higher since May.

The bond-buying program is one of America's last major economic stimulus programs, as the federal government's fiscal austerity began dragging on the economy in late 2010. In the second quarter, higher taxes appeared to hold consumers back. Consumer spending slowed to a 1.8 percent growth pace after rising at a 2.3 percent rate in the first quarter.

Problems remained in the US economy and the revision in GDP also highlighted some of those weaknesses. Consumer spending remained unchanged in the quarter and state and local government spending fell in the quarter as compared to being up in the initial estimate.

It's still just a 1.6% rise year over year, and that's soft. We are still down 2 million jobs and unemployment is still 7.4% and we are seeing significant drag from tax increases and spending cuts.

The GDP figures come amid a looming clash in Washington over the "debt ceiling"; the limit set by Congress on the US's ability to borrow. Treasury secretary Jack Lew warned earlier this week that if Congress fails to act soon, the US would hit its debt limit by mid-October.

Even with upward revisions to 2Q GDP, there has been a sea change in the composition of the global economies. For the first time ever, the combined gross domestic product of emerging and developing markets, adjusted for purchasing price parity, has eclipsed the combined measure of advanced economies. Purchasing price parity adjusts for the relative cost of comparable goods in different economic markets.

According to the International Monetary Fund—the supplier of this data—emerging and developing economies will have a purchasing price parity-adjusted GDP of $42.8 trillion in 2013, while that of emerging economies will be $44.4 trillion. In other words, emerging markets will create $1.6 trillion more value in goods and services than advanced markets this year. Another way to consider it is that the emerging markets have emerged, sort of, kind of.

It’s worth keeping in mind that the emerging economies have strength in numbers. Not only are there more emerging and developing nations; those nations also boast a larger combined population. As such, emerging and developing economies trail far behind advanced economies in per-capita terms. Their aggregate per-capita purchasing price parity-adjusted GDP is $7,415, while the same measure for advanced nations totals $41,369.

Those per capita numbers can be a bit deceptive for both emerging-markets and developed-markets. The Federal Deposit Insurance Corp. says the banking industry earned $42.2 billion in the second quarter, up 23 percent from the second quarter of 2012. CNNMoney reports that the nation’s biggest banks are expected to hand out more in compensation in 2013 than they did in 2009 including $23 billion in bonuses. Banks' losses on loans were down 30 percent from a year earlier to $14.2 billion, the lowest in six years. The biggest banks, with assets exceeding $10 billion make up only 1.5 percent of U.S. Banks, yet they accounted for about 82 percent of the industry's earnings in the April-June quarter.

Meanwhile, low wage workers kicked off the Labor Day holiday early in more than 50 cities, striking fast food restaurants. The demands are largely the same as in the past; a minimum wage of $15 per hour and protections against retaliation for joining a union.

Determining GDP numbers and most economic data is sketchy business at best, in part because the financial world is often sketchy at best. For example, the Tax Justice Network estimates that wealthy individuals are hiding between $21 trillion and $32 trillion in offshore accounts. Further, it's estimated that about 80% of the top 100 US companies are sitting on more than $1.2 trillion offshore to avoid paying taxes on it. How do you count that?

In 2009, UBS, the Swiss financial services company, reached a landmark deferred prosecution agreement with the US government and agreed to turn over the names of more than 4,000 American account holders. In the aftermath, the Internal Revenue Service has netted more than $5 billion from 38,000 Americans who came forward under a voluntary disclosure program.

Since then, US authorities have aggressively pursued Swiss banks they suspect of sheltering American tax cheats. A pending deal between U.S. and Swiss authorities could provoke another surge of recovered tax dollars. The agreement would require Swiss banks to disclose records showing outgoing transfers from American account holders. Authorities likely will use that information to pressure financial institutions in other popular offshore destinations.

A new report shows the last 30 years have been good for a few. CEOs saw their total compensation climb by 876 percent between 1978 and 2012. During that same period, worker compensation grew by 5.4%. And it doesn't seem that the so-called economic recovery is going to give workers a boost anytime soon. In June, the Bureau of Labor Statistics reported that hourly wages fell 3.8% during the first quarter of 2013 -- the biggest quarterly drop since the BLS started tracking wage growth in 1947.

A new report by the Institute of Policy Studies, called “Bailed Out, Booted and Busted” has come out with a listing of the 241 highest paid CEOs of the past two decades. An astonishing 38% of these titans of finance and industry have either been kicked out of their jobs, put in jail or had to have their companies be rescued from bankruptcy.

A poster child for overpaid CEOs performing poorly would be Richard Fuld, who raked in $466 million in salary and stocks in seven years as CEO of Lehman Brothers, the Wall Street investment bank, before the company collapsed in September 2008, precipitating global financial crisis. I don't mean to pick on Fuld; we could also look at the case of Dennis Kozlowski, or Eckhard Pfeiffer, or Ken Lay; Fuld is just one of 112 such CEOs whose companies were given a total of $258 billion in taxpayer bailouts, which means we all paid a little smidge of his paycheck.

It's easy to argue that there are a couple of bad apples in every cart, but if 38% of the apples are rotten, that indicates a problem. Shareholder activism doesn't seem to help, largely because shareholders are looking for the best returns and the thinking is that they can buy better returns, even though the results don't bear that out. Boards of directors are not going to change this. They are mostly made up of other CEOs who says if you scratch my back, I'll scratch yours. One idea is to change the makeup of the Boards. Another possible solution is  governments can eliminate taxpayer subsidies for excessive executive pay and encourage reasonable limits on total compensation by not giving out contracts to companies who pay excessive CEO salaries (effectively subsidized by the taxpayer) and rewarding those who pay their workers well.

Spare a thought this Labor Day holiday, when you fire up the barbecue for the last weekend of the summer and raise a beer for the workers in this country, and don't forget the almost 20 million who are unemployed or underemployed. 

Happy Labor Day.