U.S. Economy: Will Growth Be Roaring, or Boring?

While economies in Europe and Japan teeter into and out of recession, the U.S. economy has shown a measure of strength. Many look for a further growth acceleration as 2015 unfolds, including the forecasters at the Federal Reserve, the White House, and the International Monetary Fund (IMF). Such an economic pickup could very well occur. A selection of indicators does indeed point in that direction. At the same time, much in this economy still reflects the growth-retarding influences that have kept this recovery substandard to date. The mix puts probabilities on the side of continued growth to be sure, but perhaps not the acceleration popularly expected at the moment.1

To put this reality into more concrete terms, this week’s discussion will offer a perspective on various popular economic measures, identifying those that point to acceleration and those that tend to dampen enthusiasm.

From the Top Down
The biggest support for optimism grows out of two indicators in particular: a recent acceleration in employment growth and strong readings on gross domestic product during last year’s middle quarters. The Labor Department reports that payrolls have expanded on average by some 282,000 a month during the past six months, far better than earlier in the recovery and almost on a par with past cyclical recoveries.2 Unemployment has dropped much faster than anyone expected, falling from 6.6% of the workforce in January 2014 to 5.7% this past January. The real economy overall, after a weather-induced annualized drop of 2.1% during the first quarter last year, sprang back at an annualized rate of 4.6% in the second quarter and a still stronger 5.0% rate during the third quarter. The slower 2.6% rate of growth preliminarily reported for the fourth quarter disappointed some, but the picture nonetheless has offered encouragement.3

As good as this overall picture looks—and it does indeed look good—it requires significant caveats. The second and third quarter surges reflected a catch-up from the artificially depressed first quarter, a point that the fourth quarter slowdown seems to confirm. The average annualized growth for the four quarters came to 2.5%, not much different than other years of this slow recovery. The surge also reflects non-repeatable events. The summer quarter, for instance, saw a 16.0% annualized jump in defense spending.4 That certainly will not likely persist, even with continued operations against ISIS (Islamic State of Iraq and Syria). On the employment front, the relatively strong gains, especially in the strongest months at the close of 2014, reflected disproportionately high concentrations of hiring in temporary help services and restaurants, while finance, manufacturing, and retail have lagged. Not only does such a relative shift in emphasis explain why average weekly wages failed on average to track the expanding headcount but also it raises questions about the breadth of this recent advance. As if to underscore the chance of a pause or a return to slower growth, the Fed’s measure of industrial production, which had picked up nicely in spring and summer, slowed to a paltry rate of expansion in December 2014 and January 2015.5 And the Institute of Supply Management (ISM) index of manufacturing activity signaled a slowdown.6

Business Spending and Housing
Part of last year’s growth surge involved a pickup in new business spending on capital equipment and premises. After barely growing at all during first quarter 2014, business spending on new equipment surged at better than an 11.0% annualized rate on average during the second and third quarters. Spending on new structures also surged during this time, at an annualized rate of 8.7%. Things slowed during the year’s final quarter, with equipment spending actually dropping at a 1.9% rate and structures growth slowing to only an annualized 2.6% pace of advance. Apart from what happened in the fourth quarter, there is an additional reason to question the durability of those strong midyear trends. Such surges have occurred before in this recovery and petered out. The early quarters of 2012, for instance, enjoyed an almost 20% annualized jump in spending on new structures, which subsequently turned into a decline. Though continued strong rates of bank lending to business, at a 10.3% annualized pace during the last six months or so, suggests that the 2015 economy may avoid such a relapse, recent declines in new orders for capital goods, at almost a 7.0% annualized rate for the past three months, raises a warning flag.7

Meanwhile, the housing market continues its notably slow pace of recovery. Sales of new homes have picked up nicely, growing 10.3% during the last six months, but sales of existing homes have shown a less impressive 0.2% rate of advance during this time. New home construction, which had gotten ahead of sales earlier in 2013, has all but ceased growing. Permits for new construction have grown only 1.0% during the past 12 months.8 Real estate prices have risen on balance, but in a sign that the picture may well remain subdued, December showed a slight 0.2% dip in home prices nationally.9 One month’s data hardly signal a new adverse trend, but the data do argue against any expectation of an imminent pick up. None of this is surprising, given the increase in mortgage rates and the continued reluctance by financial institutions to lend for residential real estate. According to Fed data, bank lending in the area, after a tentative rise midyear 2014, has again begun to decline.10

The U.S. Consumer
The consumer still is 70% of the U.S. economy, but has played only a muted role in the recent growth surge. Real spending on goods and services has increased an annualized 3.3% during the last three quarters, a pickup to be sure from annualized growth of barely more than 1.0% during first quarter 2014, but otherwise little different from the average growth rate of 2.8% in 2013. The recent pickup in jobs growth does offer a basis for accelerated consumer spending going forward, but perhaps because of the shift in the composition of new jobs, household incomes have shown little acceleration, growing at an annualized pace of 3.7% during the last six months, no faster whatsoever than the prior 12 months.11 Of course, the slide in energy prices will allow those incomes to buy more, but energy prices would have to keep falling at the same pace to extend any such real spendable income surge, and that is not likely.

Overarching these possibilities is the clear caution that seems to continue to dominate household spending decisions. Whenever spending growth exceeds income growth, households, unlike periods in the more distant past, curtail spending apparently in an effort to keep up savings rates. Thus, when spending shot ahead of income growth late in 2013 and rates of saving, accordingly, fell from 5.2% of aftertax incomes to 4.4%, households subsequently curtailed spending growth to reestablish a savings rate above 5.0% by the middle of 2014. Now that spending has again picked up faster than income growth, consumers may well do the same thing this year and slow the overall pace of economic advance.12

Retail sales statistics recently gave a tentative sign that just such a pattern may prevail. Despite about a 3.0% boost to real spendable income from the drop in energy prices, these nominal figures actually fell 1.6% this past December and January. To be sure, much of the drop reflected a decline in nominal spending at the gas pump. It took a lot fewer dollars to fill the tank, and dollar (as opposed to gallon) sales at gasoline stations fell 6.5% in December alone. But spending cutbacks were more widespread, with drops recorded in spending on autos, electronics, appliances, clothing, sporting goods, and building materials. It is only one month’s data, of course, but it does offer a sign of continued spending caution among households.13

Pulling the Many Threads Together
This is hardly a depressing picture of the economy. On the contrary, it offers many indicators of relative strength, some of which even support popular expectations of a durable acceleration in the pace of growth. But it does also argue that much of what has kept this recovery slow for the past five years or so remains in place. Whatever the real possibilities of a pickup in the economy’s growth pace, the probabilities still point to a historically subdued rate of recovery.

1See, Federal Reserve website and International Monetary Fund website.
2Data from the Department of Labor.
3Data from the Department of Commerce.
5Source: Federal Reserve.
6Source: Institute of Supply Management.
7Data from the Department of Commerce.
9Data from Standard & Poor’s.
10Source: Federal Reserve.
11Data from the Department of Commerce.

The opinions in the preceding economic commentary are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. This material is not intended to be relied upon as a forecast, research, or investment advice regarding a particular investment or the markets in general. Nor is it intended to predict or depict performance of any investment. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Consult a financial advisor on the strategy best for you.

(c) Lord Abbett

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