June 1, 2005
In our desire to know how well our economy does, the Commerce Department releases information before all the facts are known. For example, the initial 3.1 percent increase in first quarter GDP was announced without knowing what happened to exports and imports in March, without knowledge of inventory investment for the month, without knowing construction expenditures for the month and without the myriad of revised data that become available in retail sales, employment, and elsewhere after their preliminary estimates are known.
Of course, Commerce warns that substantial revisions are possible, but few economists worry much about that disclaimer until more information is released.
In fact, we discovered that construction was stronger than expected, the trade deficit improved remarkably because of a drop in non-oil imports, and even retail sales were slightly better than originally reported. Not surprisingly, the combined impact of all those changes led to an upward revision in the first quarter estimates.
Now that we have a better picture of what actually happened during the winter, what do we know?
Despite weather problems about which most retailers complained, consumer spending remained surprisingly robust. In fact, with the April jump in retail spending, the consumer might even provide more growth to the economy during the spring than during the winter.
We also know that inflation has not disappeared, nor even moderated much, but that it is not intensifying either. With the upward revision in economic growth amid continued signs of modestly intensifying inflation, the Federal Reserve almost assuredly will be raising short term interest rate targets at the next several meetings.
The inventory overhang that appeared to be caused by aggressive purchases of imports was neither caused by imports nor was it a serious overhang. That $80 billion increase in inventories was sliced to $68 billion while the $65 billion gain in sales of final goods was increased to $70 billion. We still have an inventory problem, especially in SUVs, but sales incentives in April and some production cutbacks should soon eliminate problems.
However, we might see a slightly more aggressive working down of inventories because some of those warehoused goods and materials were purchased because of fears of higher prices. A year ago, commodity prices surged because of an apparent insatiable appetite by China for raw materials.
In the meantime, the Chinese have slowed the growth of their infrastructure (while their consumption growth has surged by 14 percent) and have sharply reduced their growing demand for materials. For example, a year ago, oil consumption in China was growing almost 20 percent, cement demand was surging and even steel use was jumping much faster than the world could produce the stuff.
Today, copper remains in short supply because of a Chinese housing boom (they tend to use copper in their roofing as well as their plumbing). By contrast, steel producers are cutting back their production, cement is available at prices near last year’s levels, and oil consumption is up less than 5 percent. Not surprisingly, the expected spring surge in commodity prices has not materialized.
Even if inventory accumulations slow sharply in the spring, as I expect they will, the slightly stronger consumer spending, continued growth in government and the rebound in capital spending suggested by the April durable goods report should be sufficient to permit more than 3 percent growth in the quarter.
Moreover, following the modest respite in domestic manufacturing activity, growth could rebound to slightly more than 3.5 percent for the remainder of this year.
What happens next year very much depends upon the price of oil. Too much purchasing power cannot continue to drift offshore. My guess is that the consumer will be more cautious in spending, especially if the froth in the housing market begins to moderate late this year, as I expect.
Finally, the revised GDP had the first look at operating profits for all businesses during the first quarter. The gains were surprisingly robust. The end of tax relief on some capital spending dropped the operating profits to only an 8.1 percent gain from the previous year. (That is the measure I use to determine stock market activity). However, after tax profits jumped a surprisingly strong 26.6 percent.
My number should be used for stock market valuations, but the analysts hone in on the more robust gain. Therefore, they will be increasing most of their stock ratings as the earnings are announced for individual companies. And that should make a happy beginning to the vacation season for many stock owners.