Weak GDP Growth and Falling Unemployment? Believe Neither Report

First quarter GDP rose 0.1% (annualized), which was well short of market expectations. But don’t get excited – this is a backward looking indicator. Q2 is already 2/3 over and it’s looking a lot stronger than the prior quarter and winter months. Employment in particular looks solid, but a raft of other data points to building strength.

A few points to consider:

  • GDP will be revised twice, and the final number is likely to be significantly different than 0.1%.
  • Trend growth is still improving: trailing 12-month growth is 2.3%, versus 1.3% at the end of Q1 2013.
  • Easter was late. A late Easter pulls activity from 1Q into 2Q.
  • Hours worked fell in Q1 due to bad weather. If hours worked had not fallen, Q1 growth would have been about 2.5%.

The monthly job report was much better than market expectations. But again, don’t get excited. The establishment survey showed employment rising 288k in April plus another 36k in positive revisions to prior months, but the household survey reported employment falling by 73k.

  • Household survey results reflected a falling labor force participation rate, which dropped from 63.2% to 62.8%. The real world doesn’t change that quickly.
  • The labor force participation rate is calculated by extrapolating data collected by a monthly survey of 60,000 households to the entire economy. The margin of error shows up as data volatility. The drop in the LFPR reduced the labor force (the denominator for calculating the unemployment rate) by 806k…so the unemployment rate fell 0.4% while employment fell 73k.

Plenty of Encouraging Readings on the Economy, and Some Less So
The Fed tapered another $10b and left rates unchanged. Consensus expects the taper to continue at this pace (done by year-end) and the Fed to then wait before raising the fed funds rate. The Fed’s policy statement said economic activity “has picked up recently, after having slowed sharply during the winter in part because of adverse weather conditions.”

  • March factory orders rose 1.1%, led by orders for capital equipment (ex-aircraft). New orders for durables rose 2.9%; non-durable orders fell 0.6% (this is not troubling; the decline was caused by less demand for energy—which probably reflects better weather rather than slowing activity). The inventory-to-shipment ratio was unchanged.
  • ISM manufacturing composite index rose to 54.9, powered by a jump in the employment sub-index to 54.7.
  • April auto sales came in at a 16mm annual pace. That’s a healthy pace.
  • March construction spending rose, but less than expected. Spending on multi-family housing was strong, single-family and private nonresidential were up modestly; public spending declined. Year/year, though, total spending is up 8%.
  • Initial unemployment claims rose to 344k last week, within the range for this volatile series after a stretch of low numbers, and maybe distorted by Easter. The trend is still solid, however.

Corporate Watch: Earnings and Guidance Improving
About 3/4 of the companies in the S&P 500 have reported earnings, and most of those companies have beaten consensus EPS expectations. Composite earnings expectations improved by about 1%. Corporate commentary continues to highlight bad/improving weather; guidance has become less negative.

  • Merger and Acquisition deals are getting headlines (Pfizer is bidding for AstraZeneca, GE (or maybe Siemens) is buying parts of Alstom (if the French government, which is miffed that it wasn’t consulted, doesn’t block the deal on grounds of national pride). There are a bunch of other deals going on as well.
  • In 2013, the average funding ratio of the 100 biggest defined-benefit corporate pension plans rose to 93.5%, the highest figure since 2007, according to Pensions & Investments.  Comment: ERISA (the Employee Retirement Income Security Act, passed in 1974 to ensure corporations set aside enough money to ensure their pension plans can meet their obligations) has worked. Too bad the government didn’t subject itself to the same discipline.

Eurozone: The Recovery Continues
The Markit Eurozone Manufacturing PMI rose 0.4 to 53.4 in April; every nation reported growth. This is the index’s 10th consecutive month above 50.

  • The Eurozone March unemployment rate was stable at 11.8%.
  • Eurozone flash April CPI ticked up to 0.7% year over year (y/y); core was 1% y/y – this fits in with ECB view that seasonal distortions and lower energy prices may be causing temporary weakness…and thus that more aggressive easing isn’t needed at this time. Energy prices fell.
  • Portugal formally exited from its “Troika” bailout.
  • The latest ECB credit survey showed demand for corporate loans rising for the first time since Q2 2011.
  • France’s lower house of parliament approved a package of health care and social welfare spending cuts intended to narrow the budget deficit.
  • The EBA (European Banking Association) announced the methodology and scenarios for the next round of bank stress tests. Markets were pleased.

In Japan and China
Japan: The impact of the April 1 tax hike showed up in consumer behavior, although the Bank of Japan (BOJ) isn’t blinking.

  • April auto sales were down, while March retail sales rose 11% and total household spending rose 7% month over month (m/m) as consumers stocked up before the tax increase. Meanwhile, housing starts and construction orders dropped.
  • The Bank of Japan cut its FY14 GDP forecast from 1.4% to 1.1% and reaffirmed its goal of driving inflation to 2%, and left policy unchanged for now.

China: More evidence of slowing growth, as manufacturing rose 0.1 points to 50.4 in March. The World Bank estimated that China is about to overtake the U.S. as the world’s biggest economy, although it is still a relatively poor country on a per-capita income basis.

Last week in The Capital Markets
OK economic news was balanced by rising Ukraine tensions.

  • Currencies: Another quiet week with the Yen down a couple of tenths of a percent against the dollar and the Euro up a couple of tenths. The Chinese Yuan was down about 0.1%, but most emerging market (EM) currencies were stronger against the dollar.
  • Bonds: 10-year Treasury yields yields fell 8 basis points (bps) to 2.60%; the 10-year TIP yield fell 7 bps to 0.41%…both touching 2014 lows. High yield spreads rose 4 bps to 373. The yield curve flattened further: the 2-10 spread narrowed another 7 bps.
  • Equities: The S&P 500 Index ended the week up 1%; MSCI Europe, MSCI Japan, and MSCI Emerging Markets Indexes posted similar returns. Within the S&P 500, telecoms 2.8% and tech (1.7%) led; only utilities (down 1. 4% after big outperformance last week) posted a negative return. The Dow hit an all-time high (16,580) on April 30.
  • Commodities: WTI oil was down about 1%; gold was down about 1.5%.

Data Sources: The Wall Street Journal, Financial Times, Bloomberg.

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About Sam Wardwell

Sam Wardwell, CFA, is Senior Vice President and Investment Strategist at Pioneer Investments. He joined Pioneer in 2003.
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