First Quarter GDP will be a slowdown

Morris Segall      consumer spending, corporate profit margins, Economic Growth, economic recovery, first quarter GDP growth, flattening corporate profit growth, housing weakness, inflation, inventory reorder cycle, Japanese catasrophes, overseas political unrest, rising commodity prices, sovereign debt woes, weak housing prices

We have been expecting first quarter GDP, which will be preliminarily reported this Thursday, April 28, to be slower than the growth reported for the fourth quarter of 2010 (+3.1%) because we did not expect consumer spending to be sustained at the elevated level (approximately 7% annualized rate of growth in domestic sales) achieved in last year’s fourth quarter. Therefore, we had expected first quarter GDP growth to be in the vicinity of 2.5% with reduced consumer spending being offset by strong manufacturing shipments, including exports, and a beginning of an inventory reorder cycle to replenish the strong movement of goods in the fourth quarter of last year.

However, we have been telling our clients and audiences since early April, that first quarter GDP growth could be weaker than our initial 2.5% estimate due to the rising cost of food and fuel that was stifling consumer spending more that we expected and also causing a pause in the level of discretionary business spending as businesses evaluated the impact of higher fuel and commodity prices on near term profitability. In our February 2nd economic and capital market presentation to our clients, we highlighted the flattening slope of corporate profit growth being seen in the second half of 2010 and expected to continue in 2011. We pointed out to our audience that the easy and geometric gains in corporate profits coming out of the recession were going to have be replaced by greater unit volume growth and profit margin maintenance as the economic recovery progressed. The escalation in energy, commodity and service costs is definitely pressuring corporate profits in the first quarter of this year.

In addition, to weaker than expected consumer and business spending, housing weakened dramatically in the first quarter from bad winter weather and most importantly, excess housing inventory from high levels of foreclosures, which in turn caused a further weakening in housing prices. We have been forecasting the latter since last summer but the level of housing sales in the first quarter was extraordinarily weak. This will be a further depressant to the first quarter GDP.

Given the additional negative impacts on world economic growth from continued sovereign debt woes in Europe, the earthquake and nuclear catasrophes in Japan and spreading political unrest in North Africa and the Middle East, a slowdown in first quarter GDP in likely to be incrementally weaker. At this juncture, we have been using a revised estimate of approximately 2%, plus or minus for the quarter. The weakness in the first quarter could be made up over the remainder of the year if inflation pressures recede, geopolitical events stabilize and further gains in manufacturing and employment continue. At this point we are not reducing our full year estimate of 2011 GDP growth from approximately 3% but current trends are troubling. We will have further to say after this week’s preliminary GDP announcement and the upcoming publication of our updated economic outlook presentation on our website.  

Morris R. Segall