Current U.S. Soft Patch Should Firm Up

U.S. WEEK IN REVIEW: Most of the issues that held the U.S. economy back this spring saw some improvement in June and even more in July

Robert Johnson, CFA 25 July, 2011 | 9:46AM
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Second-Quarter GDP Likely to Look a Little Soft
Last week's GDP report seems likely to indicate modest 1%-2% growth for the second quarter compared with 1.9% in the first quarter. My expectations are a little below consensus of 2.3% because of the dramatic drop in auto production (due to Japanese supply-chain issues) in the second quarter compared with very strong production levels in the first quarter. Auto-related numbers flow through a lot of accounts including consumption, business investment, and inventories, so tracking the exact effect of the production slowdown gets pretty tricky.

What we do know is that auto production added 1.2% for first-quarter GDP and will probably end up subtracting between 0.5% and 1.0% in the second quarter. That's a lot of ground to make up, 1.7% (1.2% + 0.5%) at a minimum, just to maintain the 1.9% growth rate of the first quarter.

A swing in defence spending that depressed first-quarter GDP and sharp improvement in the balance of trade, as well as increased inventories, together have the ability to salvage the GDP growth rate in the second quarter. But these are notoriously difficult categories to forecast and the import/export numbers are just estimates for June.

In addition, I am not so sure how well the market will receive the news that personal consumption fell from 4% growth in the fourth quarter of 2010 to 2.2% in the first quarter of 2011 to potentially as low as 0.5% in the second quarter. Almost all of the recent decline is due to poor auto sales, which I believe are closely related to the poor supply of Japanese autos and the resulting high prices for remaining inventory. However, that won't stop the headlines trumpeting the lowest growth in consumption of the entire recovery.

The good news is that the worse the results are in the second quarter, especially on the auto side, the better the news for the second half will be, when those Japanese plants come closer to full production. I suspect that growth in the third quarter will show a sharp acceleration to 3.5% or so with a similar gain in the fourth quarter. That would pull up full-year 2011 GDP to a range of 2.5%-3%.

GDP figures will also be revised for the past several months with the issuance of the second-quarter GDP report. I suspect they will suggest the recession was a bit deeper than previously believed and the recovery even slower.

New Home Sales Aren't Likely to Show Much Growth
A lot of last week's housing news was relatively positive, but I don't expect a lot of good news out of the new home sales report. I suspect that poor starts in earlier months and low builder confidence ratios are likely to keep new home sales relatively flat at 320,000. At this level, sales are close to the record bottom and a long ways from the top run rate in 2005, which was in excess of 1.3 million units.

Case-Shiller Home Price Index Likely to Show a Gain
Based on median listing prices tracked by our housing team and a positive report from the Federal Housing Finance Agency last week, I expect the Case-Shiller index to show its second monthly gain (and its first gain when the numbers are seasonally adjusted). This could provide at least a little cheer to the housing market. Based on our leading indexes, I suspect there could be a couple of more positive reports after this one.

Durable Goods Orders Will Be Off May's Strong Pace
Nondurable goods orders had a nice spike in May, growing 2.1% sequentially from April. I suspect those orders could fall back a bit and may perhaps not show any growth at all. The new orders component of the ISM dropped below the 50 level in June, which would be consistent with a small decline. I think we might do a little better than that based on rebounding Japanese auto manufacturers and better aircraft orders. Stripping out aircraft, durable goods orders should be able to grow at least a few tenths of a percent.

Watch the Chicago PMI on Friday
The Chicago PMI has been the best of the regional reports at helping to forecast the National PMI, which comes out the following Monday. Regional results have been mixed so far. International PMI data for June, announced last week, continued to slow. Therefore, the Chicago report may provide some important clues.

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Robert Johnson, CFA  is director of economic analysis with Morningstar.

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