While the stock market continued to crumble last week under the weight of the European situation, the U.S. economy turned in one of its better performances of the year. Retail sales continued to grow at a moderate but steady rate, prices fell, housing showed signs of life, and even the manufacturing industry seems to be recovering from its summer slumber. Initial unemployment claims managed to continue their slow but steady decline of the last two months, bolstering the employment outlook in the months ahead. If only Europe could get its act together.
The consensus seems to finally have come to the conclusion that the U.S. economy will not double dip. But nobody--including me--is willing to go out on a limb to project a very robust 2012. High debt, a poor housing market, lack of consumer confidence, high unemployment--we have all heard about the stumbling blocks. But is there anything at all that could surprise dour economists on the upside?
Certainly last week's U.S. housing data seem to suggest that there might be some stirrings of life in a market that has been flat on its back. Homebuilder sentiment, housing starts, and more forward-looking housing permits all had a very nice October. This would be the second month in a row that trends have looked better. It wouldn't take a lot more to make housing a net add to GDP instead of a detractor as it's been for most of the recovery.
The second interesting source of optimism is the continued recovery in the U.S. energy industry. With a combination of higher prices and new technology, U.S. energy production is now moving up again instead of down and is likely to do so over the next 8-10 years. I spent some time in Texas last week and was surprised to hear of all the optimism--tempered only a little by many reports of shortages of petroleum engineers (or any engineers for that matter). Even labourers and truck drivers are in short supply as the oil patch begins to advertise for new workers in places as far away as Detroit. Furthermore, the Texans acknowledged that something special is happening in North Dakota, of all places, as they continue to ramp up their energy industry and experience their own economic boomlet.
There were even furtive whispers on my return airplane that, just maybe, North Dakota production could one day rival Prudhoe Bay at its peak (even today, North Dakota is already outproducing a rapidly depleting Prudhoe Bay). All of this could potentially mean more jobs, a move towards more energy independence, and meaningful improvement in the U.S. trade deficit (petroleum represents more than half of the U.S. trade deficit). I think the market has yet to grasp the full consequences.
Second GDP Estimate Harder to Estimate than the First
Last month we got the first of three estimates of third-quarter GDP growth. This week we will see the second estimate, and the final estimate will arrive in late December.
The original estimate showed GDP growth of 2.5% and the consensus is that the second, more accurate reading will show modestly slower growth of 2.3%. However, because several components of GDP were estimates the first time around, many of which proved to be wide of the mark, a new estimate of anywhere between 2% and 3% would not surprise me. The balance of trade data used to calculate exports and imports proved to be particularly off--the government didn't even get the direction of the change right for September. It turns out that higher exports and lower imports could provide a relatively large boost to GDP. Wholesale and retail inventories also showed an unusually large discrepancy between the original estimates to compile GDP and the final report we saw last week. The magnitude here was larger than the balance of trade deficit estimation and unfortunately in the opposite direction. However, because there is an interaction between sales, prices and inventories that only government statisticians can see, the range of possibilities for the second GDP estimate remains unusually wide.
In my opinion, the potential reduction in the GDP estimate--even if GDP turns out to be lower than consensus--is not a big deal. That is because the bulk of the reduction comes from inventories that are being kept at unusually low levels and will probably have to be restocked in the fourth quarter. Even before the upcoming adjustment, inventories took over 1% off of GDP and now that number is likely to be closer to 2%. An inventory adjustment this large so early in a recovery is unusual and reflects the conservative outlook of businesses. Based on recent sales data, that outlook may prove to be too conservative.
