(By Robert Johnson, CFA) Equity markets barely budged this week, with limited economic news and less than newsworthy earnings reports from Alcoa (
AA) and Wells Fargo (
WFC) (both came in pretty close to expectations).
About the only real excitement for the week was news that China's exports had a substantial increase in December (14%), which raised hopes that China was indeed having a gradual descent and not a crash landing.
Although the export news was weaker out of Europe and the United States, markets also took some solace in reports out of Europe that the European economic situation was still weak, but that improvement later in 2013 seemed a more likely prospect, according to a European Central Bank statement. Some of the worst fears about peripheral country debt also seemed to be subsiding. I'm not sure things are that much better in Europe, but markets seemed pleased, and at least things there aren't spiraling out of control.
As neutral as most of the news was this week, my fourth-quarter GDP growth forecast of 2.0% is now looking like a long stretch, with something like a 1.0%-1.5% growth rate seeming more likely. The U.S. Treasury's December budget report seemed to suggest that government spending would take a meaningful hit in the December quarter, which will weigh heavily on the GDP report while reducing the deficit. I guess we can't have it both ways--a better deficit and a better GDP forecast--at least in the short run.
Separately, a massive increase in iPhone imports and luxury cars helped drive both U.S. imports and the trade deficit higher in November. Since this is the last trade report before the first estimate of fourth-quarter GDP growth, it now looks like trade will have a negative impact on GDP. While the long-term trade deficit situation appears to be improving and that a lot of fluky things in the report will reverse themselves in the months ahead, the improvements will come too late to save the fourth-quarter GDP report. My 2013 forecast remains unchanged at 2.0%-2.5%, or slightly ahead of 2012 GDP growth.
U.S. Budget Deficit Declines 9% in the First Three Months of Fiscal 2013
In one piece of good news on the U.S. budget front, the Treasury announced that the deficit for the first three months of fiscal 2013 fell 9% through a combination of increased tax collections and spending reductions.
If we continued at the current rate of decline, the deficit would fall from $1,090 billion in fiscal year 2012 to $980 billion for fiscal year 2013 even before the recently enacted tax increases and spending cuts were up and running. Those could take an additional $200 billion or more off of the deficit, reducing it to $780 billion, which is down from its peak of $1.4 trillion. There is still a lot of work to be done, and major entitlements will drive the deficit up again in a big way in the middle of the next decade.
However, as a word of warning, some of the spending reductions could also affect fourth-quarter GDP. The report explicitly mentions weakness in Medicare and defense spending. These categories had up-down cycles throughout 2012 that contributed to swings in GDP growth in 2012. I had assumed that total government spending at all levels would be flat between the September quarter and the December quarter. That now looks a little optimistic given that the federal portion will be down meaningfully.
Cell Phone Imports Drive Trade Deficit Higher
The trade deficit made a surprise leap in November, jumping from $42 billion to $49 billion. Although oil imports fell as I anticipated, there was a huge leap in consumer goods, including cell phones, pharmaceuticals, and autos. Exports managed a small increase, but they were dwarfed by the increase in imports.
At least part of the story here is that Hurricane Sandy slowed imports in October, and there was a huge bump as the port situation returned to normal in November. When October and November are averaged together, things look a lot less extreme. Nevertheless, without considering changing inventories (or a major improvement in December), it now looks as if trade will hurt GDP by about 0.3% in the fourth quarter. I had been thinking that trade would have a minuscule positive effect on the fourth quarter.
With imports being the big news in November, I have provided a table that shows some of the quirky items that caused the surge in imports:
I assume that at least part of the jump in cell phones relates to latest version of the iPhone. This category has been a real yo-yo lately. The jump in iPhone sales is not all bad because a greater portion of iPhone-related revenue is realized at U.S retailers than for a lot of other categories. (Selling iPhones is a lot more lucrative than selling televisions.) The pharmaceuticals category has been another highly volatile category recently as well. Big jumps here are almost always followed by big declines.
Luxury auto brands had a great year-end, particularly some of the non-U.S. nameplates. Apparently that was well anticipated by dealers as auto imports surged in November. It's highly unlikely this trend will continue for much longer. Petroleum imports, which have been shrinking at more than a $1 million rate each month, bounced back up a little for unknown reasons (U.S. energy exports, however, were up).
Taking a broader look at trade for the first 11 months of the year, exports are still up about 4.6%, with the bulk of that growth coming from increased shipments to our nearby neighbors in North and South America. Exports to Europe aren't really growing at all, but they aren't falling out of bed in a major way, either. Pacific Rim shipments have slowed, too, but not as drastically. With some improvement in China, I am hoping that we have seen the worst of its slowing.
This week, I am also looking at the major growth categories for imports and exports for the year through November. The big gainers and losers are surprisingly narrow. This is not about everything going up or down a little, but huge swings in a few categories.
On the export side, autos, aircraft, soybeans, and petroleum products were the big gainers. Two of these categories, aircraft and petroleum, should do even better in 2013. Autos are also likely to continue to show gains with some Japanese transplants beginning to use both the U.S. and Mexico as a base for worldwide shipments. Soybeans, unfortunately, will probably hurt rather than help the trade balance in 2013.
On the import side, it was a banner year for autos as Japan bounced back from the tsunami and foreign luxury cars gained in popularity. I doubt that auto imports will move up nearly as much in 2013 as they did in 2012. Oil-related imports dipped by almost $15 billion in 2012 and could do even better in 2013 as oil production ramped up sharply in the U.S. throughout 2012. That means more improvement even if oil production doesn't increase a lot from December 2012 levels.
World Macro Conditions May Do Little to Move the Trade Deficit One Way or the Other
The whining that exports/imports can't possibly get any better in 2013 because of poor global macro conditions is nearly deafening--and totally wrong. Take a look at some of the big export categories. Let's start by examining airliners: although Boeing (BA) may hit snags for other reasons, the company projects that 787 shipments will double in 2013, with many of those planes likely ending up overseas. With multiyear backlogs and delivery schedules, these shipments aren't going away even with a weak world economy.
Furthermore, the petroleum situation should only get better from here. With some pipelines serving the Midwest now reversed to allow Gulf Coast shipments of North Dakota oil, petroleum exports are highly likely to go up, especially given the lower U.S. prices for oil. As I mentioned above, even with limited increases in oil production from the record-high levels reached at the end of the year, the entire 2013 versus 2012 increase will be huge because of the steady ramp-up in U.S. oil production in 2012.
Then there is food, a global necessity. Worldwide weather trends, not generalized economic activity levels, will drive both supply and demand for U.S. crops. Just guessing, but I doubt that pharmaceutical shipments will be very dependent on economic conditions, either.
Auto exports and other capital goods could indeed be more affected by world economic conditions. However, Honda (HMC) is hoping to use the U.S. as a base for worldwide auto shipments (given the high value of the yen, exporting out of Japan doesn't make as much sense).
I am not saying the trade deficit can't hurt 2013 GDP results. It can. But that weakness is more likely to come from poor weather conditions in the U.S., continued problems at Boeing, or regulations against fracking than from Europe sliding into the abyss.
Retail Sales, Inflation, Industrial Production, and Housing Data on Tap Next Week
Next week begins with the government's official take on December and the holiday season. Recall that a lot of various holiday reports have been highly contradictory, with holiday season growth rates ranging from a meager 0.7% to more than 4.0% on a year-over-year basis.
According to the government reports, November grew about 3.7% (ex-autos and gasoline) and December looks poised to grow 4%, placing the November/December holiday season at just under 4%, the high end of the private estimate ranges. Though this is decent growth, I suspect that consumer incomes were even a little higher, giving consumers a little cushion for the January tax increases.
For reference purposes, economists estimate that the all-inclusive top-line growth rate for December will be about 0.3%, or 3.6% annualized. This could end up being just a little high given falling gasoline prices' likely reduction in aggregate expenditures on gasoline. Auto sales are a bit hard to figure, also. Unit sales were definitely down month to month, but more luxury vehicles were sold at higher-than-average price points, too. Needless to say, this report will take a lot of careful analysis.
Consensus Estimate for CPI Inflation Is Zero
Though I was once hopeful that there would be no inflation in December, this now seems a little optimistic. Unfortunately, gasoline prices usually go down in December, so the seasonally adjusted CPI won't see the full benefit of the 5% decline in gasoline prices. In addition, rising used-car prices, one more month of high food inflation, and potentially rising housing/rent metrics may offset some of the benefit of slightly lower gasoline prices.
At the consensus forecast, prices would be up 1.9% on a year-over-year, three-month moving average basis. That would be a lot better than the 3.3% rate that consumers experienced in 2011. It would also be well below the 4% level that generally tips the economy into a recession.
Industrial Production Should Be Up a Little Again
Given some better purchasing managers' data and a continued rebound from Hurricane Sandy, the market is expecting industrial production to grow 0.2%, its second monthly increase following hurricane-depressed results for October. I think the export picture is probably looking better, too. Utilities and autos remain wild cards that are hard to project. Auto production, at least as reported by the Fed, has been highly volatile, despite relatively stable improvements in auto sector employment. I don't really care all that much about the manufacturing data, but the market seems to like it when the IP report shows improvement.
Housing Data Likely to Be Fine Next Week
There is a lot of housing data next week, including builder sentiment, CoreLogic (CLGX) prices, and housing starts. Starts were a little soft in November, and the market is expecting a rebound for December. Starts are expected to improve from 862,000 to 881,000. I will also be watching permits, which have at least a small probability of crossing the 900,000 mark. For all of 2013, I believe starts will be over the 1 million mark for the first time since the recovery began. Without seasonal adjustments, the month-to-month CoreLogic Home Price Index is likely to be down modestly due to normal seasonal patterns. Year-over-year prices, however, should be up in the 5%-6% range.