Signs Of Weakness, Signs Of Strength
Real U.S. GDP grew at very robust annual rates of 4.6 percent and 5.0 percent in the second and third quarters of 2014, respectively. In the fourth quarter, however, growth slowed sharply to just 2.2 percent. The direct causes of the deceleration are easily identified: government spending fell 1.8 percent, led by a 12.4 percent drop in defense expenditures, while imports (a negative GDP factor) jumped 10.1 percent. Among the other elements, particularly private domestic demand components like consumer spending and investment in housing and businesses, real growth remained quite healthy, growing above 3 percent for the last three quarters and four of the past five quarters (Chart 2).
At the start of this year, a number of economic indicators began to show weakness as well. Measures of manufacturing activity from the Institute for Supply Management, or ISM, as well as data on industrial production, retail sales and existing home sales, all had weak or mixed details at best. Some of the weakness was anecdotally chalked up to weather – record-setting snow in Boston as well as Atlanta.
On the positive side, strong data continue to emerge for the labor market, such as initial claims for unemployment insurance, job creation, the unemployment rate and estimates for take-home pay. In addition, consumer confidence remains at generally high levels. For the corporate sector, operating earnings for the companies represented in the Standard & Poor’s 500 Index of equities are expected to hit all-time highs in coming quarters, despite a drop for the fourth quarter of 2014. Meanwhile, measures of confidence among top-level corporate executives and small business operators are at or close to post-recession highs.
Overall, evidence suggests that recent weakness in some economic indicators may be just a temporary soft patch. Supporting this view are the strong momentum in domestic private demand (consumer spending, investment in housing and businesses) through last year’s fourth quarter combined with continued gains in jobs and income as well as high levels of consumer and business confidence. However, data are data, and hints of weakness should not be ignored.
The proportion of AIER’s Business Cycle Conditions, or BCC, leading indicators deemed to be expanding fell to 50 percent in the latest month, the third decline in a row and ending a positive stretch that began just as the current expansion got under way. Each month, AIER calculates the percentage of the 12 leading indicators that are judged to be cyclically expanding, where a reading above 50 percent indicates continued economic expansion is likely.
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As of our February evaluation, 50 percent of the leading indicators were judged to be expanding, or in an upward trend, ending a string of 65 consecutive months where the percentage had been above 50 percent. Consistent readings above that midpoint suggest a low probability of recession over the next six to 12 months. Conversely, when the percentage drops below 50 percent, there is an increased chance that a recession is coming. However, before we can conclude that a downturn is probable, we look for confirmation from our cyclical score of leaders. For the current reading, that score came in at 76, down from 84 in the prior month, but still well above 50. Note that there have been instances in the past where the percentage leading indicators judged to be expanding fell to 50 or below without confirmation from the cyclical score and no recession occurred (Chart 1). So, while the evidence of weakness should not be ignored, it should not be a cause of great concern either.
The percentage of coincident indicators judged to be expanding posted a reading of 100 in February, the 38th month in a row with a perfect 100 reading and the 61st month above 50. Among our six coincident indicators, four hit new cycle highs in the latest month.
The percentage of lagging indicators judged to be expanding in February came in at 100 percent, up from 75 percent in the prior month and registering a perfect reading for the 30th time in the last 33 months. Among the lagging indicators, three of the six were at new cycle highs while the remaining three had an indeterminate or sideways trend. Overall, our leading indicators, both the percentage expanding and the cyclical score, suggest a slightly weaker economy but do not indicate that a recession is probable (Chart 3).