By Brian Jacobsen, Chief Portfolio Strategist
- The advance report of first-quarter gross domestic product (GDP) showed a 2.5% increase from the fourth quarter of 2012.
- I believe that the U.S. Federal Reserve (Fed) is likely to continue its asset purchase program at least until the summer and early fall home sales season is over.
- U.S. economic growth may have hit a high-water mark with the first-quarter reading of GDP.
The advance report of first-quarter GDP showed a 2.5% increase from the fourth quarter of 2012, on a seasonally adjusted and annualized basis. This was slightly below my estimate of 2.9%, although the GDP numbers will likely be revised over the next few months. As a reminder, the fourth-quarter GDP reading was initially a contraction but was subsequently revised to an increase of 0.4%. The growth in the first quarter may have been due do a bounce back from the weak end to 2012. Averaging the first quarter of 2013 and the fourth quarter of 2012 would likely give a strong indication as to what the rest of the year could look like.
Real personal consumption expenditures increased 3.2% in the first quarter, a substantial increase from the 1.8% growth in the fourth quarter of 2012. Consumers continued to spend despite the payroll tax increase that took effect at the beginning of this year. The effect of the higher payroll tax was apparent, along with higher other taxes and declines in dividend income in the real disposable income numbers. Real disposable income declined by 5.3% in the first quarter after increasing 6.2% in the fourth quarter. Because of the protracted debate about taxes, there was quite a bit of income shifting from 2013 back into 2012.
Spending on durable goods—items expected to last three years or longer—grew at an annualized pace of 8.1% in the first quarter, a substantial slowdown from the 13.6% increase from the prior quarter. Nondurable goods grew at a mere 1%, but spending on services increased 3.1%. Consumers are still spending, but the items being purchased are changing. As such, discounting is likely to play an important role in propping up retail sales, as employment and income growth will likely remain weak for the remainder of the year.
Business spending on structures decreased 0.3% in the first quarter after increasing 16.7% in the fourth quarter. Spending on equipment and software increased 3% after increasing 11.8% in the fourth quarter of 2012. This variability in business spending is probably due to the uncertainty around bonus depreciation rules, which encouraged businesses to shift spending into 2012. I expect spending on equipment and software to pick up toward the end of 2013 as businesses continue to substitute technology for workers to bolster the bottom line.
Government spending detracted from the GDP numbers with defense spending being the biggest drag. After declining 22.1% in the fourth quarter, defense spending dropped 11.5% in the first quarter, while nondefense spending fell by 2%. State and local government spending decreased 1.2% during the period. Despite the slowdown in government spending, overall economic activity continues to grow. Because defense spending abruptly adjusted downward, it could actually make positive contributions for the balance of the year. It’s at a lower base, and growth rates depend on the base from which it grows. That’s why much of the government spending slowdown is likely built into the first quarter and will have only minimal leaking into subsequent quarters.
During the first quarter, both exports and imports increased 2.9% and 5.4%, respectively. A stronger dollar could slow export growth and keep imports elevated. Considering the Bank of Japan’s policies and a possibly weakening euro, I think we could see a secularly strengthening dollar. For U.S.-based investors, that means foreign investments could be adversely affected by currency effects because when you buy a foreign asset, you have to translate that back into dollars. So when the dollar strengthens, some of the foreign gains can be offset.
Inflation measures were extremely subdued in the GDP report. Spending is growing slowly, and inflation is negligible. I believe that the Fed is likely to continue its asset purchase program at least until the summer and early fall home sales season is over. To the extent the Fed is keeping mortgage rates low, I don’t think it wants to mess with a good thing and risk increasing the cost of financing a home purchase. That’s why I believe the September Federal Open Market Committee (FOMC) meeting is the earliest the FOMC will taper purchases of mortgage-backed securities.
For now, central banks are trying to keep pushing liquidity into the economies, and I think we’ll continue to see that liquidity prop up asset prices. U.S. economic growth may have hit a high-water mark with the first-quarter reading of GDP. I think we’ll see a decrease of 1.5% in the second quarter and average increases of 2% for the third and fourth quarters. It won’t likely be enough to improve the labor market substantially, but it should be enough to keep corporate profits from rolling over.