Macro: The Bottom Line (5/5/2014)

 

Where did all the growth go?

 

The past week was not a good one if you're a U.S. growth optimist. For months now, increasing numbers of market commentators have jumped onto the "U.S. economy firing on all cylinders" bandwagon, painting an unequivocally rosy picture of the world's largest economy. Until Wednesday, that is, when the Commerce Department reported that the U.S. economy eked out just 0.1 percent growth in the 1st quarter.

What went wrong?

 

Well, the optimist will certainly point to the age-old culprit: the horrendous weather that much of the country saw over the winter. While mother nature almost certainly played a role, was it really enough though to single-handedly cause growth to grind to a halt? Likely not. For one, several U.S. economic indicators - including the all-important retail sales data - were already pointing to improvement even before the quarter was out. Never underestimate the resiliency of the U.S. consumer. Secondly, economists' consensus estimates for 1st quarter growth, even accounting for the adverse weather effects, were calling for a print of 1.2 percent. Not stellar, especially given what we've gotten used to lately. But certainly nowhere near the zero level.

Weather aside, the real culprits should come as no surprise to the astute follower of the U.S. economy over the last couple of years. The first was inventory overhang. As we've written previously in Red Bull, a significant factor behind the blockbuster U.S. growth figures in the second half of 2013 was rapid inventory accumulation. In fact, close to half of growth in the 3rd quarter of 2013 alone can be attributed to inventory investment. While it's arguable that this trend was in response to stronger demand (or expectations thereof), retailers cannot be expected to splurge on inventory forever. At some point, the glut will be too great relative to demand, and firms will be forced to pull the stops. And this is along the lines of what we saw in the 1st quarter: companies slowing down their pace of inventory acquisition. The second was a sharp drop in fixed capital investment, even though U.S. corporations are awash with cash. True, capital expenditures tend to exhibit wide fluctuations from quarter-to-quarter. Nonetheless, the drop does at least raise questions about why firms - for all the supposed optimism about U.S. growth prospects - are not yet voting with their cash stockpiles.

What about the other major piece of data from the past week: the blowout employment numbers on Friday? There's no denying that the numbers were encouraging: assuming the pace can be sustained, +288K jobs created in a month is a clear sign of normalization in the labor market. But here again, the data was not entirely absent of red flags. Specifically, April also saw a meaningful drop in the labor-force participation rate, taking it back down to the 35-year low of 62.8 percent reached at the end of last year. As a reminder, this figure essentially means that only about six out of every ten Americans is employed or actively looking for a job. While it helps to massage the headline unemployment number lower (down to 6.3% from 6.7%), a lower participation rate puts further strain on America's ability to deal with mounting demographic pressures - namely an ageing population and ballooning pension liabilities.

The bottom line: The U.S. economy is certainly better-positioned for recovery than many other major economies. But until we see signs of sustained business investment, robust productivity growth, and a reversal in the participation rate decline, it's premature to portend a return to the roaring 1990s.