Get Ready for Another Economic Dip before Spring

There is a growing debate among economists and traders…

Recent economic growth has been frozen. That is something everyone agrees upon.

The argument is that some have blamed this freeze in activity on the freezing weather. Others believe there are more serious problems lurking beneath the ice that threaten to slash the economy’s hull and sink us into yet another recession.

Here is some of the most recent data they’ve been looking at from last week:

• February’s Empire State Index (a monthly survey of manufacturers in New York State) came in at 4.5 versus an expected 9.0, down sharply from January’s 12.5.

• February’s Philadelphia Fed Survey (an indicator of trends in the manufacturing sector) registered a shrinkage at -6.3 versus an expected expansion of +7.3, down from January’s +9.4. It was the weakest reading in 12 months, and the first contraction in 9 months.

• February’s Home Builders Index (a monthly survey measuring positive sentiment across the single-family housing market) came in at 46 versus an expected 56, down from January’s 56.

• January’s housing starts reported 880,000 new builds versus an expected 945,000, down from December’s 1.05 million.

• January’s existing home sales fell to 4.62 million versus an expected 4.65 million, down from December’s 4.87 million.

So what’s the cause? Did the record cold weather just keep everyone indoors? Or is the U.S. economy in a more fundamental deep freeze? And what effect is this expected to have on stock markets?

Bulls Say Activity is Merely Postponed

Those optimistic of a still-strong economic recovery see these recent interruptions in productivity as mostly weather related. Shoppers staying home resulted in fewer goods sold. Fewer goods sold – plus a great deal of interruption to shipments that are currently still on the way – resulted in fewer goods ordered and a drop in manufacturing.

But this creates a backlog of pent-up shopping demand which the bulls expect to be unleashed in full force come springtime. Those who refrained from buying a home or auto in January because of the weather haven’t simply abandoned their desire for a home or car; they just postponed it. The same can be said for personal purchases of clothing, furniture, appliances and more.

True, some lost spending won’t be regained in future months. People who stayed home the last four weekends aren’t going to double up on the next four weekends and eat twice as many dinners at restaurants or see twice as many movies at the theatre.

But such cancelled purchases are small ticket items compared to all the postponed purchases like cars and furniture which cost so much more than a night out on the town.

Thus, the forecast looking ahead is rather upbeat:

• January’s Leading Economic Index (which is comprised of employment data, manufacturer orders, building permits, the money supply and interest rates among other macro data) registered 0.3 percent higher than December’s zero change, and rising a total of 3.1 percent over the past six months.

• February’s Markit Flash Purchasing Managers’ Index (which provides early indications of the performance of the private sector by tracking upcoming output, new orders and prices across the manufacturing, construction, retail and service sectors) rose to 56.7, up from December’s 53.7 – its highest level in almost 4 years. That serves as clear proof of postponed pent up demand just waiting to be unleashed.

Bears See Fundamental Weakness

On the other side of the debate, however, pessimists say there is more blowing across the economy than just bad weather. While they acknowledge the weather did account for much of the recent sluggishness, they point to consumer spending, business investment and home purchases which dropped long before temperatures did.

• January retail sales dropped 0.4 percent while December sales dropped 0.1 percent – and that was during the holiday shopping season, which is supposed to be the best time of year.

“All it seems I heard about was that momentum was picking up at the end of 2013, but I don’t see much evidence,” chief economist Stephen Stanley of Pierpont Securities noted to MarketWatch, referring to the latest retail sales report as an “unmitigated disaster.”

• January new non-farm jobs increased by only 113,000, while December’s new jobs grew by a mere 75,000 – far less than the 200,000 averaged throughout 2013.

• While GDP annual growth measured 3.3, 2.8, 3.1 and 2.0 in the four quarters of 2012 for an average annual growth of 2.8, annual GDP growth measured only 1.3, 1.6, 2.0 and 2.7 in the four quarters of 2013, for an average of 1.9 overall. And that last figure of 2.7 for Q4 is expected to be revised down to 2.4.
Bears expect such low GDP growth to persist throughout 2014. “This will not be the year we get to three percent,” Steven Ricchiuto, chief economist at Mizuho Securities predicts.

Middle of the Road for 2014

It would seem that both sides have made some good observations that should combine to make 2014 a rather tepid year for growth.

Yes, there will be a surge in retail sales, hiring, and big ticket purchases for homes and autos in April and May when the weather improves. But once the backlog is cleared out, economic activity is expected to return to a moderate pace by Q3.

Chief U.S. economist for High Frequency Economics, Jim O’Sullivan – ranked by MarketWatch as “the most accurate forecaster in America over the past 10 years” – blames part of 2013’s slower activity on “fiscal drag” caused by tax hikes and spending cuts from the sequester and government shutdown, which cut GDP by as much as 1.5 percent last year. Without such interruptions, the economy would likely have grown by 3.4 percent or more. O’Sullivan believes such fiscal drag to account for a mere 0.5 percent of wasted GDP potential in 2014.

Yet he believes this will be made up for by increased consumer spending as personal consumption rises from 2.3 percent last year to 3 percent this year, bringing overall economic growth to 3.3 percent.

Roll With the Flow

For investors, caution should be the immediate stance. While some of the recent bad reports did work their way into stock prices as the major indices corrected on average about 6 to 7 percent in January, some of the negativity has been priced out once again as the markets climbed up 4 to 5 percent this month.

The failure to reach the high levels at the start of the year is an ominous sign that the correction begun last month is not over. A double top such as we are seeing is a sign the market has no power to push into higher territory and is rolling over. Look for another dip down soon.

But come the spring when those pent up postponed purchases finally hit the stores, robust reports in April to June should pick the market back up again. Charts for 2014 will likely draw for investors a series of rolling hills throughout the year.

This can work out great for traders if they free up cash at the tops and buy again at the bottoms. Buying on the dips and locking-in profit when you’ve made 5 percent will likely prove to be a money making strategy for 2014.

Where the overall market might end the year up a mere 10 percent or so, locking in those short 5 to 10 percent bounces could add up to a good 20 to 25 percent by year’s end – doubling what you might otherwise have gained by simply holding.

Joseph Cafariello