US Week in Review

Strong mid-month auto sales and good shipping data out of both FedEx and the American Railroad Association were the highlights of last week's economic statistics in the US. More conventional data, including industrial production, consumer and producer prices, and housing starts, were all benign and in line with modest, weather-afflicted expectations.

I strongly believe that the US economy is beginning to pick up steam. This will become much clearer when we begin to see March data and some of the weather-affected February data moves into the rearview mirror.

I am now raising my GDP growth forecast for 2010 to 4.5% from my previous estimate of 4%. It now appears to me that real GDP growth in the first quarter is likely to exceed 4% or so overall, with more of the improvement coming from the consumer when compared with the December quarter. Both these figures compare with a general consensus of just 3% for the quarter and the year, and the Congressional Budget Office's forecast of just over 2%.

Recovery Cycling Sector by Sector, Producing a More Sustainable Upturn

To put the growth rate in perspective, the US grew 2.2% in the third quarter of 2009, 5.9% in the fourth quarter, and now I expect 4% growth for the first quarter of 2010. Overall, it now looks as though GDP will grow almost 4% during the first year of the recovery (the recovery will be one year old in June 2010, according to my reckoning). That would be a stronger recovery than either the recovery from the 1990 recession or the 2001 recession, but still below the average recovery of 5%.

The good news about the modest recovery is that there are still a lot of portions of the economy--including housing--that are only now starting to bounce back. Even as consumer consumption rates approach their old highs, manufacturing has yet to fully catch up. The consumption gains that we've seen thus far have been fuelled by very modest income gains and by very large stock market gains. We have yet to see any benefit from employment gains, which should be just around the corner (my best guess is a six-figure job growth number for March that will be reported in early April). So while we have made a lot of progress, I still think this economy has long legs into 2011.

1Q GDP Growth More Balanced than 4Q

While the overall rate of GDP growth will be slower in the first quarter than the fourth, it will be deemed higher-quality growth by Wall Street. I think consumer spending in the first quarter could be as high as 3%, driven by stronger auto sales and better retail sales in general compared with less than 2% consumer growth in the fourth quarter. Inventories are also likely to provide another positive contribution, albeit probably not as large as in the fourth quarter. Business investment should be another positive factor for first-quarter results.

Auto Sales and Production Are Heating Up

Earlier in the month, I still felt a bit torn about raising my economic growth forecast, but last week's news from the auto industry pushed me over the edge to increase my estimate. A combination of better weather, the availability of more auto leases and loans, and some Toyota promotions caused industry analysts to raise their forecast March sales level to over 12 million units on an annual rate basis compared with less than 10 million units a year ago. In fact, other than the August 2009 Cash for Clunkers surge, auto sales are now higher than at any time since September 2008.

Improving Sentiment by the 90% of the Employed Population Drives Recoveries

As important as the raw numbers are, the improving consumer sentiment is probably even more significant. Since new cars are expensive, consumers' willingness to open their wallets for them indicates rising confidence better than any consumer survey. This is on top of recent improving retail sales reports. Weekly shopping centre data dropped back only modestly last week after an enormous surge the prior week, showing the huge move was not some easily reversed fluke.

It bears repeating: The 90% of the consumers who have jobs will determine our economic future. Consumers with jobs, spending more of either their savings or their pay cheques, ultimately lift the economy out of a recession.

Signs of Life in the Transportation Sector

The transporters that have been laggards this recovery are showing a bit of life as more goods are being made from scratch and fewer are shipped out of inventory. The American Association of Rail reported that rail car loadings were up from the year-ago period for the third week in a row. The improvement was broad-based as well, given that 13 out of 19 categories showed gains. The expansion comes even as the shipments of coal remain severely depressed by a combination of weather, high utility inventories, and low natural gas prices.

FedEx also reported better package shipments during last week's quarterly conference call. Chairman Fred Smith declared, "A recovery is well under way." Interestingly, he also supported my thesis of consumer spending being better than many economists believe. He offered, "Though consumer spending remains cautious, US retail sales are improving. The improved consumer spending that began in late 2009 continues into this year."

The firm also noted the reinstatement of some previously frozen benefit programmes and increased capital expenditures. A lot of the FedEx commentary and data follow the roadmap for how the overall economy will get better: More consumer spending, followed by more industrial spending, followed by more capital expenditures and employee wages and/or benefit increases.

Inflation Tame for Now

On the inflation front, both consumer and producer prices came in modestly lower than expectations. On a short-term base the CPI was flat, while the PPI actually showed a small monthly decline. Given that some of the goods measured in the PPI eventually get turned into consumer goods, the short-term outlook for inflation is somewhat muted. In the short run, low rents, which make up a sizable portion of the CPI, are keeping a lid on the reported number. However, low prices were not the rule. Medical expenses, autos, and a few other categories continued to show meaningful increases. While special factors will keep inflation mercifully subdued in the short run, my forecast of stronger economic growth along with past growth in the money supply could lead to inflation closer to 3% by the end of the year.

Industrial Production: A Short Pause for a Snowstorm and Toyota

Industrial production for our snowy February managed to eke out a very tiny gain in February and managed to better beat-down expectations. Eric Landry of our industrials team wrote:

"February industrial production (IP) figures logged a weak 0.1% increase from January's downwardly revised figure on Monday. Mining and utilities were up 2.0% and 0.5%, respectively, weighed down by manufacturing's 0.2% decline. In all, the results were slightly better than most hoped for, as many were correct in thinking February's unseasonably wicked weather and Toyota's troubles would have outsized negative impacts. The latter helped contribute to the automotive products' 4.4% decline from January, which in turn fuelled a 2.3% decline in consumer durables. Construction was up a seasonally adjusted 0.3%, after a 1.1% increase in January."

Given a very strong ramp-up in auto production, I suspect this number will pop back to something closer to 1% for March. Industrial production has thus far only recovered about a third of the business lost during the recession, potentially providing more fuel to the recovery in the months ahead.

On Deck: Housing Data and Durable Goods

New and existing home sales are due this week and are expected to be relatively flat with a month ago. Poor February weather and poor pending home data (which lead existing home sales by a month or two) point to yet another month of lacklustre results. March and April should begin to look better as the weather improves and the impending threat of the expiration of the homebuyers' credit should push the March and April numbers up a bit. The February real estate data, good or bad, aren't particularly meaningful.

The consensus estimate for durable goods is for a 1% increase, with or without the volatile transportation sector. Both the national and regional purchasing managers' surveys from the ISM showed that orders grew in February, but at a slower pace than January. Therefore, the 1% figure looks just a little optimistic to me. Again, poor weather and Toyota issues are probably bigger drivers of so-so results and don't indicate any impending problem.

Robert Johnson, CFA, is associate director of economic analysis with Morningstar.