I’m back after the long weekend here in the US with a short post. Having pointed to the excesses in US credit markets on Friday, I should point out that the real economy in the US is doing pretty well at the moment. Markets can continue to rise on the back of this support.
The latest data point shows the Markit services PMI in the US at a 26-month high of 58.4 in May, up from 55.0 in April. There was a strong rebound in output and new business as well as a four-month high in job creation. 79.2% of respondents are showing positive expectations for future business. This series tracks well with US GDP growth.
On top of that, the latest S&P/Case Shiller Home Price Index figure shows a rise of 12.4% year-on-year, showing housing continuing to bolster household balance sheets. This is a principal reason we are seeing releveraging despite the lack of wage growth.
Calculated Risk was out with a post at the end of last week, highlighting a bullish outlook for Q2 GDP. While the –0.7% predicted revision for Q1 is even lower than the –0.4% number I had been seeing earlier, many economists are expecting a 3%+ number for Q2. Calculated Risk doesn’t give a number but uses this qualitative statement from Goldman:
Today we therefore ask whether our forecast that 2014-2015 will show a meaningful pickup in growth relative to the first four years of the recovery is still on track. Our answer, broadly, is yes. Although the weak first quarter is likely to hold down real GDP for 2014 as a whole, the underlying trends in economic activity are still pointing to significant improvement.
…
The basic rationale for our acceleration forecast of late 2013 was twofold—(1) an end to the fiscal drag that had weighed on growth so heavily in 2013 and (2) a positive impulse from the private sector following the completion of the balance sheet adjustments specifically among US households. Both of these points remain intact.
I agree with the reasoning here that the lack of a fiscal drag and releveraging will be important in moving GDP growth higher. However, I am sceptical as to how much higher. I am still pointing to Q3 2013’s 4.1% as a high water mark for growth in the US. And remember that this was followed by a 2.6% number for Q4. That’s well over 3% for one half year, due in large part to inventories.
Even if you get 3.5% for Q2, the average with Q1 at –0.7% is well below 2% growth, the number I am calling trend growth in the US. In fact, if the US economy grows 3% for the rest of the year, that gets you to about 2% real GDP growth for 2014, much lower than the 2013 second-half trend.
So, while we can expect the economy to pick up meaningfully, let’s be clear that this is not robust by any stretch of the imagination. Moreover, given the dynamics in the credit markets, robust growth would translate into an out-and-out bubble in credit markets and the frothier parts of the US tech sector. The latest I have heard is that Uber is now raising another pre-IPO round at a $17 billion valuation, that’s up from $10 billion just a few weeks ago. The Wall Street Journal says this valuation is so rich that some VCs are passing on the round, letting themselves get diluted. Imagine what kind of funding rounds we would see with 3%+ growth in the coming months.
Just tempering the optimism a bit, we are seeing a slight pickup in high yield default rates and in auto loan defaults as well. That says that the riskier market segments have some incipient weakness. At the same time, jobless claims are only running at 15-20,000 below year ago levels. That’s not a significant enough drop to mean we should expect 3%+ growth without some serious releveraging by households or capital spending by business.
Bottom line: I continue to expect 2%-ish growth in the US. This is decent, non-stall sped growth. But it is not the 3%+ that would definitely mean mania and bubbles, though it could do. I expect the taper to continue in the face of this outlook. We will have to see whether the economy holds enough that the Fed does raise rates in 2015.