GDP numbers were released on Wednesday for the first quarter and confirmed what we expected…the U.S. economy stalled as harsh winter weather curtailed business investment and weakness overseas hurt exports. U.S. GDP grew at a mere 0.1% pace in the first quarter, compared with a 2.6% in the fourth quarter of 2013. It was the weakest quarter for growth since the economy emerged from recession 5 years ago and was well below consensus estimates of 1.2%. The weather slowed consumer spending on goods, which rose at a 0.4% during the quarter, but households spent more on services-including energy to heat their homes and health care-causing total consumption to rise at a 3% pace. However, business investment dropped at a 2.8% annualized rate, the weakest print since the fourth quarter of 2009, reflecting a smaller gain in inventories that cut 0.6% from growth. Exports plunged 7.6%, the largest drop since the recession ended. Federal spending made a positive contribution to growth for the first time in six quarters. Despite the weaker-than-expected report, we expect a sharp rebound in growth in the second quarter as the weather improves, with the economy growing at over a 3% pace for the remainder of the year.
The Federal Reserve sticks to their Game Plan:
The Federal Reserve voted unanimously this week to further scale back its bond-buying program as Fed officials looked beyond Wednesday’s dismal first quarter GDP report in a sign of confidence for economy’s prospects. In the post-meeting statement, the Fed said that “growth in economic activity has picked up recently, after having slowed sharply during the winter in part because of adverse weather conditions.” The central bank said that household spending “appears to be rising more quickly,” while also acknowledging recent weakness in housing and business investment. All told, the Fed trimmed its bond buying program for the fourth consecutive meeting, cutting the pace of monthly purchases by an additional $10 billion to $45 billion ($25 billion in Treasuries and $20 billion in mortgage debt). The FOMC said that it will reduce asset purchases “in further measured steps at future meetings.”
The Fed also maintained its forward guidance on interest rates repeating that it’s likely to keep the benchmark Federal Funds Rate near zero for a “considerable time” after the bond purchases end and saying that it will consider a “wide range of information” in deciding when to raise rates. All nine voting members of the Committee supported the decision. It was only second time since 2012 that the FOMC has voted unanimously for a policy move, representing an unusually high degree of consensus for Fed officials who have often been divided since the financial crisis.
Business Hiring Improves:
Americans gained jobs at the fastest pace in more than two years last month and the jobless rate plunged, a sign the economy has rebounded from a winter rut. Non-farm payrolls rose 288,000 over last month, which shattered the consensus estimate of 215,000. While the number was good, economists question how much of that number comes from “catch up” hiring from the harsh winter, and how much is “organic” growth. The unemployment rate fell sharply to 6.3 percent from 6.7 percent in March. The consensus forecast estimate was 6.6 percent. However, much of this drop in the unemployment rate came from a large number of people leaving the labor force.
“Made in the USA”
Boston Consulting Group released the results of a survey of global manufacturing competitiveness this week. The ranking of the competitiveness of the world’s top 25 exporting countries concludes that the United States is the “rising star” of global manufacturing thanks to falling domestic natural gas prices, rising worker productivity and a lack of upward wage pressure. While China remains the world’s #1 country in terms of manufacturing competitiveness, its position is “under pressure” as a result of rising labor and transportation costs and lagging productivity growth. China’s manufacturing cost advantage over the U.S. is now less than 5%, according to the study.
The U.S. is now #2 in terms of overall competitiveness. Overall costs in the U.S. are now 10% to 25% lower than the world’s ten leading exporting nations, excluding China. Equally startling is the deterioration in the competitive position of some developing countries that traditionally have been regarded as low-cost manufacturing hubs such as Brazil and Poland.
This has profound implications for U.S. businesses and may accelerate the “re-shoring” trend we have seen in the past few years, where U.S. companies bring manufacturing back to the U.S.
Our economic and market outlook remains positive for the remainder of 2014. Growth could accelerate more quickly than anticipated toward the later part of the year. This would be the key driver for valuations to remain attractive going into 2015. Historically, markets move beyond fair value during the recovery stage after a severe market correction like we had in 2008. The S&P 500 currently trades at a forward Price to Earnings Ratio (P/E Ratio) of 15. With low interest rates and low inflation expected to continue in the near future, we could see P/E Ratios up to 20 in this environment.
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