One year ago, all was right in the world. Jobs were being created. Annualized GDP growth averaged an impressive 4.4% between the end of 2009 and the beginning of 2010. The Federal Reserve even felt confident enough to allow its first round of quantitative easing to expire.
Then we had a growth scare as risky assets tumbled in the wake of the eurozone debt crisis and the Greek bailout. As a result, GDP growth slowed to just 1.7% in the second quarter amid talk of a double-dip recession.
History is repeating itself. The Fed's QE2 program is about to end. The eurozone crisis is heating up, with Greece on the verge of a debt default/restructuring. And now we have fiscal austerity and inflationary pressure -- side effects of all the stimuli used to juice the economy. I think the stage is set for another slowdown in the months to come. Indeed, by some estimates, the economy may already be shrinking.
All of this is happening just as the policy supports we've enjoyed are about to be removed. With America's credit rating threatened and the debt ceiling looming, Washington will be forced to enact deep spending cuts and painful tax hikes (see my column on the subject here).
As a result, economists up and down Wall Street are marking down their Q1 growth estimates. Barclays Capital is looking for 2% growth. Standard Charted is looking for sub-2% growth. Societe Generale is looking for 1.25%. UBS is looking for 1%. This is well off of the 3.1% growth seen in the fourth quarter of 2010.
Paul Ashworth and his team at Capital Economics are among the more pessimistic, looking for growth "no higher" than 1% as shown above. And although the he notes the consensus estimate is higher, Ashworth believes the risks to his estimates are to the downside and "can't completely rule out an actual decline in GDP." He points to a slowdown in consumption growth, a possible drop in business investment, and a big drop in the external trade balance.
Much of this is due to higher inflation. Higher prices are pushing up the costs of goods and pushing down real wages. In other words, consumers with thinner pocketbooks are being asked to pay more. And higher fuel prices is pushing up the cost of imports (mainly oil), reducing the contribution of net exports to growth.
The Q1 growth estimate markdowns started last month. So it could be argued that this is already priced in to stocks and commodities. And if so, investors believe this is a temporary slowdown. Adam Parker, Morgan Stanley's equity strategist, notes that because of these expectations, "pressure on a Q2 economic rebound is mounting, an event that is far from certain."
Unfortunately, recent data suggests that the Q1 slowdown is continuing into Q2.
Initial weekly jobless claims have climbed back over 400k after hitting a low of 368k in early March -- suggesting the job market has hit a soft patch. And today's Philadelphia Fed manufacturing survey plunged to a five-month low of 18.5 in April -- down from 43.4 in March and suggestive of a slowdown in factory sector activity.
Ashworth notes that the Philly Fed data corroborates a similar drop off seen in manufacturing surveys from other countries, meaning that the slowdown is global and is likely related to supply chain issues out of Japan.
And even as the new orders, shipment, and employment sub-indices declined the prices received index climbed sharply in a sign inflation continues to rage. This is all very stagflationary.
For now, stocks and commodities are powering higher as investors enjoy the tail end of the Fed's $600 billion QE2 money-printing initiative. But beneath the surface, in realization of the growth slowdown ahead, investors are beginning to take risk off the table as defensive, non-cyclical sectors like healthcare and consumer staples begin to massively outperform with the likes of Johnson & Johnson (JNJ) and Philip Morris (PM) leading the way .
This is late-stage bull market behavior. How else can you explain the obsession with Band-Aids and cigarettes? This warned of trouble when it last happened in 2007. And it's a bad omen for what comes next.
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The author can be contacted at anthony@edgeletter.com and followed on Twitter at @EdgeLetter. Feel free to comment below.
You have to be joking, right?
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