2.4% GDP Growth Predicted For Q1 2018

ECRI Index Declines Slightly

As you can see from the chart below, the weekly ECRI index’s growth rate fell slightly from 5.4% to 5.2%. The longer it stays in the mid single digits, the better. This implies the 2^nd half of 2018 will see strong economic growth as there will be a re-acceleration after a modest first half. This indicator currently has tough comparisons just like the overall economy. A 2 year stack of double digit growth is a good sign. It appears that the Japanese and European economies are weakening more in Q1 than America, but the U.S. still will see some deceleration from the rapid 2.9% GDP growth rate in Q4.

Latest GDP Forecasts From The Regional Banks

As you can see from the chart below, the Atlanta Fed’s GDP Now forecast has moved up from 1.8% to 2.4%. It has been one of the weakest forecasts. As you can see, the blue chip expects 2.5% growth. The Atlanta Fed’s forecast improved because the forecast for inventory investment’s contribution to Q1 GDP growth increased from 0.66 points to 1.21 points after the wholesale and retail inventories report. If growth is only occurring because of a buildup in inventories, that’s a bad sign because the demand won’t be there to eat up the supply. Eventually, discounting will need to occur to get rid of the supply. This inventory buildup could mean weaker growth in Q2 because less inventory will be bought. Despite the holiday on Friday, neither the St. Louis Fed nor the NY Fed updated their Nowcasts ahead of time. I’ll review their estimates next week.

Inflation Is Still Modest

It’s interesting that the core PCE data is what the Fed focuses on the most and it is the most delayed. The report for February came out on Thursday even though April is a few days away. The month over month change in personal income was up 0.4% which met expectations and was the same as last month. The month over month consumer spending growth was 0.2% which met estimates and was the same as last month. This is a good report considering the fact that retail sales saw a month over month decline. Consumer spending will be critical to GDP growth as always.

The PCE price index was up 0.2% month over month which met estimates and was below the 0.4% growth in the prior month. This slowdown in inflation in February is consistent with this report. The core PCE was up 0.2% month over month which met estimates and was below the 0.3% growth last month. The PCE was up 1.8% year over year which beat the consensus and prior growth rate which was 1.7%. As you can see from the chart below, the year over year core PCE was up 1.6% which beat the estimates for 1.5%. The core PCE growth is at the same level when the Fed started this hike cycle. There have been cyclical shifts, but it’s still not at the Fed’s 2% target. I don’t see the need to hike rates four times if the inflation isn’t at the Fed’s target. That being said, if the Fed would have only hiked rates when the core PCE growth was above 2%, we’d have seen 0 hikes in the past 2 years. The latest Fed funds futures are pricing in a 97.9% chance of no hike at the meeting in early May. The chance of 4 hikes is about the same as 2 hikes as the Fed fund futures have become slightly more dovish in the past few weeks because of the stock market correction.

The chart below shows the breakdown of the core PCE growth. As you can see, the services inflation is the biggest driver of inflation. The housing services has been decelerating while the healthcare services inflation has been accelerating. Transportation has been flat for years and the core goods inflation has been negative for years.

Jobless Claims Move Lower

The jobless claims have done the impossible as the latest report shows they fell to 215,000 last week from 227,000 in the prior week. This report was below the consensus for 228,000 and below the lowest estimate which was 220,000. This report is the lowest level of claims since 1973. In 1973 the labor force had 87 million people. Now the labor force has 162 million people. Therefore, this report is about half that of the 1973 report when you adjust for the size of the labor force. The reason these results are impossibly small is there are a lot of new workers who weren’t considered part of the labor force and not part of the unemployment claims report. There is virtually no one filing for unemployment insurance. The people coming off the sidelines haven’t had a job in years.

Latest Correction Is Only 60 Days Old

For corrections throughout history, this one is longer than usual. However, for this bull market, this correction is still in its infancy. As you can see from the chart below, the average correction in this bull market has lasted 200 days. That’s because the 2015-2016 correction was 417 days. The shortest correction was in 2012 as it was 97 days. My forecast remains that this market will be range bound for the next few weeks. It won’t be shorter than 97 days. It’s amazing how quickly the sentiment has shifted in just 2 months. Sentiment is far from capitulation, but it’s no longer euphoric which is an accomplishment.

Conclusion

I’m with the consensus which is expecting 2.5% GDP growth. I’m expecting growth less than the 2.9% rate seen last quarter. Based on the ECRI report, I think the economy will accelerate in the next few months. When better economic data appears, the stock market should make new highs. The current hope for the bulls is that the Q2 earnings season saves them. It doesn’t start for another month, but I’d argue it has already saved the market. It would be down more than 10% if earnings were weak. It is providing downside protection rather than acting as a catalyst for upside.