So now that the price of crude oil has fallen from its record highs, the markets can start to feel good about themselves again, right? Wrong. Now the markets can go back to worrying about the same thing they were worrying about before oil started soaring: namely, the U.S. economy.
After some strong signs of growth in the spring, the American economy has been posting lacklustre numbers of late, including lower-than-expected employment growth, a fall in housing sales, anemic figures for industrial activity and this week's underwhelming GDP performance, among others.
Federal Reserve Board chairman Alan Greenspan has called this a "soft patch," a term bullish economists are clinging to like a life raft. But that raises two questions: What does "soft" mean, and how long is a "patch?" The answer could determine whether investors are in for a brief mushy spell or a moribund period that lasts into next year.
The gross domestic product report for the second quarter was probably the biggest economic news this week, and it left a lot to be desired. Annualized growth of 2.8 per cent was a little better than consensus estimates of 2.7 per cent, but that doesn't change the fact that it was down sharply from 4.5 per cent in the first quarter and was the weakest pace of growth since the first quarter of 2003.
Two major factors affected the GDP report: a slowdown in spending by consumers and a rise in the already gargantuan U.S. trade deficit. Consumer spending only rose at an annual rate of 1.6 per cent -- the slowest rate since the second quarter of 2001 -- and the trade deficit jumped to an annualized level of $588-billion (U.S.), which carved about 1.5 percentage points off the GDP.
But the GDP was hardly the only number with a black (or at least grey) cloud over it. The Philadelphia Fed survey of manufacturers, or Philly Fed for short -- a precursor to the larger Institute for Supply Management survey -- also showed weakness. It fell to 28.5 in August from 36.1 in July. Ian Shepherdson of High Frequency Economics said the details of the report showed "a clear August softening" in manufacturing activity.
Even more ominous, two indicators that have a good track record of foreshadowing the economic future also came in fairly weak. The U.S. Conference Board's leading economic indicator (LEI) fell in July for the second month in a row -- the first back-to-back decline in more than a year -- and a weekly economic index compiled by the Economic Cycle Research Institute shows U.S. growth declining to zero. That's right: zero.
Lakshman Achuthan, the managing director of the ECRI, said the data show "the predicted slowdown has begun, and while no new recession is in sight, evidence of a rebound in growth remains elusive." The ECRI also pointed out that its weekly leading index has been predicting an economic slowdown since the spring.
Economists at TD Securities said the GDP figure was nothing to worry about because "it is backward looking, and Greenspan has already indicated that he views softness in the quarter as being transient." Merrill Lynch, however, said "the reality is that [GDP] is on a softer path now than it has been for the past four to five quarters, and the consumer, despite [the] upward revision, still came in slower than many were expecting."
Merrill Lynch chief economist David Rosenberg also noted that the ECRI and Conference Board economic indicators tend to lead GDP by a couple of quarters, and historically have a better than 70-per-cent accuracy rate in predicting the future health of the economy. Thus, he said, "the current story still has the third leg to play out, which could well take us through into 2005."
What the GDP and other reports show, Wells Fargo economist Scott Anderson said, is that "the fastest growth of the recovery may already be behind us, and the probability that the economic soft patch may turn into a brier patch has increased." Lehman Brothers recently withdrew its call for above-trend growth in the United States, and said it believes the Federal Reserve will hold fast on interest rates in December as a result of weakness.
And so the markets are left still pondering: What exactly does "soft" mean, and how long is a "patch?"
