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The Flower Has Not Wilted Sufficiently to Abort Recovery

12:00 AM, May 31, 2014 • By IRWIN M. STELZER
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Little ado about not very much. Markets yawned when the government revised its initial estimate of economic growth in the first quarter from a slight positive, +0.1 percent, to a non-trivial negative of -1.0 percent. There are several reasons that the first shrinkage of the economy in three years did not deter investors from driving share prices to record levels, defying the old injunction to “sell in May and go away.”

Federal Reserve

Federal Reserve

First, economic activity in the first quarter of the year was adversely affected by the refusal of the earth to warm: cold and snow kept consumers home, disrupted supply chains and forced workers to miss work. The White House was quick to point out that starting in December of last year key economic indicators dipped in response to the “disruptive effect” of “severe weather.” 

Second, and more important, most observers followed the sensible rule—when a number seems to be an aberration, disaggregate. The picture that process produces is not exactly one of unrelieved gloom. The main driver of the recorded shrinkage in the economy was a revision in the estimate of investment in inventory, which was originally pegged at -0.6 percentage point. The bean-counters’ final look boosted that volatile figure to -1.6 percentage point. Other components moved down a bit (a revised estimate of import growth being the most important), but the reversal of previous inventory build-ups was the main culprit.      

Third, Q1 shrinkage is the gloomy view in the rear view mirror, while the forward view through the windshield has actually turned brighter. Because inventories are lower than originally thought, companies have less merchandise in their warehouses and on their shelves, meaning that they will have to produce more to meet demand than forecasters originally anticipated. Goldman Sachs’ economists decided that lower inventory levels in the first quarter mean higher levels of economic activity in the current quarter, and revised their Q2 growth estimate upward by 0.2 percentage points to 3.9%, and many analysts and investors are expecting a strong second half to follow a good second quarter. Chris Williamson, Markit’s chief economist says, “current indicators suggest this [1Q decline] was merely a temporary setback in an otherwise ongoing robust recovery, pointing to a strong rebound in the second quarter…. [and] to the strongest expansion of business activity in over four years in May.... Manufacturers enjoyed the largest monthly increase in production since February 2011 alongside a service sector that was growing at the fastest pace since March 2012….” And the index of economic activity in the Chicago area shot up in May to its highest level in three years.

This uptick in the economy in recent months is reflected in the Conference Board’s consumer survey, which showed that consumers’ assessment of both the present situation and the future outlook improved slightly in May. So did the portion of survey respondents reporting jobs plentiful vs. hard to get. All in all, consumer confidence is close to the post-recession high it reached earlier this year.

Whether that confidence will be reflected in the housing market, which after the jobs market (report due this coming Friday) is the one on which the Federal Reserve Board’s monetary policy team is most focused, remains to be seen. If the Fed’s forecast of accelerating growth is to prove correct, which would be refreshing since the Fed has consistently over-guessed future growth one-year out by some 1.6 percentage points, according to the Lindsey Group, the housing sector will have to take the, or least a laboring oar. It is difficult to tell from press reports whether the sector is up to the job. On the same day the New York Times led its report with “Home Resales Rise, but the Pace Lags,” while the Wall Street Journal told its readers, “Housing Recovery Gains Steam.”

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