Last week’s final revision to first-quarter GDP showed a shocking 1.9 percent revision to GDP, to -2.9 percent from -1 percent. This final first-quarter GDP report compared with the initial report showing GDP growth of 0.1 percent, resulted in a total revision of -3 percentage points.
Stocks shrugged off this report because economists are convinced that the first quarter was an anomaly, due to harsh winter conditions that kept consumers from spending and companies from hiring.
This week’s employment report is critical because employment is the one variable economists are pointing to as supporting the economic rebound from the first quarter. Should this report disappoint, the argument that the first quarter doesn’t matter falls apart.
Real GDP declined 2.9 percent in the first quarter, after increasing 2.6 percent in the fourth quarter of 2013. According to the Bureau of Economic Analysis, “this downturn in the percent change in real GDP primarily reflected a downturn in exports, a larger decrease in private inventory investment, a deceleration in personal consumption expenditures (PCE) and downturns in nonresidential fixed investment and in state and local government spending that were partly offset by an upturn in federal government spending.”
Everything Rides on Employment Report This Week
The economy has added an average of 231,000 net jobs a month since February, marking the second best hiring period since the United States exited the recession in mid-2009. Economists are expecting a similar gain for June, with the June report coming Thursday, just prior to the Fourth of July weekend. Several other economic reports — including car sales, the U.S. trade outlook and several manufacturing surveys — are scheduled for release in this abbreviated week as well.
The U.S. economy is forecast to expand by 3.6 percent in the second quarter of 2014 and the increase in hiring is a key reason why economists polled by MarketWatch predict a rebound in growth in the second quarter.
Job creation was significantly weaker in the first quarter, especially at the start of the quarter. Economists blame the weakness, and the weakness in GDP growth overall, on extreme weather at the beginning of the quarter. But the U.S. economy also experienced lower exports, less warehouse restocking and a surprise decline in health-care spending, all of which contributed to the decline.
Some recent data suggest that companies have begun to ramp up production. The Institute for Supply Management’s (ISM) survey of top manufacturing executives, issued Tuesday, is expected to rise slightly in June from 55.4 percent for May. Any number above 50 percent means manufacturers are doing more business instead of less. A decline in this index may give economists and investors pause as they anticipate Thursday’s jobs report from the Commerce Department.
Interestingly, manufacturers have only added 46,000 new jobs since the beginning of the year, or just 4.3 percent of all new U.S. jobs created in 2014. One would expect manufacturers to increase hiring to reflect their increase in operations and the more positive outlook reflected by the ISM index.
A jobs report showing significantly fewer jobs added in June, compared with the 231,000 average for the previous four months, could send securities markets reeling. Stocks closed up 11 points (Standard & Poor’s 500) at the end of last week, compared with Tuesday’s close immediately prior to the GDP report release Wednesday morning. Investors clearly and completely ignored the GDP report, choosing to believe that second quarter GDP has been solid.
Despite the optimism of economists, some signs of economic weakness have appeared during the second quarter. Retail sales, the most direct reflection of consumer behavior, have declined for the past two months, and are at anemic levels. April retail sales grew by just 0.5 percent, a dramatic decline from the 1.51 percent growth of March. May retail sales again declined from the previous month, showing only 0.34 percent growth.
The U.S. trade deficit, the measure of U.S. imports less exports, has been growing steadily from the November low of just under $36 billion, increasing each month from December through April, with the most recent reading of about $47.25 billion. A trade deficit means that American companies are selling less to foreigners than U.S. citizens are buying from foreign companies.
Consumer prices have also been rising, to May’s 2.13 percent from February’s 1.13 percent growth. Rising consumer prices are a key indicator of inflation that the Fed uses to determine when to raise short-term interest rates.
James Bullard, president of the Federal Reserve Bank of St. Louis, stated last week that he believes the economy should grow at about 3 percent during the second half of 2014, and that unemployment should fall below 6 percent. He also said he believes that the Fed should begin raising short-term interest rates at the end of the first quarter of 2015, much earlier than the midyear expectations of most economists.
This week’s employment report will either validate the optimistic expectations of economists, supporting investor optimism and justifying lofty stock valuations, or, if it is disappointing, will cast serious doubt on the health of the economy and the stock market.
Since economists have placed so much importance on this report, it will be difficult for investors to continue to ignore signs that the U.S. economy is faltering, if the report is weaker than expected. Thursday’s jobs report will be followed by a three-day weekend, leaving investors with plenty of time to contemplate the significance of this report.
It is going to be a very interesting week indeed!