One Negative Quarter Does Not Make A Recession

Includes: DIA, IVV, SPY
by: Calafia Beach Pundit

Real growth in the first quarter was revised down to -1%, more than expected (-.5%). The economy shrunk by about $40 billion in the first quarter, which in the great scheme of things is equivalent to a rounding error. These things happen occasionally, as you can see in the chart below. It hasn't been a jolt to the equity market because it was most likely only a temporary dip in economic activity.

The thing to focus on is not the weak first quarter, which is almost certainly weather-related, but the indicators that show the economy is very likely continuing to grow at a 2-3% pace. As a supply-sider, I think the things that drive growth are changes in work, output, incentives and investment. A quick look at key indicators of the supply-side of the economy shows everything still pointing up.

First-time claims for unemployment last week fell to just about their lowest level ever: 300K. If the economy were unraveling, businesses would be stepping up the pace of firings. Instead, the pace of layoffs is about as low as it has ever been.

With the expiration of "emergency" unemployment benefits early this year, there has been a huge increase in the incentive for the unemployed to find and accept a new job. In the past year, the number of people receiving unemployment insurance has dropped by almost half (-46%). So far this year, 2.2 million people have lost their long-term unemployment benefits. This is a significant change in incentives on the margin that will most likely work to strengthen the economy.

Industrial commodity prices have been rising for the past eight months and are at relatively high levels from an historical perspective, suggesting that global industrial activity continues to improve.

U.S. manufacturing production rose at a 2.8% annualized pace in the first four months of this year.

The private sector added 840K new jobs in the first four months of this year. That works out to about a 2% annualized pace, which is in line with the trends of the past several years. With average productivity gains of about 1% per year, this pace of jobs growth can deliver 3% real growth over time.

Bank lending to businesses - presumably to finance expansion plans - is up at strong double-digit rates so far this year. Outstanding C&I loans have increased by $90 billion year to date (through mid-May), as shown in the chart above. Banks are more willing to lend and businesses are more willing to borrow; that's a good sign of rising confidence and a leading indicator of more jobs to come.

Capital goods orders - a good proxy for business investment - are up this year, and have been rising at about a 4% annual pace for the past year.

Corporate credit spreads are at post-recession lows. The bond market does not reveal any concerns about the future of corporate profits. Moreover, swap spreads, an excellent and leading indicator of systemic risk, are very near all-time lows.

First quarter growth was disappointingly slow, but that was very likely just a temporary, weather-related dip in economic activity. Key indicators of current and future growth remain positive. Growth is likely to rebound in the current quarter.