No Denying Anymore

This GDP uptick isn't a fluke. I'm expecting this growth spurt to extend into the fourth quarter in the same 3.0%-4.0% range, driven by continued increases in auto production, inventory restocking, stimulus spending, and higher exports. The naysayers' chorus has tempered its tune somewhat, but the recovery's chief skeptics aren't ready to throw in the towel just yet. Their new mantra is that the economy's seemingly effervescent third-quarter robustness is nothing more than a fleeting mirage, a shallow side-effect of government-induced smoke-and-mirrors therapy such as the Cash for Clunkers program. When those programs end, they preach, we will surely fall back into the abyss. I say not.

Government: The Only Source of Better Results? No!
The bear argument is that any improvement we've seen is the outgrowth of large government programs and a willing Federal Reserve. While the programs have provided a substantial psychological lift, they haven't added that much to economic growth. Auto sales slumped back after the Cash for Clunkers program ended, but demand remained above the early 2009 trough even during September. October is likely to be substantially better than the Cash for Clunkers-afflicted September period based on weekly sales reports. Furthermore, it is auto production, not retail sales, that drives economic growth. Production has substantially lagged sales for most of this year, and I expect auto production to show new life again in the fourth quarter. Auto production has shown meaningful improvement for most of the year.

On the housing front, the $8,000 home-buyers credit helped, but many of the buyers would have bought their houses even without it. The big stimulus bill has yet to set the world on fire. A lot of the stimulus infrastructure spending has yet to occur, and some of that may just replace cash that would normally be spent by the state governments. Low rates from the Fed have certainly given a boost to housing affordability, but factors other than the price of credit have kept a lid on housing demand, especially at the higher end of the market. Instead of low rates generating strong demand for interest rate-sensitive sectors such as housing and autos, it appears a lot of the extra Fed cash found its way into the financial and commodity markets.

GDP Results Driven by Consumer, Higher Production
The 3.5% increase in GDP was impressive. It marks the first time in the past four quarters that GDP has swung to the plus column. Even more remarkable was the breadth of the improvement. Consumer spending was up, exports were up, autos were up, federal spending was up, and even residential housing was up. The imports number, due to increased auto imports resulting from the Cash for Clunkers program, was the sole large detractor to quarterly GDP growth. Business investment (a huge negative in past quarters), and state and local government spending both had very modest negative impacts on the quarter. Increases in consumer spending, about a third of which was auto related, and a slower drawdown in inventories (as manufacturers stepped up production) were by far the largest contributors to the quarterly results.

Manufacturing Jumps; Housing Takes a Pause; Incomes? Better Luck Next Week
In other news, the Case-Shiller Home price indexes registered another month of improvement, durable goods orders registered a healthy 1.0% increase, and the University of Michigan consumer sentiment index declined considerably less than the initial mid-month estimate. The Michigan Survey came in at a respectable 70.6 for the final October reading (the mid-month, preliminary estimate was in the mid-60s--yikes!), but still down from 73.5 the prior month. Confidence numbers in the low 70s are consistent with 3% year-over-year growth in consumer expenditures that we haven't seen, at least not yet.

Initial jobless claims were down by just 1,000 and the four-week moving average is continuing its downward trudge at a slightly faster pace.

Most disappointing this week was news that real disposable income ticked down 0.1%, its fourth consecutive monthly decline. Remember, this reading is for September and is one of the last readings to be announced for the prior month. The result isn't surprising given that employment and hours worked were both weak for September (and announced many weeks ago).

Given the strong ramp-up in production during October, I suspect that this month's hours worked, employment levels, and incomes will all look marginally better. (Employment and hours for October are due next week). Part of my optimism is based on strong regional manufacturing survey results. The Chicago Fed Manufacturing Index leaped to 54.2, up from a reading of 46.1

Offsetting this sunny report was gloomier news about home sales, which showed a 3% decline for September. Our housing analyst, Eric Landry, has been warning for some time that uncertainty about the extension of the first-time home buyers credit was likely to play havoc with new home sales trends for some time. As a general comment, I am not expecting housing to be either a big plus or a big minus for the rest of the year because of normal seasonal patterns, uncertainty regarding the home buyers' credit, and the need to digest the last six months of improvements. News on consumer spending and exports will be far more important drivers in the months ahead, not real estate or manufacturing figures.

All Eyes on Employment
Next Friday brings the overall employment report for October, the single most closely watched economic indicator. During September, we lost more jobs than I had anticipated, but I am thinking that increased manufacturing activity for October should produce at least some improvement this month. I think we have a good shot at keeping job losses under 200,000. I will be paying particular attention to the number of hours worked. As an economist, I am indifferent as to how more money gets into consumers' hands, whether by the same people working longer hours, or more workers putting in the same number of hours each. As a citizen I would love to see more people working, and hopefully we will get a little of each.

The ISM National Purchasing Managers' Survey is also due next week. Last month, the number decreased to 52.6 from 52.9, a move that I view as statistical noise that spooked the market. Based on the regional surveys I have seen, I expect to see a resumption of the upward trend during October. The new orders components of the regional surveys were particularly strong, along with big jumps in current production levels. Unfortunately, the employment portions of the survey were still nothing to write home about. Stay tuned for next week's data.

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