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June real trade balance

When the second quarter real GDP report was published I saw that trade made a major contribution to growth — exports contributed 1.12 percentage points of the 4.1% real GDP growth.  But that seemed like some sort of fluke produced by unusual conditions rather that what trend growth would generate.  Moreover, the BEA estimate was based on only two months actual data and the other month was a BEA “guesstimates”.  So new data was quite likely to generate large changes in reported real  GDP. June data was released this morning at the same time as the unemployment report, so it did not get much attention. Real exports increased and real imports imports declined. Both moved back toward their intermediate growth trend.

The trade balance is the difference between two very large numbers so that small changes in either series can generate very large changes in the trade balance.  The June real trade deficit was $ 7.9 ( B 2012 $ ) as compared to $7.7 ( B 2012$)  in April and  $7.5 ( B 2012 $) in May. The June trade balance is about where is was at the end of the first quarter.  So when the 2nd quarter real GDP is revised the major contribution from trade is likely to be revised down significantly.

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Revised real GDP growth

Along with the second quarter GDP report the BEA also published the results of its regular revision of the last five years of data.  The most significant revision was to the measure of price changes in the high tech arena. This showed that business investment had been somewhat stronger than previously reported, but it only had a very minor impact on real GDP growth.

The chart shows the year-over-year growth in real GDP over the 2012 to 2017 period with the revised data.  I doubt if you will see this data published by the Republicans.

Revised YOY Growth 2012 to 2017

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In a low inflation world firms tend to raise prices once a year — typically in the first quarter or the first quarter of their fiscal year. Consequently, over half of the annual increase in the not seasonally adjusted core CPI occurs in the first quarter and doubling the first quarter increase gives an amazingly accurate estimate of the annual rise in the core CPI.

Figure 1

This year the first quarter rise in the not seasonally adjusted core CPI was 1.2% as compared to 0.9% in 2017. This implies the core CPI will be up 2.4% in 2018 versus 1.8% last year. This would be the largest annual increase in the core CPI in a decade.

Figure 2

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Trump’s job creation record

Trump and his administration love to brag about the number of jobs created since he became president.  But the only reason he gets away with claiming that a record number of jobs have been created since he took office is the poor job the press does reporting economic data. It only takes a quick glance at the data to see that job creation under Trump has been essentially identical to Obama’s record during the expansion phase of this cycle.  Excluding the Great Recession and the bounce back from it assures that the comparisons of the two presidents record are of what happened in the expansion phase of the cycle. So both records is of job creation under essentially identical economic environments.


Figure 1

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Import and export growth and an expanding trade deficit do not need a strong dollar.

Import and export growth and an expanding trade deficit do not need a strong dollar.

We have had some discussions about dollar weakness and questions for those of us who expected the federal deficit to lead to a larger current account deficit through a strong dollar.

I’ve looked at the data in a different way and now wonder if we really need a change in the dollar to achieve a larger current account deficit.   If you look at real imports and exports you see that real imports are now 155% of real exports and the basic trend is for imports to grow much faster than exports.  Since 2013, real import growth has averaged some 3.4% annually while real exports only grew at about a 1.5% annual rate. If you project these trends out it implies that the real trade deficit would expand about 6% annually, or about a half a percentage point per month.

Interestingly, over the past year or so non-petroleum import prices have grown some 1% to 2% annually, or about the same  rate as domestic prices. So  there has been no significant changes in import prices relative to domestic prices.

So at least from this perspective I would expect  imports market penetration to continue expanding.   After all, in the overall trade balance, steel and aluminum tariffs — especially with major exceptions, like Canada — are not large enough to make much difference.

Figure 1

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Stocks have gone from overvalued to fairly valued.

With the market falling like it did over the past week it may prove valuable to look at the PE and some other economic reports.  In my PE model the market became overvalued in December and January.  The last observation is at the market close on Thursday, 8 February 2018. the previous two observation are the end of December and January values.

Notice that the PE did not rise until December . As of November, 2017 the market PE was still below where it was when Trump was elected.  If the market rallied because investors expected higher future earnings because of the tax cut, it did not show up in the PE until the tax bill was actually passed.  The usual rule is to buy the rumor and sell the fact.  But given Trumps record, it was understandable that investors were not willing to pay up for stronger earnings until the legislation was actually signed into law.

Most of the market rally for a year after Trump was elected reflected double digit earnings growth rather than  a higher PE as investors started discounting stronger earnings.  Now, we have a divergence in earnings expectations as the top down strategists and economist expect the tax cut to generate double digit earnings growth in 2018.   But the bottoms-up analysts only expect modest earnings gains. Analysts expectations are driven largely by company guidance. This divergence may suggest that corporate America is not as bullish as Wall Street has been the last few months.

Generally ignored because of the jobs report,  productivity was reported the same day as unemployment, and it was very weak.  As a consequence, the spread between unit labor cost and prices — the nonfarm deflator– narrowed sharply. This spread is the dominate determine of profit margins and is a leading to concurrent  indicator of earnings growth. It implies that earnings growth will be quite weak over the next few months.  Right now there seems to be two views on 2018 profits growth.  Economists and strategist expect the tax cut to lead to double digit earnings growth in 2018 while  analysts expect single digit earnings growth.  Analysts bottoms-up forecast are driven largely by management guidance.  So this divergence between analyst and economists may imply that corporate management may not be as bullish on the economy as Wall Street.

Moreover,my bond model implies that bond yields should be rising.  Rising rates are especially hard on the market when the market is overvalued. So you are faced with an market where rates are rising and earnings expectation are falling.

Finally, the dollar is weak despite the point that interest rate spreads between US and foreign rates are rising. Historically, the combination of rising interest rate spread and a falling dollar is a very bearish development.

The bottom line is that this market fall is being  produced in Washington. Over the last six years under Obama we had a combination of easy money and tight fiscal policy as the Republican Congress implemented restrictive fiscal policy– the deficit fell from near 10% of GDP to about 3%. –and the Fed offset it with  easy money.  But now, Congress is implementing easy fiscal policy when the economy is at or near full employment and the Fed is being  forced to offset it with tight money policy.  The agreement to give the Republicans the expanded military spending and the Democrats the expanded social spending they want is a repeat of the guns and butter policy under President Johnson. But now, the US is dependent on foreign capital inflows to  finance the deficit and the weak dollar implies that the foreign capital is not forthcoming at current interest rate spread.

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Trade in the GDP accounts

Trade was a significant factor in the weak GDP report today and as usual when this happens you see many comments that do not understand why imports are a negative in calculating GDP.

We do not directly calculate GDP.  Rather, we calculate consumption and adjust that for trade and inventories to obtain GDP indirectly.  To go from consumption to production in the US we have to subtract imports because they were not produced in the US.  However, imports show up twice in the GDP accounts.  They show up once in final demand –consumer spending, government spending or investments.  So for example if you buy a Volvo, which are not yet built in the US,  it will  be recorded in both personal consumption expenditures as a positive and in trade as an import.  So when you subtract imports all it does is offset the positive contribution recorded  in final demand.   So your buying a Volvo will have a zero impact on GDP, which is the way it should be because GDP is a measure of what is made in the US.  Most people, like Larry Kudlow on CNBC do not seem to understand this and  keep saying this it is a mistake to subtract imports.


Their is another big difference in how trade is treated in the GDP accounts.  Final demand –personal consumption expenditure, government spending and investments –is calculated as the average of the three months data that is reported monthly.  But trade is calculated as the difference between what it was in the final month of the previous quarter and the final month of the current quarter– data that is not yet reported when the first estimate of GDP is released.  In the GDP accounts trade and inventories are reported as the change over the quarter rather than the average during the quarter.  This is an adjustment that is necessary to go from the estimate of final demand or consumption to a measure of  production which is what GDP measures.  It is also normally the major reason why the first and second revisions to GDP or so significant.


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Are wages poised to rise sharply in 2018 ?

For the first time since the Great Recession my wage equation says average hourly earnings growth should be higher than the actual data shows.  Moreover, the fitted value is rising sharply.  Each of the three variables in the equation — the unemployment rate, capacity utilization and inflation expectations — is now pushing the fitted value higher.  This is the first time since that the fitted value is both above the actual growth of average hourly earnings the Great Recession and rising sharply. Rising  wages should contribute to higher nominal income growth and this in turn is a major determinate of bond yields.

Figure 1

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