Monthly Economic Outlook

Sub-Par Growth: Economic Workout Continues

Thu, Jul 10 2008, 08:14 GMT
by Wachovia Research Team - Wells Fargo Investments, LLC | View company's profile

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U.S. Overview

Sub-Par Growth: Economic Workout Continues

Once again, we are faced with the hard reality that the economic workout continues, keeping pressure on profits and household incomes. There is no easy-out for the economy. We expect continued weakness in consumer spending, residential investment and capital spending in the second half of this year. In contrast, government spending and net exports should maintain positive momentum. Overall, our expectation is that real final sales will slow in 2008 and again in 2009 from the 2007 pace of 2.5 percent.

Inflation, measured by the core PCE deflator, remains at the top end of the Fed’s perceived target range. Higher priced imports, energy and food are all adding to the upward momentum in prices. This combination of sub-par growth and persistent inflation suggests that the Fed will keep the funds rate on hold through the rest of this year. Finally, sub-par growth coupled with rising input prices should deliver a decline in pre-tax profits for the second half of this year.

Our forecast has changed modestly over the past month. Estimates for 2009 have been lowered, reflecting more modest growth in consumer spending, a deeper pullback in commercial construction, and less growth in exports. In addition, the BEA will revise the GDP data for the past three years later this month, which may lower the trajectory of economic growth.

International Overview

U.S. Slowdown Spreading to Other Countries

The slowdown in the United States appears to be spreading to other economies. U.K. economic activity is the weakest it has been since 2001, and growth in the Euro-zone seems to have slowed significantly in the second quarter. Even developing countries, which have enjoyed rapid growth over the past few years, have not been immune to the slowdown. Why has growth slowed abroad? First, exports to the United States from many countries have weakened. Second, credit market dislocations have weakened growth in countries that are extensively financed via capital markets and/or experienced significant run-ups in house prices. Third, the sharp rise in the price of oil is eating into real income in many countries, effectively slowing consumer spending. Finally, foreign central banks have tightened monetary policy in response to rising inflation, engendered by the sharp rise in the price of oil. We have marked down our global growth forecasts for the rest of this year and 2009, which likely will see the slowest year for global growth since 2002. If there is a silver lining, it is that inflation in many countries should come down going forward. Indeed, core rates of inflation in most countries are lower than overall rates at present If oil prices stabilize overall rates of inflation should come back down to the core rates in the quarters ahead. Consequently, central banks in most major economies likely will refrain from tightening further.

Sub-Par Growth: Consumer and Business Restraint

Consumer spending is expected to remain weak after the initial stimulus from the tax rebates. Real personal income growth has slowed this year relative to the prior two years as inflation has picked up while job growth has turned negative. Slower real income growth, combined with losses in real estate and financial wealth have dragged consumer confidence down and should hold consumer spending to just a 1.8 percent pace this year compared to 2.9 percent in 2007.

Over the second half of the year, much of consumer spending will be concentrated in core needs and non-discretionary items. Consumer spending on discretionary items will likely remain pressured. While the tax rebates may help sustain spending short term, we expect an outright decline in real consumer spending in the fourth quarter once those checks are spent.Weakness is also the story for business fixed investment. For the second half of this year we anticipate the combination of slower top line revenue expectations, tighter credit, and reduced corporate profits will lead to slower capital spending on equipment and software. Spending on structures is expected to slow significantly. This weakness will be in contrast to the solid gains we have seen in investment during the prior three years.

Housing Continues to Struggle

On the downside, residential construction likely declined at over a 20 percent annual rate in the first half of this year and is expected to continue to decline at a double-digit pace in the second half. The fundamentals remain negative. Housing demand is limited by sluggish income growth, low consumer confidence, tighter lending standards and a prevailing concern about further price declines. On the supply side, the inventory of homes remains large relative to the pace of sales in many areas. Lower interest rates and falling home prices have led to an increase in housing affordability. However the concerns of buyers and creditors have kept many on the sidelines.

Trade remains a big positive in the economy. We anticipate trade will add one-half of one percent to growth for the second half of 2008. The weaker dollar and stronger growth abroad are the key drivers. Inflation has heated up considerably abroad, however, and central banks, particularly in emerging markets, are beginning to hike interest rates.

Profits Weak & Interest Rates Flat

Pre-tax profits are expected to decline about six percent in 2008 compared to a gain of 2.7 percent in 2007 and 13.2 percent two years ago. The downturn in profits is consistent with slower top line revenue as well as higher input costs signaled by manufacturer surveys and commodity indices.

Short-term rates are likely to remain range-bound as the Federal Reserve balances the dual challenge of below-trend economic growth and above-target inflation. Long-term rates are expected to drift upward once calm returns to the financial markets. Concerns about the dollar and further Treasury financing needs are likely to limit any Treasury rallies despite continued soft economic news.

Credit spreads are not expected to narrow, as event risk remains a concern for investors. Capital markets continue to search for a new risk/reward tradeoff. At present, the trend in the TED spread (three month futures contract for U.S. Treasuries less the three month Eurodollar futures contract) suggests the new equilibrium spread will remain higher than where it had been during the 2004-2006 period. Risk is being priced back into the fixed income market, but the market is still determining what the equilibrium price will be.

Download Full Monthly Economic Outlook

Published On Thu, Jul 10 2008, 08:23 GMT

About this Report

Wells Fargo Investments, LLC

https://www.wellsfargo.com/

sam.bullard@wachovia.com

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For example, you place an order to buy at a stop of $50 which is above the current price of $45. If the price of the stock moves to or above the $50 stop price, the order becomes a market order and will execute at the current market price. Your trade will be executed above, below or at the $50 stop price. In a fast market, the execution price could be drastically different than the stop price. A "sell stop" is very similar. You own a stock with a current market price of $70 a share. You place a sell stop at $67. If the stock drops to $67 or less, the trade becomes a market order and your trade will be executed above, below or at the $67 stop price. In a fast market, the execution price could be drastically different than the stop price. A stop limit has two major differences from a stop order. With a stop limit, you are not guaranteed to get an execution. If you do get an execution on your trade, you are guaranteed to get your limit price or better. For example, you place an order to sell stock you own at a stop limit of $67. If the stock drops to $67 or less, the trade becomes a limit order and your trade will only be executed at $67 or better. Glossary All or None (AON) A stipulation of a buy or sell order which instructs the broker to either fill the whole order or don't fill it at all; but in the latter case, don't cancel it, as the broker would if the order were filled or killed. Day Order A buy or sell order that automatically expires if it is not executed during that trading session. Fill or Kill An order placed that must immediately be filled in its entirety or, if this is not possible, totally canceled. Good Til Canceled (GTC) An order to buy or sell which remains in effect until it is either executed or canceled (WellsTrade® accounts have set a limit of 60 days, after which we will automatically cancel the order). Immediate or Cancel An order condition that requires all or part of an order to be executed immediately. The part of the order that cannot be executed immediately is canceled. Limit Order An order to buy or sell a stated quantity of a security at a specified price or at a better price (higher for sales or lower for purchases). Maintenance Call A call from a broker demanding the deposit of cash or marginable securities to satisfy Regulation T requirements and/or the House Maintenance Requirement. This may happen when the customer's margin account balance falls below the minimum requirements due to market fluctuations or other activity. Margin Requirement Minimum amount that a client must deposit in the form of cash or eligible securities in a margin account as spelled out in Regulation T of the Federal Reserve Board. Reg. T requires a minimum of $2,000 or 50% of the purchase price of eligible securities bought on margin or 50% of the proceeds of short sales. Market Makers NASD member firms that buy and sell NASDAQ securities, at prices they display in NASDAQ, for their own account. There are currently over 500 firms that act as NASDAQ Market Makers. One of the major differences between the NASDAQ Stock Market and other major markets in the U.S. is NASDAQ's structure of competing Market Makers. Each Market Maker competes for customer order flow by displaying buy and sell quotations for a guaranteed number of shares. Once an order is received, the Market Maker will immediately purchase for or sell from its own inventory, or seek the other side of the trade until it is executed, often in a matter of seconds. Market Order An order to buy or sell a stated amount of a security at the best price available at the time the order is received in the trading marketplace. Specialists Specialist firms are those securities firms which hold seats on national securities exchanges and are charged with maintaining orderly markets in the securities in which they have exclusive franchises. They buy securities from investors who want to sell and sell when investors want to buy. Stop An order that becomes a market order once the security has traded through the designated stop price. Buy stops are entered above the current ask price. If the price moves to or above the stop price, the order becomes a market order and will be executed at the current market price. This price may be higher or lower than the stop price. Sell stops are entered below the current market price. If the price moves to or below the stop price, the order becomes a market order and will be executed at the current market price. Stop Limit An order that becomes a limit order once the security trades at the designated stop price. A stop limit order instructs a broker to buy or sell at a specific price or better, but only after a given stop price has been reached or passed. It is a combination of a stop order and a limit order. These articles are for information and education purposes only. You will need to evaluate the merits and risks associated with relying on any information provided. 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