Trade Deficit - Increase In Exports To Be Short Lived
The U.S. trade balance in September improved, largely on petroleum, with a rebound in exports. This was good news for a single economic data point and it sent mainstream economists to mistakenly begin boosting third quarter GDP estimates to 2.9% from the 1st estimate of 2.0% that we saw last month. By the numbers for September, the trade deficit narrowed to $-41.5 billion from $-43.8 billion in August with exports bouncing 3.1%, following a 1.0% decline in August and a 1.08% decline in July. Imports increased 1.5% after slipping 0.2% in August, 0.6% July and -1.5% June. In fact this is the first uptick in imports since March.
The important point is that the trend of exports, and imports, has been negative as the recession in Europe, and slowdown in China, have reduced end demand. This has been very much reflected in the third quarter corporate earnings announcements and forecasts through the end of the year.
The chart below shows the trend of deterioration in imports and exports and its net effect on the economy. As always, it is trend of the data that is far more important than any single data point. Economics change at the margin and understanding the direction of the data is far more important when trying to develop a macro outlook.
There has been a wide variety of anomalous data as of late, such as the surge in employment and the boost to GDP by government spending, which has boosted the economic results. However, as economist are busy ramping up third quarter GDP estimates, it may be worth noting that had it not been for an outsized government expenditure in defense related spending - growth in the third quarter would have been unchanged at 1.3%. The chart below shows defense related spending as a percent of GDP since the beginning of 2011. As you will notice there has been a negative contribution to GDP in the last three prior quarters until just before the election which gave a 0.64% boost to GDP. Sustainability will be the key issue.
In that same regard the boost in exports, which reduced the trade deficit, also may be an ephemeral artifact due to disruptions in the flow of trade-data reporting related the impact of Hurricane Sandy. Due to the late October arrival of the storm - some of the reports on imports have likely been delayed leading to a shortfall in the trade estimates. Such distortions should be corrected in next month's reporting which will send economists scrambling to reduce the GDP estimates once again. (We are also like to see a rather large downward revision to defense spending as well in the next month now that the election is over.)
Regardless of such distortions in the short term the longer term trend of imports and exports is clearly one of deterioration which will keep downward pressure on both economic activity and corporate earnings reports. What is important to understand, as it relates to economic growth, is that while the shrinking in the trade gap was led by the petroleum deficit, which decreased to $21.7 billion in September from $23.5 billion in August, it was the non-petroleum goods shortfall that is the most concerning. The shortfall in non-petroleum related goods actually grew to $35.2 billion from $34.9 billion for the prior month.
As we have discussed previously the importance of exports, as it relates to economic growth should not be overlooked. At 13% of the gross domestic product (as opposed to housing and automobile manufacturing which comprise about 2.5% each) the drag on exports from a recessionary Eurozone will slow economic growth. As the chart below shows - historically when exports, as a percentage of GDP, have turned down the economy has fallen into a recession.
The chart below shows real, inflation adjusted, GDP with a polynomial trend line. As you can see when the trend of growth in recent quarters has slowed rapidly. There is no reason why, at this particular point in time, that the economy should begin sprouting "green shoots" when many of the broad macroeconomic indicators are showing signs of significant deterioration. Furthermore, the negative outlooks from corporations, and the weakness in earnings and expectations, also signal a weaker economy ahead.
It is for these reasons that the recent positive boosts to the trade deficit data are more likely temporary in nature and will be revised away in the months ahead.
Again, it is important to remember that the most recent data is for a single month. If the data is truly improving we will need to see a string of consecutive positive months ahead. This is highly unlikely. The negative trends of the import and export data is pointing to a weaker economy, and a recession, in the months ahead. As we discussed in our recent article on recession probabilities: "Regardless of when the NBER officially announces the start date of the next recession - the damage will have already been done to investors. The current decline in earnings and revenue, the drop in exports and the weakness in incomes will likely impact stock prices long before the mainstream media recognizes that a recession has set in. As stated above there are many confirming indications that a recession is already underway in the U.S. economy - the only question is how long it will be before the stock market recognizes it and begins to realign prices with revised valuations."