Goldman Sachs Research: Settling Into Subpar Recovery Mode

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US Economics Analyst

Issue No: 09/47November 25, 2009

FOR THOSE PERMISSIONED:

Goldman Sachs Global ECS Researchat

https://360.gs.com

Settling into Subpar Recovery Mode

The recent data have been consistent withour view that the economy is recovering, but at a distinctly subpar pace. Growthlooks too sluggish to lower the 10%+unemployment rate to a meaningful degreeanytime soon.Real GDP grew only 2.8% (annualized) inthe third quarter, below the 3.5% “advance”release. At this point, the risks to our 3%estimate for fourth-quarter growth are tiltedsomewhat to the upside, but the basic pattern of our forecast—3% growth in2009H2 followed by a modest slowdown in2010—looks intact.The housing news has been mixed in recentmonths. Home sales have improvedsharply, driven partly by pull-forwardeffects related to concerns that thehomebuyer tax credit might expire(although it was ultimately extended).However, home prices have weakened anewand probably declined in September on aseasonally adjusted month-to-month basis.Meanwhile, the industrial news over the past few months has been faintlydisappointing. Although industrial output isnow rising on the back of the inventoryswing, the October durable goods reportshows that the demand for capital goodsremains exceptionally low.The labor market is making progress towardstabilization as the pace of layoffs appearsto be falling sharply, judging from a bigdrop in initial jobless claims over the pasttwo months. However, hiring remainsdepressed, and overall employment levelsstill seem to be falling (we forecast a100,000 payroll decline in November).

Slower Growth in Q3

-10-8-6-4-20246-8-6-4-20246Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Real GDPReal Gross Domestic IncomePercent change, annual ratePercent change, annual rateSource: Department of Commerce.200720082009AdvanceRevised

Home Prices Soften Anew

-40-20020402004200520062007200820092010-40-2002040Case-Shiller FHFA Purchase-OnlyLoan PerformancePercent change, annual rateSource: S&P. LoanPerformance. FHFA. Haver Analytics.Percent change, annual rateSeasonally Adjusted HomePrice Indexes:

Jan Hatziusjan.hatzius@gs.com212 902 0394Ed McKelveyed.mckelvey@gs.com212 902 3393Alec Phillipsalec.phillips@gs.com202 637 3746Andrew Tiltonandrew.tilton@gs.com212 357 2619David Kelleydavid.kelley@gs.com212 902 3053Maria Acosta-Cruzmaria.acosta-cruz@gs.com212 902 6709Important disclosures appear at the back of this document.

GS Global ECS US Research US Economics AnalystIssue No: 09/47

November 25, 2009

Settling into Subpar Recovery Mode

The recent economic data have been consistent withour view that the economy is recovering, but at adistinctly subpar pace. Consider the following:

1. Only moderate growth in the third quarter.

Real GDP grew only 2.8% (annualized) in the thirdquarter, well below the “advance” estimate of 3.5% published a month ago. The downward revision isconsistent with other indications that the economicrecovery remains more moderate than had beensuggested by the “advance” GDP release. Theseinclude the weakness in the labor market and thedownbeat mood among small businesses. Indeed, wecontinue to believe that the current set of economicstatistics is at risk of further downward revisions viathe annual “benchmarking” process, as the performance of small businesses is difficult to observefor government statisticians in a timely manner.There is also some evidence in the GDP release itself that may point to further downward revisions(although these may take considerable time to appear).In the third quarter, real gross domestic income(GDI)—a measure that is conceptually equivalent toreal GDP but can differ because of errors andomissions in either series—rose 0.8 percentage pointless than real gross domestic product. As shown inExhibit 1, real GDI has generally been even weaker than real GDP over the past couple of years.Although there is no way of knowing which series is“correct” in any particular instance, GDI has often proven to be a more accurate gauge in the past.

2. Mixed news on housing.

The recent housing news has been mixed. The goodnews is that home sales—both new and especiallyexisting—beat expectations in October by asignificant margin. As shown in Exhibit 2, new homesales rose 6.2%, while existing home sales surged10.1% (on top of an 8.8% gain in September).Undoubtedly, the recent home sales figures have benefited from expectations that the homebuyer taxcredit might expire at the end of the year, and it islikely that we will see some “payback” in comingmonths. Nevertheless, the fact that sales have

See Jeremy J. Nalewaik, “Estimating Probabilities of Recession in Real Time Using GDP and GDI,”Federal Reserve

Finance and Economics DiscussionSeries

, 2007-07. The author finds that “...GDI…hasdone a better job recognizing the start of recessionsthan…GDP.” Indeed, this was again true in the mostrecent episode—which was not covered in the Nalewaik study—when real-time GDI turned downearlier and more clearly than real-time GDP.

responded so strongly to the tax credit must count as a positive development.However the news on house prices has been lessencouraging. After a period of consistent upsidesurprises in the spring and summer, it appears that prices in September eased slightly. Although the S&PCase-Shiller index (20-city composite) showed a 0.3%seasonally adjusted increase in September, it isimportant to note that this index is calculated as a 3-month moving average. It is impossible to “unwind”this average without access to the underlying data, butthe recent behavior of the index as well as theinformation from other home price measures suggeststhat the Case-Shiller data declined in September on an“unsmoothed” basis (see Exhibit 3).

Exhibit 1:Slower Growth in Q3

-10-8-6-4-20246-8-6-4-20246Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Real GDPReal Gross Domestic IncomePercent change, annual ratePercent change, annual rateSource: Department of Commerce.200720082009AdvanceRevised

Exhibit 2: Home Sales Have Improved…

300400500600700800900100011001200200620072008200920104000450050005500600065007000New Home Sales (left)Existing Home Sales (right)Thousands, annual rateThousands, annual rateSource: National Association of Realtors. Department of Commerce.

GS Global ECS US Research US Economics AnalystIssue No: 09/47

November 25, 2009

3. Disappointments in the industrial sector.

The industrial news over the past couple of monthshas been faintly disappointing. Although theindustrial sector is expanding, it appears that theinventory cycle is already quite far advanced withoutdelivering quite as much of a “kick” to productiongrowth as many—including ourselves—had expected3-6 months ago.The reason seems to be that the positive impact fromthe inventory cycle is being blunted by the continuedweakness in final demand. The October durablegoods release is a case in point. As shown in Exhibit4, “core” capital goods orders and shipments have been going sideways to down over the past 4-5months. Our interpretation is that the low level of capacity utilization continues to keep capital spendingdemand at rock-bottom levels, and we expect this tochange only very gradually over the next year.

4. Layoffs abate, but hiring remains weak.

Perhaps the most positive signal of the past few weekshas been the sharp drop in initial jobless claims, whichfell to 466,000 last week from the 550,000 area twomonths ago. Although the level of initial claimsremains high, the pace of gross job losses is clearlyabating quickly.However, there is much less sign of a meaningfulimprovement in hiring, which typically is the moreimportant driver of cyclical labor market fluctuations.

Indeed, household job market perceptions as measuredin the Conference Board’s consumer confidencesurvey deteriorated a bit further in November, and thenewspaper help-wanted index declined to another record low of 9 in September (see Exhibit 5).Although newspaper job advertising is in secular decline, we have found changes in this indexmoderately useful for predicting employment; theonline help-wanted data from Monster.com and theConference Board will be released next week.Taking together these and other labor market signals,we estimate a 100,000 decline in nonfarm payroll anda 0.1-point dip in the unemployment rate to 10.1% for the November employment report to be released onFriday, November 4. Our forecast is slightly moreoptimistic than the consensus because we believethere is some chance that labor market collapse thatstarted in November 2008 may lead the Labor Department’s seasonal adjustment process to“anticipate” excessively negative figures on aseasonally unadjusted basis.

Jan Hatzius

See “All Eyes on the Labor Market for 2010,”

US Economics Analyst

, 09/46, November 20, 2009.

Exhibit 3: …But Home Prices Weaken Anew

Exhibit 4:

Capital Goods DemandRemains Depressed

4550556065700001020304050607080910455055606570New OrdersShipmentsBillions of dollarsBillions of dollarsSource: Department of Commerce.Nondefense Capital Goodsex Aircraft:

Exhibit 5: Layoffs Abate, But Hiring Still Weak

2253003754505256006752005200620072008200920107.515.022.530.037.545.0Initial Jobless ClaimsHelp-Wanted IndexThousandsIndex, 1987 = 100Source: Department of Labor. The Conference Board.

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