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Early Freeze Could Derail Economic Growth Forecasts

Lance Roberts
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This past August I discussed the potential for the market to rise to 2100 along with "5-risks" to that forecast. One of those risks related to the "Polar Vortex" that shut down economic activity across much of the northern part of the economy, to wit:

"Farmer's Almanac, the 198-year-old publication that correctly predicted the past nasty winter while federal forecasters blew it, is predicting more of the same for the coming season. "Polar Vortex's" are already likely forming and will impact roughly three-fourths of the U.S. this winter. Considering Q1 took more than a 2% plunge, WITH the Federal Reserve pumping in billions of dollars, it begs the question of how bad it could get without support this winter?"

Currently, economic growth estimates are set for 3.0% through the end of this year, and it is hoped that the domestic economy can finally reach "escape velocity." However, this has been the hope every year for the past five years as a series of issues has held back stronger sustained economic growth.

GDP-Real-111014

Unfortunately, economic predictions may once again be set up for disappointment as another wave of cold air is set to smash temperature records across the country the winter. This comes at a time when the "life support" from the Federal Reserve has been removed from a patient still in an extremely weak condition. As reported by Reuters this past weekend:

"The coldest air of the season is set to reach into some 42 states this week as an Arctic blast drops temperatures from the Canadian border down to the Gulf of Mexico. Some 200 million people are expected to be affected by the cold, with only Florida, Hawaii, and the Southwest being spared.

Winter storm warnings are in effect for Montana, North and South Dakota, Wyoming and Minnesota as they braced for a major snowstorm forecast for the leading edge of that Arctic blast, according to the National Weather Service. The storm is set dump up to two feet (61 cm) of snow in parts of Minnesota, Michigan and Wisconsin by Tuesday, according to the service.

Monday also marks the start of two weeks of subfreezing temperatures in the Midwest, including Illinois and Missouri.

The weather shift can be blamed on what forecasters call a polar vortex reaching into the United States from the north."

Polar-Vortex-2.0

The issue with virtually all economic forecasts is that they never take into account the potential for exogenous shocks. However, it was just this time last year that nearly three straight months of extremely cold weather clipped about $100 billion from trendline economic growth.

The negative impact to the economy is exacerbated when considering that the Eurozone is teetering on a recession, Japan is in one and the China and Russia are dragging on growth. Weakness is already being reflected in the drop in demand for exports which fuels about 40% of corporate domestic profits. Furthermore, sluggish import demand, which is a reflection of a weak consumer, compounds the potential economic risks. (Notice the high level of corresponding movement between imports/export growth and economic activity. The current decline suggest slower economic growth rates ahead.)

Imports-Exports-NetChg-111014

Given the extreme complacency that has already returned to the financial markets, combined with the consensus belief that the U.S. can indefinitely decouple from the rest of an extremely weak global economy; the risk of disappointment has risen significantly.  The chart below is the combined individual and institutional bullish/bearish sentiment index. At 3.57, the ratio is at the highest level of bullishness ever on record.

AAII-INVI-BearishSentiment-111014-2

While this does not mean that a market crash is imminent, such extreme levels of complacency have been previously associated with intermediate to longer-term corrections. 

Over the next several weeks, as Turkey's are roasted and "stockings are hung with care," the economic environment may be put at risk as shoppers are shuddered, construction halted and production slowed. As cold winter weather blasts through much of the country, the impact to economic growth could be significant as 200-plus million U.S. citizens are driven indoors by wind chills in the single digits or lower.

As suggested above, given that economic forecasts are never hedged against exogenous events, the impact from an extremely cold winter against a backdrop of weak demand and excessive complacency is not the "holiday brew" that one would be hoping for.

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