Economic Trends and Risks

The Week Ahead

I'll be away this week and unable to comment on the incoming economic reports.  The brief previews below lay out the improving news expected. 

Tuesday -- Consumer Confidence.   The index reached a record low in February, edged higher in March and is expected to rise by a larger margin in April.  The expectations component is expected to be the driver as consumers are beginning to see the light at the end of the tunnel.  Improving confidence is needed before household spending/investment begins a sustained lift.

Wednesday -- GDP.  The big daddy of the economic measures will include some positive news with gains in personal spending and global trade.  A very large decline in inventories can be seen as clearing the way for increased production in coming quarters as business investment and housing will show continued declines.  First quarter expectations center around -5% after the -6.3% fourth quarter plunge.  I continue to expect flat/positive growth in the third quarter.

Thursday -- Personal Income and Spending.  The data are embedded in Wednesday's GDP report but revisions leave March growth unclear.  A repeat of the -0.2% decline in February income growth leaves the annual gain near half a percent as the wage and salary component already has fallen in to negative growth from a year ago.  Generally, income drives spending and is directed by the pace of payroll growth.  Tax cuts and federal spending will provide welcome aid to the economy as annual spending growth fell in to decline at year end. 

Weekly Unemployment Claims.  This will provide more excitement with another decline.  The April level for initial claims is already lower than March for the payroll (read employment) survey week.  Initial claims are a forward read on payroll growth and suggest another decline from January's massive -741,000 plunge.  A continued rise in continued claims argue for another lift in the unemployment rate from 8.5% in March. 

 

Friday -- ISM Manufacturing Index.  The survey provides a forward read on manufacturing and has been creeping higher since December's quarter century low.  However, the index remains quite depressed (see chart).   A strong March rise in new orders should translate into stronger levels for production. 

 

Signs of Stability?

Today's releases on new home sales and durable goods orders showed modest March declines.   But after the February gains still stand above the January cyclical lows. Too early to call a turn in the trend but even stability is a very welcome state after the sharp and steady declines in 2008.

Durable goods orders represent demand for longer lasting capital investment.  Sure, consumer cars and household appliances are included but its largely of measure of business investment which has fallen like a stone since mid 2008.

Core capital goods which exclude military equipment and weighty aircraft orders are the best early measure of business investment demand as the back to back monthly gains followed a very steep January drop.   However, shipments (sales) which follow orders and are reflected in the GDP report showed continued declines and should leave even a stronger first quarter decline in business investment than the plunge in the fourth quarter.  Bottom line, the forward read is improving.

 

New home sales edged lower in March but also stand above the January level.  Here also we're watching for signs of stabilization after the collapse over the last few years.  Signs of stabilization have been noted by some in existing home sales but the inclusion there of foreclosure sales has left a deceiving headline (West coast resales are up 19% from a year ago and there's no booming market in CA or Las Vegas).

Stability in new home sales (home demand) leads to increased stability in home prices and foreclosures and new building before the turn higher takes shape.  Early signs are beginning to show up and will provide more lift to consumer confidence as well as the deeply injured housing market.  Turning points are easy to see only well after they have arrived. 

 

Telling Economic Indicators

Rather than personal opinion of which economic indicators provide the best read on the economy, I'll use the leading and coincident indicators which the Conference Board has tested as the best. 

 

The index of leading indicators is made up of ten indicators which provide a forward read on the economy.  By rank of their weighting in the index they include real money supply, manufacturing hours, the spread between 10-year Treasury note yields and the policy rate, manufacturing's consumer goods orders, the deliveries index from the ISM manufacturing index, stock prices, initial unemployment claims, consumer expectations, building permits and non-defense capital goods orders. 

The leaders index identified the start of recession in December 2007 as it declined for a third consecutive month and the 6 month growth was below -1%.  The March 2009 index released Monday also showed a third consecutive month of decline (without a rise in nine months) as the 6 month average reached a low -2.5%. The index provides warning of recession, but no  read on its exit from economic contraction.

The Conference Board's coincident index is made up of just 4 indicators, the same four the National Bureau of Economic Research uses to determine the timing of a recession.  This is a better index to watch currently as it better tells when the key recession indicators have turned toward growth.  The four components are (again by order of their weighting in the index) payroll employment (with over half the weight), real personal income less transfers, industrial production and real business sales. 

Both real income and sales showed gains in March as declines in employment and industrial production provided the -0.4% decline -- the smallest in the last five months.  The recovery waits for payrolls and industrial production to turn upward providing the other two remain in neutral or positive.  I suspect that employment may continue to decline early in the recovery, which leaves only industrial production to turn direction and bring economic growth.  Well, at least according to these indicators. 

Falling Production, Economic Slack and Inflation

The -1.5% decline in March industrial production left a very weighty -20% annual decline in the first quarter and nearly a -13% fall from a year ago.  The massive -35% 12 month decline in motor vehicles was topped by a -43% annual plunge in primary metals as overall manufacturing has fallen -15% since March of 2008.

Moreover, given manufacturing's capacity to produce a far larger supply of goods it's capacity utilization rate fell to the lowest in the half century the Fed has been recording these figures.  The 66% capacity utilization in manufacturing compares to the equally disturbing 69% for all industrial industries. 

The severity of the decline suggests the worst may be nearly over.  Reduced production leaves less inventories on the shelves and lots arguing that a return toward stronger production shouldn't be too far down the road.  Inventory corrections typically set up for the turn in the economy out of recession.

Also, longer term inflation worries are focused on the immense amount of funds the Fed and Administration are pumping in to the banking system (and promising to be flushed out later).  A far more reliable inflation indicator is the amount of economic "slack" best summarized by the unemployment and capacity utilization rates.   Simple logic states that as labor or productive resources grow scarce the prices of their output rises (i.e. demand pull inflation).  An unemployment rate below 5% (and largely expected to top 10% in this cycle) and a capacity utilization rate above 84% are indicators of inflation and it will take years to reach those points under the best of circumstances.

Retail Sales Show First Decline of 2009

March retail sales provided a downward surprise. With a small gain expected, retail goods sales fell -1.1% after gains in January and February.  Despite the weak finish to the quarter we still expect a positive gain in first quarter consumer spending which includes service spending not seen in retail sales.  Real (inflation adjusted) consumer spending showed a 4.3% decline in the fourth quarter after the 3.8% drop in the third quarter.

All the major retail sales components showed March declines outside the staples of food and health care.  The biggest surprise was a -2.3% drop in auto sales (dollar sales) which contrasts with the 8.2% rise in the number sold.  Massive discounts explain some of the miss as does sales to auto rental companies which bypass the dealers surveyed. 

The shift of Easter timing from late March last year to April provided some delay in merchandise sales which fell off.  Weaker sales at gas stations left a -34% decline from a year ago. 

Overall the decline leaves retail sales down a large -9.4% from a year ago after the modest lift of January and February.  The view ahead is for continued weakness given the underlying economy.  As employment falls so does income and spending growth.  Tax refunds and the later timing of Easter will provide a lift in April and May but the underlying pace of spending depends on income growth.  Household wealth provides a much smaller effect on spending but is a large drag after showed a record decline in the fourth quarter (see March 13 post Record Wealth Decline).

Severe Drop in Global Trade (and the Deficit)

The U.S. trade deficit plunged more than $10 bln in February  leaving more than a halving in just the last four months.  The deficit was more than $60 bln in August and fell to just $26 bln (well, $25.96) in February.  The sharp decline seems to answer the concerns arising from the large deficit but in fact only notes the severe decline in global trade since mid 2008.  Its all tied to the weak global economy, but like all else with that link, isn't good news.

Both imports and exports reached record levels in July as the drop in oil prices added to the diminishing trends in non-petrol trade. Since July, imports have fallen by a third as exports have dropped by a quarter.  Imports have shown declines in each of those months as February's tick higher in exports was the first in seven months and helped provide the sharp decline in the deficit.  Expectations for another export gain in March seem overly optimistic.

Most of the trade declines are tied to volumes but prices have had a part too.  Obviously the dive in imported oil prices have had the largest effect but non-petroleum import prices are down 4% from a year ago to leave total import prices down 15% yoy.   Export prices have fallen 7% as the 22% plunge in agricultural prices adds to the 5% fall in ex-agricultural prices. 

The lower import prices add to the deflationary powers of the economic recession which the Fed is aggressively fighting with the massive amount of funds its providing to the financial markets.  As far as economic growth is concerned I expect first quarter GDP to fall near 4.5% (after the 6.3% Q4 plunge) despite lifts from the falling trade deficit and (surprisingly) consumer spending.

 

 

Confidence?

Today's NY Times cover story titled Poll Finds Brightening Outlook on U.S. Economy requires some clarification.  Polls address what their creators seek but don't gain much credibility if they don't provide any insight to the path ahead. 

There are plenty of confidence polls on the attitudes of consumers, business, investors and seemingly every segment of the economy.  The polls the market usually watches are not showing the same bright glow as the NYT/CBS poll.

The NYT/CBS poll seems weighted toward politics rather than the economy.  Are you surprised that a popular, newly elected president is finding support in his direction of the nation's economy and foreign policy?  The key index showed that 39% of the respondents believe the country in going in the right direction from under 10% in late 2008 before Obama's inauguration.   Another question showed that the economy is slowly improving.

The consumer confidence polls the market watches provide a valuable read on future consumer spending and the economy.  They focus on business conditions, job availability, income expectations and plans to buy homes, autos or take a vacation over the coming half year.  One survey component is telling enough to be used as one of the ten components in the index of leading economic indicators. 

 

The larger consumer confidence survey (from the Conference Board) reached a record (42 year) low in February before rising less that a point in March.  Lower than during Watergate trials, the early '80s with both inflation and unemployment rising above 10%, the horror of 9/11 and other confidence shaking events.  The index is 70% below the low of the 2001 recession.   The other key index from the University of Michigan reached its cyclical low in November as the March index was just 2 points higher.  Both are holding close to their lows and will be watched for any pickup in the coming months.   It hasn't hit yet.

 

 

Very Ugly Labor Market

The government released the March employment report which showed a 25 year high in the unemployment rate to 8.5% and a continued massive pace of layoffs.  The only way to see these harsh figures in a bright light is that they aren't worse than expected (yeah, that helps drive the equity markets) and that the downward revisions leave stronger declines at the turn of the year which may suggest the start of a slow turn -- that is, the declines may be lessening.

The report echos the ugly condition of the labor market.  The unemployment rate rose a full 1% over the last two months and stands at the highest level since 1983.  Unemployment follows (lags) the economy so expect a far higher rate ahead. 

Payrolls serve as a better coincident economic indicator.  The recent declines(-681k in Dec, -741K in Jan, -651K in Feb and -663K in March) are the largest in 50 years, as the declines as a percent of the total are the largest in the last 35 years (1974).  The declines are seen in all sectors outside of health care as even one of the leading indicators -- temporary help -- continues to suggest little turn in momentum. 

The Obama tax cuts began April 1 and will boost tax home pay (less withholding taxes) which provides some much needed aid, though small when seen at a weekly basis. 

While the hourly earnings figures remain somewhat firm at 3.4% from a year ago, the plunge in employment has turned the wage and salary component of personal income growth to negative annual growth and down -3% over the last six months.   The tax cuts will offset some of the downturn in aggregate wage and salary growth but given the massive plunge in household wealth (see March 13's Record Wealth Decline) the outlook for consumer spending and economic growth hasn't shown a real shift yet.

No Good News Expected from Employment Report

The equity market bottom has foretold the recession end by about four months  since the 1980s as any hint of current economic stability has brought some market enthusiasm.   Nothing could be more conclusive to the expectant market than in improvement in the labor market.  However, the early indicators don't suggest any improvement in the March employment figures due out Friday.  In fact, the payroll declines may top -700K as the employment rate jumps to 8.5% or higher.

Initial claims for unemployment benefits are released weekly as those first time filers (those just laid off) rose again in March and suggest an even larger decline in payrolls.  Continued claims (those repeating the trip for  benefits) also showed a significant gain arguing for another large jump in the unemployment rate.

ADP, the private company that distributes a large supply of the nation's payroll checks, put out its March payroll estimate today.  At -742,000 the estimate for private payrolls is the largest plunge seen to date and compares to a small three month miss of just 38K.  Moreover, downward revisions are expected to be included in the recent payroll count.

The market is looking for a March decline in payrolls near -650K (-711K to -525K range) in line with the last two months.  A larger decline will steal away some of the market's lift in confidence despite the lagging nature of the labor market to the economy.  Bottom line is as long as payrolls are declining (and that decline seems to be still accelerating) personal income falls leading spending and production lower.  We haven't seen the bottom in the economy, yet.