The economic data last week are best characterised as mixed, and the S&P index reacted accordingly, falling 0.7% for the week. There's no denying that there was a lot of bad news this week, including poor initial unemployment claims data, housing data that continued to bump along the bottom, and some worrying signs out of a slowing manufacturing sector. But there was good news, too. Industrial production jumped over a percent, corporate spending and merger activity continued to accelerate, and banks appear to be slowly opening their purse strings according to a recent Federal Reserve report. Low rates and increased mortgage refinancings should also bode well for consumers. However, the positive data were largely ignored.
Based on the last couple of months of data, I have little choice but to reduce my GDP growth estimates for 2010 to the 2.5%-3.0% range from as high as 4.0%-4.5% as recently as March of 2010. I have been very bullish on the economy since the spring of 2009--a bit too bullish over the past six months. I am still bullish on the United States and world economies, but the short-term picture remains cloudy. With autos and housing operating so far below what I believe is the replacement/population growth demand level (autos at close to 12 million units versus a more typical 15 million-17 million units and housing starts at the half-million level versus Morningstar's natural demand forecast of 1.5 million units per year), it is shocking to me that we've got this far in the recovery without better news from these all-important sectors.
So Where Did I Blow It?
There is no one answer about how I missed, but miss I did. Perhaps my biggest error was underestimating the leakage in consumer spending to overseas economies (although exports did help jump-start the US economy early on--live by the sword, die by the sword).
Once an economy gets rolling, consumers generally spend more, which leads to more production and more employment and incomes, leading in turn to more spending and production. This cycle generally continues until the economy pushes up against some kind of capacity limit or a major policy/geopolitical event intervenes.
This time, our system experienced a major leak. Frugal consumers opted for consumer electronics and apparel as their small splurges when they were feeling more optimistic. Unfortunately, the non-US content in these items is high, meaning that more spending led to more production--just not in the US. Perhaps a bit dramatically, Capital Economics, a major economic forecasting service, recently noted that while GDP growth in the second quarter is likely to slow to 1.5% or so, imports are likely to a jump by more than 30%, both on an annualised basis. I, of all people, should have better grasped that the booming market in even simple electronic components such as capacitors was an early sign of potential import troubles. Even a couple of months ago, I hadn't fully grasped the implications of a consumer rebound driven largely by electronics.
The iPad Economy Is Slowing Growth; Services Hurting, Too
While the import problem and the "iPad economy" is finally gaining front page coverage, slow growth in the service economy isn't helping either, and that's something that isn't getting much recognition. Healthcare is still eking out some modest growth, but that growth is much lower now than it was during the worst months of the recession. Consumer spending on financial services is still shrinking.
The fact that healthcare and financial services are performing so slowly this far into a recession is unusual. Whether it's recent changes in the subsidisation of health insurance for laid-off workers (COBRA) or just a tremendously lagging indicator (when layoffs start, people rush to the doctor before they lose coverage; when people get new jobs, they sometimes have to wait before coverage begins). Maybe even uncertainty around the new healthcare legislation caused people to hold off on seeking medical attention. It's probably too soon to say for sure, but I am hopeful that a little more healthcare spending is in the cards.
Stimulus More Harmful in the Longer Term Than I Thought
Although I have generally been supportive of many recent stimulus events and policy decisions, these devices have sure mucked up the numbers this summer. The on-again, off-again housing credits didn't seem to have all that big a positive effect on the way up, so I wasn't really expecting to see much negative effect once they began burning off. Boy, was I wrong on that one! Some housing data are now back to approaching their worst levels of the recession. Whether that is a reflection of poor underlying demand or just the pull-ahead effect of the credits is impossible to determine. And because of reporting lags and effects, it could be several more months before we know the answer.
Likewise, I think some of the appliance rebate programmes stimulated demand this spring only to fall back once the rebates wore off. Even Cash for Clunkers didn't help long-term demand very much. Consumer auto sales are still up less than 10% from their bottom (fleet and corporate sales have driven most of the improvement in auto sales). Instead of priming the economic pump, a lot of the federal programmes seem to have further conditioned consumers to buy only when special discounts and rebates are available.
Restated Numbers Changed the Whole Perspective
The restatement of a lot of personal income and expenditures data, which I talked about last week, certainly didn't help matters either. The original data seemed to indicate the consumer was spending close to what was economically feasible, and spending levels were at pre-recession highs. The new data painted a picture of a far more frugal consumer. The good news is that the consumer has more room to increase spending in the months ahead, if confidence can return. I do regularly question government data and have often pointed to data that would need to be restated. I confess to not seeing this one coming.
While Near-Term Growth May Be Weaker, There Is No Reason to Give Up on the US Economy
Over the long term I expect housing and autos will lead to a better economy. Sometime over the next five years housing starts may have to as much as triple from here. Autos probably have 25% more headroom from current levels. In the shorter term, substantially the higher savings levels of the last year should provide the wherewithal for more consumer spending. Once some odd auto numbers and census numbers work through the employment reports, I suspect modest job growth for the rest of the year will further improve consumer sentiment and consumer incomes. However, the economy is still weak enough that a major policy blunder could throw us into another recession.
Initial Unemployment Claims Jump
Initial unemployment claims jumped to 500,000 last week, while the less volatile four-week moving average jumped to 482,500. The four-week average is now at its highest level since November 2009. These numbers are certainly discouraging, but we are still substantially better off than a year ago when the claims were at 571,000.
Because of seasonal adjustments, this is one of those weeks where the actual number of claims is multiplied by 1.25 to get the reported numbers, one of the highest multipliers of this year. This means that even small changes are amplified. The numbers seem just a bit suspect as many net employment reports, including the ISM report, show continued progress on the employment front. My discussion with a major outplacement executive seemed to indicate that conditions in that industry had softened, with the main source of new business being merger-and-acquisition related outplacements.
As I've said before, at this stage of a recovery, it is not unusual to have the unemployment numbers back up some, even as hiring increases and overall employment begins to improve. Unfortunately, there are few more weeks of high multipliers in front of us. However, the late Labor Day this year is likely to give us some respite in the increase in claims in early September.
Industrial Production Looked Strong
Industrial production for July jumped 1.1%, better than expectations, and June's dismal negative 0.1% showing. The truth probably lies between the two months. Lack of a summer shutdown at GM depressed June numbers (no need for a pre-shutdown rush) and boosted July (usually not open for business much of the month). Even excluding autos, the production figures were up a strong 0.6%.
The market tended to give the highly positive numbers short shrift as some of the news out of the regional purchasing manager reports were mixed. The Empire State Report showed growth in the manufacturing sector, albeit at a slower pace, while the Philly Fed report showed manufacturing conditions in their first decline since their recovery began. These series are volatile but probably do not bode well for the national report at the beginning of September. Again, this is not a disaster, but clearly numbers are moving in the wrong direction in the short run. Like the initial claims numbers, the manufacturing numbers are less useful in the middle of a recovery than at the beginning of a recovery. I also suspect that the lack of summer shutdowns at GM may have had an effect on the purchasing managers' reports as well.
Truck Sales, Corporate Computer Sales, and Construction Equipment Looking Good
While the consumer is looking a little worried, corporate spending continues to power ahead. Last week our trucking analyst, Basili Alukos, reported that Class 8 truck sales surged 28% last month. Sustained higher shipping volumes (up 7% year on year) and increased profitability of truckers are behind the move according to Alukos. Likewise, Deere and Caterpillar reported 59% and 32% gains in dealer sales for the most recent quarterly periods in the construction equipment sector. Hewlett-Packard reported an 11% sales gain driven by personal computers, enterprise storage, and business servers. Hewlett-Packard management also raised its outlook for the next quarter. Businesses are continuing to spend; let's hope the consumer rejoins them soon.
News Flow Likely to Continue Negative
The current news flow is bad and is likely to get worse in the weeks ahead. Early this the week, existing home sales are expected to drop to 4.9 million units from 5.4 million units on a seasonally adjusted annual rate basis as the benefits of the housing credit continue to burn off for another month or two. I suspect that existing home sales will remain in the 4.5 million-5.5 million unit range for some time.
GDP is likely to be restated down a substantial amount on Friday due to the surprisingly high import numbers for June (these were unavailable for the first estimate of GDP last month). The estimate is likely to be reduced to 1.5% from 2.4%.
In the first week of September the employment report is likely to look anaemic, as the poor initial claims data this week and likely drop in auto jobs when including seasonal adjustment factors, as well as a continue decline in census workers, will hurt the overall employment number. Lack of one major strike in Illinois and continuing positive hiring numbers in the major purchasing managers' reports should help the results, but not enough to offset the negative data points.
The headline durable good numbers, often a decent economic indicator, could be as high as 2.5% compared to a decline in the previous month. Unfortunately, all of the improvement is likely to be in the aircraft sector. Without aircraft, durable goods orders are likely to be down.
