Summer Is Almost Over, Thank Goodness!
We’ve just past an anniversary. It might have been in May but more likely in June or July. Our economic recovery is now a year old, hard to believe since there is about as much angst about the economy now as there was a year ago or two years ago. Most people in the investing world worry about the economic future all the time, but usually the worry is about just how fast we’re growing. Today the worry is whether or not we’re growing. This whole debate misses one very important point, we’re still growing!
The situation today is a lot more ‘normal’ than maybe we’d like to think. The last two recoveries were also somewhat understated. Remember the election of 1992? Bill Clinton was running around with his catch phrase “it’s the economy, stupid.” Well, if you look at the economic numbers, the economy in 1992 was growing and had been for over a year. If anyone had resorted to facts, that election may have turned out differently. But, because of the lack of job growth, people were unsure of that recovery until 1993. But, then it went on to be the longest expansion the US economy had ever experienced.
In 2001, we had the mildest recession in US history but we still had another ‘jobless’ recovery that didn’t really get any traction until 2003. By then, we’d had two tax cuts to stimulate the economy, one at about the same time the economy began to grow, and another when it was already growing nicely. The point here is that ‘jobless’ recoveries are a lot more normal than we’d like to think.
The economy isn’t as strong as we’d like to see, but it isn’t a disaster either. Let’s look at some facts:
- Jobs – at its worst, the economy was losing over 700,000 jobs a month, now we are gaining (as many as 240,000 in one month). That is improvement of nearly a million jobs a month. We can’t keep up that kind of improvement forever, but we can settle in at gains of 150,000 or so. (But, that wouldn’t be enough to lower unemployment.)
- Incomes – wages are rising and hours worked in the economy are higher. There is more than one way to get more income into the hands of workers, give them more money and ask them to work more hours. We’re doing that already.
- Consumption – Personal Consumption Expenditures (money we spend on goods and services) had been declining but now are rising modestly. We had a ‘buyers strike’ during the recession, but now we’re just being cautious about our spending but will buy when we perceive a bargain.
- Investment – Capital Expenditures (business investments) were declining and now are rising. Inventories are being rebuilt and productivity is rising.
- Housing – prices had been falling but now are stable to rising across most of the country. This is the weakest part of the economy but it can’t hardly get any worse.
- Trade – Imports have been halved while exports are growing.
Most of our economy isn’t all that susceptible to rapid changes – government spending, personal consumption and services are all pretty stable month to month, year to year, changes in these segments are usually very slow. Other parts of the economy are very cyclical – housing, autos, business investment and inventories. The cyclical parts are mostly getting better these days. Housing is still very slow, but auto production is rebounding. Business investment is rising and inventories are being rebuilt. Also, the highly cyclical parts of our economy used to be a much larger share of the economy. Back in 1982, manufacturing plus construction were roughly 25% of our economy; now they make up about 15%. Government (at all levels) used to be about 18% of our economy; now it is nearer 25%. Consumption is a big piece of our economy, nearly 70%, but in the past it was more like 65%. (The difference is imports.)
When we measure this recovery against the last two, we find that the pace is not all that different, and is stronger in many regards. The big difference between this last cycle and the previous ones is that the recession was much deeper, and we probably all assumed the recovery would be a lot stronger. And it had been early on. Unlike 1991 or 2001 there was a big change from receding to growing, a swing of some 10% at an annual rate between the first quarter of 2009 and the third quarter.
This recovery could have been a lot stronger, but it isn’t. What we seem to be experiencing is a modest recovery from a pretty severe recession. But, we are not falling back into another recession. To fall into recession we’d have to assume that our consumption falls again like it did a couple of years ago, not just stabilize but retreat. This is a possibility, but not a high probability. We’d have to assume that our manufacturing sector would shrink again after it is has already started growing. We’d have to assume that investment would stop or reverse. It really takes a lot of assuming to get past the fact that we are growing, albeit modestly. That growth ought to continue unless we get some sort of exogenous shock to the system.
We have a lot of positives to rely on when it comes to continuing to grow. The Federal Reserve is providing ample money to the economy and promises to continue to do so. The Federal Government is pushing stimulus spending, though that can’t go on forever. The corporate sector is very competitive with strong balance sheets and high productivity. The household sector has increased its savings and is reducing debt. All we need to do is keep at it and the rest will take care of itself.
What about all the pending ‘crises’ around the globe? The European sovereign debt crisis of the spring seems to have blown over. Rapid fiscal and monetary policy responses from the effected nations and their neighbors have turned that around. Japan is still wallowing in slow growth and deflation, but that has been the case for nearly twenty years and the rest of the world doesn’t seem to be following down that path. There is the usual assortment of political and military crises to worry about – Iran, Afghanistan, Sudan, Venezuela, Myanmar, North Korea, but that has always been the case.
The emergence of the emerging economies is continuing to absorb more of the world’s manufacturing jobs and production. The related trend is these nations are developing a larger middle class that has a good job, a higher standard of living and stronger consumption. Someday, these new emerging consumers will augment the US and European consumers in driving the world economy.
There is good reason to be concerned in a world where bad things can happen. But, this is the case when times are good as well as when times are bad. We are in-between these two scenarios right now. It would be a lot better if things were good. If profits were higher, if employment were improving, if Americans were saving more and spending less, wait, that is exactly what is going on right now!
Issue of the Week
Let’s see, we’ve ranted about employment statistics recently, deflation, and we’ll be ranting about real estate momentarily. What else is going on worthy of a rant? Well, last week, we had the Jackson Hole conference for the Federal Reserve. That gathering, in Wyoming, brought together most of the US monetary policy elite, plus many international visitors, academics and the occasional financial industry representative. The agenda for this meeting was undoubtedly long and complicated as there are so many issues confronting monetary policy these days.
The big thing is whether the financial authorities are going to change the direction of US and world monetary policy. We doubt they can at this point. The chance to raise rates last year has past and they can’t go back and retroactively do that now. The need to keep monetary policy fairly loose is what everybody is talking about, but how loose? Do we need further monetary easing? The trend in much of the world is toward fiscal policy tightening. That would mean less spending and higher taxes. The US fisc is still in stimulus mode for a time yet. There is still a bit of the March 2009 stimulus to get through before that is over and in the meantime Congress (the opposite of progress) has passed other stimulus plus lots of non-economic legislation with economic impacts.
Bernanke argues that the Fed has plenty of policy tools at its disposal to push monetary policy further if need be. They can do further quantitative easing (buying Treasury debt or mortgages to put more money in circulation). They can charge interest on excess reserves held at the Federal Reserve as a way to encourage banks to lend the money rather than just sit on it. They can buy other assets to bolster the prices of say corporate bonds or asset-backed bonds like credit card receivables or auto loans. The one thing they can not do is lower interest rates further. They went all the way on that almost immediately during this crisis and have stuck with it despite our impassioned pleas to raise rates and declare the crisis at an end. They blew it. We tried to help, but no one listened.
Bernanke did say that the Fed will not allow a deflationary environment to get established. That should be easy enough with rates where they are and ample liquidity available. They could start by working to lower the value of the dollar in foreign exchange markets. That shouldn’t be all that tough to do. We have one of the least disciplined fiscal policies on the planet and an economy that needs loose monetary policy. Nearly all our major trading partners are in better shape than we are on those scores. All we really need is a period of few crises in other parts of the world and the dollar should drop all on its own.
But, the markets are still focused, laser-like, on the economy. Whether they understand the impact of each number or not, if it isn’t better than expected, we sell. The beautiful thing now is that expectations have gotten so low that beating expectations has gotten pretty easy. This week, we have several important numbers to get through. First, there is consumer spending and income data today (Monday, August 30) that came in much better than expected. On Wednesday, there is the Institute of Supply Management manufacturing index, which as long as it stays above 52 will be seen as pretty good. Then there is the employment report on Friday, which is widely seen as being near zero, but any kind of positive number would be incredible.
That is another problem; we won’t believe good news but will glob onto bad news and not let go. We expect bad news, we affirm bad news and we reject good news. You will know when the current reign of terror is over when we accept good news at face value and react appropriately.
Existing home sales in July were awful due to the long shadow of the latest home-buyer incentives. The pace was the slowest in over 15 years as the tax credit drew buyer demand forward and left this yawning gap in the housing market. Just think of it, if you were going to buy a home regardless wouldn’t you accelerate your purchase to get the tax benefit? So did nearly everybody else. The real question ought to be why did the 3.83 million people (seasonally adjusted at an annual rate – so roughly 350,000 actual people) who bought homes in July not figure out the system? The pace of sales is liable to shift higher next month and the month after that as the shadow of the incentives recedes into the past. But, housing continues to be slow. Distressed sales, foreclosures and short sales, made up about a third of sales in July, about the same as most recent months.
New home sales in July likewise plunged to a new all-time low (since 1965). The count of 276,000 (seasonally adjusted at an annual rate) is the lowest ever and well below analyst’s expectations. Last month’s tally of 315,000 was still being impacted by the home-buyer incentives it seems. Without those incentives in effect, new home sales fell. As above, the incentives tended to draw sales forward in the year as just about everyone who was thinking of buying hurried to get it done during the incentive period. The average sales price in July had fallen to $235,300, down 13.2% in the past year.
FHFA home prices rose in the second quarter from the first by 0.9%. June’s data was actually down from May by 0.3%. Note this is June data, not July. Thus it looks like prices may slip further in July based on the above trends from existing and new home sales.
Housing rant: All this focus on housing connotes a continued reliance on residential housing as a determination of our economic well-being. That is pretty sad. People have invested way too much in housing and now they can’t let go. Our economy won’t be healthy again until we lose this fixation on housing and start focusing instead on saving and investment. Much of the many trillions it took to finance the housing bubble was wasted. Investment in housing is fairly sterile, especially in the largest, grandest homes. A house is a place to live. Even if your home is a place to live well, there is little productivity gained from a large house. Smaller homes are more convenient. But, the large home, the status symbol, is still desirable. The really big house just shows how much money we can waste on a really big house. It says a lot more about our earning power than anything else. As such, it will continue to be a goal, but a silly goal.
Durable goods orders were 0.3% higher in July. This is a disappointing number as many economists were expecting a gain of a couple percent. The number would have been much worse but for a huge gain in aircraft orders. At the same time, orders for June were revised higher, from the original 1.2% decline to a 0.1% decline. So, some of the expected strength in July might have come in June.
Consumer sentiment rose in August to 68.9% from 67.8% in July. The gain was in line with expectations.
Second quarter GDP was revised downward to a gain of 1.6% versus the original guess of a gain of 2.4%. The downward adjustment was widely expected and expected to be a little bit worse, actually, Wall Street’s guess centered on a 1.3% number. The areas of weakness were generally imports, which subtract from growth and less inventory building than thought a month ago. As we have noted before, the early estimates of GDP (and most other economic series for that matter) use incomplete data and are full of estimates. As further data comes in, estimates can be replaced with actuals. The first estimate of second quarter GDP announced a month ago did not have very much data for June and now much of that data is available. Even now, there are many estimates still in the GDP number. There will be a further revision of these estimates in a month and again in what are called benchmark revisions, where more elaborate statistical analyses try to get a better picture of the economy from data received later.
Areas of continued strength in the economy are business investment and exports, though recent numbers argue for more modest growth in both areas going forward. Areas of weakness were housing, inventories and especially imports. The surge in imports reduced GDP by over 4% as imports grew 32% from the first quarter pace. The strong dollar has made imports more attractive to US consumers and we took advantage of it.
Since this is all you’re going to get in the way of market comment and won’t get the usual accompanying Weekly Review piece until Wednesday, you’d better listen up.
Pop quiz, how bad was it last week? A) Down less than 1%; B) down between 1% and 2%; C) Down 2% or more; D) up at all?
Well it depends what you look at, but the NASDAQ was a B; the Russell was a D; and the Dow and S&P were both A’s. Much of the developed markets were either A’s or B’s with Japan the only C. Most of the developing markets were B’s with the occasional C, but there were A’s and D’s in that group too.
World bond markets were mixed with Europe mostly higher, Japan and the US lower and much of the developing world higher.
Real estate and commodities were generally higher despite the other markets.
Have a great week.
Karl Schroeder, RFC, CSA
Investment Advisor Representative
Schroeder Financial Services, Inc.