Last week's announcement that the recession was over in June 2009 didn't surprise many economists, but many consumers were scratching their heads, as we discuss in last week's video.
The good news is that after such declarations, the economy almost always continues to expand for a considerable period of time based on 11 post-World War II recoveries. In other news, the markets were pleased that major real estate indicators have stabilized, albeit at low levels, after the initial tumble related to the expiration of the housing credit at the end of April.
Manufacturing news last week was decidedly mixed as the European Purchasing Managers report showed a larger-than-expected decline, while the U.S. Census Department's new durable goods order report, excluding transportation, was surprisingly robust. My personal opinion is that the market has become too fixated on manufacturing data, which at this stage of the recovery is more volatile and less conclusive than earlier in a recovery. It appears some analysts are confusing slowing manufacturing growth rates with outright declines, which isn't helping matters, either.
Initial unemployment claims moved the wrong way again last week after two weeks of holiday-induced positive news.
Last Week's Reports Reinforce My Third-Quarter GDP Forecast of 2.0%-2.5%
My overall thesis on the economy has been that an improved net export number combined with a decent business investment number would provide the fuel for an improved third-quarter GDP number (2%-2.5% versus 1.6% for the second quarter) as the consumer continues to chug along at a pretty sluggish pace of 2% or so. Last week's durable goods report reinforces the private-investment portion of that thesis. Construction spending and real estate brokerage commissions are likely to be the two big factors that will weigh negatively on the GDP report.
National Bureau of Economic Analysis Declares an End to the Recession of 2007
While many of us suspected that the economy left the recession in June 2009, it's now official. The National Bureau of Economic Research, the official arbiter of recessions (and not a governmental body, for the cynics noting the approaching elections), officially declared the recession over as of June 2009. The recession lasted 18 months, beating the previous record of 16 months for the recessions of 1973 and 1981.
From peak to trough the economy fell 4.1% (so far we have recovered about 3% of that) in terms of real GDP, which is the largest postwar decline ever recorded. As I point out in last week's video, the official declaration of the end of the recession just means that things aren't getting worse--it doesn't address the pace of improvement or even whether we've gotten back to where we started.
As slow as the recovery has been, things could be worse. Even though the 2001 recession was officially over in late 2001, it wasn't until almost two years later that employment stopped going down. This time around, employment started moving about six months after the recession was over.
The Official Declaration Means Reduced Risk of a Double Dip
Although the declaration isn't particularly useful, as investors surmised the recession was coming to a close over a year ago, it does have a practical application. The NBER is extremely cautious in declaring an end to a recession. For starters, they use several major data points, not just GDP growth, as many people assume. They also wait for the major data revisions (the last of them is personal income and consumption data revised each July) so that a major revision doesn't end up forcing the arbiters to reverse their decision.
Because of the NBER's cautious approach, real GDP growth has never gone negative immediately after a recession's end date. The shortest of the postwar recoveries was 12 months (the closest to a double dip, with the recovery lasting just July 1980 to July 1981). The average of the 11 post-World War II recoveries was 58 months (median 45 months and second-shortest 24 months). Economies put in positive motion tend to stay in motion due to the virtuous cycle of improving consumer incomes, more spending, more production, leading to more income, and so on.
The Financial Crisis May Hold Back the Recovery, but Less than Some Fear
As many readers have pointed out, the financial component of this recession is likely to hold back economic recovery some. Professors Kenneth Rogoff and Carmen Reinhart produced a paper showing that the combination of a normal cyclical recession with a financial calamity produces much slower and much smaller economic recoveries.
I think the headwind may be a little less than this study indicates in the case of the U.S. Sustained powerful actions by the Federal Reserve and certain other governmental bodies may have stopped some of the worst effects. Furthermore, the sheer size of the U.S. economy and its reserve currency status probably will lessen some of the normal pain inflicted by financial collapses. Investors can clearly opt out of the debt of Spain, Finland, Norway, and so on, all cited in the report, but they can't, as a practical matter, dump all of their U.S. debt holdings, at least in the short run.
Housing Data Stabilizing, but Still in Intensive Care
Housing starts managed their second consecutive month of improvement, assuaging fears that the housing starts would continue to fall even after the initial negative effects of the expiration of the homebuyers' credit. Housing starts jumped 10.9% to 598,000 units in August on a seasonally adjusted annual rate basis compared with July.
However, I wouldn't get too excited about that number; housing starts remain painfully close to this recession's low point in April 2009 of 477,000 units and the year-to-date low of 539,000 units in June. Morningstar's housing team believes that natural demand for housing is about 1.5 million units based on normal population growth and normal wear and tear. At its peak in February 2005, starts were a record 2.2 million units. Although poor construction data hurts GDP, fewer new homes on the market should help reduce the total inventory of homes to be sold.
Existing home sales also came in better than anticipated, growing 7% sequentially to 4.1 million units on a seasonally adjusted annual rate basis. Like housing starts, this is still an extremely depressed number, but the market took some comfort from the fact that the housing market has stabilized and is no longer in the free-fall induced by the expiration of the homebuyers' credit. Our housing team believes the longer-term norm is for 4.5 million-5.5 million homes to change hands annually. The number got as high as 6 million-plus units in the buying frenzy resulting from the homebuyers' credit.
European Manufacturing Sector Lays an Egg
The markets remain hypersensitive to overseas news as a larger-than-expected decline in the overall European purchasing managers' index triggered a sell-off in European and U.S. markets. Given the positive role of manufacturing and exports in this recovery, the market's reaction is not totally unfounded. However, I should point out the index is still indicating growth at a reading of just over 53, with any reading above 50 indicating expansion.
The September reading reflects a reduction from 56.2 the prior month. Even powerhouse Germany's index fell to 54.8 from 58.4 sequentially. Given all the global linkages, a European decline does not bode well for the U.S. index, scheduled for Oct. 1.
U.S. PMI Can Give a False Alarm
At market troughs, the U.S. PMI manufacturing indexes are outstanding indicators of economic turning points. Interpretation of the PMI index gets a little trickier at economic tops. The lead times between PMI peaks and economic decline can be highly variable and often provide false readings.
The 1991-2001 expansion really highlights the dangers of using the U.S. PMI to predict recessions. During that expansion the monthly PMI dropped below 50 on six separate occasions, with only the last move correctly signaling an oncoming recession.
Using a less jagged three-month moving average, the index average has fallen below 50 six times between 1990 and 2010, which compares to only three recessions. It did a little better forecasting industrial production, but even here the record was not perfect. In the expansion of 2001-07, the PMI peaked in May of 2004 and moved persistently down for the rest of the expansion. The index crossed below the magic 50 level in January 2007, about a year before the economy peaked.
Why doesn't the PMI work so well at forecasting peaks in the real economy? Manufacturing as a percentage of the economy has been shrinking for some time, and that provides some clue as to why the index may have lost some of its value.
Secondly, the index is a dispersion index, meaning it just reports the number of companies seeing ups and downs in their businesses without a focus on the magnitude of the those ups and downs. Typically the base of companies showing growth narrows during the course of a recovery. The real trick is trying to figure out the difference between an unhealthy narrowing (tech equipment in 1999 and 2000) and a return to a normal expansion, where not every company can expect to see growth and be above average. There are always industries in secular decline--such as tobacco, newspapers, and landline phones--that will weigh negatively on the index. In a recovery from a deep recession, even these declining industries might report temporary growth, which is why the index often jumps to its recovery high very early on.
Nevertheless, the PMI index is a valuable tool in an economist's arsenal. However, the economist's interpretation needs to be a lot more nuanced than the trader who sees an index trending down and automatically hits the panic button. One needs to consider company comments, capacity utilization, what industries are seeing the slowing, and what components of the index are moving to properly interpret the data.
The PMI index has slowed in both the U.S. and the rest of the world, and it looks like the index could slow more over the next month or two. As I showed previously, I think the weaker manufacturing data reflects slower consumer spending in May and June; spending seems to be at least a little better now, and that will in turn drive manufacturing and economic growth later this year. But one cannot rule out the possibility that consumers are spending more of their dollars on services. In that case the economy could continue its improvement without massive improvements in manufacturing. Given that services--a much larger part of the economy--has been a bit of a laggard this recovery, a catch-up move on the services side would not come as a surprise to me.
Durable Goods Orders for August Beat Expectations
Interpreting the durable goods orders numbers is always a bit tricky, and this month is no exception. Volatility, especially in aircraft orders, really complicates the interpretation. The headline number showed orders declining 1.3% in August, slightly better than the most recent consensus of negative 1.4% but off from last month's positive 0.7%. Excluding the transportation orders (non-civilian aircraft orders plunged 40%, killing the overall number) durable goods orders were up an impressive 2%.
When pulling apart the individual categories, there was no single category that showed down orders. In fact, non-transportation order growth accelerated in every category except one between July and August. This squares with the positive comments from manufacturing executives and last week's very positive report from Emerson Electric, a major manufacturer of capital goods. Emerson noted acceleration in orders in most categories and in the overall order situation for the three-month period ending in August. Keep in mind that my discussion of orders pertains primarily to August and that the potentially difficult purchasing manager numbers that I allude to above are for September.
Nondefense capital goods orders, an excellent measure of businesses' capital spending plans, were up an impressive 4.1% after last month's scary 5.3% decline. Capital goods shipments were also up nicely this month, which is a direct input into the fixed investment category of the GDP report.
Market's Fixation on Manufacturing Is Misplaced--Watch the Consumer Instead
I think the current preoccupation with manufacturing is a bit overdone. Yes, manufacturing moved relatively early in this cycle. Yes, it greatly amplified some relatively modest gains in consumer spending. But manufacturing could not have moved without the consumer moving first. Manufacturers don't suddenly decide to make more stuff on a whim. It takes demand from consumers to get manufacturers going again. Improving consumer sentiment and improving inflation adjusted incomes will drive that consumer. That is why I'll be watching hours worked, real hourly wages, and employment levels in the months ahead as key determinants for the direction of the economy.
We Won't Have to Wait Long to See if the Consumer Is in Better Shape
This week brings a ton of data on the consumer, and the following week's employment report will bring a lot more important numbers to the table. On Oct. 1 we'll get personal income figures (the wherewithal for consumer spending), the personal consumption price index (which shows exactly how far those dollars went), and personal spending (how much of those inflation-adjusted dollars consumers parted with).
These data are from August, and past employment reports and retail sales reports suggest decent but not spectacular numbers. The consensus for personal income is 0.2% following a 0.2% gain the previous month, which strikes me as potentially a little light given dividend increases and resumption of extended unemployment benefits. The inflation figure is estimated at a mere 0.1%, which also seems a little low given the 0.3% increase in the Consumer Price Index for the same period (the CPI has a substantially greater weight on housing-related products, and those have been depressed). On the other hand, the anticipated 0.3% increase in consumer spending seems relatively consistent with recent retail sales reports.
Purchasing Managers Report Has the Market on Edge
As I have foreshadowed above, I am anticipating a disappointing ISM national Purchasing Managers Report based on last week's European report and relatively sloppy U.S. regional reports. The market anticipates a decline from 56.3 last month to 55 this month. A bigger drop would not surprise me or change my outlook.
Case-Shiller Home Price Index Due for a Decline
After several months of increases, I think the Case-Shiller home price index is finally likely to show a small decline. Recall that this is the data set for the three-month period ending way back in July. This will be the first time the series will not include a month directly affected by the housing credit that expired in April. Other pricing data sets that are not moving averages have already shown some small declines. The Federal Housing Finance Agency number showed a 0.5% decline in July, its second decline in a row. Again, small price declines will not change my overall outlook.
This is an edited version. The article originated from Robert Johnson’s column at Morningstar.com.
