US Perspectives: Not the Great Recession II

As bad as some of the numbers have been, the signs don't point to another recession.

Robert Johnson, CFA 31.08.2010
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The economic news last week was pretty bleak. Apparently, a lot of that was already baked in, as the market declined a modest 0.6% overall. Existing home sales, new home sales and durable goods orders were weak and below expectations. Intel also warned that weak consumer spending would hurt September quarter sales, but business spending remained robust.


The GDP report for the June quarter was revised down from 2.4% to 1.6%, slightly better than expected. While still elevated, initial unemployment claims were far better than expected, falling by 31,000 people. On Friday, Federal Reserve chairman Bernanke's pledge to do whatever it takes to save us from deflation was met with applause on Wall Street, igniting a small rally. Consumer loan delinquencies also managed to eke out a small improvement in August, building a small but nevertheless positive trend.


Not the Great Recession II

As bad as some of the numbers have been (and will continue to be for a few weeks), I am still not convinced that we are going back to a horrible recession. Slow growth, maybe. Generally, a recession results from many parts of the economy nearing capacity limitations. This causes sharply rising prices, reducing inflation-adjusted consumer spending capabilities. Fed tightening, to control the inflation further limits consumer spending. That starts production moving downward and the vicious cycle of declines begins.


However, real disposable income has shown marked improvement almost every month this year. The economy is not approaching any capacity limitations and Bernanke reaffirmed that rates are not going up anytime soon. In addition, the savings rate almost always falls going into a new recession, but our savings rate continues to accelerate.


Yes, jobs aren't growing as robustly as I would like to see, but do you really think that corporations have the capability to lay off even more people? Meanwhile, falling interest rates, mortgage payments, and some commodity prices mean more spendable cash will move into the hands of those with jobs.


Can the Numbers Really Be This Bad?

Some of the poor economic indicators are suspect, too, in that even as orders deteriorate, a lot of manufacturing firms are making positive public statements, and manufacturing employment growth is having one of its most noticeable runs in many, many years. I am not saying that the numbers are wrong, but I wonder if the summer doldrums, a run of positive unsustainable order growth, large seasonal adjustment factors, and the lack of a summer shutdown at GM (causing some months to look better and others worse) accentuated many indicators that admittedly slowed. Running 500,000 people onto the Census payroll this spring and running them off just as quickly this summer doesn't make data interpretation any easier. Yes, the employment adjustment is easy to make, but how did this change spending patterns?


Strong Imports Killed What Could Have Been a Great June Quarter

The GDP estimate was revised down from 2.4% growth to 1.6% for the June quarter, not quite as bad as some expected. Compared to the earlier estimate, consumer spending was revised upward, and net exports were revised sharply downward along with smaller changes in construction spending and a slightly smaller inventory build in the quarter. These adjustments were widely anticipated based on recently released data.


But although GDP has been volatile from quarter to quarter, consumer spending growth has shown remarkable consistency.


Annualized Consumption Growth (%)

Q3 2009


Q4 2009


Q1 2010


Q2 2010


Source: Bureau of Economic Analysis, Morningstar


A shifting preference for overseas goods has certainly held back growth in other economic categories. Import growth was responsible for reducing GDP growth by more than 4%. I suspect that slowing consumer electronics spending (as telegraphed by Intel last week), a weaker dollar, and more U.S. agricultural sales will dim the negative effect of net imports in the third and fourth quarter GDP reports.


The overall quality of the GDP report this time was higher, too, as inventories contributed a substantially smaller amount to GDP growth than the prior three quarters. Business spending on equipment and software was booming too, as the tiny GDP category contributed 1.55 to GDP growth.


Durable Goods Orders Fail to Impress

Durable goods orders looked terrible at just 0.3% growth for July (compared to June) despite stunningly good aircraft numbers. The numbers were way below expectations and frankly, didn't match the relatively bullish tone of many of our industrial companies. July is a seasonally weak period anyway (and August might not be a lot better), and combined with unsustainable strength earlier in the year, might explain some of the weakness.


Three of the seven categories in the report showed improvement and four showed declines, so the report was not a total washout. August might not be the best month to expect much improvement, but I would hope that things begin to look up in September, as the quarter ends and some employees return from vacations.


Existing Home Sales Plummet as Homebuyer Credit Wears Off

Our housing analyst Eric Landry summed up last week's housing news as follows:  

As expected, existing home sales suffered an awful July, cratering 27% from June and 26% from July of last year. Single-family sales fell by the same amount as total sales, both sequentially and annually, while condo sales fell by 24% and 28%, respectively. All in all, a perfectly awful month, as July's 3.83 million SAAR is the lowest level in the short 12-year history of the total sales series. The 3.37 million single-family SAAR is the lowest reading since 1995. That said, the result shouldn't have been a huge surprise given the expiration of the housing credit and the pending home sale index. The good news is that the market has likely seen the end of the sharp declines, and can now start to slowly rebuild from here.

 Initial Unemployment Claims Finally Break Their Jinx

The initial unemployment claims figure managed to finally show some meaningful improvement last week, though I caution that these numbers are very volatile on a weekly basis. The weekly claims number fell 31,000 in one week to 473,000 on a seasonally-adjusted basis, one of the larger weekly declines this year.


The seasonal adjustment multiplier for the week is still one of the highest of the year. The non-seasonally-adjusted claims numbers fell to 380,935, the lowest level since September 2008. I can't help but think that consumers are noticing that fewer of their friends and neighbors are getting laid off, even though this is not typically the time of year when layoffs occur. If the trend continues, it could improve consumer sentiment in the months ahead. Again, I don't want to read too much into these numbers, but it was a small ray of hope in an otherwise dismal week of economic news.


Personal Income and Employment on Tap for This Week

This week brings a raft of economic data, starting with personal income for the month of July at the beginning of the week and the official employment report at the end of the week. For many months the consumer has seen meaningful improvements in income but has been husbanding the extra cash as the savings rate has been on a generally increasing pattern.


For July I suspect that income and spending patterns may be closer than in previous months. For July, the consensus is for a modest 0.2% increase in personal income (but no growth whatsoever when adjusted for inflation). The dismal forecast makes sense given that the incomes will be weighted down by the brief stoppage in extended unemployment benefits in July, a falling number of temporary census workers, and a construction strike in Illinois. Some of these factors will reverse themselves in August, leading to a much improved personal income number for August.


Personal income is the fuel for consumer spending and includes everything from wage income, small business owner profits, rents, and dividends. Wages are the largest component and continue to show relatively lackluster growth. Dividends and rents that were deeply depressed during the recession are beginning to show signs of life, and could be an important driver of growth in the months ahead. Over the long run, I would like to see inflation-adjusted incomes grow 0.2% or 0.3% per month (2.4%-3.6% annualized) to support total GDP growth of 3.0%-3.5% over the next several years.


Consensus forecasts for consumption are for 0.3% growth, and would likely produce inflation-adjusted growth of just 0.1%, modestly ahead of a zero income growth forecast. In 2010, spending has exceeded incomes only during the month of February, as consumers battened down the hatches. Therefore, I continue to believe that the consumer has the wherewithal if not the desire to spend a little more to drive the economy forward.


Given all the regional purchasing manager reports, and some negative news on the durable goods orders last week, it looks like another disappointing purchasing managers report is in the cards for August. After peaking at 60.4 in April, the national index fell to 55.5 in July. A fall into the range of 50-53 for August would not surprise me or necessarily panic me either.


Many analysts focus on the magical 50 number where the number of people seeing increases theoretically equals those seeing declines. However, analysis and correlation of past results show that readings as low as 42 are consistent with continued growth in GDP. I suspect that a broad range (and numerically significant) number of corporations show no growth or even modest declines when an economy has returned to normal growth. For example, in normal times, we may see little growth in tobacco sales or paper goods from month to month, while a fairly narrow set of firms and products--such as consumer electronics or prescription drugs--drive economic growth forward. Because the ISM just asks if orders are up or down and not by how much, the ISM index has less relevance as we move through a recovery.


The employment report for August is also likely to be another downer as the layoff of Census workers is likely to move the headline employment number into negative territory yet again. The consensus forecasts for overall job losses of 106,000 and private job gains of 47,000 (versus 71,000 in July) seem to make overall sense and might actually be just a little bit too positive. I believe that the lack of a summer shutdown at most GM plants during July make the application of past seasonal adjustment factors look silly. I think the changed shutdown schedule added as many as 30,000 jobs to the July report and will subtract a like number from the August report. Poor weekly initial unemployment claims data in August doesn't bode well for the report, either. There are two pieces of good news. Return of 10,000 striking construction workers in Illinois will help the August jobs report. Also, the overall ISM report and many of the regional reports continue showing increased hiring, which just doesn't seem consistent with weaker order numbers coming out of both the ISM reports and out of the U.S. Census Department.


As always, I will be watching the report closely for average hours worked and the hourly average wage. I suspect some improvement in both categories but the improvement may be a little less robust than the past few months.


This week will also provide some interesting and potentially positive news on the housing front. The Case Shiller housing price index is likely to show another small increase given that some homebuyer-credit-affected months are still included in this three-month moving average. Toward the end of the week we will see pending home sales for June, which will drive existing home sales reports for the following two or three months. After several months of disastrous results in existing home sales, a better pending home sales index could indicate that existing home sales made their bottom in July, after a hitting a near-record low.



This is an edited version. The article originated from Robert Johnson’s column at

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Robert Johnson, CFA  Robert Johnson, CFA, is director of economic analysis with Morningstar.

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