US Perspectives: Grim Numbers Now, Grimmer Numbers on the Way

Exogenous factors could produce shockingly bad statistics for another month or two.

Robert Johnson, CFA 07.06.2011
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The week ended on a low note as the employment report showed job growth of a paltry 54,000 versus expectations a week ago of 180,000 new jobs and 241,000 new jobs in the prior month.

 

Housing prices continued to erode, the national purchasing managers' reports for manufacturers showed a major decline, and auto sales laid an egg as high prices and short supply drove customers away. At least initial unemployment claims went down and the purchasing managers' survey of services looked better than expected. Both the June monthly and the pre-Memorial Day week of data showed that the consumer has still not given up the ghost.

 

Unfortunately, based on news already in the pipeline, even worse numbers lie ahead. A confluence of Japanese auto and supply chain issues, bad weather, record gasoline prices, and stagnant wages have produced a perfect storm of negative news that is exceptionally difficult to disentangle. The good news is the Japanese situation is on the mend and improving faster than earlier anticipated. And I have to believe that weather effects (too cold to buy summer clothes, too wet and rainy to begin home and garden projects) will run their course.

 

Even gasoline on a national basis is down from $3.98 a gallon at its high to $3.78 recently (still dangerously high compared with the $2.78 level of a year ago). The prognosis for real wage growth is less positive, resulting in the need for me to cut my 2011 economic forecast. And without some better news on the inflation front, even that estimate is suspect.

 

Officially Reducing My Real 2011 GDP Forecast to 2.75%

There is no doubt that the employment report was less than wonderful. Slower hiring was a concern (though the numbers may not be quite as bleak as they look), but I was much more concerned by the hourly wage numbers, which moved into negative territory on a year-over-year basis (three-month moving average) since early 2010.

 

Without increased earnings, it is going to be increasingly difficult for consumers to spend more. Yes, the upper income strata has done better than the hourly wage group. Yes, there are a lot of stock market gains being spent at the likes of Nordstrom, Saks, and Tiffany. Nevertheless, I think my 3.5% estimate for real GDP growth in 2011 is looking too aggressive. Therefore, I've reduced my economic growth forecast to a range of 2.5%-3.0% with a single-point estimate of 2.75%.

 

I think second-quarter GDP growth will have a hard time exceeding 2% (we already have 1.8% growth on the books for the first quarter) given the issues with the auto industry described below. However, as those plants are brought back online in the third quarter, quarterly growth in excess of 4% seems like a possibility.

 

Exogenous Factors Could Produce Shockingly Bad Statistics for Another Month or Two

Weather, changing seasonal effects, and major Japanese supply changes will continue to wreak havoc on economic statistics. All the variability will render a lot of statistics nearly useless, and there are no easy fixes for adjusting the data. For another month, maybe two, the biases will probably be on the downside (weakened auto sales could devastate May consumption statistics).

 

Then as Japanese plants come back online, weather improves, and seasonal adjustments become less onerous, we could see some stunning economic statistics later this summer. In the meantime, I have some fear that the short-run statistics look so bad that they will cause both businesses and consumers to panic, exacerbating the situation. So far it looks like businesses are doing most of the panicking even as consumer spending on non-auto- and non-gasoline-related products continues to show surprising strength. Business caution was certainly in evidence in this month's slower hiring report.

 

Employment Data Disappoints

Just the week before last week I had been relatively confident that job growth would continue at a decent pace of 180,000 or so jobs. Instead, jobs grew by just 54,000 overall as retail, government, and leisure related slowness torpedoed my forecast. Percentage growth rates were down in all categories with the exception of finance, which showed an acceleration in growth. That said, only nondurable manufacturing, retail, and leisure showed slowing that could be described as meaningful.

 

Though there's some reason to doubt the magnitude of the decline in job growth, it's clear that labor markets were weaker in May than any of us hoped. Businesses clearly pulled back as rising gas prices affected consumer behavior, commodity price increases pressured the bottom line, and the effects of the Japanese tsunami and the renewed European debt crisis weighed on the minds of CEOs. The reported job growth of 54,000 per month represents annual employment growth of just 0.5% annualized, far short of what is needed to reach my economic forecast or to make a dent in unemployment.

 

Data Issues Suggest Headline Data May Be Overstated

That said, there are a few oddities in this month's data. First, the establishment estimate of job growth in the private sector (which is derived from asking businesses about job growth) was a gain of just 84,000; when households were asked about jobs, job growth was a much more robust 319,000. While the establishment survey is considered to be more statistically defensible, the household survey does sometimes lead the establishment report, and over time the reports tend to converge.

 

Sequential Job Growth (Thousands of Jobs)

 

Household Survey

Establishment Survey

December

157

167

January

106

94

February

272

261

March

265

219

April

240

251

May

319

83

Source: Bureau of Labor Statistics

 

Retail Employment Makes an Odd Tumble

By category retail employment grew an unusually strong 78,000 in April and then fell to just 3,000 new jobs in May. Some of that may have been the timing of the Easter holiday, which was later than usual in April. I had mentioned last month that the huge 78,000 gain was not sustainable. Within retail, home stores were particularly weak, losing about 8,000 jobs, probably due at least in part to cold and wet weather across much of the country.

 

Real Wages Move Negative

More troubling to me than the overall employment number was the real wage figure. The real wage number looks at the average hourly adjusted annual wage and adjusts for inflation (as measured by the PCE). The year-over-year index has been moving down since February (on a three-month moving average basis) and it now appears that it will move into negative territory for the month of May.

 

I have written on different variants of this measure (some use CPI, some use CPE, some look at month to month, and so on) in the past. No matter which version one chooses to use, the results point to a least a soft patch in the economy. I've been reluctant to pull the plug on my forecast based solely on this measure as wage income has shrunk as a percent of total income (with small business profits, rental income, dividends, and transfer payments picking up the slack). Also, high earners, with stock market gains to burn and tinier portions of their incomes devoted to expensive gasoline, have been the key drivers of consumer spending as of late.

 

Year-Over-Year Real Wage Growth

 

3-Month Moving Average

December

1.0%

January

1.1%

February

1.0%

March

0.7%

April

0.2%

May (e)

-0.2%

May inflation estimated at 0.4%
Source BEA, BLS and Morningstar

 

Year-Over-Year Retail Sales Continue to Grow, Aided by Luxury Spending

Data from the International Council of Shopping Centers showed that monthly retail sales, as reported by individual stores, accelerated slightly to 5.3%, exceeding the Council's expectations of 3.0%-3.5% growth. Most trends were unchanged, with luxury goods stores continuing to show stellar results even as discounters remained mired in the mud and as warehouse clubs benefit from higher gas prices. The only real surprise was apparel stores taking it on the chin in May as cold weather kept shoppers from buying their summer wardrobes. Weekly data showed a sharp acceleration in apparel sales during the last week of May as weather in the Northeast finally broke to the hot side (we Midwesterners continued to suffer). The table below shows the trend data since September. I have combined the March and April data to aid comparability as Easter benefited the March period in 2010 and the April period of 2011.

 

Consumers Keep Spending

Year Over Year
% Change

Dec 2010

Jan 2011

Feb 2011

Avg Mar/Apr

May

Total Comparable

3.1

4.7

4.2

4.0

5.4

Total Less Drugstore

3.2

4.7

4.9

4.3

5.8

Apparel

0.8

6.3

3.2

3.4

1.0

Department

4.6

2.5

5.7

4.3

4.2

Luxury

8.1

6.0

10.1

8.1

10.4

Discount

1.2

1.8

2.1

1.7

2.6

Drug

2.3

4.8

2.4

3.2

1.3

Wholesale Clubs

5.7

8.3

7.7

7.2

12.3

Source: International Council of Shopping Centers

 

Real Manufacturing Decline or Japan Disaster Effect?

Last week's purchasing managers' survey index dropped sharply to 53.5 from 60.4. Given the weakness in a couple of regional reports from the Northeast two weeks ago as well as a fall in the Chicago report the day before the national report, the news should not really have come as much of a surprise. Nor do I find the numbers all that troubling. The anecdotal comments in the report seemed more positive than negative.

 

More importantly, Japanese transplant auto manufacturers have been reeling since the March earthquake. Between 40% and 50% of U.S. auto production is from the U.S. factories of Japanese companies. Production from these Japanese plants has been off more than 50% at various points since the crisis began in March 2011. Although the Detroit Three and the non-Japanese transplants have stepped up their game, they certainly haven't made up for issues in Japan. Seasonally adjusted production estimates for the car and light truck market appear below. The numbers would have been even worse if Nissan, Honda, and Toyota didn't all have different worst months for production. The damage was spread out, so to speak.

 

Total U.S. Production, Car and Light Trucks

 

Millions of Cars
Seasonally Adj. Annual Rate

January

7.76

February

8.38

March

8.76

April

7.65

May (e)

7.65

June (e)

8.10

Source: Federal Reserve; Estimates, Morningstar

 

Given that automakers buy parts and materials from many different types of vendors (steel, cloth, and plastics to name a few), a slowdown in auto sales has a disproportionate effect on various manufacturing indexes. This is especially true for the PMIs that measure the number of firms reporting better or worse results without regard to the magnitude. Auto problems tend to affect a lot of firms a little. The influence of the auto industry is far beyond the mere 2.5%-3.0% of GDP that it currently represents.

 

One of my readers was kind enough to send along a copy of an article by Bespoke Investment Group showing that in the aftermath of Kobe earthquake in 1995, the PMI did indeed decline along with decreased Japanese auto production. In fact, they also noted that the resulting manufacturing disruptions also caused a spike in initial unemployment claims in the U.S. After a long downturn in U.S. initial claims, those claims spiked sharply upward in April 2011 when the effects of the earthquake were more fully felt in the U.S. This spike came despite the fact that Challenger Gray & Christmas reported continuing declines in large company layoffs throughout the winter and spring.

 

Overall employment data may have been affected by the Japanese supply chain situation. Though the direct effect on auto employment was modest, it is hard to estimate some of the more indirect effects. What about the reduced advertising by auto manufacturers because of limited supply of cars, or fewer bank loans for autos, or fewer restaurant visits near major Japanese auto plants?

 

Auto Industry Issues Extend Beyond Manufacturing, and Could Affect Consumption, Inflation, and GDP

Unfortunately, the impact of the auto production issues will spill into broader measures of the economy--including GDP. Strong auto production in the first quarter accounted for 1.3% of the total economic growth of 1.8% reported in the first quarter. It looks to me like auto production could take 0.5%-1% off of second-quarter real GDP growth. I should point out, however, that lower imports from Japan (of autos, auto parts, and electronics) might offset some of the production-related effects on GDP.

 

There are further consequences. Car shortages have enabled manufacturers to raise prices. Recent incentive levels are at their lowest in nine years. And sticker prices are going up. Ford is already on its third price increase of the year. That certainly won't help the CPI in the short run. I bet there will be some great incentives once Toyota gets back in the game. And the higher prices for cars (along with gasoline) are keeping consumers away from auto dealerships in droves. That will make consumer spending look just awful for a few months.

 

It Doesn't Stop There

I believe supply chain issues extend beyond the U.S. and Japan as well. Japanese auto production in Japan plunged from 731,000 units in April 2010 to 292,000 in April 2011--a 60% reduction. Given that steel, copper, aluminum, and other goods that go into cars come from world markets, the slowing effects probably extended well beyond Japan and may have contributed to weaker world purchasing managers' reports over the past several months.

 

Japan, Inc Makes Progress

The good news is that the Japanese have already made great strides in improving their supply chain issues. As we noted previously, Toyota moved its timeline for moving back to full production forward considerably. Once the problems are resolved, Toyota hopes to step up production in a big way. For the full year of 2011, Toyota now hopes to produce as much as in 2010, and only modestly off of its 2011 forecast. So while the current quarter of economic data is being greatly depressed by the Japanese supply chain issues, they are likely to cause a strong move in the opposite direction in the third quarter.

 

Trade Data on Tap

I'm interested to see whether the Japanese-related auto issues and auto supply factors will meaningfully dent U.S. import statistics for the month of April. Consensus forecasts are for the trade deficit to remain flat at $48 billion between March and April. The hope is that lower import quantities of oil will offset the price increase (prices were still moving up at a meaningful clip in April). We might see some meaningful decline in auto and electronic imports from Japan that could bring the deficit down at least a few billion dollars.

 

 

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


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

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