Recovery Thesis Holding

It has been a busy week for news on the economy and most of it has been good. The best comes today with news that unemployment in the US has fallen to a three-year low of 8.3%. Payroll jobs grew 243,000 in January following gains of 203,000 December and a 157,000 rise in November. The averages for workweek and hourly earnings improved which will continue to propel consumer income growth which got a bump first of the week.  

Personal income grew 0.5% in November, following a 0.1% rise in October. Wages and salaries also grew strongly. The consumer has been using much of his discretionary income to reduce debt. Debt service relative to income has fallen from 14% to 11%. While this is healthy for households, flat spending holds down the economy, which is largely fueled by the consumer. Spending in December was flat, following only a 0.1% increase in November.

What money the consumer is spending (or more aptly, borrowing) seems aimed squarely at the new car industry. Vehicle sales jumped to a 14.2 million annual rate in January for a 5% gain over December, according to Econoday. Sales were concentrated on cars which jumped 13% to a 7.4 million rate. Truck sales actually fell in January, down 4% to a 6.8 million rate. This is the first time in nine months that the car sales rate exceeded the truck sales rate.

Rising gas prices and continued high unemployment drag on consumers’ assessment of current conditions. The government’s survey of confidence fell in January to 61.1 from December’s 64.8. The present situation component fell more than 8 points to 38.4, nearly erasing December's strong showing. Econoday suggests that weakness in confidence centers on the jobs market where 43.5% of respondents say that jobs are hard to get. Perhaps today’s unemployment number will improve the readings on confidence in the months that follow.

But while falling unemployment may boost consumer confidence, the falling values of their homes will surely keep it muted. Case-Shiller reports that home prices continue to fall with no meaningful signs of turning around soon. For the third straight month, November’s composite-20 index fell a sizable 0.7%. All but 3 of the 20 cities in the index show monthly contraction. The year-on-year rate of contraction for the composite-20 deepened slightly to minus 3.7% from a minus 3.4%. Lower prices drive sales, but existing homeowners are faced with declining net worth or negative net-worth, limiting resale options. 

The manufacturing sector of the economy continues steadily along despite troubles in Europe and Asia. The ISM manufacturing report for January rose to 54.1, safely over 50 to indicate monthly expansion and 1 point over December to indicate a slightly faster rate of expansion according to Econoday. A key highlight was that new orders rose nearly 3 points to 57.6, indicating perhaps a more significant rate of expansion.

Two of the regional Fed reports were also supportive of the national trends in manufacturing. The Texas general business activity index shot up to 15.3 after dipping to minus 0.3 in December. The company outlook index also increased markedly, rising from 5.0 in December to 13.5. Both indexes reached their highest readings in 10 months. Business conditions in the Chicago area also remain quite strong, though they slowed 2 points in January to 60.2 (still quite beyond the 50 to indicate expansion).

 Factory orders were up a strong 1.1% in December following an even stronger November reading of 2.2%. Durable goods led the index with a 3.0% increase compared to a 4.2% rise in November. Buying, not surprisingly is focused on value and longevity.

Productivity bucked the improving trend in the fourth quarter. Even though output was up hours worked increased faster. Nonfarm business productivity eased to an annualized 0.7% in the fourth quarter after gaining 1.9% in the previous quarter, according to Econoday. Compensation rose an annualized 1.9% after a 0.3% dip in the third quarter.

 Construction spending in December jumped another 1.5% after a 0.4% increase the month before. Private nonresidential outlays produced a 3.3% rise in December, following a 0.5% dip in November. Residential spending rebounded 0.8% after a 0.3% decline. Public outlays rose 0.5%, following a 1.7% boost in November.

Finally the week ended with two exclamation points; unemployment dropping to 8.3% and a very strong ISM non-manufacturing report with the headline composite index up 56.8, well beyond economists’ consensus of 53.3 and 3.6 points above December’s upwardly revised 53. New orders jumped nearly 5 points to a 59.4 level that indicates strong monthly growth and points to acceleration in general activity in the months ahead. But Econoday points out that the employment index was the headliner, up 8 points to 57.4 for by far the strongest reading of the recovery so far.

Optimism appears high among stock investors as the broad US stock market is up 3.2% as I write this Brief. The S&P is up 2% and the Dow is up 1.5%. Treasuries on the other hand are down. The Barclay’s 7-10 year Treasury index, which we use in our models, is down .8% and the Barclay’s 20+ Year Treasury Index is down 2.9%. Yields increased today as bondholders fear inflation may be on the rise with an improving economy.  

While it’s been a good week based on the data, it is clearly too early to extrapolate too far into the future. It is quite possible that the recent momentum is fueled by the billions of dollars of stimulus heaped on the economy as well as historically low interest rates. The major problems of debt and deficit spending are not being addressed. Remedies will place huge strains on the economy for years likely extending beyond a presidential cycle.  

Federal Reserve Chairman Ben S. Bernanke spoke this week on Capitol Hill to defend his newly established 2% annual inflation goal. He rejected suggestions by lawmakers that he was prepared to allow higher inflation in order to create jobs. The Fed has a dual mandate to hold inflation down and to promote an economy that creates job growth.

 Bernanke said he sees signs the economy is improving, though it remains vulnerable to shocks. He also called on lawmakers to reduce the long-term US budget deficit. He pleaded “To achieve economic and financial stability, US fiscal policy must be placed on a sustainable path that ensures that debt relative to national income is at least stable or, preferably, declining over time.”  

So we have to wonder whether Republicans or Democrats will have the political will or staying power to see it through. We are heading into a wall built of past excesses at high speed. We will hit that wall precisely when the US dollar is no longer the world’s currency. Until then, we have a grace period unlike that of any other country on earth or in history to get our national house in order. Will we squander it and face collapse like Europe, or will we bridge the ideological gulf that divides us long enough to jettison the weight that will surely swamp us?