March 22nd, 2012
Written by Macrotides
Job growth has improved, especially over the last three months, when it averaged 245,000 jobs versus 160,000 in the three prior months. Retail sales have also been decent. Core retail sales, which exclude sales of gasoline, autos, and building materials, were up .5% in February, after increasing 1.0% in January. Lending by U.S. banks has modestly increased. Consumer and small business confidence have also risen in recent months. Despite these encouraging reports, we think intermediate and long term challenges will prevent the economy from accelerating from current levels, as it has during “normal” post World War II recoveries. As this growth spurt loses steam, we believe a gradually slowing will take hold by late summer. In addition, some of implied strength during the last few months may be the result of statistical variability, rather than actual demand.
Most of the economic reports we receive are not based on raw data. Government number crunchers seasonally adjust the raw data to smooth out recurring seasonal variations in the data. For instance, there are more homes sold during the summer than in winter. Retailers hire aggressively in the fall to handle the holiday sales stampede, and let most of the workers go in January. We do not think there is anything sinister going on, i.e., skewing the data to favor one political party over another, or make the economy look better. Adjusting the raw data is an honest attempt to make the information meaningful over time, so a more accurate appraisal can be made as to the economy’s health.
This winter has been the fourth mildest on record, according to the National Weather Service. The affect of this deviation from the “average” winter is likely giving the raw data an extra boost, based on normal seasonal adjustments. More people are out shopping or eating in a restaurant since it is 50 degrees, rather than staying warm at home, as they would normally when it’s 15 degrees in February.
Seasonal adjustments are also impacted by outlier data points, when compared to prior data. In the fourth quarter of 2008 and first quarter of 2009, the U.S. economy experienced an extremely large decline that affected all the data sets, when compared to the fourth and first quarters of preceding years. The formulas used to measure activity in subsequent years are compared to an average of prior fourth and first quarters. This skew in the prior data will have the effect of making the subsequent years look better than they really are, until time removes the negative impact of the data from 2008 and 2009. This statistic anomaly has likely adjusted the raw data higher in the fourth and first quarters in 2010, 2011, and 2012. This dynamic suggests the second and third quarter of 2012 will not benefit from this statistical lift, and, as a result, will register slower growth, even if growth is maintained at first quarter levels.
Our expectation of a gradual slowdown though extends beyond seasonal adjustments. In prior post World War II recoveries, job growth would be averaging 350,000 jobs or more, forty four months after a recession ended, and all the lost jobs would have been recovered. Although the last three months of job growth have been good, there are still 5.3 million workers out of work. The average work week was unchanged in February, so the need to hire additional workers is not high. More importantly, average hourly earnings were up only 1.9% from a year ago. The cost of living has increased more, so the purchasing power of the 132 million consumers who have jobs is less than a year ago, which outweighs by far the modest improvement in job growth.
The price of gasoline has jumped in the last six months, with the national average for regular unleaded reaching $3.83 last week. Fortunately, the mild winter kept heating oil prices down and an excess of natural gas pushed prices to ten year lows. According to estimates by the Energy Information Administration, the additional $14.8 billion shelled out by consumers since last October, was partially offset by the $9.0 billion saved from the other energy sources. However, with the summer driving season right around the corner, higher gasoline bills won’t be offset by other energy savings. Expectations of higher gas prices, is already dimming consumer optimism, according to the BD/TIPP Optimism Index. If gasoline prices push higher during the summer driving season, as they usually do, consumers will have less spending money.
Although consumer sentiment and small business optimism have improved since last fall, they are still well below the levels associated with a normal recovery. Since 1975, the Michigan Consumer Sentiment Index has been comfortably above 80 when the economy has enjoyed healthy growth. The current reading of 74.3 has only occurred during periods of recession. The financial stress on the average family is reflected by the 45 million Americans participating in the Supplemental Nutrition Assistance Program. Of the 311 million people in this country, 14.6% are relying on Food Stamps. Since 1986, recessions have been coincident when the Small Business Optimism Index has been below 95. Even after months of improvement it is still comfortably below that threshold.
We expected the economy to get a lift in the fourth quarter of last year from the investment tax credit that allowed companies to write off 100% of business investments completed by December 31. We assumed this incentive would pull demand forward from early 2012 into 2011, and result in a dip in the first half of this year. Although the ISM manufacturing index is still above 50, which delineates growth and contraction, it did drop in February, after climbing from a low last July. This may prove a foreshadowing of the gradual slowing we expect.
State and local government finances have improved significantly since 2010, as states raised taxes, cut costs to close budget deficits, and an improved economy lifted tax receipts. Since mid-2008, state and local governments have reduced their collective payrolls by 647,000. Despite these actions, state and local governments face a shortfall of $47 billion for their 2013 budget which begins on July 1. In order to balance their budgets, as mandated by law, more tax increases and job cuts will be implemented and have a small drag on the economy in the second half of this year.
Ironically, some of the large budget deficit states also have the highest rates of unemployment, and high taxes. Clearly, state tax rates do matter. If workers have a degree of mobility, they will gravitate to states that have no taxes or low taxes, as will the companies that employ them. The migration of labor away from high tax states makes it even more difficult for them to balance their budgets, as tax revenue growth is too weak to offset spending increases. The experience from 2001-2010 shows how significant this has been. In 2010 and 2011, exports grew 15%, adding more than 1% to GDP growth.
As noted last month, Europe is our largest trading partner representing 20% of exports. In January, exports to Europe fell 7.5%. We don’t expect Europe to rebound anytime soon. Although China, South Korea, Brazil, and India will continue to grow in 2012, their growth rates will be slower than in 2010 and 2011. This suggests that export growth is not likely to accelerate from current levels.
Of the 11 prior recessions and recoveries since World War II, the current expansion has been the weakest by far. Real personal income is still more than 4% below its pre-recession level, even though it’s been 32 months since the recovery began in June 2009. The overall economy as measured by GDP has been sustained by an unprecedented level of income transfers that have supported consumer spending. For every $1.00 of total personal income, the federal government is providing almost $.20, financed with trillion dollar deficits. This is so obviously unsustainable, but the will to address the coming budgetary crisis in the U.S. is lacking. We are following the same path taken by Greece, and it’s no Yellow Brick Road.
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Macrotides is a monthly subscription newsletter written by a wealth manager associated with a major Wall Street investment bank. The author’s firm has requested that he not use his name to avoid any incorrect implication that his views might reflect those of the bank. The author has written investment advisory subscription newsletters based on macroeconomic analysis and market technicals for more than 20 years. Enquiries can be made email@example.com.