Why the Economic Recovery Isnít Stronger
FORECASTS & TRENDS E-LETTER
IN THIS ISSUE:
2. Home Front: The Latest News was Dismal
3. Bank Lending Has Yet to Recover
4. Consumer Spending is Back, But Recovery Remains Slow
5. Conclusions – This is a Very Uncertain Time
As I reported last week, the state of the economic recovery continues to rank #1 on Americans’ minds based on numerous recent polls. With that in mind, we will take a look at the latest economic reports to see if the recovery will continue, or if the economy is rolling over to the downside once again as some now fear.
The latest housing news for February was very discouraging. Sales fell more than expected across the board, and new home sales plunged to a record low. Housing starts fell to the second lowest level ever. Home foreclosures topped one million in 2010 for the first time ever. Yet there may be some reasons to believe we may be close to the bottom.
The credit markets may be unfreezing but commercial and industrial loans remain in the tank. Ditto for lending to small businesses. The Fed reported that only 12% of banks it surveyed have loosened their lending requirements since the credit crisis unfolded.
On a positive note, annualized consumer spending has now recovered back to the level where it was before the Great Recession - of course not to the level it would have been without the recession. So why does this recovery seem so sluggish? One reason is that private domestic investment fell off a cliff in the recession and remains far below pre-recession levels. I think you’ll find this discussion very interesting.
The Economy: Consumer Confidence Tumbles
The Commerce Department released its third and final estimate of 4Q GDP last year. The number was revised upward from 2.9% to 3.1% (annual rate), which was slightly better than the pre-report consensus. This means that GDP rose by 2.78% for all of 2010 following two negative years in 2008 and 2009.
The positive growth in the 4Q was primarily due to personal consumption expenditures, exports and non-residential fixed investment, the government stated. Negative contributions were seen in private inventory investment, state and local spending and imports.
The Blue Chip Economic Indicators average of 50 economists has the US economy growing at the rate of 3.1% for all of 2011, but that number will likely fall slightly in the survey for April now that oil prices are back above $100 a barrel. The latest BCEI survey will be out in a few days, and I will report if there are any significant changes.
We won’t get our first official glimpse of 1Q GDP growth until April 28 when the Commerce Department will release its first “advance” estimate. However the Index of Leading Economic Indicators (LEI) continued to rise in February, up a solid 0.8%, thus continuing the upward trend. This would suggest that GDP grew by at least 3% in the 1Q, but we’ll see.
The most surprising economic report of late was last Tuesday’s Consumer Confidence Index (CCI). The Conference Board reported that the Index plunged from a three-year high in February of 72.0 to 63.4 in March, the largest monthly drop in a year. This was well below the pre-report consensus. In a similar move, the University of Michigan Consumer Sentiment Index fell from 77.5 in February to 67.5 in March.
Another question in the Conference Board’s monthly confidence survey asks respondents how they feel about the future – the so-called Expectations Index. That number plunged to 81.1 in March from 97.5 in February, making it the largest drop since the financial crisis in October 2008 and one of the five largest declines ever.
According to the latest data from the folks at Gallup, the outlook of consumers is now changing rapidly. The main culprit is energy costs, what with gasoline prices near or above $4 a gallon in many parts of the country, followed closely by rising food prices and new housing woes.
Consumer confidence can have a significant impact on consumer spending for obvious reasons. Thus, it will be very important to see if the indexes reverse and go higher in April. The CCI had risen for five consecutive months to the high of 72.0 in February. To put that number into perspective, a reading around 90 in the CCI indicates a healthy economy. We haven’t seen a number like that since before the recession began in late 2007.
The mood among small business owners has recently swung lower as well. DiscoverCard conducts a monthly survey of small business owners and the confidence index dropped sharply in March. 54% of small business owners said the economy is getting worse, up from 41% in February – that’s a huge move in one month. As for their own business, 42% say conditions are getting worse, with only 30% saying it’s getting better. 56% rate the economy as “poor” and only 35% rate it as “fair.” (See link to this story in SPECIAL ARTICLES below.)
Elsewhere, the latest economic reports were mixed. Retail sales rose 1.0% in February (latest data available), about as expected. Orders for durable goods, on the other hand, fell 0.9% in February, well below expectations. Factory orders for February fell 0.1%, which was below expectations, following a healthy rise of 3.3% in January. The ISM manufacturing index held fairly steady in February at 61.2 versus 61.4 in January, with both being good numbers.
The unemployment rate fell to 8.8% in March, a bit lower than expected, to the lowest level since March 2009. The economy added 216,000 jobs last month as compared to 194,000 in February. The U-6 unemployment rate, which includes those not looking for work and the under-employed, fell to 15.7%.
Overall, it looks like the economic recovery will continue at a relatively slow pace, depending on what happens with consumer confidence just ahead. But the longer that oil remains above $100 per barrel and food prices remain high, the more consumer spending will dial back.
As discussed in a previous letter, most economists believe that an oil price of $100 per barrel only shaves off apprx. one-half of 1% of GDP. This time around, however, it could be more than that. With all the unrest in the Middle East, consumers are more concerned than usual. Thus, anything can happen going forward.
Home Front: The Latest News was Dismal
The bad housing news actually began on January 13 when RealtyTrac reported that home foreclosures toppedone million units in 2010 for the first time ever. This number does not include default notices, auctions or repossessions. Add those in and the number goes to a record 2.9 million.
The foreclosure number could be even higher this year. You will remember that many home foreclosure proceedings were halted in the 4Q due to the documentation and procedures scandal at some large lenders. As a result, many of those proceedings are happening this year. Reuters recently reported that over half of all home foreclosures in 2011 will be involuntary.
The news got worse on March 16 when the Commerce Department reported that housing starts fell 22.5% in February as compared to January, the second slowest pace on record. Then on March 21, the National Association of Realtors (NAR) reported that sales of existing homes plunged 9.6% in February to an annual rate of 4.88 million units. But it gets even worse.
The Commerce Department reported that new home sales collapsed in February to a new record low. Sales plunged 16.9% to a seasonally adjusted 250,000 units. Compared to February of 2010, new home sales were down 28%. Every region in the country but the West saw record lows, and in the Northeast, sales dropped by 50% compared to year-earlier levels.
As you might expect, sale prices for existing homes continue to fall. The median sale price has now dipped below $160,000 for the first time since 2002. Making matters worse, the NAR reports that 39% of existing home sales in February were in distressed properties that sell well below the asking price, so it’s safe to assume that most sellers got hammered.
Interestingly, 33% of existing homes sold in February were paid for in cash, the highest level on record. The significant increase in cash sales this year suggests that these buyers include investors who believe the market is near the bottom, and they might well be correct.
Remember the weather was terrible in much of the country in February, and most analysts believe the housing market will show some kind of a bounce for March, and then we move into the higher demand period in the spring and summer. So it’s possible we could be seeing the long-awaited bottom in the market. Or not.
Bank Lending Has Yet to Recover
When you read that one-third of all existing home sales were cash transactions, you know right away that the credit markets have not remotely recovered to their pre-recession levels. The chart below, which I have reprinted numerous times over the last two years, shows that commercial and industrial lending, like the mortgage market, has not yet recovered either. Commercial lending fell at the fastest pace on record in 2009 and then bottomed out last year – maybe – and has only upticked modestly recently.
I say maybe only because you’ll notice in the chart below that it took almost three years for C&I lending to turn up following the recession of 2001. That makes one wonder if the modest uptick so far this year is really the sign of a bottom. Only time will tell.
In February, the Small Business Administration (SBA) reported that lending to small businesses fell by $59 billion between June 2008 and June 2010. It seems odd that the SBA would not have more current information, but apparently they only update their data once each year.
A Fed survey in January found that only 12% of banks reported that they have loosened their lending standards since the worst of the credit crisis. Given that, it is still much harder for small businesses to get loans or credit lines than before the crisis, and it could remain that way for quite some time.
Consumer Spending is Back, But Recovery Remains Slow
It is widely agreed that consumer spending makes up two-thirds to 70% of the economy. Data from the Commerce Department shows that personal consumption spending (PCE) recovered to pre-recession levels by the end of last year, actually eclipsing it slightly.
Here are the numbers: PCE spending on Goods (not services) peaked in September 2007 at $3.29 trillion (annualized rate). It bottomed at $ 3.05 trillion in December 2008. The total drop was $24 billion or 7.2%. Annualized PCE ended last year at $3.36 trillion, well above the previous peak. The following chart from The Economist illustrates what has happened with PCE – Goods:
If consumer spending is back to a new high, why then is the unemployment rate still near 9% (15.7% if we count those no longer looking for work and the under-employed), why does the recovery feel so sluggish, and why is consumer confidence falling again?
Some argue that since consumer spending on goods fell only 7.2%, there was not a lot of so-called “pent-up demand.” And I would say that’s probably part of it. But I would argue that there’s something much more important that is holding our economy back.
Gross Private Domestic Investment in the US fell off a cliff during the Great Recession. Gross Private Domestic Investment (GPDI) is expenditures on capital goods to be used for productive activities in the economy. Actually, GPDI turned lower well before the recession began. According to the Commerce Department, GPDI peaked in the 3Q of 2006 at $2.35 trillion, and it bottomed in the 3Q of 2009 at $1.53 trillion. That was a huge drop of $822 billion or 35%.
As you can see in the chart above, the drop from late 2006 to late 2009 more than wiped out all the growth in GDPI since the 2001 recession, although it did rebound somewhat last year. The point is, it was by far the worst drop in private investment since records have been kept.
Some economists believe that that the collapse in private investment may have contributed as much to causing the recession as did the drop off in consumer spending. Unfortunately, it is much harder to revive private investment than it is consumer spending in the current environment in which business lending is still in the tank.
In addition to private investment, a lot of the money we need to truly revive the economy will have to come from foreigners. If you are a foreigner with capital, what are the risks of investing in the US? The obvious risk is the falling US dollar, which is the policy of the Treasury and the Fed. Next there is the issue of very low returns on Treasury securities, not to mention the fear that our trillion-dollar deficits could result in a downgrade in the US credit rating and increase the default risk.
Most foreign investors, like the rest of us, want to wait until after June to see what happens when the Fed ends QE2. Also, most foreign investors recognize that the current Administration is not exactly pro-business. They also know that if the current occupant of the White House is re-elected next year, the US will face a huge, across-the-board income tax increase in 2013 (end of the Bush tax cuts), which won’t be good for the economy in general.
Fortunately, there is plenty of foreign investment capital sloshing around in the global markets. Many emerging markets are trying to slow down capital inflows. The Obama White House should embrace economic policies that will attract the glut of foreign capital looking for a home to the US. Unfortunately, I don’t see that happening.
Conclusions – This Is a Very Uncertain Time
The US stock markets are enjoying one of the most impressive bull runs ever, despite a lot of disappointing news on the economy. With the equity markets shrugging off a lot of bad news recently, many analysts are now virtually guaranteeing that we’ll see a move to new record highs this year – what else is new?
While the economic recovery seems to be on track to continue mildly positive growth, that assumes the housing market doesn’t continue to implode – and that’s a big assumption. As discussed above, bank lending is still anemic, and the Fed is on track to end massive QE2 bond purchases at the end of June – no one knows what will happen then.
There are other headwinds I did not discuss this week that are facing the economy as well. The Eurozone sovereign debt problem is back at the forefront. If you thought that problem was over, Portugal’s recent dilemma proved otherwise. More big bailouts are coming.
While the situation in the Middle East has recently centered on Libya, there are other hot spots that could affect the price of oil which, in turn, will serve as a headwind to the continued US economic recovery. The situation in Bahrain can only be described as a “powder keg,” with Sunnis and Shiites striving for control.
It is also coming to light that some of the rebels the US and NATO are backing in Libya may actually include Jihadists who fought US forces in Iraq and Afghanistan. That’s just what we need – install a new government in Libya that may be even worse than Gadhafi. Needless to say, turmoil in the Middle East does not bode well for oil prices or economic certainty.
Last but certainly not least, the US money supply (as measured by the Adjusted Monetary Base) is exploding. Historically, this means that higher inflation is just around the corner. I’ll have more to say about this concern just ahead.
While the stock markets have impressively shrugged off these headwinds this year, that is not a guarantee that they will continue to do so. When the view is that there’s nowhere to go but up, the markets often react otherwise. I’m glad I have most of my net worth invested with money managers that can go to cash or hedge long positions if the headwinds get too strong.
You can check them out at http://www.halbertwealth.com/.
Very best regards,
Gary D. Halbert
Bank of America predicts 1Q growth of only 1.5%
Over half of small businesses say economy is getting worse.
New SBA loan fund not very popular with small business
Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.