Up and Down We Go

As if right on cue today’s news encapsulates everything we’ve been talking about all week: despite all the brouhaha about recovery our progress is precarious.

First: durable goods orders.

Today’s report is bad news. Durable goods orders fell at a 2.4% rate in August. That’s the second drop in the last three months, but follows what we all thought was a turn around in July when they rose a strong 4.8%.

As usual I caution everyone about taking one month’s data and making it the whole story. Durable goods orders are notoriously ‘chunky’. The numbers include a whole mix of things and run the gamut from refrigerators to airplanes. One order for a few airplanes and the index can leap, only to plummet next month. So we should look at the numbers in both more detail and over time.

The problem with this is that the story doesn’t improve too much.

Durable goods orders are typically seen a harbinger of future activity since they include machinery needed to re-tool factories. They are also, obviously, a factory based set of products so they give us insight into the state of play in manufacturing.

There are two major possible distortions that could cause the data to mislead us: the aircraft orders I mentioned already, and defense spending. Both tend to come in batches of large orders and thus can skew the data off of a ‘normal’ trajectory. Since it is that trajectory we are interested in it is sensible to look at the data without them.

Unfortunately that doesn’t help us. Take out aircraft and defense and orders still declined. Clearly businesses are being very reticent about investment. They are sitting and waiting for more insight into the nature of the economy as it grows over the next few months. This report suggests a continuing lack of optimism throughout the business world.

Worse: the drop in orders has now caused the backlog of unfilled orders to decline. That means our factories are looking at a few months of flat or slightly lower activity. If this data means anything it tells us that the hope for an acceleration in manufacturing is more hope than reality.

One consequence of this is that factories are not about to begin a burst of re-hiring. So our job market will remain weak, at least in the manufacturing sector. A flat order book provides no incentive to re-hire or to expand capacity, and with so much idle capacity already out there we are probably looking at a few more months of moving sideways rather than making solid gains.

On a different front today’s report of weaker than expected new home sales is also bad news. They rose only a meager 0.7%, which is a poor record given that home prices have dropped so significantly over the past year or so. The mean price of a new home dropped 9.5% between July and August – the largest one month decline on record – and the median price has declined by 11.7% over the past year. Couple these price drops with the recent tax credit for first time buyers, and I think many people expected a stronger performance in August. In this context that 0.7% gain looks anemic to say the least.

As I wrote yesterday the housing market is all muddle at the moment. Builders are completing fewer new homes as they try to avoid sitting on inventories of unsold homes: completions dropped 5.8% last month, and that helped reduce the inventory of unsold homes to about a 7 month supply – the lowest since early 2007. But builders are facing very stiff competition for buyers because of the flood of cheap foreclosed homes: many first time buyers who normally would have bought a new home were able to purchase a cheaper foreclosed home. The bad news within the data is that a new home, once completed is now taking as much as a year to sell. We are used to thinking of a 6 month unsold home inventory as ‘normal’, so, given the ‘stickiness’ of sales it looks as if it will be a few months more before we reach that level – perhaps by the first quarter next year. After that I think the market will stabilize around a lower volume, at which point housing will once again be a net positive for the economy as a whole.

Rather than leave you on such a low note I should also mention today’s release of the University of Michigan’s regular Consumer Sentiment survey. The index of confidence jumped from 70.2 to 73.5 in the the first couple of weeks of September and compares really strongly with August’s overall reading of 65.7. Consumer confidence is a very difficult statistic to get our arms around simply because it is intangible. The big question is whether rising confidence will lead to more sales. If it does then the steady improvement we are now seeing in consumer outlooks should translate into the kind of consumption that would cause those reticent businesses I mentioned earlier to start investing and blowing the cobwebs off their factories.

Setting this all in the big picture:

Our economy is suffering from a massive reduction in demand. We have production capacity sitting idle waiting for signs of a revival in spending. While that revival looks suspect or way off in the future businesses will not invest – this is why durable goods orders are weak at the moment and is also why we will continue to keep an eye on them. Every month we go without getting back on track costs us hugely in lost wealth we will never recoup: at our current rate we are losing, for ever, around $200 billion of national wealth. So that uptick in consumer confidence cannot come at a better time – let’s hope it translates into sales in the stores.

Meanwhile: keep in mind that $200 billion a month figure.

Nest time someone you know argues about the cost of bail-outs or stimulus plans think about their cost in the context of the wealth leaking away. The contraction has cost us almost $2 trillion. So the spending of about $trillion to get things going again was a good deal. Remember that without that spending we would have fallen deeper and longer into the abyss. At that point the $2 trillion loss could easily have doubled.

Yes, it is expensive to have the government bail out the private economy, but the private sector collapsed and we had no option. Deficit spending is not something I advocate as a permanent policy, far from it, but there is a time and place for it.

Like now.

It works. Now let’s move on.