Good News: The Service Sector Springs to Life

Two relatively minor reports this morning both have the same message: the economy is growing and that growth is spreading across all sectors. Good news all around.

The first report is the Institute for Supply Management’s non-manufacturing activity index, which captures the trend in basic business activity across all aspects of the service sector. This index is technically known as a ‘diffusion’ index which means that it tells us the percentage of businesses reporting higher levels of activity. Any time it reads more than 50% we can assume that the economy is growing since more than half of the companies reporting are saying their businesses are getting busier than before.

So this March’s reading of 55.4% is a strong sign of recovery, and was a good sized increase from February’s 53.0%. This increase is important for a couple of reasons beyond the obvious that it implies growth. First: the service sector has been lagging behind manufacturing so far in this cycle. That is very normal, but if we are to get to point where growth is self-sustaining and not reliant upon government stimulus, we need the service sector to catch up. March’s data suggests that the catch up is well in progress. Second: the service sector is the largest component of our economy which reinforces the need for catch up. If we are to generate jobs any time soon we will need a robust performance from services. It looks as if we are finally approaching the threshold: the sub-index that measures only employment activity in the service industries crept up to 49.8%, meaning that we are very close to the point where job gains outnumber job losses. This will be a crucial data point to watch for next month.

Elsewhere in other sub-indices the story was much the same: strong improvement over February. New orders jumped to 62.3% from 55.0%; general business activity hit 60.0%, up from 54.8%; inventory re-stocking rose slightly to 46.5% from 45.0%; and new export orders rose rapidly from 47.0% in february to 57.5% in March. Better yet the responsiveness of suppliers fell 53.5% in February to 49.5% in March – a sure sign that activity is quickening because suppliers are facing an influx of new orders and are therefore having trouble keeping up.

The second report this morning is the monthly release of pending home sales from the National Association of Realtors.

One of the more difficult issues we have faced over the winter is getting a good handle on the real estate market. After last summer and early fall housing dropped back into the doldrums with all signs of activity fading from their October peaks. Prices started to slide again, sales declined, and pending sales fell away sharply – by 20% since October. All these signals told us that real estate is in for a very long and slow recovery and that it will not be a leading player for growth generation over the next few years.

So the question became: just how much of a quagmire are we in?

Today’s report that pending sales jumped 8.2% in February suggests that the decline has been arrested and that we will see the usual seasonal uptick as the spring and summer months arrive.Whether this reversal of the previous few month’s decline is sufficient to propel housing into a strong recovery is highly questionable. There remain plenty of signs that housing is still suffering from the after-effects of its mania, and prices are now only barely within historical ranges of affordability. So I think the outlook for housing remains cautious. But at least it doesn’t appear as bleak as it did just last week when price reports suggested more erosion on the way.

In the context of the current economy we don’t need real estate to become an engine of growth. Far from it – we need to avoid another bubble. But we do need it to recover enough that it is no longer a drag on household wealth and mobility. This latter point is often left unremarked upon. As households find themselves living in homes with negative equity, their ability to sell and then to move in search of a new job is frozen. If this phenomenon occurs on a large enough scale the economy’s ability to generate jobs is hampered by the increased lack of mobility within the workforce. Whilst, by itself, this is not enough to grind the employment market to a halt, it can often be a powerful secondary effect to be added to other forces. So a recovery in housing will have a welcome knock-on impact in the job market. Which is why this morning’s report is encouraging in ways beyond its meaning for real estate alone.

So what do we make of today’s news?

That the signs we are now seeing of recovery are not isolated and that the recovery seems to be spreading across the entire spectrum of activity. This does not imply that we should update our forecast for the year: growth of around 2.0% is still the most likely outcome as long as unemployment is stuck above 9%. We can however downscale the chances of a second recession this year. That alone is a healthy sign.

So we start the week off with some good news for a change. Spring is finally here!