consumer confidence

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Home Prices Fall Again

One of the factors weighing down on consumer sentiment is the persistent fall in home values. So it is worth noting today’s report on the Case-Shiller Index, which showed yet another month of decline – by 1.1% in February, the latest month of data available.

The index is a composite of prices in the top twenty housing cities in the country, and of those twenty only one, Detroit, has an increase in February. And only one, Washington DC, has shown an increase over the past twelve months.

Clearly the real estate market is still stuck deeply in the mire of the aftermath of the bubble. Indeed, after a brief rise in prices in late 2009 and early 2010, the market has either moved sideways or fallen slightly. We are now very close to giving up all that slight recovery. Prices fell 3.3% overall in the last year and are still headed down. Since the peak in prices back in 2005 they have fallen 32.5%.

The market is plagued by problems in both supply and demand. On the supply side there remains a very large, but not clearly defined, ‘shadow inventory’ of homes people would like to sell but which are not actively listed for sale because of low prices. The glut of foreclosed properties is also exerting downward pressure, and making it difficult to determine exactly what a sustainable price is in some areas. Even after the dramatic collapse in construction the supply of unsold new homes, at about 7.5 months worth of sales, is well above levels we see during times of healthy economic activity. On the demand side, even well qualified buyers are having a hard time finding financing as the banks do their usual about face on credit standards – banks always overcompensate for their sins, and hence add volatility to the very markets they complain about being volatile.

One of the great ironies of this cycle has been that an incredibly loose monetary policy has had little effect in boosting the interest rate sensitive aspects of the economy. With mortgage rates as low as they have been, we could have expected a more rapid recovery in housing. But the enormous drag of unemployment and the ongoing fragility of banking have overwhelmed the Fed’s efforts to boost activity.

When will this decline end?

Who knows.

In many respects we are at risk of overshooting the bottom in prices. By this I mean we are likely to see prices drop below the long term trend that affordability ratios suggest is the “normal” level around which prices cluster. The problem at the moment is that stagnant wages are preventing that long term trend line form rising, and the other factors, all of which are short term in nature, are thus dominating price formation.

Look for prices to keep on going down. One respite could be during the spring months as buyers sense interest rates might rise. In view of such potential they might be impelled to buy now rather than wait for even lower prices. Don’t bet on it though. Consumer sentiment is rotten despite April’s slight increase in confidence. Those higher gasoline prices are going to sap away at confidence over the summer, so, in the absence of a sudden pick up in the jobs market, I expect housing to fester all year long and well into next year too.

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Wobbly Numbers. Wobbly Economy?

Just as we enter the big debate over cutting the deficit we are getting a string of mixed signals about the economy. It isn’t as robust as it should be, especially in view of the inevitable negative impact resulting from austerity measures. We don’t have a great deal of room to maneuver, which makes the task of cutting sensitive. Unfortunately sensitivity is in short supply. So I am concerned we may be about to shoot ourselves in the foot.

Let’s begin with the better news. The index of leading indicators rose 0.4% in March. I don’t usually focus on this index since it is simply an aggregation of other data, but it is widely used as a bellwether for activity, so we should note it’s continued rise. As usual the devil is in the details, and the problem hidden by the overall rise is the consumer confidence component. Expectations of improvement, as expressed by individual consumers, has taken a hit lately. This is largely due to the recent spike in food and fuel prices, but it also appears to be driven by nagging doubts about the strength of the recovery, and about howlittle what recovery we have experienced has seeped down into the lower reaches of the economy. Average people are still skeptical. Rightly so, given the very meager improvement in wages. The headlines and the media may be excited by the enormous profit gains being reported, but those numbers are meaningless unless they are translated into household level gains as well. Right now that is not happening either fast or sufficiently enough to turn the tide of expectations. On the contrary, the laggardly nature of employment improvement and the continued woes in real estate cast a pall over the near term.

Business may be booming. But so what?

Just how booming is more questionable after today’s release of the Philly Fed’s measure of manufacturing activity. The sudden drop in the index to a five month low of 18.5 in April, from March’s 43.4 caught us all by surprise. The drop may be partly explained by the fact that March’s reading was the highest since 1984, and thus may have been a distortion of reality that April countered. Even so, the drop seems sharp enough to cause concern. In particular the damage to the score coming from a 22 point drop in new orders should make us worry about the sustainability of our recent run of growth. I don’t think this signals an outright reversal, but what momentum was there may have vanished. We may have arrived early at the second phase of the recovery during which growth continues, but at a slower pace.

If so, this is not good news for employment. And that, in turn, will disrupt the political theater as we approach the next election.

On the employment front: today’s report on new claims for unemployment assistance was disappointing. You may recall that last week we saw a sudden jump in claims back beyond the 400,000 level analysts harp on a sign of returning health in the labor market. The excuse given last week was that there were statistical quirks in the end of first quarter data gathering that would unwind this week. Well not quite. Claims did drop, back to 400,000 from 413,000, but remain stubbornly high. My own rule of thumb is that we need claims to be down around the 325,000 mark before we can call the labor market robust. Obviously we are a long way from there. And progress is still annoyingly halting.

One last thing to bear in mind: the Fed is fast coming up to the end of its existing monetary easing program. Its QE2 series of asset purchases will end in a month and a half. That opens up the debate about what to do next. Should it continue with easy money? Or should it begin to tighten?

Naturally the hawks are circling and calling for an earlier tightening. They point to the spike in consumer prices as evidence that there is more inflationary bias in the economy than is healthy, and that, since growth is now assured, we should shift towards an anti-inflationary stance.

As you can tell from my earlier comments I am not so certain about the economy’s growth pattern. Further, my view is that inflation is only a surface phenomenon at present – wages are the real driver of long term inflation, and they are flat – and that austerity budgets will slow the economy from what already appears to be a weak path. Add this all together and there is no justification at all for a tightening. None.

Indeed if we look at the simple Taylor rule often used to indicate the target level of interest rates, we should be calling for substantial easing. The target rate at present is still negative at between -4% and -5%. Since we cannot get negative rates from our current position the only alternative would be to re-up and go for QE3. In the current political environment I doubt that will happen. So the best we can hope for is neutrality for the rest of this year and at least a postponement of a rate hike until next year. Maybe not even then. The irony, of course, in this discussion is that one way to get negative rates would be to allow inflation to rise so a close to zero nominal rate is turned into a sharply negative real rate. But the hawks want to go in the opposite direction. Why? To curtail the very inflation that would have helped. This is truly messed up policy making.

If this is the best scenario we can hope for we are in trouble. Why?

Because all those wobbly indicators, the persistence of high unemployment, a rotten real estate market, distortions in global inflation and trade balances, tightening fiscal policy, and now an end to easy monetary policy combine to suggest slower growth and rising risk.

This is, I am afraid, the price we pay for weakness in 2009/2010 when the opportunity for clear and bold policy was spurned for a muddle through approach on fiscal policy. When the inevitable fiscal burden of cleaning up the mess foisted on us all by the banks caught everyone’s attention, and started a panic – wrongly – over short term budget and debt problems, we were never going to be able to go back and take a second, better, shot at stimulus. Policy has taken on a patchwork texture since, with small side deals taking the place of grand, coordinated, head on attacks on our problems.

So timidity at the top, and a determination to preserve rather than reform the financial system, no matter how rotten it is, has led us into this sideways motion. Neither accelerating nor, yet, declining.

Today’s data confirm that this recovery is just not very strong.

For that, we have only ourselves to blame.

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What Spring?

It’s a couple of years since Ben Bernanke used the springtime “green shoots” description of the economy. Since then we have had a few good quarters of warming weather, but we never arrived at a fully fledged summer. We seem, to extend the saying, stuck in perpetual springtime.

The reason, I think, is clear. Average folks are not seeing much to cheer about. And since they form the bulk of the consuming population they are not providing the power to generate that burst sufficient to allow us to break out.

A couple of recent statistics get at the heart of the problem.

House prices continue to drop. It is astonishing how long this decline has been going on. Yes, there have been a few false dawns along the way, but the trend remains resolutely downwards. Today’s Case-Shiller index merely confirms the gloomy news. Our housing malaise is a long way from being settled. Eighteen of the twenty cities in the index have seen declines in the last twelve months. The worst affected was Phoenix where the drop was 9.1%, whereas Boston saw the least decline at 0.6%. Only San Diego and Washington DC saw increases. Even then San Diego’s growth was minimal at 0.1%. The 3.1% drop in the overall index in January was worse than the 2.4% drop recorded in last December, and the outlook remains bleak

It is glaringly obvious that our housing problems are here for a while longer, and while they linger the shadow they cast is very long indeed. The real estate market has yet to end its adjustment back to a sustainable price level. The inventory of unsold homes is an illusion since it fails to account for a very large number of homes people would like to sell, but are unwilling to do so at what they consider to be temporarily reduced prices. I am surprised that it is taking so long for sellers to realize that their homes are simply not worth what they would like to receive for them. This imbalance, this inability or unwillingness to grasp reality, is creating a burden in the market that is depressing activity and making matters worse. By elongating the period of adjustment we have allowed the adverse psychology to build to a point where the market clearing price is probably lower than it might have been had sellers been willing, or able, to withstand the earlier price declines. In other words had the original decline been sharp enough, and had people acted to dump homes in order to avoid further losses, we might well have arrived at a position from which the market could recover. Instead we are stuck in a long winded meandering decline that casts a pall over whatever recovery may be going on elsewhere.

This story has become so prolonged that there is no real news in it anymore. Yet is is still important to reflect on. As long as the housing market fades the way it is, households will remain reluctant to spend, and will be forced to save to offset the steady erosion of wealth caused by lost home values. The support of the vaunted wealth effect has become the erosion of an insidious poverty effect. Such is the inevitable way with real estate, an asset we should all view with as much skepticism as any other.

As if to support this thesis immediately, consumer confidence has taken a decided turn for the worse.

The Conference Board reports that its measure of consumer confidence dropped sharply in March, down to 63.4 from February’s 72.0. Prior to this decline the index had shown five months of steady increase, so March’s drop stands out as being a sudden reversal of trend. There is no real surprise in the factors driving the decline: food and gasoline prices have spiked up sharply lately; and wages are not keeping up. Add in the rotten employment market and people are realizing that the economy is just not as healthy as it ought to be. Yes, it has risen from the depths of the crisis, but, no, most of the benefit of that recovery has not flowed into average households. Indeed with disposable incomes under pressure from the spike in prices and with profits rather than wagesscarfing up the gains from the recovery we are building a platform for possible decline in growth from its current rather poor level. Big businesses seem intent on shooting themselves in the foot by hoarding cash and not investing. And our government seems intent on aiding and abetting the decline by cutting government expenditure – which means jobs – before we have accelerated enough to withstand the blow. So our economy is not just leaderless, it is being badly led. The direction is the wrong one, and households are reacting by being more circumspect and pessimistic about their prospects.

In essence our leadership, business, political, and professional, has abandoned the task of encouraging economic growth and has entered a phase of self-destructive policy and strategy decision making. Presumably this is the course of least resistance. For business it is always easier to cut costs that to generate new streams of revenues. It is always simpler to offshore activities to low cost production facilities than it is to innovate domestically. And it is more straightforward to deploy attorneys and accountants to reduce tax burdens than it is to boost gross revenues.

As for the politicians. It is a much easier task to sell austerity and reduction, than it is to explain why we need to run larger deficits. After all voters understand the rhetoric of cutbacks more than the more convoluted argument in favor of spending.

So we are locked into decline. Or rather mediocrity. Voters accept that the economy is not going to provide for them. This acceptance is borne out of thirty years of experience with the stagnation associated with the relaxation of regulation and the massive growth in power of business. We have produced an economy that protects profit well. The cost has been the loss of opportunity and relative wealth of the very households who we now need to carry us along. That their confidence is dented or skittish, and that their belief in our leadership is skeptical to say the least, should come as no surprise. The combination of cynicism, anger, and abandonment embodied in our political discourse is dangerous. These are unhealthy times for democracy. But for capitalists the boom continues.

Good for them.

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Decent Numbers

The end of the week brought a flurry of economic reports, none were surprising and all were supportive of the notion that economic growth is steady, but not spectacular.

Retail sales rose a decent, but not terrific, 0.6% in December. This is off a little from November’s 0.8%, but is still within the realm of sufficiency. For the year as a whole sales were up 6.6% which, again, is better than we have seen recently, but not breathtakingly good. The key point to take away is that consumers are returning to the stores, which means that the consumption component of GDP will continue to tick along. This is critical since it amounts to about 70% of the entire economy. One thing to follow closely is the level of auto sales. Car makers are experiencing a revival at the moment and car sales skewed the overall retail sales figures. Take them out and sales grew more slowly at 0.5% in December. This is the opposite of the skew in November, when a swing in auto sales actually reduced the total rather than added to it. The point being that auto sales are trending up but have, as they always do, a very bumpy trajectory around that trend line. In any given month auto sales can muddy the overall view quite a bit. Hence the need to back them out in order to understand the basic trends.

A similar problem exists in the Consumer Price Index. We saw a big jump in prices in December, CPI rose 0.5%, compared to 0.1% in November. But before we all start to jump on the impending inflation band wagon, let’s back out fuel prices: when we do that December “jump” is eliminated and we drop back to the same 0.1% we had in November. So the recent rise in oil prices has skewed the data. Should we be concerned? Not yet. Fuel and food prices are notorious for jumping around. They can often hide the real trend in inflation and so we need to look at prices both with and without them. The so-called core inflation rate, which excludes food and fuel prices, is low and very stable. It is the basic trend we refer to when we talk about disinflation. For the whole year 2010 core inflation was a very low 0.8% compared with 2009’s 1.8%. So at a base level prices have shown a decreasing rather than increasing trend over the last twelve months. Even the entire CPI including the more volatile items trended down: it rose 1.5% for the entire year compared with 2.7% in 2009.

So inflation is not a problem at the moment.

But those fuel and food prices could become troublesome in 2011 and beyond as worldwide demand stays ahead of production. This is likely to be especially true in raw material prices, so we should expect commodity prices to rise more rapidly than other prices. Food too looks to be a problem. The US just downgraded its forecast crop yields, a move that immediately sent food futures rising. Longer term this is more a problem of infrastructure than capacity: food availability and prices in many poorer countries is more a function of bad transportation than it is of capacity to produce. Africa in particular suffers from this problem. Then again there is the distortion in world prices caused by the pervasive subsidization of food prices in wealthy countries. Many rich countries are loath to cut those subsidies and expose their farms to worldwide competition. High sugar prices in the US are a notorious example of the consequences of such subsidies. At the same time, by giving agriculture so much welfare both the US and Europe end up producing too much food. This excess gets dumped on the world markets where it depresses prices and forces local producers in places like Africa out of production. So one of the largest causes of periodic famine in Africa is not the local infrastructure or practice, which are both bad, but the ongoing subsidy to American and European farmers. Which makes a mockery of the usual subsequent “gifts” of food from those places. The gifts turn out to be drawn from an excess that caused the famine the gifts are supposed to ameliorate.

Other data released today shows that industrial production jumped 0.8% in December. Once again we need to dig beneath the surface. When we do we find that it was utility output adding an extra bounce to the increase. December was a cold month for much of the country and so utilities were generating extra power. Take that bump out and production grew at a lesser rate or about 0.3%. For the entire year 2010, industrial production rose 5.9%, not a bad recovery, but not a boom. This increase in production pushed capacity utilization rates up as well, to 76.0%, an increase of 0.6%. But this level of utilization is still way below the average – by between 4.5% and 5.0% – for the thirty years ended in 2009. So the economy is still flush with spare capacity in need of use before we arrive at a period of new expansion.

One last report worth talking about is the University of Michigan consumer sentiment index for early January. This shows a slight decrease in optimism, driven apparently by that jump in oil prices I mentioned above. The decline in optimism is not huge, but were food and fuel prices to keep up steady increases it may be sufficient to dampen consumption later in the spring or early summer.

So there you have it. A fairly routine round up of the data.

None of it is a surprise. None of disturbs the overall outlook. None of it is great cause for alarm.

Which is good. We could all do with a little hum drum news as we continue to dig out of the mess caused by great recession.

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Consumer Confidence Slips Again

It’s tough to have a vibrant economy when the people who comprise that economy are in a funk. So the news that consumer confidence has slipped a little more and is now below where it was at the beginning of the year is not good news.

The Conference Board calls the 48.5 reading for September on its overall confidence gauge as “quite grim”. This was a decline from the August reading of 53.2. The index has a base of 100 back in 1985, and has been bouncing around in the 40 to 60 range for about 18 months.

While consumer confidence is not an economic factor in the way that spending is, it does give us insight into the likely trajectory of those more direct measures of activity. So this period of decline so far in 2010 does not augur well for the near term. We should expect consumption to wallow in its current range and savings to track higher as households either hoard cash or pay down debt rather than spend.

If this turns out to be the case GDP will be weighed down and will also stumble along at an unacceptably low level.

Perhaps the most alarming aspect of today’s report was the number of people who are expecting things to deteriorate. Whether it is business conditions or the employment outlook respondents in September’s survey were appreciably more pessimistic than those a month earlier.

The lingering malaise shows no signs of abating.

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