ISM Business Conditions Index

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Hiring On The Rise?

Just days after I issued my forecast for a rather dull 2012 we read that the US private sector hired 325,000 people in December. This is according to ADP the payroll processing company that keeps an eye on such things. This is a noteworthy jump in activity by any standard and deserves to be commented on. If this number holds up tomorrow when we hear from the government in its total payroll data, then we all should breath better: the economy is showing signs of life.

But.

ADP has a track record of being a rotten forecaster at year end. Its seasonal adjusting is a little whacky. So the past couple of years its December figures have not been borne out either by the government numbers, or by subsequent evidence. So be warned: this may be a false dawn.

In order to root out support for the optimistic interpretation of ADP’s report we should look for possible corroborating trends.

New claims for unemployment assistance have also been trending down. Today’s report has them at 372,000 last week, compared with 387,000 the week before. Bear in mind that two week’s ago we saw a mild upward blip in claims, otherwise the recent trend has been steady, if unspectacular, progress. The tone in the job market is clearly improving, the data all are pointing in the right direction, the problem is that progress is still insufficient to break the back of our high unemployment levels any time soon. The gains are real but incremental. We need claims in the 325,000 a week range before we can think in terms of a healthy job market.

Beyond jobs we have evidence of improvement in manufacturing. Yesterday’s look at factory orders showed more strengthening. Orders were up 1.8%, right in line with expectations and much improved over November’s -0.4% dip. Couple this with Tuesday’s brighter Institute of Supply Management’s report on business conditions – their index of activity ticked up nicely to 53.9% in December from 52.7% in November – and the outlook seems better as we enter the new year. With both orders and general activity rising we can infer that the recent improvement in hiring will continue.

So, notwithstanding ADP’s seasonal issues, I think we can accept that things are on the rise. Probably at a less rapid pace than suggested by the ADP report, but nonetheless at a higher rate than the second half of last year.

Does this alter my forecast?

No.

I will stick to the view that the recent improvement has all the makings of a phase that will ebb when we butt up against the slow down being forced onto Europe by its 1930’s style policies. Add in the glaring fact that wages are stuck which means that even if people have a job they don’t have oodles of spare cash to go out and spend. Especially if they are still trying to pay down debt.

It is this debt liquidation that still dominates all other trends. There will come a moment when households reach a level of debt they feel comfortable with. I doubt they are there yet. Although US debt levels are down considerably they are not yet at sustainable levels in an economy that seems unable to generate many well paying jobs, and where asset prices – both stocks and houses – are still highly uncertain.

While this process continues we cannot expect consumption to pick up rapidly. So businesses will still be faced by stagnant sales and will only be able to boost activity in stores by repeating profit eroding discount programs. Thus, while overall activity may look better, the underlying issues remain sufficiently negative to drag growth back into the 2.0% range I have been predicting, rather than accelerating it above 3.0% where we need it to be to bring us back to full employment and a feeling of full recovery.

This is why I suggest we should be a little leery of the ADP figures. Let’s se what tomorrow brings.

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News not Greek

It is hard at the moment not to be mesmerized by the melt down of the Euro. One moment we are told a major position has been established. The next, what was impregnable crumbles to dust in the face of inexorable economic and financial logic. As I see it default is both inevitable and desirable. Inevitable because the burden of debt on top of horribly ill-conceived austerity measures is creating a social backlash that cannot be resisted. Desirable because it would give space to the Greek economy within which much needed reforms can take place without undermining civil society. Desirable also because creditors need to be disciplined just as much as debtors: they need to be reminded that lending is a risky game, and that losses are a natural part of the process of banking. Both buyer and seller need to beware. Stuff happens, and money may not get paid back.

Meanwhile in news not Greek:

The US economy meanders along in it well established stagnant rut.

This week you may not have noticed the news amidst all that Greek drama – on a personal note, my late father-in-law was Greek and grew up in the town of Drama, so he would have enjoyed the current dramatics on a decidedly personal level. Here’s a brief summary of this week’s action:

The Chicago index of industrial activity slipped from 60.4% to 58.4% this month. This supports the general notion that things are not accelerating, but that they are still not collapsing either.

On a slightly more worrying note, the Institute of Supply Management’s measure of manufacturing edged down also, to 50.8% in October from 51.6% in September. Neither of these readings is particularly strong – a reading of over 50% indicates more companies are expanding than contracting. Obviously if we slip any further we should all be concerned that we are seeing the beginnings of a more broad contraction. That October result is perilously close to the borderline. So this index bears watching over the next few months.

Worrying too was the drop in construction spending, which has hardly been robust of late anyway. The latest figures are for September when construction eked out only a 0.2% gain. August had seen a 1.6% gain, so things have slowed down a bit, from rotten to really rotten. This decline didn’t make the headlines, however, because most forecasts had been for an even worse result, and weather may have distorted things too. Still, there is no sign of an incipient boom anywhere to be found. The meander continues.

Lastly, and to support the prognosis of stagnation, today’s ADP report on private payrolls is nothing to write home about. The private sector added 110,000 jobs in October. This is neither good, nor atrocious. It is down slightly from September’s 116,000, but not significantly enough to worry about.

All of this sideways motion contributed into the Fed’s decision to stand pat on monetary policy. The two day Federal Open Markets Committee meeting concluded this morning with a rather tepid press release. At this point I usually launch into a tirade about the Fed’s hawks because they perpetually interpret all this mediocre news as a sign of an imminent burst of growth, sufficient to cause rapid a inflationary spiral. They are thus normally on the side of caution and want to see the Fed start to undo its easing and to tighten things up. How they arrive at this position I have no idea, they seem to be content to ignore the actual evidence and to rely, instead, on fantasy visions and doom laden scenarios in their minds.

But, not today. The only dissenter from the Fed’s current position sees things as more gloomy than me. He wants more easing. This is so unusual I have to bring it to your attention. When even the hawks are quiet, and when the only dissent is on the side of easing, the economy cannot be in the rosiest of shape.

That our hawks are quiet is of little help in global terms. The crazies running the European Central Bank seems intent on being horribly destructive. Those hawks make ours look positively sparrow like. The economists at the ECB qualify for the title of ‘weapons of mass destruction’. Perhaps the US should invade the ECB on that pretext?

Oh. Wait. We used that excuse already.

How did that work out?

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This Is Not Good

What’s that old saying? The rich get richer and the poor get poorer. Today’s blizzard of news brings that saying to the fore. I no longer think our political class is simply inept. It is supremely cynical as well. It has vectored into a discussion of issues that it alone is concerned with. At the same time it has brushed aside issues that the average household is vitally engaged with. In crude terms, I don’t think anyone in Washington gives true thought to our unemployed. The attitude appears to be that they gave it a try, albeit half hearted, and now they can no longer be bothered by it.

Why am I in this mood?

Today’s news is just not good.

The ADP jobs report shows that the private sector added a paltry 38,000 jobs in May. That’s not bad. That’s awful. Consider this: most analysts were expecting a number around 175,000. No wonder the stock market dropped like a stone today. May’s figure was rotten. It was more the kind of outcome we expect in a very poor economy, not one supposedly growing.

Then there was the report on manufacturing which seems to be in retreat as well. The Institute for Supply Management’s monthly index dropped sharply from April’s 60.4% to 53.5% in May. Any reading over 50% means that the sector is growing, but a drop of that magnitude right in the middle of an expansion is not a good sign at all. Manufacturing performed relatively well over the last two years as businesses rebuilt inventories and the global economy grew back from the low levels of the crisis. But with the effect of both those two now tapering off, there is too little strength in the basic economy to sustain much expansion. So manufacturing is falling back to a much lower level of activity – one more in keeping with a stagnant economy.

The car makers too hit a wall. Ford and GM’s sales were nearly flat in May, and all three of the big Japanese makers saw declines. Only Chrysler had a gain – about 10% – largely due to strong Jeep sales.

Adding to our misery, yesterday we heard that home prices are continuing to fall. The Case-Shiller index registered a 4.2% decline in the first quarter this year. While some headlines breathlessly announced this as signs of a “double dip recession” in housing. I disagree. There is no double dip because the decline has been inexorable and predictable. Yes, there was a short respite last year when the government’s tax credit for first time buyers bolstered demand, but that was always going to be a temporary blip in an otherwise continuous decline. So real estate is in the midst of a depression that shows no sign of ending. The price decline is simply confirming this. The extraordinary boom in prices that took off around 1998 has now imploded. We are back at about 2002 prices and headed south. Anyone who bought a house in the last nine years is most likely looking at a loss of some sort. Of course Case-Shiller’s headline number is a national index and there are local pockets moving in the other direction. But those pockets are few and far between. The US real estate bubble of recent years is one of epic proportions and will go down in history as a supreme example of irrational behavior.

Shiller called it exuberance in his analysis years ago. I think it is stupidity. The truly sad part is that regular people were bewitched by the supposed never ending gains available in home prices – how many times did we hear how smart people thought themselves to be, when in fact they were being dumb? And now the reckoning is appalling. Home owners are having to confront not just paper losses, but cash losses as well. And those losses are continuing to mount. As each month presses prices down more households learn that their home is worth less than they paid for it. This erodes confidence and locks people into homes they would prefer to sell. Slowly this accumulates into a block on overall activity. Think of it as a form of economic sclerosis. Until those losses are taken, however painful that may be, and people free to begin afresh we will find the economy weighed down by our unfortunate and ill advised obsession with real estate.

Combine this downcast psychology with our plainly inept banking system that is totally unprepared for dealing with the level of foreclosures it generated through its incompetent – and unethical – lending, and we paint a picture of a nation dogged by its own hubris and massive miscalculation. No wonder people are risk averse right now. They regard the stock market as gambling. And their fabled faith in home prices too has been exposed as a charade. With interest rates near zero the average person has nowhere to turn to generate a decent return.

Thus ends the years of illusion. With private debt piled up, and years of illusory gains to be unwound at the same time, households have precious little room for maneuver.

Getting a population of consumers thus battered to spring back into action is a fool’s game.

Especially when we add in the burden of oil and food prices. There is ample evidence that these combined effects are the reason the economy seems to be slipping into a period of stagnation.

Meanwhile American Express reports that its largely affluent customer base is alive and well. They are back spending at high enough levels to lift Amex’s earnings by a goodly percentage. So the top echelon of society is back in ruddy health. As for the rest? Who cares?

Not Washington, that’s for sure.

In view of all this, and in view of the dismal wreck that is our political process – never in my memory has a western political system been exposed as so bankrupt, corrupt, and in need of repair – I just don’t see how we can expect much strength in the economy. Nothing being debated in Washington is remotely stimulative. Indeed it is mostlyjust the opposite.

As I said: we appear stuck. The rich are getting richer. The rest are abandoned and trying to survive. And this is supposed to be a recovery.

This is not good. Not good at all.

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Good Stuff? And The GOP Plan To Cut Jobs

There are a few interesting pieces of news to report today. My take on them is a little different, so here goes:

Manufacturing

We heard today that the Institute of Supply Management’s index of manufacturing activity rose yet again. It reached 61.4% in February, up from 60.8% in January, and is now at its highest level since 2004. This makes nineteen straight months of increase. Evidently things are looking good in our factories. Heck, they even added jobs consistently during 2010 making it the first year since 1997 when more factory jobs were added than lost. The only down note in the report is the news – actually not news at all – that raw material prices are rising right across industry and are putting some pressure on margins.

Even my perpetually sour outlook has to welcome this news. Except, of course, that it means little in general terms unless those employment figures accelerate much more quickly. Having busier factories on the back of extra overtime and only slight job gains does little to improve anything but profits.

Bernanke

Ben was chipper today as well. He fended off criticism of Fed monetary policy by arguing that any current inflation increases are likely to be temporary and are not a function of Fed activity, but reflect growth in demand overseas and political instability in the Middle East. While I am not a huge Bernanke fan, I have to agree with him on this. Inflation has picked up slightly, as we would expect when the economy awakens from its slumber, but there is enough slack in the system and no sign of rapid wage increases, so the long term trend is still very flat. This probably disappoints those whose ideology requires them to see inflationary ghosts under every Fed policy bed, but those folks are not driven by facts anyway. This is not to say that short term risks are not a worry: obviously ongoing turmoil in the Middle East is causing oil prices to jump around, and raw material costs are rising worldwide as demand grows. Plus food supplies are tight. Take all these together and the near term inflation outlook is for it to rise. But that is not a cause for the Fed to react by raising rates; and it also likely to abate later in the year as [if] things settle down again.

Construction Spending

There’s not much we can say: construction spending continues to tank. It fell 0.7% in January, which was much worse than expected – some had thought it would stay flat – but at least December’s dismal decline of -2.5% has now been revised to a less awful -1.6%. For these things we give thanks.

So what do we make of this?

Consistent with yesterday’s story I think these reports tell us the economy is chugging along at a decent enough pace. 2011 will definitely be a year of solid growth. The problem remains the enormous imbalance in the job market and the yawning inequality that is weighing down on our ability to accelerate. As long as the rewards of growth are asymmetrically channeled to the advantage of a small number of privileged people, and not broadly spread across all groups, spending and investment will reflect the median and not the mean increase. The intense clustering of wealth at one end of the economic spectrum deprives us of power to propel growth. The average may look great, but since most households are not sharing in that growth, the recovery will be slower to gain traction. Indeed it may well falter before it has healed the employment problem at all.

Which is why the current wave of anti-union activity or sentiment is so important. To the extent workers are deprived of their ability to extract wage increases from productivity gains through collective bargaining – which merely offsets the existent asymmetries in the workplace and does not introduce them – we can expect the scenario I just described to persist or worsen. Too many people seem to have forgotten how important the unions were in the creation of the middle class. Perhaps that is a sign of the union’s success and the complacency that resulted from that success. But it is indisputable that workers have not shared in the productivity boom of the last few years. Profits have garnered an historically large share.

Meanwhile, the Republicans are up in arms over the recent issue of several analyses of their budget cuts, all of which conclude those cuts will both slow the economy and cost jobs. I don’t see how anyone could argue otherwise. Cutting costs from government implies cutting demand and reducing government payrolls. That’s it. Plain and simple. The impact of the current set of budget cuts proposed by the GOP seems to be to reduce GDP by a minimum of 0.3% this year and 0.2% in 2012. It may be more. The cuts could also cost about 700,00o jobs over the next two years. Since the economy is creating a paltry 80,000 to 90,000 jobs a month, I will leave you to draw your own conclusions. The Republicans are busy undoing all the good work of the stimulus. Since they never believed in the stimulus I suppose they are blind to both its great success – just confirmed yet again by the Congressional Budget Office – and the negative effects of their policies.

Thank goodness the economy is growing fast enough to keep up a recovery despite their efforts. How long it can withstand the assault I don’t know. Bernanke was very evasive today when asked his opinion on the GOP cuts. Then again he’s a Republican. Even though they hate him.

Poor Ben. Stuck in the middle again.

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More [Fairly] Good News

So far we have managed to avoid reducing the size of our economy in the name of austerity. That makes us better off than the UK where the government decided, for reasons best known only to itself, to make everything much smaller. In view of the news so far this week we may even be lucky enough to get away without too much silliness, although judging by the posturing over debt limits I doubt we will avoid lunacy altogether.

Was the news good?

Pretty much. As usual there’s a mix. And also as usual you can find facts to fit any economic narrative you want to weave.

The biggest surprise was today’s Institute Of Supply Management Index. This provides us with the results of monthly surveys conducted by the ISM, and measures levels of activity in various stages of production. Today’s release focused on manufacturing. The jump from December’s 58.5% to January’s 60.8% caught most people off guard. Given the anecdotal data floating around the general view was that there would be no increase at all. So the uptick caused quite a wave of euphoria on Wall Street which is already in the throes of an optimistic rise. Basically this ISM index, they have others, gives us the proportion of manufacturers who report they are expanding their operations. So any reading over 50% means activity in general is picking up. The January performance was the eighteenth straight month over that 50% mark and is the highest since May 2004.

Most importantly, the sub-indices have now shifted into growth mode as well. So the entire structure of manufacturing seems well set. One of those sub-indices is for employment, and has now shown expansion for sixteen months in a row. It is rated as accelerating, and hit the 61.7% mark in January.

One other, perhaps more cautionary, sub-index to note is that for prices, which has shot up to 81.5% in January, from 72.5% in December. Obviously as activity expands pricing power shifts around and raw material costs creep up. Whether this will show up in finished product prices is debatable. Profits are at all time high levels and so there seems to be plenty of margin to be eroded before producers feel the need to pass along higher prices to consumers. This is especially true as long as consumption remains fairly weak. Still, this is something to watch.

Speaking of consumption: we saw the data on December and the fourth quarter yesterday. It, too, was fairly strong.

Personal consumption rose 0.7% in December, up from 0.3% in November. Adjusted for inflation December’s rise was 0.3%. The fourth quarter as a whole saw annualized growth of 4.4%, which is the most rapid since early 2006.

Obviously consumers are back spending.

The problem is that they are back spending at a rate faster than incomes are growing. This puts a limit on expansion since household debt levels are still relatively high and one of the themes of recent quarters has been the desire to reduce debt. Incomes grew only 0.4% in December, the second straight month at this pace. The savings rate reflected the shift by dropping from 5.5% of disposable incomes to 5.3% in December.

One last number to ponder: construction spending dropped -2.5% in December, following a drop of -0.2% in November. This was a small shock since many people who follow construction more closely than I do had predicted slight growth. What can I say? Construction is going nowhere fast.

So what story do we weave from these dry numbers?

No great shifts. They confirm what we already know. The economy is now growing and is likely to stay that way throughout the year. That will slowly have an impact on unemployment, but probably not a dramatic impact. Conversely, lingering high unemployment and underemployment limit the extent to which the economy can truly “take-off”. Personal incomes are not growing fast enough to set things on fire. And even though profits are very high, businesses still refuse steadfastly to re-hire at anything other than a glacial pace.

Apart from our unstable financial sector, the biggest threats are now policy driven. As more states shift towards austerity the cumulative effect will be to dampen growth. We could see similar problems emerge at the Federal level as well where fractious politics and the early beginning to the 2012 election may well create confusion and could even produce damaging spending cuts.

The economy is just not well enough healed to withstand a round of demand reduction.

If you want to know what is likely to happen if we cut spending too soon, just look at the UK.

On second thoughts don’t, it’s not too pretty.

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