The US Economy: Muddling Through


Through  the past three quarters, dating from the start of this recovery, GDP growth has averaged 3.5%. Leading economic indicators still point to a fairly robust expansion extending late into the calendar year.


The ratio of Conference Board Coincident to Lagging Indicators continues to rise, which also points to continued growth in the economy.

Industrial production tracks nicely with the Ceridian-UCLA Pulse of Commerce Index which showed significant strength in May. US Industrial production jumped 1.2% in May.

The Philly Fed ADS Business Conditions Index is also healthy although the more recent data points are worsening somewhat.


On the negative side, the ECRI leading indicator seems to be pointing to a slowdown but, according the one of the co-founders of ECRI, not a double dip. The main problem with the ECRI is that 5 of its 7 components are financial which can create some self-feeding.


Nonetheless, Gluskin Sheff’s David Rosenberg reading of the ECRI puts the odds of a recession at 52%.

The growth rate in the ECRI index dropped further, to -7.7% on June 25th from -6.9% on June 18th and -5.8% on June 11th — this was the eighth week in a row of deterioration. It may end up being different this time, but never before has a -7.7% print sent off a “head fake”.

In fact, the only two false signals occurred at levels that were not as negative as what we have on our hands today: the -4.5% print in 1998 after the LTCM debacle and -6.8% in the aftermath of the crash of ’87.


A lot of the recovery so far stemmed from inventory rebuilding. What about final demand? David Rosenberg points out that real final sales have grown only 1.2% in the last 4 quarters (0.8% in Q1 2010) compared with the 4.5% average recovery bounce since WWII.


The consumer represents 70% of GDP, making it a decent proxy for end-market demand. In fact, personal consumption expenditures have grown at a 2.5% average annual rate in the last 3 quarters.

Households need work in order to supplant the temporary relief offered by generous government-sponsored income support  programs. To put the size of these various programs in a context, government transfers have increased from 14.4% of personal income just as the labor market rolled over to 18.2% more recently – equivalent to $500 billion in direct support. imageimage imageSo far, employment is recovering very slowly. But it is recovering, even though unemployment claims remain stubbornly high. Governments (federal, state and local) seem to be the main factor behind the slow employment trend as Challenger Gray notes:

The government and non-profit sector has continued to struggle even as other areas of the economy begin to recover. It is the leading job-cut sector so far this year with 98,776 announced layoffs, including 5,306 in June.

image Private employment has not grown as much as expected from the improving economic and profit conditions. Recent surveys of corporate executives reveal their reluctance to add labor. A recent McKinsey survey noted that

Executives still expect low consumer spending to be the biggest threat to growth, and they are a little more worried than they were: the share expecting demand to increase has fallen back to half, the level in February, from 60 percent in April.

Other surveys point to uncertainty on rising health care costs as a major impediment to increased hirings.

So far, at least, corporate uncertainty and cautiousness have largely offset improving economic conditions as far as job creation is concerned.


image The US Business Roundtable survey is also more positive on job creation:



"We have been waiting for the labor market to show signs of a sustained recovery," said Jeff Joerres, Manpower Inc. Chairman and CEO. "The survey results for the third quarter (of 2010) are indicating a trend of hiring intention that has historically proven to be the positive inflection point of accelerated job growth."

Importantly, National Bank Financial Group points out that even with the disappointing June job report, employment growth is better than after the last 2 recessions.

While recognizing the softness of the data, we are taking some comfort by the fact that in the current recovery, the U.S. economy is experiencing an above average cycle in its investment in machinery and equipment, a GDP component that shows a tight relationship with employment.

As the following chart shows, the fact remains that this recovery is so far creating jobs faster than the last two where there was no double dip at all. While it took several quarters or even years in the previous two
recoveries to generate decent employment gains, a
positive job growth of 1.6% annualized was registered in


The Bank Credit Analyst supports this more optimistic view:

Despite market fears of a "jobless recovery" the current cycle is not far behind previous cycles in terms of year-over-year job growth, and is in fact stronger than the 2001 cycle (of course, the level of employment is still lagging previous recoveries because of the severe depth of the recession). Growth in temporary employment is running ahead of past recoveries, which implies that employers have been slightly more reluctant to make permanent additions to their workforce. However, the reliance on temporary workers does not appear to be out of line with past recoveries.

One source of angst that we do share with market participants is the lack of hiring in the small business sector. However, there are some signs that the recovery in the small business sector is gaining traction. The National Federation of Independent Business (NFIB) survey reported that hiring plans among small businesses finally turned positive in June.

Our employment model has historically been an accurate indicator of job growth with a six month lead. The current message is that payrolls will expand at an annual pace of at least 1% over the next few months, which corresponds to an average of 200,000 new jobs per month – not stellar but enough to keep the lackluster recovery on track.


Meanwhile, thankfully, US consumers are hanging in. Personal consumption expenditures are up 3.6% (ar) year-to-date, although only 1.5% (ar) in Q2 so far.


The weak housing sector, slow car sales and declining gas prices are having a meaningful impact on total expenditures.

image image image image

Department Store Type Merchandise (DSTM), on the other hand, have performed quite well rising at a 6.5% annual rate in the first 5 months of 2010 in spite of weak April and May sales. DSTM are a decent proxy for discretionary spending as opposed to less discretionary purchases such as groceries and gasoline.

Weekly chain store sales, a weekly proxy for DSTM sales have rebounded in late June.


The problem here is sustainability:

  • Employment has yet to show steady and meaningful growth;
  • The average workweek declined in June;
  • Average hourly earnings declined in June. The YoY change in hourly earnings is now 1.7% and declining;
  • Declining hours and declining hourly wages is nothing to help spending, especially when transfer payments are slowing down.
  • Roughly 2 million jobless workers will lose their
    extended UI benefits between late June and mid-July
  • Tax rates have come down in 2009 but they will start climbing again in 2010 and future years, not to mention the increases in various fees and levies that will hit Americans in the near future. Goldman Sachs estimates that

Tax policy over the next year is likely to see more substantial changes than at any point since 2001, and is likely to see taxation rise more than any point since 1993.

Obviously, employment needs to accelerate to offset these major headwinds.

Fortunately, inflation is well contained, gasoline prices are pretty stable, short term interest rates will remain low for the foreseeable future and low long-term rates are dragging mortgage rate lower. These positive factors provide some support to consumer real purchasing power.

In all, the double dip scenario seems less probable than equity markets seem to be discounting, assuming that employment data do not get worse. Yet, with the Federal fiscal stimulus turning to a drag in Q3 and given Europe’s fiscal problems and China’s slowdown, the best we can probably hope for at this point is a “muddling through” scenario where GDP grows 1.5-2.5% for an extended period beginning in Q3 2010. Probabilities for mild surprises is on the upside as the foundations for better employment stats seem to be in place.

The more negative double dip scenario, however low its probabilities are, must be duly considered given its dire consequences. There are not many policy options left to re-stimulate. Interest rates are as low as they get and the federal deficit is already untenable. Inflation is ready to trade the “in” for “de” with economic and financial consequences that few market participants are old enough to fully appreciate.

Equity markets are cheap but the risks out there justify some caution.



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