Some Green Shoots, But We Need Rain

07/31/2012 10:30 am EST


John Reese

Founder and CEO, And Validea Capital Management

There's some encouraging signs for the economy, but we're not out of the woods by any stretch, so look for the bright spots and avoid the danger signs, writes John Reese of Validea Hot List.

The economy continues to offer a very mixed bag, with a sluggish job market and consumer pullback being offset by signs of strength in a couple other key areas.

One of the bright spots comes from the industrial sector. Industrial production increased 0.7% in June, according to a new report from the Federal Reserve (here and below all comparisons of successive weeks/months are seasonally adjusted; comparisons to year-ago periods are unadjusted).

The gain came despite a decline of nearly 2% in utility output, which tends to be the most volatile of the three industry groups that make up the sector. The other two groups did more than pick up the slack, however, with manufacturing output increasing 0.7%—reversing a 0.7% decline from the previous month—and mining output also increasing 0.7%.

The other area of the economy offering good news was the housing market. Housing starts rose nearly 7% in June versus May, according to new data from the Commerce Department. The annualized figure of 760,000 starts represented the highest level seen since the fall of 2008. Housing starts are now about 25% above their year-ago level.

Permit issuance for new housing fell, however, by 3.7% versus May, but is about 15% above year-ago levels. That, combined with the latest US home price data, which showed that prices moved upward in April for the first time in several months, means we're continuing to see signs that the housing sector may at long last be ready to take part in the economic recovery that began in mid-2009.

If that is indeed what is happening, it comes at a good time. That's because US consumers continue to pull back. Retail and foodservice sales declined in June, falling 0.5% vs. May, according to the Commerce Department. It was the third straight month that the figure has dropped, after nearly a year straight of monthly gains. Sales remain about 3.6% above their year-ago level, though the year-over-year increases have been shrinking rather rapidly in recent months.

The consumer pullback very likely has a lot to do with the jobs market, which remains soft. Since our last newsletter, new claims for unemployment have risen by about 2.7%, while continuing claims have stayed pretty much flat.

What's interesting to note, however, is that using unadjusted numbers, new claims were just 3.6% lower in the most recent week than they were in the corresponding week a year ago, a much lower spread than we've seen in recent months. That could just be an aberration. But given some of the questions that have arisen recently regarding the way the government makes seasonal adjustments to its data, most notably those raised by the highly regarded Economic Cycle Research Institute, it's something to keep an eye on.

On the macro front, the debt crisis news coming out of Europe has slowed over the past couple of weeks, as policymakers try to hammer out the details of some of their recent compromises. Hopefully, the relative quiet is a sign of the most contentious and potentially dangerous phase of the crisis has ended, though to be sure, much work still needs to be done.

Taking center stage in Europe's absence has been Ben Bernanke and talk of another round of quantitative easing by the Federal Reserve. So far, the Fed has seemed hesitant to implement such a plan, and frankly that may be a good thing, considering the diminishing returns we've seen on the Fed's previous easing efforts.

Are We in a Recession?
As job growth, retail sales, and even (according to some reports) manufacturing activity have slowed in recent months, some notable strategists, including Lakshman Achuthan, who heads the ECRI, and fund manager John Hussman, have suggested that we have entered a new recession.

To be sure, the economy has slowed since the first quarter. But have we entered a new recession? Morningstar Director of Economic Analysis Robert Johnson recently provided some interesting data indicating that, while growth isn't gangbusters, we haven't fallen into recession.

Johnson notes that, while many people think of a recession as simply being two quarters of negative growth, the official determination is made based on four factors: industrial production, retail sales adjusted for inflation, personal income less transfer payments (unemployment, disability, Social Security) adjusted for inflation, and employment.

For each of the past 13 months, he looked at how the three-month average in each of those four categories compared to the same period a year earlier—and how it compared to the levels in December 2007, when the US entered the Great Recession.

What did the data show? Well, Johnson found that industrial production is actually increasing at a more rapid pace than it was a year ago, posting 4.9% growth as of June 1 vs. 3.6% a year earlier. (You should be aware that the June data uses Morningstar's estimates.) That 4.9% pace is nearly twice the 2.5% growth we were seeing heading into the Great Recession.

As for job growth, it was increasing at a 1.4% pace through June 1, ahead of the 1% rate from a year earlier. In December 2007, it was at 0.9%.

Retail sales, meanwhile, have been trending downward and were increasing at a 3.4% pace as of June 1, vs. 4.5% a year earlier. But they are well ahead of the December 2007 start-of-recession pace, which was a meager 0.2%. Only personal income is very close to the Great Recession starting level; it was at 1.7% entering the Great Recession, and was at 1.8% as of June 1 (vs. 2.7% a year earlier). But it has also been rising for three straight months since falling to 1% earlier this year.

A key part of the analysis for a couple of those categories seems to involve inflation, something that many pundits don't look at when examining such numbers. That's something to keep in mind when looking at the consumer-related figures—it's about real purchasing power, not a simple headline number.

"Most of the metrics are currently improving after hitting lower growth rates earlier in 2012. Only retail sales are in a clear downward trend, and that is largely because of falling gasoline prices, which is actually a good thing for the economy," Johnson writes.

"It certainly doesn't seem like we are about to fall into a recession, especially with falling prices and an improving housing market. In addition, at the end of 2007, inflation peaked at 4.6%, helping to push us into a recession; it is now a much more subdued 2.2% and still improving."

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Related Reading:

Watch the Water and Paddle Like Hell

Essential Services Remain the Smart Path

Volatily Just Ain't What It Used to Be

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