Last week, markets experienced one of their worst weeks since the recovery began as a result of spreading debt contagion issues in Europe, a messy resolution to the U.S. debt crisis, and what many viewed as weak economic news. Pundits jumped on and misinterpreted the consumer income and expenditures reports and an admittedly weak ISM Purchasing Managers Report. Meanwhile, a jump in auto sales, a steady decline in initial unemployment claims, and even a respectable jobs report went largely ignored. While I can't portray the economy as robust, the U.S. economy is certainly not about to fall back into the abyss.
I would characterise the economy as neither booming nor busting. At times it certainly felt like it was about to boom (after those stellar jobs reports of February, March, and April of 2011). At other times it looked more like a bust. Just last August we had a run of bad employment and manufacturing reports that spooked the Federal Reserve. After a run of bad reports, the Fed began to openly discuss QE2 (the government's programme to repurchase long-term government bonds to reduce interest rates). Many of those very short-term booms and busts appear to be nothing more than statistical mirages. Those boom and bust conditions always seemed to revert to a steady state, slow growth economy that just isn't very satisfying. Worse, those at the bottom of the economic ladder appear to still be going backward. The unemployment rate for those with less than a high school education has increased by more than 1% even as the rate for the entire population has fallen.
To be honest, I've been in the booming camp for most of this recovery, which has made me look right about half the time and like a stubborn fool the other half. I will admit to a certain bullish bias about recoveries based on growing up in the 1970s. The U.S. faced then what I viewed as horrendous problems including double-digit inflation, a war lost, riots in the streets, and even a president facing impeachment procedures. Penn Central Railroad went bankrupt and New York City came awfully close. My view has been if we could recover from that, we could recover from just about anything. And periodically, data from this recovery have supported that view. However, a lot of government numbers have either been restated or partially flawed, further confusing the interpretation of where we are now, let alone where we are going. Nevertheless, I surmise that even with the revised data I would have stayed relatively bullish (though I was probably more bearish than anybody else on the second-quarter GDP forecast due to Morningstar's analysis of auto production data).
However, recent results have made me temper that attitude. My belief now is that truly booming conditions typical of most economic recoveries are not going to happen this time, at least not without a big change in the housing market. I still think we're going to get to a better housing market--it will just take longer than I thought. Population growth almost guarantees it has to get better at some point. But the psychology of home buying has changed drastically and it's going to take time to work through. These issues extend well beyond foreclosures and upside-down mortgages, too.
The Tale of Two Neighbors
Attending a recent college graduation party brought home to me how big the change has been in potential home buyer attitudes. The 2011 graduate, who was lucky enough to get a great job, will be living at home despite the fact that he lives 45 minutes away from his new job (on a good day). At a similar party for another neighbour five years ago, the neighbour's son announced that he had bought a small condo in the city. The thought then was that if you didn't get in the housing market early, you'd miss your whole chance to ever afford a house. I know similar cases where the parents even helped provide some of the down payment money. Such buying accelerated the housing market of the mid-2000s and is now weighing heavily on the low end of the market. But even the 2011 graduate will most likely buy a home when he/she begins forming a family. Truly this is demand deferred, not permanently destroyed.
The Jobs Market Can't Make Huge Strides Without Housing
About a fourth of the eight million jobs lost during the recession were direct construction jobs. If one were to add in things like mortgage processors, realtors, lumberjacks, and so on, the job losses due to a poor housing/construction market would exceed 40% of the total. Yet construction employment levels have gone up less than 5% from the recession low. In fact, construction employment was still going down until January of 2011, more than a year and a half after the recovery began. I believe this is the true reason employment gains have been so hard fought.
Consumption, Income, and Manufacturing Data Spook an Already Jittery Market
Last week started off on a bad note with the national purchasing managers' report showing growth in the manufacturing economy but at a sharply lower rate. Consumer income and expenditure numbers also looked weak (on the surface and when not adjusting for inflation), convincing the market that a weaker economy was in the works. But a lot of other data including better auto sales, lower unemployment claims, improving real incomes, and growing employment all suggest that we may have seen the bottom of this soft spot in the economy. I still hold to the belief that a confluence of odd events--political unrest in the Middle East (driving oil and gasoline prices higher), Japanese supply chain issues, and bad weather--badly distorted second-quarter data. I believe the second half will be substantially stronger than the first half. My biggest fear is no longer inflation, but that we scare ourselves back into another recession.
