(By Robert Johnson, CFA) A couple of notable economists, including Lakshman Achuthan of ECRI, have recently indicated that they believe the economy may have already drifted back into yet another recession, and it will just be a matter of months before we realize it. The data we have today (although I caution these figures could be revised again) do not support that conclusion.
While many commentators define a recession as two negative quarters of GDP growth, the official statisticians look at four metrics: industrial production, retail sales adjusted for inflation, personal income less transfer payments (unemployment, disability, Social Security) adjusted for inflation, and employment. 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.
I have posted the year-over-year growth rates for these metrics for December 2007, the last time we went into a recession. In every case, current readings are ahead of the December 2007 readings. Some of those 2007 indicators had been in a freefall for some time before the official December 2007 recession start date. That doesn't seem to be the case just yet this time.
At the same time, it is hard to argue that the economy is booming. Income growth has improved with falling inflation, but isn't at normal levels. And waiting for the key four metrics to turn negative is not a good strategy, either. Typically, growth rates slow before the recession begins, but do not move into negative territory until several months after the recession has already started
However, 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.
Earnings Warning Yet Again
There really wasn't a lot of economic news this week and corporate earnings news won't pick up in earnest until next week. Alcoa's (AA) earnings news was relatively uneventful but the market was clearly disturbed by an earnings warning out of Cummins (CMI) that showed a slowing Europe and China was beginning to make its mark on corporate results. A quick rebound is not expected, either, which the market found particularly disturbing.
Some of the early news out of the tech sector was not good, as the personal computer cycle (a new Microsoft (MSFT) operating system is due later this year, as is a new iPad, prompting consumers to wait) and government austerity hit home.
On the economic front, economists spent most of the week worrying about just how bad things were in China, but they were greatly relieved Friday when the official numbers came in just as expected, with 7.6% year-over-year growth in the June quarter compared with 8.1% in the first quarter. Up until Friday there were some real worries that China would miss expectations.
The news flow this week also seemed to suggest that markets were finally catching on that it isn't just China and Europe that are soft. This week there were increased mentions of weakness in India and Brazil as well.
Fed News (or Rather No News) Hits Markets Midweek
With little news flow, traders got excited Wednesday when the Fed posted its Federal Open Market Committee minutes. Fed watchers focused in on the lack of enthusiasm for the new easing program, and largely ignored portions of the report that said the Fed was monitoring the economy and that it was more than willing to act (no mention of how) if further weakness appeared.
Secondary Economic Reports Were Mixed and Muddled by the July 4 Holiday
Small-business confidence, as reported by the National Federation of Independent Businesses, fell meaningfully from 94 to 91 from May to June. This report had been acting better in recent months, so this was a disappointment. The bad news is that small businesses are feeling less confident just as large businesses, which are more dependent on exports, are pulling in the reins. That said, this index doesn't have the best track record. Like consumer confidence indexes, it seems to be more reflective of current headlines than meaningful changes in business conditions.
Weather conditions did not get any better this week, either, with drought conditions spreading farther across the country. Unfortunately, this is likely to drive food prices up in the months ahead and hurt consumers who were just beginning to get ahead of inflation again.
On the positive side of the ledger, initial unemployment claims fell sharply, though the holiday probably helped this week's results and hurt last week's. Unfortunately, that detracts from the fact that this week's single-point claims numbers was the best number so far this recovery. The Labor Department's job openings report for June rebounded nicely, recapturing two thirds of the losses reported in the dismal May report.
Turning to retail sales, our shopping center data also rebounded well this week, again probably at least partially helped by the holiday. As positive as the weekly number was, we are still tracing the lower bounds of this metric on a five-week moving-average basis. Producer prices were also under good control, inching up just 0.1% in June, although price increases driven by the recent drought probably won't show up until this fall.
Import/Export Data Shows Little Change From Trend
The trade deficit for May shrank from $50.6 billion in April to $48.7 billion, driven primarily by falling oil imports. Exports were relatively unchanged month to month as imports declined by 0.7%, with oil imports declining and other imports increasing. I found it interesting that among the turmoil and morass in Europe and China, exports to both those regions increased from April to May. That said, export growth has clearly been slowing for some time, as shown in the table below.
The table also shows that the slowing is not limited to any one geographic area. Finally, with two months of data, it now looks like the best case is for overall trade to have a net neutral effect on second-quarter GDP growth with a good possibility that it will be a small negative. I am hopeful that the housing industry may offset some of that weakness.
Housing Data Leads the Way Next Week
Next week three housing reports will see the light of day: builder sentiment (a leading indicator for housing starts), new home starts and permits (which eventually drives the residential construction component of GDP), and existing home sales and inventories.
Sentiment data comes first and the consensus is looking for a relatively flat reading of 29. We had a big surge this spring, so I would be happy if we could just keep the sentiment reading in the high 20s. Housing starts for May sank to 708,000, which came as a bit of a surprise given continuing good news on the permits front. The consensus is expecting a big rebound in starts to 760,000 units in June. I suspect starts won't quite make it to that level, but I believe that we will get close and that the miserly 708,000 for May will be revised upward.
Economists are also optimistic about existing home sales, which are expected to rise from 4.55 million units at an annualized rate to 4.7 million units. If existing home sales do rise to the 4.7 million level, that would be the best reading in more than five years (2007), excluding two housing credit inflated months in 2010. Shortage of quality inventories is holding back the existing home sales data or results might be even higher. Prices of the median house sold made a huge spike in May because of a shortage of homes in the lower-price categories. I suspect prices just might give back some of those gains in June.
Headline Retail Sales Will Look OK; Without Autos, Sales Likely to Be Flat
A lot of the retail metrics have acted suspiciously weak over the past several weeks and I suspect that softness will turn up in the retail sales report. However, booming auto sales will mask some of that weakness in the headline number. Excluding autos, the retail sales number is likely to be just about flat month to month.
Falling gasoline prices, along with used car prices and the move to more generic drugs (as Lipitor, in particular, has come off patent) are certainly making sections of the retail sales report look puny. The retail report we get on Monday is not adjusted for prices. A maturing electronics market characterized by collapsing large-screen TV sales and prices isn't helping, either. Even smartphone growth (at least from the import-export market) isn't what it once was. I think this is due more to market saturation than a slowing economy.
Still, it is clear that consumers are not spending their cost savings or their diminished purchases of electronics on any other category just yet. It seems odd that spending has slowed just as incomes have finally begun to show some improvement. I'm not really buying the "they're scared" argument, because autos and housing have been considerably stronger than year-ago levels. Make these types of long-term purchases requires considerable confidence. And this week's consumer credit report showed that consumers are taking out more loans, too. About the only explanation for the modest slowing trend in retail sales is that the time, money, and energy required for home and auto shopping has cut into consumer spending in other categories.
Industrial Production Could Show a Slight Rebound
Things on the manufacturing side have been nothing to write home about lately, but June's Industrial Production Report might look a little better than usual because of a jump in utility usage related to the unusually warm summer weather. News out of both the auto industry and Boeing (BA) continues to be good, which is keeping the U.S. manufacturing sector stronger than in many other parts of the world. However, the parts of the manufacturing sector that are dependent on foreign exports and commodity-related issues are suffering now, and it is turning up in a number of earnings warnings reports already. Putting improved utilities, autos, and aircraft against export and commodity issues, the consensus is expecting industrial production to increase 0.4% month to month for June, up from negative 0.1%. That sounds aggressive, but it is possible.
Consumer Prices Under Good Control, for Now
Consumer prices are expected to increase by 0.1% with some price increases being offset by falling gasoline prices and used car prices. This is not as good as May's price decline of 0.3%, but still is good enough that consumer incomes (driven by higher employment levels, more hours worked, and higher wages) will likely outpace inflation by a large margin for the third month in a row. Unfortunately, higher food prices and slowing decreases in gasoline prices mean that the inflation news will not be nearly as good this fall.