The Economy Hits a Soft Patch—But How Soft and How Long?
American Century Investments
June 16, 2011
Based on a variety of economic releases over the past several weeks, most economists concur that the economy recently has hit a “soft patch.” The revised estimate of first quarter GDP1 growth was only 1.8% on an annualized basis. Nonfarm payrolls grew only 54,000 in May, a substantial downward change from February to April when approximately 200,000 new jobs were added each month. And average housing prices have now declined for six consecutive months. The question investors are asking is whether this slowdown is temporary (based on the recent oil price increases, the tsunami and earthquake that affected Japan, and extreme weather this spring in the U.S.) or a sign of a longer-term slowdown that is coming just as the U.S. Federal Reserve winds down its latest round of monetary stimulus at the end of June.
Recent Trends in Economic Indicators
As the table below illustrates, a number of economic indicators have recently gone from positive to neutral or even negative.
Sources: Unemployment Rate: U.S. Bureau of Labor Statistics; Housing Prices: Standard & Poor's; Consumer Confidence: The Conference Board; ISM Index: Institute of Supply Managers; Real GDP Growth: U.S. Department of Commerce; Retail Sales: Bloomberg; New Housing Starts: U.S. Census Bureau; New Automobile Sales: Bloomberg; Monthly Change in Payrolls: U.S. Bureau of Labor Statistics
Unemployment and Housing Remain the Major Challenges
Unemployment and housing remain the two most troubled areas of the economy (if we ignore federal and state government budget deficits). But other areas of concern have recently emerged such as the slowdown in the growth of consumer spending—likely due in part to rising gasoline prices—along with decline in consumer confidence. The chart below paints one picture of the severity of the housing and unemployment challenges we face. It plots both new home sales (newly constructed homes—not existing home sales—which are much more closely linked to employment in the construction industry) and the civilian unemployment rate over the past six years from May 2005 to 2011. New home sales have declined an astonishing 80% over this time frame while unemployment has risen from 4.4% (as recently as May 2007) to 10.1% in October 2009. And as the dashed oval highlights in the chart, the recent trend in unemployment since March has been reversed from four months of solid declines beginning last December (dropping one percent overall) to a jump upward in unemployment of 0.3% since March.
The impact of these trends on home prices can be seen in the chart below which plots the year-over-year percent change in home values using the Case-Shiller 20 Index that tracks residential real estate housing price changes for 20 large metropolitan markets in the U.S. (A year-over-year change is calculated using prices for the same calendar month over consecutive years). The chart is an interesting visual retrospective of those heady days in the first half of the last decade when the expectation by owners and real estate agents was for a 10-15% average annual increase in home prices each year. (Those were the days!) It also illustrates the rapid deceleration in home price increases (smaller and smaller positive percent changes) between 2006 and 2007 to actual deflation (negative percent changes) as the Great Recession unfolded and the housing bubble burst from 2007 to early 2010.
The more concerning trend is highlighted by the dashed oval. While average home prices stopped their downward trend in March of last year, by October the modest positive percent increases reversed again to declines. And since then, we’ve had renewed deflation in average home prices according to the Case-Shiller 20 Index through March of this year (there is a two-month lag before index data are published—thus, March is the most recent month available). This is led many housing market observers to conclude we are in the midst of a “double dip” housing price decline. Unlike the price declines from 2007 to early 2010 which were associated with the bursting of the housing bubble, this second dip has been pinned on efforts by financial institutions to accelerate the foreclosure process on homes with non-performing mortgages, leading to a new supply of homes at a time when the market is still very weak. But in addition, continued high unemployment has also been a contributing factor as homeowners are either unable to find new jobs or discover the available jobs are at substantially lower wage and salary levels than what they previously earned.
Job Growth and Consumer Confidence Sag
Perhaps the most concerning development among the recent spate of economic data was the very low growth in non-farm jobs for the month of May. While this number had averaged approximately 200,000 over the February to April time frame, in May the economy generated just 54,000 jobs (see bars in the chart below). Underlying this low number was an actual decline in manufacturing employment of 5,000. Job losses also occurred in retail trade (down 9,000) and the leisure and hospitality industry (down 6,000). Government payrolls also fell by 29,000 primarily at the state and local level as these governments sought to cut costs in the face of record budget deficits.
As the chart below illustrates with the pattern of the bars representing monthly job gains and losses since January 2007, one gets the distinct impression that this economic recovery (which began in July 2009) has sputtered at best in terms of jobs creation. After three very encouraging months one year ago (March through May 2010) when job growth seemed to be accelerating and peaked at 458,000 in May, the following 12 months have been disappointing with overall growth of only 870,000, or an average of 73,000 per month. This is much too low an average monthly growth rate to make any impact on the unemployment rate.
The chart below also plots consumer confidence as measured by the Conference Board Index. Visually, one can see the relationship between this index and the trend in job growth. It plummeted as the Great Recession led to the loss of millions of jobs and recovered briefly as job growth temporarily surged one year ago. More recently, consumer confidence in their economic circumstances and outlook had been on a definite increase since last September, rising from an index value of 48.6 (fairly pessimistic) to 72 (fairly neutral) by this past February. But it has since fallen back to 60.8 in May. Some market observers place the blame on rises in oil and gasoline prices over the past six months. But slowing job growth and the reversal in declines for the unemployment rate since March are also contributing factors to a growing uneasiness and uncertainty about the future for most households.
How Soft and How Long?
Will this recent soft patch be a temporary phenomenon lasting just a few months at most? At the moment, most economists are leaning in this direction. But the attitude of many can probably best be summarized by one economist who was quoted in a recent Wall Street Journal blog post: “The economy has substantial underlying resilience and can quickly recover, but [based on the May jobs report] consider me worried.”5 And the most worrying aspects of all the recent economic data remain the labor market and housing. It’s safe to assume that without meaningful improvements in both these areas, the current economic recovery will at best continue to limp along in terms of growth in income, spending, and consumer confidence.
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1Gross domestic product (or GDP) is a measure of the total economic output in goods and services for an economy.
2The Case-Shiller 20 Index is published by Standard & Poor’s. It tracks changes in the value of residential real estate in 20 metropolitan regions. The index is calculated monthly and published with a two-month lag.
3The Conference Board Consumer Confidence Index is a barometer of the health of the U.S. economy from the perspective of the consumer. The index is based on consumers’ perceptions of current business and employment conditions, as well as their expectations for six months hence regarding business conditions, employment, and income.
4The Institute of Supply Management (ISM) Purchasing Managers Index tracks five components economic activity — new orders, production, employment, supplier deliveries and inventories — for normal seasonal variations, applies equal weights to each and then calculates them into a single monthly index number.
5Wall Street Journal Real Time Economics blog, “Economists React: ‘Consider Me Worried’”, June 3, 2011.
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