Much Ado About Nothing
By: Jim Scheinberg – July 20, 2012
Not sure why, but back in April, I just felt like taking off my economist hat for the second quarter. I had a hunch not much would happen. Not much would change. Not much would be resolved. No new phase would be entered. No corners would be turned. In the end, I sort of wish I had taken it off. After a lot of conjecture about a potential fracturing of the EU, sparked by fiscal shortfalls and the seemingly game-changing election of a Socialist in France, more stop gap measures were put in place… thus preventing the European sky from falling once again. Here at home, our pace of growth ebbed from robust to moderate, yet again threatening anemia. Is anyone starting to feel the déjà vu? Is anyone starting to feel the déjà vu?
If there was any good news, it’s that this seemingly annual cycle of a decelerating growth phase seems to be getting shorter and shorter lived, causing less and less reaction in the global equity markets. Unlike the drops during Q3 2011 and Summer 2010, Q2’s pullback in the global equity markets was rather muted. In the U.S., the S&P 500 contracted less than the required 10% from high to low necessary to technically call the intra-quarter drop in May a correction (falling just 9.5%). In the end, U.S. stocks only gave back a few percentage points off of their impressive Q1 gains. International equities were down a tad more, but mostly due to a 3.3% rally in the U.S. Dollar Index during the quarter. When measured in their own currencies, their losses were only a fraction worse than those of domestic stocks. A slowdown of the emerging markets economies lead to those equity markets posting the biggest losses for the quarter (down 7%-9%).
Once again, fear drove investors out of risk-assets like stocks, and toward the perceived safety of U.S. Treasuries. Yield on the benchmark 10-year Treasury Note dropped from 2.22% from the start of Q2 to 1.66% by the end. The volatility in the traditionally safe government bond market at the long end of the curve is starting to rival that of equities. In fact, since the end of the crisis, long Govies have had four quarters of 5% or greater declines vs. just two quarters for the S&P 500. Risk is ‘where it’s at’ in the bond markets these days. High Yield and Emerging Markets debt continue to be the bright spots, with returns now exceeding 7% each for the year.
Here We Slow Again
We have consistently held that for the first few years of economic recovery following 2008, it was business-tobusiness activity that provided the basis for growth. In the past year we have seen contributions from consumer spending and exports join the fray. Well, if the latest reading from the Institute of Supply Management proves to be more than just a blip, we had better hope that these other areas stay strong, because business-to-business appears to be slowing.
Coming in at 49.7, June’s Manufacturing Index dropped below the key 50 mark for the first time since July of 2009. (Readings below 50 indicate contraction.) What’s more concerning is that new orders plummeted from 60.1 in May to 47.8 in June. Backlogs of orders have also been dropping. The news on the services side of the economy is slightly better, but the recent trends show a similar slowing pattern. The ISM Non-Manufacturing Index sunk to 52.1 in June from 53.7 in May. New orders are still showing expansion at 53.3 for June, but backlogs dropped to 47.5. This may be a short-term aberration due to a fear ripple. However, I suspect it may be something more substantive. Globally, the consumption recovery may be taking a breather.
It deserves to be noted that the Purchasing Managers Index (PMI), similar to the consumer sentiment data, is merely a current reading on opinions of purchasing managers in business throughout the country. Though usually much less fickle than the attitudes of consumers, these are still momentary opinions and may not necessarily be directly indicative of actual longer-term spending patterns. What hopefully will prove to be a more reliable trend is that capital expenditures continue to exhibit impressive, steady growth. In fact, CapEx is approaching the record levels last seen just before the onset of the financial crisis in 2008.
Men at Work – “Statistics Slide to a Land Down Under”
After three disappointing monthly jobs reports in a row, we get it; Q2 was slower than desired. With new job creation falling over 50% quarter over quarter, recent gains in labor look to be plateauing, at least for the moment. Though the unemployment rate held steady in the low 8% range, no real progress was made during the last three months to whittle the rate down further. One hope is that a formally dormant area of the economy, construction spending, is ratcheting up. If we begin to march back towards the long-term norms of 5¼% of total employment being attributed to construction (up from around 4¼% now), we could see data start to improve as early as this summer. But what are the real prospects of that happening?
Lookin’ Real-E Promising
Most signs point to a bottom, and now a turn, in the U.S. residential real estate market. The Case Schiller Index showed its third consecutive monthly climb in the latest reading (April) with surprising spikes in Miami and Phoenix, two of the markets hit hardest when the bubble burst. Los Angeles and San Diego are showing initial signs of improvement as well. The National Association of Realtors recently reported, “The national median existing-home price for all housing types rose 7.9 percent to $182,600 in May from a year ago.” The Pending Home Sales Index which is an indicator of houses under contract but not yet closed, shows an even more impressive 13.3% percent gain year over year vs. May 2011. Further, inventories across the country have fallen dramatically over the last year to around a 6.5 month supply in the latest April reading. Inventories are now being described as ‘tight’ in almost all regions in the U.S. Not only is that good for the future prospect of price increases, but also indicates that the massive inventory of foreclosures once held by the banks may have finally been worked through. Good news for housing, better news for the banks.
If inventories continue to stay low, this bodes well for the new home market too, which leads to jobs directly in construction and indirectly in manufacturing of home items like furniture and washing machines. We are already seeing strong incremental improvements in construction spending which is up nearly 11% since the bottom just 5 quarters ago. This has been led mostly by sharp increases in new apartment construction. If the single family sector joins the party, we are sure to see this area of our economy accelerate.
Europe: Where There’s a Will, There’s a Way – Out
I recently returned from a month long research trip that took me through Germany, Italy, France and Spain. Though I gathered loads of valuable insight into inter-EU money flow, labor disparities and political polarization, there was one thing that I absorbed that was outright shocking. EVERYONE I spoke with, without exception, emphatically wanted the EU to stay together. This was true as well of people I interviewed from the UK, Switzerland, Scandinavia, and Eastern Europe. And this opinion was not hard to draw out; it was offered quite freely. But how could this be? I think most of those in the financial industry here in the U.S. would agree that this sentiment is rarely, if ever, portrayed in our financial press. In fact, quite the opposite: we here in the U.S. are fed a regular diet of a hope/fear cycle regarding the prognosis of the EU, where “fixes” are presented as fragile and short lived at best. The facts on the ground, however, appear to be quite the opposite. There seems to be a universal undercurrent of ‘steadfast will’ that meets every new challenge. Is the road ahead clear and smooth? As I have imparted time and time again, certainly not. But the resilient will and desire of the people of Europe provide the key ingredient, a willingness to stay with the issue until a workable solution is attained. Coming from a country whose own two-party political system is paralyzed by its own infighting, this concept is lost, if not outright inconceivable. Nonetheless, it is real.
Speaking of a country whose politicians just can’t seem to get along, don’t we have an election coming around the corner? As a politico junky, I have to say, it’s not just my economist hat that I felt like taking off in the second quarter. After all the rancor and dramatic lead changes early on in the Republican primaries, it seems to me that these last few months in the presidential campaign have been outright boring. I’m not the only one who thinks so. The Independent reports that rating agency Nielsen shows CNN, MSNBC and FOX news are all hemorrhaging viewers (down 50%, 20% and 10% in the last year respectively). Though it is true that people may be getting more and more of their information from alternative sources, I suspect there is more to it than that. Anecdotally, many of my friends and colleagues have been less interested this time around, despite the importance of the outcome to our country at this fragile time in our history. As of now it’s a dead heat between Romney and Obama. I’ll reserve my prognostication about the outcome and its impact for my next commentary.
From where I sit, it is very unlikely that the EU will fall, leading to another financial calamity as many dread. No matter how bumpy the road ahead, they will stay the course in creating a structural solution that is sustainable for generations to come. As for the rest of the globe, my bet is still on the emerging consumer story continuing out of the BRIC nations. 10s of millions of new consumers a quarter can’t be wrong! And with over 3 Trillion in reserves and a massive trade surplus, I somehow don’t think China is without tools necessary to reheat their economy from its currently ‘anemic’ 7% growth rate. That turns our attention to the good ole USofA. In all earnest, I think this is the last dark before the big dawn. Real Estate is heating up folks. Enough said.
OK, perhaps a tad more need be said… Real estate brought us all into this mess and we can’t truly emerge without it. Prices are turning up. The flood of foreclosures has largely receded. The real estate collateral that banks lend on is becoming more reliable. (Once this is universally believed, lending standards will ease, fast.) We know that consumer confidence and spending are inextricably tied to home prices and is likely to improve from already decent levels. And importantly, new construction leads to all sorts of jobs in the economy, through the easiest ‘trickle down’ there is to track. Unlike Obama, who inherited a financial mess, and Bush who was saddled with 9-11, the next President will likely come into office with the fresh breezes of recovery at his back… whoever he ends up being.
From my PIERspective the coming months will likely prove to be very interesting. The election cycle is going to heat up and my intuition tells me that the economy is going to start heating up with it. Keep your hats on folks… all of them. The second half of the year bound to be a doozy.