US Perspectives: Can Consumers' Muscle-Flexing Lift Employment?

Morningstar's Bob Johnson is betting on strong consumer spending to help the U.S. avoid a new recession.

Robert Johnson, CFA 06.09.2011
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The economic data last week were for the most part positive with the exception of the national purchasing managers' report and the employment report that came late in the week. Factory orders looked good, as did home prices, retail sales, and consumer spending. Equity markets followed the news flow, moving up early in the week with all of the positive news before faltering on the bad news a few days later. The market last week ended little changed from previous week. While the news at the end of the week was bad, it probably wasn't bad enough to stir Dr. Bernanke into reconsidering QE3--hence, the market collapse Friday.

 

Key Data Points Contradicting Each Other

Unfortunately, all of the data wasn't logically consistent as one might hope. Actual factory orders reported on Wednesday ticked up even as the purchasing managers' report on manufacturing fell yet again on Thursday. Consumer spending remained surprisingly strong even as the official job report showed no job growth. Even Hurricane Irene barely made a dent in the most recent monthly and weekly shopping center data. Despite the fact that most of the East Coast was shut down during key the end-of-the-month selling days, auto sales remained remarkably resilient. For now, I'm placing my chips on the consumer and believe that we will manage to avoid a recession.

 

Employment Data Disappoints

Last week's employment report disappointingly showed no growth for the month of August, falling below expectations of growth of 55,000 jobs. The report was distorted by 45,000 striking Verizon Communications employees who were not counted as employed. Governments also reported a job loss of 17,000 employees, while the private sector grew a still sluggish 62,000, adjusting for the Verizon strike. Almost all that growth came out of the health-care and business services sectors; every other category was virtually unchanged. Even the manufacturing sector, which has averaged 20,000 or so jobs for most of the year, shrank by 3,000 in August. Government jobs continued to shrink, as well. However, the rates of decline in government dropped from 71,000 jobs lost last month to just 17,000 this month (and compared to a trend of down 40,000-50,000 per month). So far this recovery, manufacturing and construction have added close to half a million and the much larger services sector 2 million jobs, while the government has managed to lose half a million jobs, offsetting some of the gains in the private sector. Recall that we lost over 8 million jobs and recovered just under 2 million of those.

 

Some of the Employment Data Look a Little Fluky

Electronics stores fell by a shockingly large 8,000 jobs (for a tiny sector of the job market). One number that defies explanation is auto employment--it's down, even in the face of a big step-up in production from Japan. Anomalies like this force me to look at a three-month moving average of these reports and compare those three months to the same period a year ago. On this basis we are still bouncing around at a barely acceptable rate of 1.6% (this compares to annual population growth of 1%), as we have been for almost all of 2011.

 

 

Private Sector Employment Growth*

 

Year-Over-Year

Employment Growth

(% Change)

January

1.06

February

1.27

March

1.42

April

1.54

May

1.58

June

1.60

July

1.64

August

1.65

* Three-Month Moving Average

Source: Bureau of Labour Statistics

 

 

Employment Report Details Contain Good News and Bad News

The bad news is that hourly wages and hours worked were down, though falling inflation and summer vacations may explain a portion of the poor news. However, hours worked in particular helps project employment growth in future months. Obviously, the news here is not so great.

 

On a more positive note, the long-term unemployed number dropped by 150,000 or so, breaking a string of increases. Also, employment as reported by households grew by over 300,000 (which is why the unemployment rate held flat at 9.1% despite a jump in the participation rate). Lately, the household report has been a predictor of the more statistically valid establishment report (the one that showed no growth in August) in subsequent months.

 

Not all the employment news was bad last week, as initial unemployment claims fell to 409,000 from 421,000. Also, after spiking in July, the Challenger Gray layoff report fell to 51,000 from 66,000. Finally, the ADP employment report for August showed stronger private sector growth of 91,000 new employees (versus 62,000 from the official government report).

 

Consumers Continue to Spend

I have talked extensively about how well consumer spending, especially on the retail store level, had been holding up. This month we got further confirmation of a consumer that just won't give up from the comprehensive consumption report, which grew a stunning 0.5% from June (that's 6% at an annualized rate) even after adjusting for the effects of inflation. In fact, the inflation adjustment was a subtraction of 0.4%. Next month the inflation figure should drop to close to zero with cheaper gasoline and cheaper cars, potentially aiding the inflation-adjusted consumption number for August.

 

 

Broad Based Consumption

 

Month-to-Month

% Change

January

0.0

February

0.4

March

0.2

April

-0.1

May

0.0

June

0.0

July

0.5

Source: Bureau of Economic Analysis

 

 

More Recent Data Show a Confident Consumer

Both weekly and monthly data from the International Council of Shopping Centers show that spending continued at a healthy pace in August. Same-store sales were up 4.6% despite Hurricane Irene. That's the same rate of growth as in July, despite all the chaos in Washington. As usual, wholesale clubs and luxury goods purveyors led the way. Weekly sales were up 3.0% from the year-ago period, in line with the prior week, again despite the hurricane.

 

Auto sales fell dramatically this spring because of a shortage of Japanese cars and sky-high prices. As production came back on line and prices stabilized, auto sales to consumers rose sharply, helping drive overall consumption upward in July after causing some major pain this spring. As auto production nears normal levels, auto incentives and lease deals reappear, and serious shortages of used cars continues, I suspect auto sales will make greater contributions to consumption and GDP in the months ahead.

 

Auto Sales Hang in Despite Huge Headwinds

Speaking of auto sales, August auto sales were basically flat with July at 12.1 million units on a seasonally adjusted, annual rate basis, though up almost 8% from a year ago. I view these as favorable results in light of huge supply constraints from Honda and Toyota, and Hurricane Irene at the very end of the month,  a key selling period. Dave Whiston, Morningstar's auto analyst, summed up the August auto sales as follows:

August auto sales poor as expected but Detroit Three look strong. Automakers reported weak August auto sales on Thursday thanks to Hurricane Irene, continued supply problems from Toyota and Honda (their sales were down 13% and 24% respectively), and weak consumer confidence. Sales came in at 1,072,379, up 7.5% from August 2010. The seasonally adjusted annualized selling rate (SAAR) according to Automotive News was 12.1 million compared to 10.8 million last August. There were many headwinds this month as Ford reported a deterioration in its sales cadence as the month progressed and Paul Taylor, the chief economist of the National Automobile Dealers Association, estimated that Hurricane Irene reduced industry demand by 3%. The plummeting stock market also did not bode well for consumer confidence in August and inventory shortages continue for Toyota and Honda. Ford also saw a 9% decline in its new Focus due to ongoing supply chain issues unrelated to the quake but said Thursday that these issues are resolved.

 

We continue to expect more of the same for September sales but will be looking for a material improvement in industry sales starting in October, in part due to the new Camry going on sale at that time, and because we believe current sales levels are far too low. General Motors is still looking for industry sales on the low-end of 13.0-13.5 million and Ford announced a 9% increase in North American production for 4Q 2011 vs. 4Q 2010. We continue to expect 13 million for this year but the quake and slowdown in the U.S. economy will make this level tough to reach. That said, the Detroit automakers' results show that if great product is made it will sell--even in a sluggish economy. Chrysler continues to have a strong 2011, posting an August year-over-year increase of 28%. Jeep was up 58% year-over-year and Chrysler Group has posted increases of at least 20% in six of the year's eight months.

The national purchasing managers' index for manufacturing (PMI) fell this month to 50.6 from 50.9, better than the widespread expectations for a reading below 50. Though I'm not thrilled about that number, I have generally been more concerned about the consumer than manufacturing. (Without demand from customers, manufacturers will have to stop building stuff.) However, one negative consequence of a slowing manufacturing economy--however temporary--is that it does depress manufacturing employment, which did decline this month. I am also a bit concerned by the falling export component of the PMI. Exports along with consumer durable goods have been the major drivers of GDP growth so far this recovery.

 

Adam Fleck of our industrials team sums up the U.S. PMI report as follows:

ISM manufacturing survey continued to slow in August, though remained in positive growth territory. The Institute for Supply Management released its monthly purchasing manager's survey, with the headline number falling to 50.6 from 50.9 in July. Although anything above 50 indicates expectations of positive growth, the metric clearly suggests further slowing is likely. Export growth dropped off the sharpest, to a reading of 50.5 from 54 the month prior, corresponding with recent slowing seen at companies like Caterpillar, which are facing more-difficult year-over-year comparisons. Encouragingly, price growth continued to moderate, with survey results falling to 55.5 from 59 (the lowest level since November 2009), and new orders--while still contracting--improved sequentially to 49.6 from 49.2. In all, we are likely in for further anemic industrial growth, but we're not ready to throw in the towel just yet on continued recovery.

Housing Prices Halt Their Decline for Now
One positive sign in the housing industry is that prices have begun to turn up again after a year-long decline. The Case-Shiller Home Price Index showed a relatively strong 3.6% gain in the second quarter and 1.1% for the month of June. The gains were less impressive when seasonally adjusted. Nevertheless, the decline in home prices seen over the last year appears to have been arrested. For the month of June, prices were up in 19 of 20 cities in the survey. Twelve of the 20 markets reporting have now stacked together three consecutive months of price gains, as has the overall index. More modest growth in homes entering the foreclosure process, higher rents, and lower interest rates, in addition to stabilizing home prices, may provide the catalysts to lift the construction market in 2012.

 

CoreLogic, a real estate information processing company, also provides more up-to-date data than does Case-Shiller. CoreLogic showed that prices extended their gains to July (though again, those gains all but disappear using seasonal adjustment factors). The other notable fact from the CoreLogic report is that foreclosed and other distressed home transactions are what has been holding back home prices. Distressed situations show housing price declines in the midsingle digits even as nondistressed properties are showing price increases.

 

Balance of Trade, Back in Balance?

The biggest news this week is the balance of trade report. The last report, for June, ballooned to $53 billion, bad enough to cause a downward revision in the most recent GDP report. Lower oil prices and a softer economy should cause the deficit to decline in July, though we have yet to see the big expected bump from Japan ramping up its export machine after the tsunami. The consensus estimate is for the deficit to dip to $52 billion. My guess is that it makes a bigger dip--potentially to the $50 billion level.


 

This is an edited version. The article originated from Robert Johnson’s column at Morningstar.com.


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Robert Johnson, CFA  Robert Johnson, CFA, is Director of Economic Analysis with Morningstar.

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