A Recovery Is Hard to Stop

Armed with last week's labor report, the economic bears are coming back out of their caves. There's no doubt that a weaker stock market and the crisis in Greece are slowing U.S. consumer spending a bit. A temporary slowing in real hourly wages several months ago isn't helping matters, either. But the economy is still in the very early stages of a recovery.

Without a major policy boo-boo--something that can never be ruled out--it is usually more difficult to stop an economic recovery than a recession. The virtuous cycle of more spending, more production, more employment, more spending, is hard to stop. Although we have had several recessions in which we've seen a quarter or two of modest contraction after a recovery began, the back-to-back recessions of the early 1980s are the only example of a true double-dip recession since World War II (that is 10 recessions, for those counting along). I am not ready to panic and don't think we will be double-dipping anytime soon. However, the evidence to prove my thesis may take another month or two to appear.

My real hourly wage metric, which is an extremely early indicator, began softening last September after some stunning gains in the summer of 2009. Those summer gains translated into much stronger retail sales at the end of 2009 and early 2010. Now some of the weakness in real hourly wages late in 2009 is translating into weaker retail sales five to six months later. (More on retail sales below.)

Fortunately, monthly nominal hourly wages have been improving again for the past couple of months. Combined with lower inflation, nominal wages are finally beginning to turn this all-important metric around. I will be watching this metric like a hawk over the next several months. Resumption of the downward pattern of wage growth would be the major factor that would cause me to re-evaluate my bullish stand on the economy. Hours worked and total employment as well as inflation are the other metrics that will drive my economic thinking in the months ahead. So far, data on those fronts have begun to show dramatic improvement.

Retail Sales Disappoint, but There Is More to the Story
The U.S. retail sales report was disappointing this week, showing a 1.2% overall decline led by building materials down 9.3% (following two months of similar-sized gains), gasoline down 3.3%, and autos down 1.7%. Excluding building materials and gasoline, retail sales were actually slightly positive for the month of May but still well below the pace in March and even April (which was revised upward).

The retail sales report is always incredibly difficult to interpret, and this month some data are outright contradictory to other government reports. For example, unit auto sales were up in May as reported by the auto companies, but dollar sales were down according to the retail sales report (pricing and fleet sales may have had a hand in some of the difference). Likewise, building materials were down sharply according to the retail sales report, despite positive ongoing statements from the likes of  Home Depot (HD) and  Lowe's (LOW).

Given that the auto sales and building material sales data used to compile the GDP report (and the monthly consumer spending reports) are compiled from these separate sources and not the retail sales report, I am not racing to change my 3.5%-4.0% GDP forecast for the second quarter.

China Boosts the World on Its Shoulders
For a change, positive news from outside the United States had a favorable impact on both U.S. and world markets this week. U.S. stock exchanges turned in their third-best performance of the year Thursday on news that Chinese exports in general, and exports to Europe in particular, continued to surge during May.

Analysts had feared that the Greek crisis would have drastically reduced demand for goods in Europe, especially imported goods. This would then create a domino effect reducing demand for imports from China, which in turn would slow the growth of one of the largest and fastest-growing economies in the world. As it turns out, overall Chinese exports soared 48% year over year for May compared with just 31% in April.

Month-to-month exports to major European importing countries from China remained at healthy double-digit rates in May. These gains came in the face of Greek problems that have been escalating since March. Interestingly, European imports plunged just a month or two after the financial crisis of fall 2008. Perhaps the Greek crisis is not the rerun of the subprime contagion after all. Next week we will see part of the reason why. European export sales are expected to show double-digit gains when they are announced next week.

Other Bright Spots
A lot of the minor economic reports this week were nicely positive. Job openings increased sharply in April according to the Labor Department, and  Manpower  (MAN) reported improved hiring patterns for both the U.S. and the world economy for the third quarter. Apparently small businesses are feeling better, too, with continued improvement in the composite indicator from the National Federation of Independent Businesses as well as the first positive reading in the employment sub-index in 19 months.

Even the non-manufacturing ISM purchasing managers report showed the first growth reading (over 50) of this recovery. Although the relatively small manufacturing sector has been improving for some time, this is the first positive reading from the much larger services sector. This should bode well for the employment numbers for the month ahead. In general, a sharply improving manufacturing economy, which has still recovered less than half of what was lost during the recession, will continue to drive the economy forward.

Sales in the economy are still growing far faster than inventories. In fact, the important ratio of inventories to sales is still at a record low of 1.23 for the month of April, according to our industrials team. This means even a small improvement in demand will translate into more production. That is why I am not panicked by a few months of softening in consumer spending.

Prices and Home Starts on Deck
I expect both the consumer price index and producer price index for May to show modest declines driven by lower energy and commodity prices. Lower prices, especially for energy, will be a key feature in improving consumer spending in the months ahead. Money not spent on oil can be spent on an array of other goods and services, many of which don't need to be imported. Unfortunately, some segments like health care, public services, and used auto prices are likely to show continued increases. A strong dollar will eventually weigh down the price indexes as well.

Housing starts for May are also due next week. This will be the first month of data after the housing credit expired at the end of April. I would suspect that starts would be down some, but the exact relation between starts and signings could muddle the data a bit. Anything between flat and a big drop wouldn't surprise me--or change my economic outlook. The consensus is for 649,000 starts, just modestly off April's level of 672,000, which I think is a tad optimistic.

Both the Empire State and Philly Fed manufacturing surveys are due next week. While I expect both of these indicators to remain in growth mode, some softening in the manufacturing sector rate of growth would not come as any great surprise. That's especially true given that we are now almost one and a half years past the bottom in the ISM's national manufacturing index. Low inventories, as discussed earlier, and production levels not yet approaching normal levels are why slightly slowing growth rates from next week's regional reports would be no reason to panic. Likewise, recently strong rail and trucking reports seem to indicate that the real economy is in good shape.

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