The Real Economy Is Still Doing All Right

Given all the breathless headlines about the sequester (even though the sequester represents just about 0.5% of GDP) and the payroll tax, one would think the economy is already jumping into a major recession.

Sure, the consumer has backed off some, but the consumer spending numbers are still positive--and certainly no disaster. The weekly consumer data did take a hit at the beginning of February (and the full month of February will probably not look as good as January). But, the weekly data later in the month suggests the worst may be past us now, especially if the spring run in gas prices has run its course. While consumer woes are hitting low-end retailer and restaurateurs hard, home and auto sales continue to move ahead despite weather that has been less than optimal. Quietly, right beneath our collective nose, the manufacturing sector has taken a surprise turn for the better with some of the best data in a couple of years. I suspect that an improving housing economy should get a lot of the credit for the improving manufacturing sector. Housing is indeed the long-term prize, and we need to keep our eye on it as it currently represents just over 2% of GDP versus a long-term average much closer to 5%. That's a lot of runway room ahead of us.

So Where is the Consumer Getting Cash?

There are a lot of questions about just where the consumers are finding all this money they are spending. A lot of the answer is embedded in this month's housing reports. The slowest-growing housing metric shows that home prices were up just about 6% in 2012. Applying that 6% increase to a base of about $20 trillion in real estate owned--that amounts to $1.2 trillion of new wealth. The prospects are very good that prices will grow that fast again in 2013. Direct stock and mutual fund ownership totals another $15 trillion of consumer assets and those markets were up 16% in 2012 for another $2.4 trillion of additional wealth (and that excludes pension funds, insurance, and 401(k)s. Again, I am not implying that all of this is available for spending. However, the wealth increases of several trillion dollars dwarfs the $85 billion of sequester issues that are dominating the news. Then there are the lower interest payments on mortgages, as more and more homeowners are able to refinance mortgages at considerably lower rates.

Personal Income Report Difficult to Interpret

The consumer income report was even more difficult to interpret than I expected with relatively large adjustments to old data (July-December). Additionally the increased Social Security taxes in January caused a major swoon in the real disposable income number. Then, there was the race to pay dividends and bonuses at the end of 2012, which boosted income artificially in 2012 and killed January 2013 data. Some of those payments were for money that would normally have been paid in early 2013, but a lot of it was a one-time payout of cash that had been accumulating over the past several years. The amounts involved in the extra dividend and bonus payments in November and December managed to dwarf the payroll tax increase in January, at least on a monthly basis. Unfortunately, the payroll tax impact continues each month, but the positive dividend impact is largely over.

Ex-Special Factors, Consumer Incomes Look OK

The Bureau of Economic Analysis did do us one favor and disclosed that adjusting for all the special factors, non-inflation adjusted personal income was up 0.3% in December and January, which annualizes to about 3.6%. That data is relatively consistent with earlier months, with one big exception: There was no inflation over the past two months. The other good news is that even including the full impact of payroll tax and the shift of dividends to December, real disposable personal income was up 0.6% from January a year ago. That's not a lot, but at least it wasn't a negative number. With higher inflation in February, the number could temporarily move in to negative territory for February and maybe even March. However, I doubt the loss would go much over 1%, which is tiny compared with the 5%-plus income losses experienced during many months of the Great Recession.

Consumers Down but Not Out

After a bit of a spending spurt in November, consumers did pull in their horns in December and January as consumption expenditures increased a very modest 0.1% in each month, adjusted for inflation. In other words, consumers seemed to have battened down the hatches before all the new taxes kicked in, spreading the pain on the economy a little more evenly. Like the income data, the February consumption is likely to look worse than December and January given both higher gasoline prices and a full-month effect of the payroll tax increase.

Inflation Even More Important in Determining the Fate of the Consumer in the Months Ahead

I mentioned many times that inflation is the third rail of any economic recovery.  Any time inflation has gotten over 4% on a year-over-year, three-month averaged basis, the U.S. has experienced a recession. That is because as prices spurt, consumers, who tend to receive annual wage increases, have to cut back on their short-term spending. Less spending means less production and less employment and the vicious cycle of a recession begins. Why do I bring this up now? I suggest that the sudden increase in the payroll tax rate is similar to the sudden shock of a price increase. With the payroll tax increase, the consumer's ability to adapt to inflationary pressures is probably less than the 4% norm. But by how much is less than certain. I suppose in the worst case, one could take the 2% payroll tax increase off of the normal 4% limit, reducing inflation tolerance to a meager 2%. However, the payroll tax increase is only 0.8% of the entire personal income number, suggesting inflation tolerance of about 3.2%. The good news is that inflation is running at just 1.7% right now, which is below both figures. Even with a big spike in gasoline prices in February, I estimate year-over-year inflation will remain under 2% for at least a couple of months.

Consumer Watch: Payroll Taxes and Other Headwinds

One of the real problems with the personal and consumption report is that it comes so far after the fact. The data we just got was for January. Anecdotal evidence suggests that February was tough month for the consumer, based on delayed tax refunds, higher gas taxes, and most importantly, the higher payroll tax rate. To gauge current performance I've even resorted to looking at individual weekly data to determine the effects of the triumvirate of economic issues more precisely. The news this week was reassuring. Year-over-year shopping center data indicated a 2.9% increase in same-store sales after spending two weeks under 2% as refund checks began arriving in consumers' mail boxes and bank accounts. My other key watch category is the initial unemployment claims report, which managed a surprisingly large (and probably unsustainable) drop, indicating that employers aren't giving up on the consumer and the economy just yet. And after nine weeks and $0.50 of gasoline price increases, prices finally stopped going up. Falling oil prices and weaker demand from Europe just might keep those prices going down from here. 

Auto Sales Looking Good

On Friday, there was more good news for the consumer--this time it was monthly automobile sales data. Auto sales came in at 15.36 million units on an annualized, seasonally adjusted rate, representing the fourth month in a row above 15 million units sold, with retail sales being particularly strong in February. This would seem to indicate that the consumer is not giving up the ghost just yet. Auto sales have been the bedrock of this recovery and the good news seems to keep progressing, despite the government's tax and spending tightening.

Real Estate Data Up Again

Housing data remains on a roll, payroll tax or not. Homes prices, pending home sales, and new home sales continued to show improvement in December, January, and January, respectively. Year-over-year home prices from December 2011 to December 2012 (three-month average) were up 6.9%, according to Case Shiller 20-City Index and 5.8%, according to the Federal Housing Finance Administration. Each of these indexes also showed healthy month-to-month increases between November and December, which is not usually the case during the holiday period. Seasonally adjusted, Case Shiller reported that all 20 cities in the index showed increases. The Case Shiller index most recently bottomed in March 2012. Anyone who purchased a home before mid-2003 or after late 2008 is at least at break-even levels before commissions and expenses. That's a relatively hefty chunk of all homeowners and getting bigger with each passing month.

Pending Home Sales Bounce, but in for a Pause

Investors were greatly relieved that pending home sales, a usually reliable indicator of existing home sales, experienced a 4.5% jump between December and January after a slump in December. However, the year-over-year data continues to slow, indicating a genuine shortage of inventory for sale.

Prices aren't high enough just yet to entice potential sellers. In fact, in the same report, the National Association of Realtors dropped its existing home sales forecast from 5.1 million units to 5.0 million units, but raised its price forecast from 5.75% to 7% for 2013. Increasing demand coupled with lack of supply explains the large back-to-back increases in forecast housing prices. The data below show much of the same across the industry:

U.S. Manufacturing: Happy Days Here Again

I talk about manufacturing data each and every month and repeat my mantra that this sector is not a key economic driver on either the upside or the downside. However, the metrics continue to draw a lot more interest than they deserve, and recently the news has gotten so good that even I can no longer ignore the rebound in manufacturing. This week durable goods orders, ex-aircraft, showed some surprising strength. Apparently, the resolution of the fiscal cliff, combined with better than expected consumer data late last year, inspired corporations to spend more. Orders less transportation goods grew 1.9% in January (in one month, not annualized). That increase is the fifth one in a row and the best showing in more than a year. Diving deeper, core capital goods orders have increased a stunning 32%, annualized, over the last three months.

ISM Data Confirms Durable Goods Order Report

The purchasing managers survey as compiled by ISM continued on its upward swing, hitting its highest level in more than a year at 54.2, indicating that meaningfully more manufacturers are reporting business improvement than decline (50 represents equal up and down readings). This is the highest reading since mid-2011. Even better, the more forward-looking new orders portion of the ISM index increased to 57.8, indicating there at least a few more good months in front of us for manufacturing. My guess is that the rebound in housing construction and robust auto sales are largely responsible for the increases.

 

Just Employment and Trade Data on Tap for Next Week

The calendar is mercifully thin next week after a deluge of data this week, including a 4 p.m. release of auto sales on Friday. The trade balance is due on Thursday and the previous release for December probably fell in the category of being just a little too good to be true and the market is expecting a meaningful bounce in the metric from $38.5 billion in December to $43 billion in January. Slightly higher oil imports (at higher prices to boot) are likely to boost imports while continuing European woes and a stronger dollar are likely to weigh on exports. However, even at $43 billion the deficit would be smaller than two thirds of the monthly deficits experienced in 2012. The January total is likely to be way below the $52 billion monthly high reached in early 2012.

Given stable to improving initial unemployment claims, I suspect monthly job growth is likely to remain in its current rut of 150,000-170,000 total jobs added for the month of February. Government jobs are expected to decrease again and private sector jobs could grow by as many as 180,000 jobs. Better manufacturing and housing data point to the potential for an upside surprise, but poor weather and weak restaurant sales could just as easily provide a downside surprise. Unless growth falls out of the 100,000 range to the 200,000 range, I would see little reason to change my current outlook of 2%-plus GDP growth for 2013.