Indicators Looking Up, But Mind the Headwinds
Coincident indicators are turning up after a dip over the last year, and many leading indicators look stronger, but don't overlook the yellow flags, says Morningstar's Bob Johnson.
Jason Stipp: I'm Jason Stipp from Morningstar.
Some conflicting data in recent times may leave some wondering, where are we now with the economy, where are we headed, what are the worry signs, what's looking up? Here to offer some insights is Morningstar's Bob Johnson, our director of economic analysis.
Thanks for being here, Bob.
Bob Johnson: Great to be here.
Stipp: A good way to gauge where we are now, or at least a good starting point, is to look at the so-called coincident indicators, which are supposed to tell us what the health of the economy is right now. You have a list of some widely used coincident indicators. What do they say?
Johnson: Four of them are used by the National Bureau of Economic Research that help us set whether or not we're in a recession--we're certainly not at that point right now--but there are four interesting benchmarks to look at.
The first one I always like to look at is manufacturing. Then we also have income, employment, and finally retail sales.
Stipp: Let's start with manufacturing. There has been some softness in manufacturing recently related to trade.
Johnson: Yes. The manufacturing data has been softening for quite some time. The year-over-year growth rate, the highest it's been over the last period of years, was last July, and at that time, growth was about 5.1%. Well, now we've dipped all the way back to 2% growth in industrial production, so we've really fallen back. But now it looks like maybe for July we'll finally increase that. Maybe we've hit bottom in that manufacturing number.
Stipp: That's a trend that you've seen across some of these different [coincident] indicators is that we did hit a peak [in the middle of] last year, and then we started to see some softness. Let's talk about employment growth. You can tell a little bit about the current state of the economy by looking at that growth rate, and that's been relatively steady.
Johnson: Yes, and that's real people putting money into their businesses when they're hiring. So I tend to gauge it as a true strength of the economy. And on the private sector employment growth, we got a peak last July of about 2.2%. We dipped back this spring to about 1.9%, and now we're back to 2.0%. So, again, not quite back to where we were, but at least we've got the boat turned in the right direction again.
Stipp: Retail sales is an important part of gaining a sense of where the economy is right now. And we also saw some recent softness there. But the numbers are looking a little bit better now?
Johnson: When you inflation-adjust the retail sales numbers, we actually fell from something like a 2.8%-2.9% [year-over-year growth rate last year] all the way down to 2% this spring, when the payroll tax [increase] had maximum effect. Now we've come back to 2.8%. We've almost gotten back to where we were before, not so much because we're spending wildly, but partly because inflation came down, because they do inflation-adjust those numbers.
Stipp: And income is one [area] that you've been tracking and have been a little bit worried about.
Johnson: That one is worrisome, because that number was not doing so well to start with, and then we had the fact that the payroll tax went up, which really brought income growth [down]. Now on a year-over-year basis we're at about 0.7%, and about 1% of that fall-off is due to the payroll tax. So we would normally be at 1.8% [year-over-year growth], and that would be OK--not great. But the payroll tax has certainly had its impact. And income is important, because that's where people get their money to spend.
Stipp: The payroll tax was part of the fiscal cliff deal, the fact that our payroll taxes went up a little bit. Do you think the fiscal cliff and some of the bickering that we saw in Washington is responsible for the fact that we got a peak mid-2012, and then we got some softness? Is that the culprit here?
Johnson: I think it is. I think part of the softness at the end of last year … was probably a little bit Hurricane Sandy-related, too, in all fairness. So it was a storm, but not a congressional storm, that probably did us in the second half of last year. Certainly that had an effect on the fourth quarter, but the third-quarter [softness] was probably [due to] some of the wrangling going on in Washington and some of the new issues coming out of Europe. I'd say those would be the two issues that caused that point to be the interim top, if you will. We had that, then we had Sandy, and then we had the payroll tax. So we had a triple whammy, three quarters in a row. Now, I think we've started to come out of some of that funk a little bit.
Stipp: These are coincident indicators looking at the economy right now. We can also look at some forward-looking indicators that traditionally give us a sense of where the economy might be going. You say that when you look at those, we see a picture of consistency, but no big, escape-velocity type of growth.
Johnson: They've certainly all gotten better and off their bottoms. There is quite a wide list of them, and it's actually hard to find one that you use as a quick, short-term measure that's in negative camp anymore. The Purchasing Managers Indexes have had three or four good months in manufacturing here in the U.S., and now even the ones in Europe are picking up a little bit. The services number we got for the PMI this week, which is an even bigger part of the economy, was really pretty stunning. So those have gotten better.
Initial unemployment claims [are looking good]; some of that may be because of the way the auto industry has shut down this summer, which may have helped [the data] along a little bit. We're at a recovery low in initial unemployment claims, which is good.
The new orders out of the durable goods report have been improving three or four months in a row.
The Architectural Billing Index has been looking pretty good again. Construction has been one of the things holding the economy back. We've had such good news on the housing front, and we lost it all to the business [construction] side of the house. Now it's good to see the ABI numbers, Architectural Billing Index, looking up, which is an 11-month leading indicator. So it might mean we've got several good months in front of us yet.
Stipp: But you say that we probably shouldn't get our hopes up too high. Hopefully, we can maintain that steady growth rate that we've been seeing, but some worrisome things, same yellow flags at least, indicate that we probably won't necessarily increase our growth rate a whole lot. What's worrying you?
Johnson: Certainly the sequester issue is one of them. One of the [takeaways] out of the GDP report the last time around is that the government really wasn't a very big drag in the June quarter. I'm afraid there is a little bit of a cash accounting issue of matching when exactly expenditures are recognized by the government and when it begins to really affect employment. This week I'm hearing from our analysts upstairs that the sequester issues are affecting defense companies, which we've known for some time. But now even utilities in the Washington, D.C., area are reporting issues and down power usage, because the ships aren't coming into port at Virginia Beach. Things just aren't as busy in Washington. So I thought that was an interesting sidelight.
I think there's another shoe to fall on sequestration. I think the worst of it will be here in the September quarter, because I think a lot of [government] people may have said, well, I'll believe it when I see it, or I'll do a few furloughs. But at the end of the year, they actually have to stop the payments.
Stipp: How worried are you about China?
Johnson: China has been slowing, and they continue to seem to bring things in there, and it's only 1% of our GDP, so I'm not particularly scared. But a lot of our commodities goods and a lot of our manufacturing goods that had been going over there, those are seeing some slowing and are being affected. But I think we're probably at the point of maximum pressure right now, unless things get a little worse in China. And again, I wasn't too worried before, and I'm not terribly worried now.
Stipp: Interest rates came up 1 percentage point in a very short amount of time recently. Are higher interest rates going to be a big headwind for the economy? How worried are you? How are you thinking about interest rates?
Johnson: It's something that's going to keep a lid on things a little bit, but I don't think it's a total disaster. But it's another one of those little pain-in-the-neck headwinds that we're going to face.
There are a few positives to the number. A lot of fence-sitters began to spend in anticipation of these rates going up, [thinking] I can't sit here and not buy a home or [not] do this capital investment. It got people off the fence. That may be why so many of the forward-looking data points finally have started to look a little better is because it got some of those people off the fence.
Then it also contributes to people who are in retirement; their incomes can go up a little bit. It gets some of the pressure off some of the pension [issues] that we've all been hearing about. So those are all good things that come out of [higher rates].
But then again, it makes the home a little bit less affordable and so forth. So it's a mixed bag; it's unknown. Certainly I didn't think we'd rise the full 1.1%, or whatever we are up so far, in a couple of months. I thought maybe it'd play out just a little bit longer than that, and certainly that big move may have an effect in the quarters ahead.
Stipp: We saw bonds took a hit when interest rates went up, as you would expect. The stock market also didn't seem to like it very much and doesn't like the idea that the Fed might taper in the fall. Also if China runs into some trouble, that can cause volatility in the stock market, and that can have a knock-on effect--maybe not a direct effect--but a knock-on effect on the economy.
Johnson: Consumption has been running quite a bit ahead of income for the last couple of months because of the payroll tax, and people have found other ways to finance their spending. Certainly, drawing down savings, pulling down slightly more loans, although that hasn't been a big source. Frankly, a lot of it has been spending stock market income. I think if the stock market tumbles back a little bit here, that's certainly a reason for concern in terms of spending, because so much of the spending now is done by the higher-earning consumer that has a big stock portfolio. So the ups and the downs in the market do seem to affect them.
Stipp: Bob, some great insights on where we are now, where we might be going, and also some things to keep on your radar. Thanks for joining me today.
Johnson: Thank you.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.