All posts by joel

April Consumer Spending and Income and May Consumer Sentiment

KEY DATA:  Consumption: -13.6%; Disposable Income: +12.9%; Wages: -8.0%; Savings Rate: 33.0%; Prices: -0.5%; Ex-Food and Energy: -0.4%/ Sentiment: up 0.5 point

IN A NUTSHELL:  “Right now, the economy is totally dependent upon the largesse of the government.”

WHAT IT MEANS:  The horrible April data continued today as consumer spending collapsed in April.  The percentage decline was nearly seven times the previous largest drop.  You just don’t see numbers like that.  Consumption of durables, nondurables and services were all down by double digits, so you cannot simply ascribe the collapse to just a fall off in vehicle purchases.  On the income side, the numbers were totally different, but just as worrisome.  Income surged, but it was all due to an additional $3 trillion in government payments, a 90% increase.  However, wages and salaries were down nearly $880 billion, an 8% drop.  Rising income, regardless of the source, coupled with cratering spending led to a record-high savings rate of 33%.  That is nearly double the previous peak.  Households are saving for the rainy day that is already here.  On the inflation front, prices were down fairly sharply.  We started off the quarter with consumption falling at a greater than fifty percent annualized pace, compared to the level of spending in the first quarter.  That will likely moderate going forward, but it shows the huge hurdle the economy faces in getting back to more normal levels of consumption.  It also explains why some forecasters have growth declining by upwards of forty percent in the quarter.  I have been at -22%, but it is early.  Hopefully, some of the savings will be put to use in May and June and the decline will be less than feared. 

Will consumers spend more going forward?  Undoubtedly yes, but the issue is how much?  Confidence will be the key and the University of Michigan’s Consumer Sentiment Index was a disappointment.  The final May number was just a touch above the April level and was below the mid-month reading.  Current conditions were up from April, but expectations were down.  That is worrisome, as the reopening of the economy should have caused households to be more confident about the future.  So far, it hasn’t.

IMPLICATIONS: Nearly two months ago I posted my view on what I expected the recovery to look like.  I called it a “Big V little u” recovery.  That is, the third quarter would be strong, the fourth solid but afterward, the expansion would lose steam.  My biggest concern was what would happen when the economy had to stop depending upon government assistance and the private sector would have to stand on its own.  The income numbers show just how reliant the current economy is on government welfare.  Some of the savings will be spent over the next few months, but if concerns about the future that we saw in the University of Michigan’s survey continue, don’t look for a surge in demand.  Regardless, the extra funding will start running out during the summer.  What will the economy do then?  Will the federal government keep sending out checks or will the household and business welfare payments dry up?  Will state and local governments be able to keep cutbacks to a minimum or will the unwillingness to provide funding similar to what has been given to businesses and households lead to major spending and payroll reductions?  Income gains will have to come from private sector job growth that is not limited to the reopening of businesses.  We are likely to have an unemployment rate in the 10% range even at the end of the year and that means total personal income would be below where it was at the end of 2019.  These were all the points I made two months ago and the data seem to be supporting my concerns.  I am not trying to be negative; it’s just that I believe it is time to get realistic about the potential for growth over the next year, not the just next few months. 

Weekly Jobless Claims, April Durable Goods Orders and Pending Home Sales and Revised 1st Quarter GDP

KEY DATA:  Claims: 2.1 million; Insured: -3.86 million/ Durables: -17.2%; Vehicles: -52.8%; Capital Spending: -5.8%/ Pending Sales: -21.8%/ GDP: -5.0% (previously -4.8%)

IN A NUTSHELL:  “People are going back to work, but layoffs remain extraordinarily high.”

WHAT IT MEANS: The economy is opening and the PPP is kicking in, so what is happening to layoffs?  They remained above two million, a number that just two months ago would have been characterized as incomprehensible.  In this world of “what have you done for me lately”, this is likely to be viewed as “good” because it is the lowest in nine weeks.  But really, is there any reason to see something positive in this level of claims?  No.  It signals that firms and governments are still massively cutting workers.  The number of people receiving unemployment checks fell dramatically.  That, of course, was expected to happen.  As a consequence, the so-called insured rate, which is the percentage of the labor force receiving benefits, fell. 

Durable goods orders plummeted in April, but the decline was actually in line with estimates.  April was when everything shut down, so a double-digit drop was hardly a surprise.  The biggest decline was in the vehicle sector.  With sales cratering, and the assembly lines shuttered, that too was not a shock.  Conditions are changing in May, so look for things to start to turnaround in the next report.  One number, though, should be watched more closely.  The proxy for business investment spending – nondefense, nonaircraft capital goods orders – fell significantly.  It is not clear if, when or why this measure will turnaround. 

The National Association of Realtors reported that pending home sales, a measure of future existing home purchases, fell sharply in April.  That does not bode well for the spring sales numbers.  The largest drop was in the Northeast, where signed contracts fell by nearly fifty percent.  But the declines were fifteen percent or more in the other three regions, so you can say that the weakness was widespread. 

First quarter GDP was revised downward a touch, but the new number doesn’t change anything.  It really doesn’t matter if we are talking about a drop of 4.8% or 5%, activity fell sharply in the first quarter.  What is important is that the hole we are digging turned out to be a little bit deeper than initially thought. And with second quarter GDP likely to be down at least 20%, even with the economy reopening, it could take two years to get back to the fourth quarter 2019 GDP level.     

IMPLICATIONS: We are entering the confusion stage for the employment and unemployment numbers.  Reopening of the economy is taking people from government payrolls to private sector payrolls, which is good.  But the PPP is creating problems with understanding what exactly is happening.  As I noted in my many criticisms of the PPP, the requirements of hiring back a high percentage of form employees, whether they were needed or not, would hide the true state of unemployment.  Those workers who are rehired to meet the PPP requirements but who essentially do nothing, are still functionally unemployed.  But for statistical purposes, they are considered to be employed.  That artificially lowers the unemployment rate without raising production.  It also artificially raises the payroll numbers.  I am pretty sure that obfuscating the true state of the labor market was an intent of the law, as it only made it difficult for firms to operate efficiently.  Thus, the massive drop in the number of people on unemployment doesn’t necessarily translate into a strong rise in output.It does, however, hide the true labor market weakness.  What worries me is that once the PPP deadlines are met, if the firm still doesn’t need the workers, we could see a surge in layoffs.  That would be happening even though the number of people on unemployment would have been falling for weeks.  The point is that as we move through June and start approaching the PPP deadlines, the likely decline in insured unemployment could be overstating the pace of improvement.That is what happens when politicians develop programs aimed at altering economic data, not economic reality.Indeed, if many workers are forced to leave unemployment for lower-paying, non-productive private sector jobs, consumer spending and productivity could decline.  That would wind up hurting the recovery, not helping it.  I will try to provide the necessary caveats about the data, but since we have no measure of the number of workers hired because of the PPP but who are functionally unemployed, any interpretation will be suspect.

May Consumer Confidence and Philadelphia Fed NonManufacturing Index, April New Home Sales and National Activity

KEY DATA:  Confidence: +0.9 point, Phil. Fed (NonMan.): +41.1 points/ Home Sales: +0.6%/ CFNAI: -11.8 points 

IN A NUTSHELL:  “The free fall started to stabilize in May, but the economy is in a really deep hole.”

WHAT IT MEANS:  We expected April to be the cruelest economic data month and it was.  In contrast, the May and June data should start to tell us the extent to which conditions have stabilized or maybe even turned.  One critical measure is consumer confidence and in May, the Conference Board’s Index rose a touch, which was good to see.  However, the current conditions index continued its decline, though that drop was modest.  There was a slightly larger increase in expectations, which was expected given that the economy did start to reopen during the survey period.  While it was nice to see that the overall confidence index is no longer collapsing, it was disturbing to see that the percent of respondents saying that business conditions were bad rose fairly solidly and is now over fifty percent.

The May Philadelphia Fed’s NonManufacturing Index rose sharply.  But don’t look at that gain as being good.  The level of the index was coming off of record lows and remains in deep recession mode.  Also, this is a diffusion index, which does not measure levels, only relative changes.  In April, manufacturing crashed and burned.  In May, the conflagration continued. 

The good news today was that new home sales actually increased.  That was totally unexpected.  Even though many states allowed construction to continue, it was expected that sales contracts would drop. Demand was up in three of the four regions with only the West reporting a decline.  The other eye-opener in the report was the 8.6% drop in prices.  It is hard to really know whether this represents builders having “fire” sales (pardon the pun) or just a shift toward lower priced homes, but the decline was quite large. 

The Chicago Fed’s National Activity Index plunged in April.  This is a very broad measure as it includes eighty-five indicators and it signaled that the downturn was spread across the entire economy.  That should not surprise anyone, but it will take a lot just to get us back to expansion mode from deep recession mode.

IMPLICATIONS: It was good to see that consumer confidence has stabilized.  Given that every state is now starting to reopen, the outlook for the future should improve solidly in the months to come.  At least for the next few months, it is the measures of current conditions that may matter more.  If they start improving significantly, it would be a sign that households are ready to spend money.  Modest improvements, though, would be warnings that consumption may not surge and that would mean a more tepid recovery.  Meanwhile, investors are more focused on vaccine issues than the economic data.  Anytime hopes for a vaccine being found by year’s end rise, the markets soar.  But as I have noted, it could take up to two years to get back to where we were at the end of 2020.  That should factor into earnings potential, since one assumes that the level of activity has something to do with the level of potential earnings.  Yet the S&P is back to late October 2019 levels, when investors were factoring in decent growth this year.  (It is also back to early March, but that was when the markets were collapsing.)  So, does earnings growth or do earnings levels matter?  Ask investors. I’m just an economist who teaches corporate finance and theory and practice don’t seem to be in synch to me.  Also, part of today’s rally is likely due to Dr. Fauci saying last week:  “I think it is conceivable, if we don’t run into things that are, as they say, unanticipated setbacks, that we could have a vaccine that we could be beginning to deploy at the end of this calendar year, December 2020, or into January, 2021”.  Man, he sounds just like an economist, hedging his forecast in every way possible. Let’s hope he is close to being right.     

April Housing Starts and Permits

KEY DATA:  Starts: -30.2%; Year-to-Date: +7.6%; 1-Family: -29.4%; Multi-Family: -40.1%/ Permits: -20.8%; Year-to-Date: +3.7%; 1-Family: -24.3%; Multi-Family: -14.2%

IN A NUTSHELL:  “The housing market has taken a big hit, but don’t count it out just yet.”

WHAT IT MEANS:  As expected, home construction faltered in April.  Multi-family projects were cut back more than single-family, but both were down massively.  Regionally, the differences were fairly large, though every area posted a decline. Starts fell by “only” 14.9% in the Midwest, were off 26% in the South and cratered by over 40% in both the Midwest and Northeast.  But these data need to be put into perspective.  Construction was really strong going into the pandemic and the total number of units started during the first four months of this year was still up sharply over the same period in 2019.  That was in spite of two months of huge declines.  The only area where activity was down during the first four months was in the Northeast and that decline was modest.  Looking forward, permit requests were not off as much as starts and the gap between the two grew dramatically.  As I have noted in the past, builders don’t pay for permits just to have them sitting around.  Indeed, homes permitted but not yet started were down from the April 2019 level, so there is not a great backlog. From the peak set in January, April housing starts were down 45%.  That provides lots of room for improvement, especially since permit requests were off only about 30%.  So look for activity to rise going forward.

IMPLICATIONS:The housing market was leading the way until the pandemic shut things down.  Where it goes from here is not totally clear but it is likely that April was the cruelest month for this sector as it was for just about every other one in the economy.  Mortgage rates are down to historic lows and demand seems to be reviving.  But the problem is buyer uncertainty about making a purchase in this environment.  That consists of both the willingness to visit homes and the ability or readiness to commit to the largest purchase they make.  Listings are dropping like rocks and it is not clear that virtual tours do it for many or even most buyers.  That is less of an issue for new-home buyers, but still a concern. Starts were at such a low level in April that it is still likely that residential construction will be off by at least 25% this quarter and it could take a year or more to get back to the January peak pace.  Meanwhile, back in the markets, investors keep searching for the positive and are largely dismissing the negative as being a remnant of the past.  That is what has powered the massive upturn, not any hard evidence that a vaccine will be ready anytime soon or that opening up in the random way we are doing it will be safe.  Hope may run eternal, but it is reality that counts.  Here is a story I like to tell.  In the early 1980s, I attended a U.S. House of Representative hearing on oil shale production.  An industry representative was asked how long it would take to start producing oil.  Remember, the country was desperate for domestic supply given the oil embargoes of the seventies.  The answer was, if everything goes right, about twelve months (at least that is what I remember).  Nearly forty years later, we are still waiting.  Actually, we no longer care.  There is nothing wrong with hoping for the best, but it is always best to plan for the worst.  I am not sure investors are doing that.  They seem to be hoping for the best and planning for even better.

Weekly Jobless Claims and April Import and Export Prices

KEY DATA:  Claims: 2.98 million (down 195,000); Continuing Claims: 22.83 million (up 456,000)/ Import Prices: -2.6%; Fuel: -31.5%/ Exports: -3.3%; Farm: -3.1%

IN A NUTSHELL:  “New unemployment claims remain at extraordinarily high levels and the modest decline points to an extended deterioration in the labor markets.”

WHAT IT MEANS:  New claims for unemployment insurance eased a touch last week, but the deceleration in the rate of filings was disappointing.  The level remains in the three million range and has been there or above for eight weeks now.  Over that time period, 36.6 million people have filed for unemployment compensation.  Not every person who files receives compensation and right now only about sixty percent who have filed have made it onto the rolls.  It looks like there is a major backlog that states still have to get through.  That is bad news but also good news.  Too many households don’t have money to spend, but once they start receiving the checks, consumption should pick up.  Maybe more importantly, as the backlogs disappear, the continuing claims number could take center stage.  With the economy reopening, that number will provide a weekly indication of how well the back-to-work process is reducing the number unemployed.

Prices for lots of things keep coming down, at least that is what the government data claim.  Import prices dropped sharply in April, but as we saw with consumer and wholesale costs, most of that was in energy, where prices simply cratered.  Imported consumer goods costs were off modestly as food prices dropped.  But vehicle and capital goods prices were up.  On the export side, the farm sector continues to be battered as the prices of the goods they sell fell again. 

IMPLICATIONS:  About the only good thing about recessions is that prices generally don’t go up and often they fall.  But that is usually a short-term phenomenon that is followed by a steady recovery back to more normal inflation.  The problem facing the Fed is that its “normal” of 2% had been hard to reach since the Great Recession.  So running into a massive economic collapse cannot help in its drive to revive inflation.  Right now, low inflation is not the Fed’s number one concern.  However, while it was pretty much back to 2% earlier this year, the progress has been lost.  Since deflation is the major fear for developed nations, the focus of attention will shift quickly once the economy is well on its way to opening up completely.  Just as the peak in the unemployment rate will determine how difficult it will be to get the labor markets back to a reasonable position, the inflation rate nadir will determine the difficulty in getting inflation back to a desirable rate.  Simply put, the lower the rate, the longer the Fed will have to keep rates at rock bottom.  That is something investors should keep in mind. 

April Producer Prices, Help Wanted OnLine Index and Fed Chair Powell Speech

KEY DATA:  PPI: -1.3%; Ex-Energy: -0.3%; Energy: -19%/ HWOL: -40.8 points

IN A NUTSHELL:  “Decelerating inflation and limited job openings are likely to be with us for a while.  ”

WHAT IT MEANS:  With the biggies, the employment and GDP reports, behind us, there are still some important numbers to watch as we go through the month.  Yesterday we saw that while headline consumer inflation decelerated sharply in April, it was largely due to energy prices.  Similarly, the April Producer Price Index cratered, also driven by energy.  Excluding energy, wholesale costs declined somewhat only moderately.  About the only thing that posted major gains were the margins of wholesalers and retailers.  Otherwise, prices were down just about everywhere else, including food.  Goods (excluding energy) prices fell a little more services costs, but the declines were not that great. Looking into the future, intermediate costs, especially for unprocessed goods, were off significantly and that points to continued downward pressure on producer and possibly consumer prices.

The Conference Board reported that online want ads collapsed in April.  With firms closed, that was inevitable.  The index level was the lowest since March 2012, but it is still well above the record low set in July 2009.  I am not sure we will take that bottom out as firms are starting to reopen. 

Fed Chair Powell Speech: Fed Chair Jerome Powell gave a talk today and he raised some important warnings, especially about the potential need for a lot more policy actions on the part of both the Fed and the government.  He is worried about an extended recession that devastates small businesses and limits the recovery.  He discussed the need to get people back to work quickly or risk extending the period of high unemployment.  And he made it clear that Congress has to spend the vast amount of money needed to prevent those concerns from happening.  Here are some sections from his speech and they need no further commentary:

While the economic response has been both timely and appropriately large, it may not be the final chapter, given that the path ahead is both highly uncertain and subject to significant downside risks. Economic forecasts are uncertain in the best of times, and today the virus raises a new set of questions: How quickly and sustainably will it be brought under control? Can new outbreaks be avoided as social-distancing measures lapse? How long will it take for confidence to return and normal spending to resume? And what will be the scope and timing of new therapies, testing, or a vaccine? The answers to these questions will go a long way toward setting the timing and pace of the economic recovery. Since the answers are currently unknowable, policies will need to be ready to address a range of possible outcomes.

The overall policy response to date has provided a measure of relief and stability, and will provide some support to the recovery when it comes. But the coronavirus crisis raises longer-term concerns as well. The record shows that deeper and longer recessions can leave behind lasting damage to the productive capacity of the economy. … The result could be an extended period of low productivity growth and stagnant incomes.

We ought to do what we can to avoid these outcomes, and that may require additional policy measures. At the Fed, we will continue to use our tools to their fullest until the crisis has passed and the economic recovery is well under way… Additional fiscal support could be costly, but worth it if it helps avoid long-term economic damage and leaves us with a stronger recovery. This tradeoff is one for our elected representatives, who wield powers of taxation and spending.

April Consumer Prices and Real Earnings

KEY DATA:  CPI: -0.8%; Over-Year: 0.3%; Ex-Food and Energy: -0.4%; Gasoline: -20.6%; Ex-Energy: -0.2%.  Food at Home: +2.6%/ Real Hourly Earnings: +5.6%; Over-Year: +7.5%

IN A NUTSHELL:  “Though most consumer prices fell, supermarkets did manage to push through some pretty hefty price increases.”

WHAT IT MEANS: It should be no surprise that when the economy shut down, prices fell.  And in April, that is precisely what happened.  Household expenses cratered, led by a massive drop in motor fuel costs.  Excluding food and energy, consumer costs were down by the largest amount ever.  The decline was only the ninth in the sixty-three years the series has been in existence.  With people not able to shop around, supermarket prices jumped.  Most distressingly, the prices of bakery goods soared.  However, Wawa has been running specials on my new favorite breakfast nuggets, Entenmann’s Pop’ems, so I was okay.  Restaurants that were open for take out managed to push through increases, though it is hard to criticize them for doing that as their sales collapsed.  On the goods side, alcohol, appliance and home furnishings prices soared but clothing and most medical supplies, excluding prescriptions of course, declined.  As for services, most travel related prices cratered.  However, our wonderful cable and satellite operators jacked up prices.  People were stuck at home so it was time to stick it to them. 

It is becoming clear from the data that the people being clobbered by the shut downs are low paid workers. Inflation-adjusted hourly wages skyrocketed.  Did worker wages really soar?  Not really.  But if you take out the bottom of the wage distribution, you wind up with a higher weighted average wage.  That wages were up so much implies that much of the loss of jobs were predominately in the lower wage segments of the economy.    

IMPLICATIONS:  Consumer prices fell sharply in April, but the decline looks a lot more positive on the surface than in reality.  The majority of the drop came from energy.  Excluding energy, costs fell modestly.  When you are living on savings and unemployment, the key expense is food, and that was where prices surged.  Gasoline prices have stabilized and are starting to rise, so the May report should look a lot different.  It will be interesting to see what happens to prices once the economy reopens.  Will firms try to recoup lost revenues by raising prices or will they try to attract customers back by running sales?  Supermarket weekly circulars have shrunk dramatically and a lot of products are being sold at full price.  Will that be sustained?  I doubt it.  On the other hand, I would not be surprised to see restaurants raising prices in an attempt to make up for their lost sales.  Once workers start commuting again, gasoline prices are likely to rise.  But ultimately, it will be how households shop that will matter.  Goods that require some form of in-person sales have been able to raise prices, as the inability to comparison shop has been limited.  That advantage will likely be lost with increased mobility.  But now that people have a better handle on internet shopping for a greater variety of products, those goods that can be readily comparison shopped online are likely to see a permanent increase in demand.  So the shopping patterns that emerge from the shut down will determine if inflation accelerates or decelerates. 

As for investors, the markets are back to where they were in the last quarter of 2019.  I keep asking the same question: Are earnings estimates the same now for 2020 and 2021 as they were toward the end of last year?  The only way that can be is if you believe in the Big-V recovery scenario.  Most of my colleagues have abandoned that forecast.  Most are now looking for a short-term sharp pick up in growth followed by an extended slow to moderate period.  That doesn’t argue for strong earnings growth over the next 12-18 months.  More importantly, the level of activity is now well below what was expected at the end of 2019.  The consensus is for a decline in the current quarter by 25% to 30%.  Assuming a 25% annualized drop, GDP would be about 7.5% below the level posted in the last quarter of 2019.  To get back to the previous peak, the economy would have to average a 3.9% annual growth pace for two full years.  Is that possible?  Hard to see.  For example, even if growth were 5% in the first year, it would still have to be over 2.8% in the second year. And then, total economic activity would only reach the fourth quarter 2019 level in spring 2022!  So, are the earnings forecasts that have to underlie the current market prices realistic?  I don’t know, but investors seem to think that is possible.      

April Employment Report

KEY DATA:  Payrolls: -20.5 million; Private: -19.5 million; Manufacturing: -1.3 million; Leisure and Hospitality: -7.7 million; Health Care: -2.1 million; Retail: -2.1 million/ Unemployment Rate: 14.7%; Labor Force: -6.4 million; Unemployed: +15.9 million

IN A NUTSHELL:  “The employment declines were historic and the unemployment rate hit a post WWII record, so it is hard to find anything good in this report.”

WHAT IT MEANS:  Welcome to the world of pandemic economic numbers and they aren’t very pretty.  The April employment report was expected to set records and it did.  Let’s start with the jobs situation.  The 20.5 million payroll decline was the largest for any single month or year.  The declines were so broad based that fewer than five percent of the 258 private industries posted a payroll gain.  Even at the worst point in the Great Recession, over fifteen percent of the industries posted gains.  The loss leaders were, as expected, leisure and hospitality, retail and manufacturing. Health care took a huge hit and that included hospitals.  Emergency/Covid-19 care requirements could not overcome the loss of demand for every other type of health care service as people stopped going to doctors and dentists, except in emergencies.  The only private sector industry that posted a rise of any significance was retail warehouses, such as Costco and BJs.  Otherwise, it was basically all red.  There was also a data calculation issue. BLS noted that, “Business births and deaths cannot be adequately captured by the establishment survey as they occur”.  I suspect that in this shuttered economy, the death rate is a lot higher than normal while the birth rate is significantly lower. That implies a larger decline in total payrolls than estimated.  But the estimation process could not capture that change in behavior, so consider the job loss a lower bound.  The real job loss number was likely a lot higher, though it is impossible to know by how much.

As for the unemployment rate, it did not rise to as high a level as projectedBut that was due to the some special circumstances.  First, the labor force collapsed.  Over the past two months, 8.1 million people have left the labor market and most of those workers are likely unemployed.  They just didn’t see any reason to look for jobs since there weren’t any, so they were not counted as unemployed.  That alone could have added almost five percentage points to the rate.  There were other data collection/identification/classification issues as well, including rules that determine how to determine whether a person who is not working is employed or unemployed.  In a special comment in the report, BLS noted the data collection and identification issues and pointed out that If the workers who were recorded as employed but absent from work due to “other reasons” (over and above the number absent for other reasons in a typical April) had been classified as unemployed on temporary layoff, the overall unemployment rate would have been almost 5 percentage points higher than reported (on a not seasonally adjusted basis)”.  Simply put, the 14.7% rate is a lower bound and the “real” number is probably close to 20%.  Indeed, the so-called “real unemployment rate” was 22.8%.  This includes people who gave up looking for jobs, which is a real issue now. 

There were a couple of other interesting (odd?) numbers in the report.  The average hourly wage soared by 4.7%, compared to a couple of tenths that is normal.  Also the workweek rose.  It looks like low-income workers bore the brunt of the job losses and people who could continue working either picked up hours or if they worked from home, kept their hours.  Finally, the labor force participation rate fell to its lowest level since January 1973.  That was the start of the Baby-Boomers surge into the labor force.

IMPLICATIONS:As bad as the data were in April, the problems with classification and collection, as well as the continued surge in jobless claims, indicate that the job loss and unemployment numbers were lower bounds, not accurate measures of what really is going on.It is likely that the May unemployment rate will approach if not exceed 20%, that it probably was already in April. I would not be surprised if investors are celebrating the lower than expected unemployment rate, but if they are doing so, they are misreading the data.  But there is a threat to the markets from the underestimation of the unemployment rate due to the declining labor force.  Once the economy starts reopening and job losses fade, the workers who left the labor market will start returning.  That would slow the decline in the unemployment rate.  If investors are expecting a rapid drop in the rate, they are likely to be greatly disappointed.  And once the data collectors start getting more information on births and deaths, we will probably see job gains grow more slowly, as bankruptcies are likely surging.  The point is that the labor market is in even worse shape than these terrible numbers indicate, which as I have noted before, means it will take longer to dig ourselves out of this hole. 

Weekly Jobless Claims and 1st Quarter Productivity

KEY DATA:  Claims: 3.2 million/ Productivity: -2.5%; Output: -6.2%; Labor Costs: +4.8%

IN A NUTSHELL:  “The stubbornly high number of new unemployment claims points to an unemployment rate that is nowhere near peaking.”

WHAT IT MEANS:  We knew it was bad out there but it is looking like it is even worse that we thought. For the week ending May 2nd, new claims for unemployment insurance came in above 3 million once again.  It had been expected that the number of layoffs would start tailing off fairly rapidly, but that doesn’t seem to be the case.  Yes they are going down, but this was the seventh consecutive week that the level exceeded the three million mark.  Over that period of time, 33.5 million workers have filed for assistance.  Using the March labor force level, that translates into 20.6% of the workforce.  Given the sluggish nature of the decline in claims and growing number of layoffs in government, health care and larger companies who have tried to hold on, the unemployment rate could be headed toward 25%.  That is not likely to be the number in the April report, but we could get there in the May or June. 

If you shut down operations but don’t cut workers as quickly, it tends to have a really negative impact on productivity and that was indeed the case in the first quarter.  Output was off significantly, despite the shutdowns not starting in earnest until the middle of March.  But layoffs lagged initially, so output per worker dropped sharply.  Meanwhile, compensation continued to rise.  The combination of lower productivity and higher wages is not something businesses like to see as it leads to surging labor costs, which is precisely what happened. 

IMPLICATIONS:We are close to halfway through the second quarter and while there has been some reopening of businesses, layoffs are continuing at an extraordinary pace.I thought unemployment claims might peak at 35 million, but that outcome looks to have the same probability as my winning the lottery.  Now I am wondering if we will hit 40 million, which would take us to an unemployment rate of 25% or more.  That is truly scary, as you have to go back to the early 1930s, during the Great Depression, to see anything nearly like that.  I don’t see getting up there, but I cannot rule it out.  The level of unemployment is important for many reasons, one of them being it can affect the speed at which businesses will rehire their workers once they get the green light.  Expected demand will be the driving force and you can assume managers to hire cautiously, at least initially.  The last thing they want to do is pay unnecessary labor costs, which would happen if they have too many workers.  They can always bring workers more on but firing people after a short time could have devastating impacts.  Consequently, the logical strategy is to rehire slowly.  That means there will be enormous numbers of people remaining on unemployment and that implies demand will grow slowly.But the slower the growth rate, the longer it takes to whittle down the unemployment rate and a high unemployment rate keeps managers from hiring robustly.  That sounds like a vicious cycle to me that could take an extended period to break.  It might not be the best strategy to buy into the idea that the peak unemployment rate doesn’t matter because once firms reopen, they will hire everyone back.  That is not likely to be the case.  So the higher the peak rate, the longer it will take to get back to even moderate rates of unemployment and the slower the recovery. 

INDICATOR: April NonManufacturing Activity and March Trade Deficit

NAROFF ECONOMICS, LLC

Joel L. Naroff

President and Chief Economist

215-497-9050

joel@naroffeconomics.com

INDICATOR:  April NonManufacturing Activity and March Trade Deficit

KEY DATA:  ISM (NonManufacturing): -10.7 points; Activity: -22 points; Orders: -20 points; Employment: -17 points/ Trade Deficit: $4.6 billion wider; Exports: -9.6%; Imports: -6.2%

IN A NUTSHELL:  “Declining world economic activity hit the U.S. hard in March, but the empire will likely strike back in April, when domestic activity shut down.”

WHAT IT MEANS:  It wasn’t just the industrial portion of the economy that shut down in March and into April.  Non-Manufacturing also cratered.  The Institute for Supply Management’s index dropped to its lowest level in eleven years, as all the key sub-indices, business activity, orders and employment, flat lined.  With order books thinning, conditions are likely to worsen over the next few months, despite the beginnings of the economy reopening. 

The COVID-19 pandemic is a global economic disaster and we can see that in the trade data.  In March, U.S. imports fell sharply, led by massive declines in consumer goods and vehicles.  With the economy operating for half the month, demand for foreign capital goods, industrial products and food were up.  But with the rest of the world, especially China, having already moved into shut down mode, our exports fell even more.  Every major category, including food, was down. As for the situation with China, the March deficit was down 43% from March 2019.  That may change over time, but at least the outflow of income to China has slowed for a while. With exports falling more than imports, there was a major widening in the trade deficit.  It looks like the initial reading on the trade deficit that was in the first quarter GDP report may have been a little light and we could see growth revised downward.  Looking forward, with businesses shuttered and consumers hunkered down, look for our imports to disappear in the next trade report and the deficit to narrow.  That has been the typical pattern when we go into recession. 

MARKETS AND FED POLICY IMPLICATIONS:  We are already beginning to see the depths of the downturn that we are in and the most distressing April numbers have not even come out.  While there is some reopening, it is happening in fits and starts and is unevenly distributed across the country.  If you thought that it would be quick and easy, think again.  This is going to be a very long process that should stretch through the summer.  And that assumes no major resurgence in the number of new cases and deaths.  That is hardly assured, if you believe the scientists – which I do.  You also have to factor in the reduction in government welfare payments to households and businesses, the likelihood of growing numbers of bankruptcies and simple fear on the part of consumers and workers in returning to what we call more normal lives.  Friday we get the April employment report and it could show the largest decline in employment in the history of the country – something in the range of 22 million.  The unemployment rate should rise above 15%.  I have it more like 18.5%, but it may take us a month or more to peak.  Regardless, the hole has been dug and we have to figure out how to fill it in.  Given it is the size of the Grand Canyon, as I keep saying, it will be a long time before we get back to the employment level we had in February and an even longer period before we see an unemployment rate near 5%, let alone the 3.5% rate we had two months ago.  I am not trying to be negative, just realistic.  Hope for the best but plan for the more likely and that is “u” not a “V”-shaped recovery.