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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 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.      

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


Joel L. Naroff

President and Chief Economist


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.

March Existing Home Sales and April Philadelphia Fed NonManufacturing Survey

KEY DATA:  Sales: -8.5%; Over-Year: +0.8%; Prices (Over-Year): +8%/ Phil. Fed (NonMan.): down 61.3 points; Firm Activity: down 69.7 points; Expectations: down 8.9 points

IN A NUTSHELL:  “The housing market is starting to get sick.”

WHAT IT MEANS:  Few sectors are immune from the virus ravaging the economy and it is not a surprise that housing is starting to show strains as well.  Going into March, this portion of the economy was in really good shape and was expected to lead the way.  Sales were strong and prices were starting to firm.  However, given the realities of social distancing, it is hard to convince people making their largest purchase that the house they are seeing on the Internet is the home for them.  True, everything you see on the Internet is true and accurate, but it you believe that, I’ve got a fixer-upper that is in pristine condition.  Make me an offer.  And that is the problem now, especially on the demand side.  The National Association of Realtors reported that sales fell sharply March and every region declined.  But to show how strong the market has been, the sales pace was still above the level posted in March 2019.  Though the inventory of homes for sale rose, it is still low. It will be interested to see if supply drops in the April report.  I have heard from realtors that they are pulling a lot of homes temporarily from the market.  Finally, prices soared.

The Philadelphia Fed’s index of nonmanufacturing firms crashed and burned in early April.  The index of economic activity dropped to -96.4.  The lowest possible is -100 and that was not reached because 1.8% of the respondents said regional business activity rose. The other 98.2% said it declined.  No one said it remained the same.  Amazing.  As for their own firm, 85.4% said activity fell while only 2.9% indicated it was up.  But those are hardly surprising results.  What was discouraging were the expectations data.  Confidence about regional and firm activity six months from now deteriorated.  Despite all the stories of reopening, business leaders seem to be less hopeful a return to good growth is in the cards. 

MARKETS AND FED POLICY IMPLICATIONS:The March data are trickling in and they are hard to get a good handle on the extent of the damage.  For some industries, the shutdowns didn’t occur until well into the month.  Thus, the readings represent a combination of pre and post-shut-down economies.  That is the case with the housing market.  We will not really know the extent of the harm until the April numbers are released.  It is hard, though hardly impossible, for closings to happen (for existing homes sales) or for contracts to be signed, which go into new home sales.  But virtual visits don’t replace in-person walk-throughs and as anyone who has bought a home knows, it is the feel that usually matters.  Pending home sales, which will be released on April 29th, should tell us a lot about the existing market. As for the economy, some states are trying to start things back up.The risk/reward of that is being hotly debated, but the downside seems to be a lot greater than the upside since there will be only modest initial increases in hiring and output.  A resurgence of the virus in those states could set back the process significantly.  But the governors in those states are willing to take that chance, so we are starting what is rare in social science: A real world mass experiment.  Meanwhile, the total and complete collapse of near-term oil prices shows the extent of devastation (and the impact of the Russia/Saudi price war).  It is unclear whether this will alter the thinking of most investors who apparent believe that the pathway back to normal is a V-shaped huge and rapid recovery.But it is a warning.When you start paying people to hold your product, you are in deep trouble.  That is what negative interest rates signal – massive economic weakness.  The Fed seems willing to shower the economy with all the liquidity it can handle and more, if necessary, so I don’t expect negative rates to become policy – thankfully.  But negative commodity prices are something we should not simply dismiss, even if they are only temporary.  The enormous problems we face in restarting an economy this big and this damaged have to be discussed first and then addressed.  Policymakers are treating the symptoms but have not even started the process of formulating a plan to reverse the damage. 

Weekly Jobless Claims, March Housing Starts and April Philadelphia Fed Manufacturing Survey

KEY DATA:  Claims: 5.245 million; 4-Week Total: 22.03 million/ Starts: -22.3%; Over-Year: +1.4%; Permits: -6.8%; Over-Year: +5%/ Phila. Fed (Manufacturing): down 43.9 points; Orders: down 55.4 points; Future Activity: up 7.8 points

IN A NUTSHELL:  “Another week of massive unemployment claims and the end is not in sight.”

WHAT IT MEANS: When you shut down the economy, people become unemployed – duh – and the numbers we are seeing are unimaginable.  Over 5 million people filed for unemployment insurance last week, bringing the total to over 22 million in just the last four weeks alone.  Let me put this into perspective.  During the Great Recession’s peak filing period, which occurred in March 2009, “only” 2.64 million people filed during a four-week period.  That is, over eight times as many people filed for unemployment this year compared to eleven years ago.  While the claims numbers should decelerate, they could remain incredibly high for the next few weeks, as some states have just started to put in social distancing curbs.  It is likely the total will reach 30 million by mid-May.  It is hard to see the unemployment rate peaking below 20%.  That would be double the top reached during the Great Recession and it could probably even double the post-WWII 10.8% rate hit in November and December 1982.

Housing starts plummeted in March, but even that sharp decline may be misleading.  Construction had been on a roll for a year and it looked like this sector would lead the economy this year.  Thus, the large drop in construction may look bad, but starts were still higher than they were in March 2019.  I suspect that if we had the numbers for the last week of the month, they would show a much greater decline and that is the level we need to be factoring into the outlook for the economy.  It is unclear how far residential new construction activity will fall.  Only a few states are limiting activity and that is often just for spec construction.  The problem may be more in the multi-family area as social distancing requirements are harder to satisfy in large projects.

The Philadelphia Fed’s April index of manufacturing tanked, which was hardly a surprise.  There were some interesting numbers in the report.  Not one firm reported a rise in new orders while 71% said they declined.  But while order books thinned, the decline was not excessively large and over 16% saw their backlogs increase.  Despite the current carnage, respondents were more optimistic about the future.  The index of activity six months from now rose.  The easiest interpretation is that respondents believe we have hit rock bottom and there is no way to go but up.  Let’s hope they are right.    

IMPLICATIONS:  It seems investors think there is no amount of short-term damage to the economy that matters.  In the three weeks from March 21st, when the first massive job claims number was released and we saw that claims, not those unemployed, just those who could maneuver through the websites and file unemployment claims, reached a total of 22 million, the equity markets rose by double-digits and a record weekly gain were recorded.  Really, did anyone factor that many unemployed people into equity prices?  I doubt it.  And that total will only rise a lot more.  Previously, the largest number of people unemployed was 15.4 million in October 2009.  We are likely to see more than twice that number this time.  And even if the CARES Act artificially lowers the unemployment rate by shifting unemployment compensation payments from direct government checks to indirect government checks, the actual unemployment situation will not change.  Those private sector-government paid workers eventually have to actually work and businesses will have to make enough money to pay them. Over thirty million is a large number to find real work when the reopening is going to be phased in.  But hey, the relationship of Wall Street to Main has been tenuous for a long time so I guess we can chalk this up to … well I have no idea what.   

March Retail Sales, Industrial Production, April Home Builders Index and Empire State Manufacturing Survey

KEY DATA:  Retail Sales: -8.7%; Ex-Vehicles: -4.5%/ IP: -5.4%; Manufacturing: -6.3%; Capacity Utilization (Man.): -4.7 points/NAHB: -42 points/Empire State: -56.7 points

IN A NUTSHELL:  “The decline in economic activity is breathtaking.”

WHAT IT MEANS:  The data are just starting to come for March and early April and they are even worse than expected.  Indeed, the declines were breathtaking.  Let’s start with March retail sales, which were down massively. Gasoline sales cratered, though some of that was due to the decline in prices.  But the rest of the categories show how demand has shifted.  The declining categories:  Vehicles (-25.6%), furniture (-26.8%), electronics (-15.1%), gasoline (-17.2%), Clothing (-50.5%), sporting goods (-23.3%), department stores (-19.7%) and restaurants (-26.5%).  Keep in mind, most of the closings were in the second half of the month.  Not surprisingly, supermarkets soared, posting a 26.9% rise.  Health care, building supply and online stores were up strongly, but those increases paled in comparison.  

A closed economy means reduced production and every single industry posted a decline in output.  This was the third greatest decline on record, with the other two occurring during the post-WWII demobilization period.  The largest drop was in vehicles, as the assembly rate declined by over one-third.  Eight of the nineteen manufacturing industry groups were off by double-digits.  Capacity utilization also fell off the cliff, dropping by the largest amount on record. 

Moving into early April, the National Association of Home Builders index was down an amazing 42 points.  It went from 72 to 30. Traffic largely disappeared.  So much for the housing market.  The New York Fed’s Empire State Manufacturing Index disappeared from sight.  That should not surprise anyone given that the New York metro area has been the epicenter of the pandemic. 

IMPLICATIONS:The economic numbers are coming in even worse than most economists expected.  We really cannot wrap our minds around these enormous levels of changes, so it is hard to forecast the total collapse that we are starting to see.  And the April numbers, which will reflect a whole month, are likely to be a lot worse.  Which brings us to the equity markets.  The spread of the virus may be easing, at least we hope.  New York looks like it is near or at the peak, but other areas are starting to heat up.  Every state is now involved.  Starting to open the economy in two weeks (May 1st) is hardly likely and when the economy does start to open, it is not going to happen quickly or easily.  Yet investors have been exuberant the last three weeks.  Is it rational or irrational?  Where is Alan Greenspan when we need him? First quarter earnings are just starting to come in and for most firms they are gruesome.  And that was with less than one month of a shutdown.  What happens when we have two or even three months of restricted activity in a quarter followed by a slow, rolling reopening?  It is hard to comprehend why businesses would invest in this type of economy.  Businesses may start opening, but which ones?  Without wide scale testing capacity, can we really open retail establishments that require social contact?  The rest of the world is also going to slowly reopen and who knows when that will happen.  And state and local governments are already starting to downsize as tax revenues are crashing.  It is one thing to say that the government and the Fed are pouring trillions into the economy, but it is another to say that demand will recover to anywhere close to what it had been in February.  And if it doesn’t, firms will not see demand raise enough to keep the government funded workers, so layoffs and business closings could resume.  Households will have used up some of the money they were given and if they don’t have jobs (the unemployment rate could still be double-digits in July), spending will fade.  And that could trigger a significant increase in loan losses and pressure on financial institutions.  That is the prospect for the summer/fall economy.  And what if the reopening has a set back due to a resurgence in parts of the country, even if those relapses are minor?  So, where are the profits going to come from?  I am just an economist, but I simply don’t see what investors are seeing and to be honest, what other economists are saying is going to happen.  I focus on the underlying factors that will drive future economic growth and earnings and while we will see an initial upturn once the economy reopens, the strength and length of that recovery is not clear at all.

March Consumer Prices and Real Earnings

KEY DATA:  CPI: -0.4%; Over-Year: 1.5%; Ex-Energy: 0.0%; Over-Year: 2.1%/ Real Earnings: +0.8%; Over-Year: +1.6%

IN A NUTSHELL:  “Inflation is really not doing much, which is a surprise given the craziness in the economy.”

WHAT IT MEANS:  Consumer prices fell in March, which surprised no one.  Given the collapse in the economy, that was expected.  But much of that decline was due to a double digit declines in gasoline and fuel oil.  The price war between Russia and Saudi Arabia made that happen and was expected.  Excluding energy, costs were flat, which was a surprise.  Food prices, both at home and away, were up solidly, while services prices were flat.  In the services component, shelter expenses, which had been surging, flattened out.  But medical costs, which also had been rising sharply, increased even more.  Transportation was down sharply. 

The earnings numbers in March implied that workers did really well, as wages rose sharply.  Adjusted for the decline in prices, that meant real earnings soared.  But these data are misleading.  The large rise in average hourly wages was due to the way the number is calculated.  It is a weighted average.  In March, the huge drop in employment came from major layoffs in lower paying industries.  Higher paying sectors lost relatively less.  So, when you do a weighted average and you take out more from the bottom than the top, the average rises.  I don’t think workers did particularly well in March.    

MARKETS AND FED POLICY IMPLICATIONS:  In some respects the relatively mild decline in consumer prices and the flat change excluding energy is good news.  Core inflation, which excludes volatile food and energy, had been slowly climbing back to target levels.  A massive collapse in the economy was expected to lead to a major deceleration in inflation, which could be worrisome.  That did not happen.  With energy prices bouncing off the bottom, we could see the headline number up in April.  Thus, the shut down of the economy has not yet lead to a deflationary environment. It is hard enough to fight a virus-induced decline in economic activity, having to deal with falling prices as well is not something the Fed wants to face.  Of course, getting the economy going again will be the best way to fight any decline in inflation.  I think the economy will have a ‘Vu’ recovery.  We may get a major rebound, if only because opening closed sectors means that activity will surge.  But it is the following few quarters that really matter and it will be hard to sustain demand when we start with and unemployment rate that could hit 20%.  The unemployment rate in February was 3.5%.  Getting back to an unemployment rate close to that level, and I define close as one percentage point above the bottom, could take five years.  That was the pattern in the past and it could easily take that long after this crisis.  That means after the rebound, there could be a slowdown as the government’s welfare program fades and businesses have to actually earn money to pay for their workers.  That would then lead to a slow recovery, similar to what we saw after the Great Recession.  Investors may think that the problems are behind us, but reopening and repairing the economy is not going to be easy and it will take a long time.