KEY DATA:  Claims: 6.6 million; Insured (Level): 7.46 million/ Sentiment: -18.1 points; Current Conditions:  -31.3 points

IN A NUTSHELL:  “With 16.8 million new unemployment claims in just the past three weeks, the unemployment rate could easily reach 20%.”

WHAT IT MEANS:  The drumbeat of shockingly bad labor market numbers continues.  Another 6.6 million people filed for unemployment insurance last week, bringing the total for just the past three weeks to 16.8 million workers.  Keep in mind, not everyone is eligible for unemployment insurance.  However, with CARES Act allowing small business owners to file (they made unemployment insurance payments but weren’t eligible themselves), the number is a better measure of the loss of jobs than previous numbers.  Regardless, what we are seeing is an emptying out of the employment rolls that represents the impacts of the shut downs.  And with some states just starting to close business, these numbers should remain high for a few more weeks.  However, I do expect them to start trending downward.  The number of insured is lagging the claims numbers and that is already at a record high.  So, expect us to take out the Great Recession unemployment high of 10% and even the post-WWII high of 10.8% posted in December 1982, possibly as soon as the April report.

The consumer confidence numbers are starting to catch up with reality.  The University of Michigan’s early reading of April Consumer Sentiment fell sharply.  But it was the Current Conditions Index that crashed and burned.  I had noted in the last commentary about this indicator that households seemed to be delusional.  No longer.  And there was a clear warning in this report: “Consumers need to be prepared for a longer and deeper recession rather than the now discredited message that pent-up demand will spark a quick, robust, and sustained economic recovery.”  

Labor and Equity Market Implications:  When all is said and done, the unemployment rate could exceed 20%.  That depends upon how many workers are transferred from the unemployment insurance rolls to the CARES Act, government paid, private sector payrolls.  Those being paid by the government but carried by private firms are technically not unemployed, so as I have noted before, the unemployment rate will be an artificial measure.  Nice trick.  But the CARES Act also creates a conundrum for low to moderate-income workers.  For as long as the extra $600 per week addition to unemployment compensation persists, total payments to lower paid workers will likely replace all of what they lost (and maybe even more).  Thus, the incentive for many unemployed is to not accept a job offer to return to work.  That sets up a potential battle between employers and former employees.  For the CARES Act loans to become grants, firms need to rehire/replace a significant proportion of their former payrolls.   This will incent firms to pressure workers to take job offers, even if those jobs are not in the best interest of the workers.  Welcome to the world of unintended consequences.  And even if the unemployment rate winds up maxing out “only” in the low to mid-teens, it would still be well above the Great Recession high of 10%. 

After the back-to-back recessions in the early 1980s, it took over four years to get within one percentage point of the previous expansion’s low unemployment rate.  It took five and a half years after the peak in the unemployment rate was reached during the Great Recession to get back to within a one percentage point of the previous low.  Since the CARES Act unemployment rate will already include a large number of rehired workers, we might not see a surge in hirings once the economy is reopened.  Thus, it could take five years to get within one percentage point of the February 2020 rate.  That has some significant implications for the equity markets.  Currently, investors seem to think that the massive government and Federal Reserve loan and grant programs will get the economy bouncing back quickly.  It seems like a V-shaped recovery is getting baked into the cake.  But those programs will start to wear off.  The government doesn’t have an infinite amount of money to keep paying workers that are on private payrolls.  Those firms will eventually have to become profitable enough to pay their workers by themselves.  Yes, public welfare is great when you are receiving the funds for free and business owners are gratified for the largesse.  But that approach is only a crisis-created way of life.  Eventually, capitalism must be reign and with the unemployment rate so high, spending power will be limited.  Eventually, earnings growth for the second half of this year and for 2021 has to be factored into equity prices. The claims data point to double-digit unemployment rates and if we do hit 20%, don’t expect earnings to be great for many companies for quite some time.  Worse, if the rate remains near 10% for an extended period, the level of demand will not be enough to support many of the smaller businesses that were already living hand to mouth before the pandemic.  So expect layoffs to resume during the second half of the year as the government funds get withdrawn.  The alternative is longer and more expensive government subsidies and a massive budget deficit that will lead, ultimately, to crushing spending and tax changes.  If anyone thinks that we can spend our way out of this at the level we are spending, without longer-term consequences, they are deluding themselves.

KEY DATA:  Payrolls: +273,000; Private: 228,000; Revisions: +85,000; Unemployment Rate: 3.5% (down 0.1 point); Wages: +0.3%; Over-Year: 3.0%/ Trade Deficit: $3.3 billion narrower

IN A NUTSHELL:  “A solid economy, warm weather and lots of government hiring are keeping job gains elevated, but that could change quickly if the corona virus becomes widespread.”

WHAT IT MEANS:  The economy is in good shape and nothing shows that more than robust job gain we got in February.  Payrolls rose much more than expected, powered by huge increases in a wide range of sectors, but many may have been weather-related.  For example, construction, real estate and restaurants together added 107,000 new workers.  Those gains don’t include related industries such as finance and architecture, which also hired very strongly.  Undoubtedly, those increases were hyped by the unseasonably mild winter that allowed people to get out/eat out and buy homes.  Other strength was seen in medical care, social assistance and, very surprisingly, manufacturing.  Finally, governments are hiring like crazy but much of that may be for the census. 

On the unemployment front, the rate ticked down, driven by a decline in the labor force.  That happens periodically, so don’t be surprised if the rate moves back up in March.  The labor market is tight, but that is not translating into strong wage gains.  Hourly wages were up solidly over the month, but you would expect much more than the 3% rise over the year.

The trade deficit narrowed sharply in January. Both imports and exports fell, which is not the way you want to see the deficit decline.  The large fall off in imports wasn’t due simply to declining oil prices.  Indeed, the largest drop was in nonmonetary gold.  Don’t ask me why.  Energy and nonmonetary gold accounted for seventy percent of the import decline.  There were also reductions in demand for capital goods and vehicles but increases in food and consumer products.  Exports were also down, but by much less.  We sold more farm product vehicles and consumer products, which was good news.

MARKETS AND FED POLICY IMPLICATIONS:  That was then but this is now.  The data will not likely start reflecting the impact of the coronavirus until we start get the March numbers, at the earliest.  And those will likely reflect the issues we are seeing outside the U.S. The jobs and trade data are two reports that could see major virus-related impacts.  For example, traffic at West Coast ports is down sharply and that should lead to continued declines in imports – a positive for growth.  But as the coronavirus effects expand in the U.S., we should start seeing the effects on hiring and income.  And then there is the seasonal adjustment factor to consider.  If I am correct in my argument that the mild winter has hyped the payroll increases, then as we move through the spring, those gains will be backed out.  And if the census hiring is boosting the government numbers, those people will start dropping off the rolls in the summer.  So, when you add it up, the weather, the census and the coronavirus look like they could create some really dismal job numbers in the spring and summer.  So don’t get too excited about the current condition of the economy, as the past is not likely to be prologue.  Investors understand that and will be buffeted by the U.S. news on the coronavirus.  The volatility is not expected to end anytime soon.  And then there is the Fed.  I like to say the markets are efficient but not necessarily rational but I haven’t in the past argued that the Fed decision-making has a large element of irrationality in it as well.  Unfortunately, you cannot rule that out right now.  After this week, who knows what they will do and when they will do it.  The best guess is that once the effects of the coronavirus start hitting the economic data, and I assume they will, the Fed members will have to conclude that they need more rate cuts.  Why they think that going from one percent to zero will do anything other than send the message that the sky is falling is beyond me, but as I just noted, there seems to be an element of irrationality (or panic) in the Fed’s thinking right now.   

KEY DATA: ISM (NonMan.): +1.8 points; Orders: +6.9 points/ ADP: +183,000; Large Businesses: 133,000

IN A NUTSHELL:  “Going into any potential coronavirus slowdown, the economy is in good shape.”

WHAT IT MEANS:  Last week I noted that the potential for a recession depends upon the strength of the economy going into a possible coronavirus outbreak and the extent of any outbreak in this country.   As we saw last week and now this week, the current state of the economy is good.  While the Institute for Supply Management (ISM) reported yesterday that manufacturing activity expanded a little slower in February, today it pointed to continued, even growing strength in the nonmanufacturing portion.  The ISM NonManufacturing index rose decently led by a strong increase in new orders.  Hiring improved and order books fattened.  If we weren’t facing a potential virus-driven slowdown, I would be saying the economy might be poised to grow faster.

As for the job market, it too looks like it is still in very decent shape.  On Friday we get the government’s take on payroll gains, but today ADP weighed in with its estimate of private sector job growth.  It was actually pretty good.  The warm weather allowed construction activity to flourish and job gains in that sector were solid.  The one disappointment in the report was the relatively modest gains in small and mid-sized companies.  Most of the growth has been coming from large companies and while there is nothing wrong with that, we need the smaller companies to join in.  They are usually the key to continued strong job gains. 

MARKETS AND FED POLICY IMPLICATIONS:  It is too soon to see much if any impact from the problems in China on U.S. economic activity.  So the solid and even strong February numbers are hardly a surprise.  But the spring data should be telling.  There is a very high likelihood that second quarter growth will take a major hit.  Supply chain issues, the slowing of demand in countries dealing with the virus and, very simply fear should all start showing up in the numbers.  The question is how far into this year will the effects last.  The U. S. may have been slow in reacting, but hopefully that will change.  But as the virus spreads and more importantly, as the death toll rises, which it unfortunately it is likely to do, then human nature will step in.  The fear factor is what we have to watch for.  It will not only restrict activity but may lead to drastic actions to control the epidemic if it becomes widespread.  It is at that point the economy would falter and a recession becomes inevitable. Of course, if there is no widespread virus epidemic, then given the current strength of the economy, we are likely to escape a recession, though we still might have a negative quarter.       

KEY DATA:  Orders: -0.2%; Ex-Aircraft: -2.5%; Capital Spending: +1.1%/ Pending Sales: +5.2%; Over-Year: +5.7%/ GDP: +2.1% (Unchanged)

IN A NUTSHELL:  “Other than housing, there is not a lot of oomph in the economy.”

WHAT IT MEANS:  Yes, it is all about Covid-19, but the economic data keep coming in and they provide a picture of the state of the economy just in case the virus strikes the U.S. hard.  Today’s key number was durable goods orders.  Demand for big-ticket items were off in January slightly, but the decline was kept to a minimum because civilian aircraft orders surged by 346%.  I prefer to take out aircraft, as rising or falling orders for civilian or military planes don’t usually translate into changes in production in the near term.  When you do that, demand for big-ticket items was off sharply. But the other details in the report indicate that business investment is holding in but not booming.  The best measure of capital spending, nondefense/nonaircraft orders, rose solidly, after having declined in December.  Orders for machinery, computers and metals rose.  However, demand for communications equipment, electrical equipment and vehicles were down.  With backlogs flat for the past two months, it is not clear we will see any pick up in production.  

The strongest sector, at least for now, is housing and pending home sales jumped in January.  The National Association of Realtors’ index rebounded from a large drop in December.  The index level is solid and points to an uptick in home sales over the next couple of months. 

The Bureau of Economic Affairs released its second estimate of fourth quarter growth and it was unchanged from its initial calculation.  There were only small revisions to a number of components.  Consumption and investment were a little lower, the trade deficit a touch wider and inventories were somewhat higher.  Inflation was even slower than initially thought.  None of the changes should alter economists’ view of first quarter growth, which is already muddled by the coronavirus.  

MARKETS AND FED POLICY IMPLICATIONS:  It is hard to look at the current economic data and assume the past is prologue. Let’s face it, the coronavirus is the economic story and the way it plays out will determine if the U.S. economy continues its record expansion or comes to a crashing halt.  The potential for a recession, though, depends upon the strength of the economy going into a possible coronavirus outbreak and the extent of any outbreak in this country.  Right now, economic conditions are solid enough to withstand a mild epidemic (if there is such a thing).  But growth is not so strong that if there were a major outbreak, the economy would keep on ticking.  The likelihood is that the first quarter growth will come in somewhere between 1.5% and 2%.  Consumers are still spending and with housing hyped by the weather, any slowdown in business investment and exports should be overcome.

The impacts of the virus could start showing up with a vengeance in the second quarter.  The housing gains, which were driven by weather, should unwind.  Exports could be cut and the lack of tourism is likely to wreck big-ticket retail and to some extent, export services.  Business investment could also be hit quite hard.  If the virus worsens through the spring, spending on structures and equipment could be brought to a halt.  That would add to the problems in the energy sector. With prices way down, investment plans are already being slashed and the lower energy prices go, the greater the cutbacks.  This looks like an insidious virus and you cannot build a wall around the U.S. to keep it out. The best we can do is prepare the health system to handle it and while that would up health care and government spending, you can forget business and consumer spending. We might stay out of a recession if there is only a mild outbreak in the U.S.  If not and it lingers, a recession is likely – and the Fed would be able to do little to stop it. 

KEY DATA: Confidence: +0.3 point; Present Situation: -8.8 points; Expectations: +6.4 points/ FHFA (Month): +0.6%; Over-Year: 5.2%/ Case-Shiller (Month): +0.5%; Over-Year: +3.8%

IN A NUTSHELL:  “Consumers remain confident, but continued declines in the equity markets are likely to test their resolve.”

WHAT IT MEANS:  The markets are beginning to face reality but for most of the last couple of months, investors have generally paid little attention to the potential impact on the U.S. and world economies.  Thus, with equity prices generally rising and the labor market solid, it was hardly a surprise that the Conference Board’s Consumer Confidence Index rose in February.  Yes, the gain was less than expected, but the level remains high.  That said, there was a real warning in the data: The Present Situation index fell sharply.  That offset a jump in expectations.  The likelihood is that U.S. growth will moderate over the next few months and if the stock market doesn’t bounce back quickly, then both components could decline.  Consumers are going to spend decently, but their broad shoulders are likely to start slumping.

Home prices rose sharply in December and it looks like the decelerating price pattern is turning around.  Both the Case-Shiller and Federal Housing Finance Agency’s national price indices were up solidly at the end of last year.  The big difference was in the gain for the year.  The FHFA number was significantly higher than the Case-Shiller rise.  If we average the two, the increase was moderate and sustainable, which is what you would expect in an economy that is expanding moderately.  But there is a concern.  Price gains have been decelerating for at least two years and that is in a market where there is an immense supply shortage.  Prices in more areas should be rising faster.  If the economy slows more than expected, we could see price increases fade significantly.    MARKETS AND FED POLICY IMPLICATIONS: Well, I have been asking for weeks when or even if investors would wake and smell the antiseptic and it looks like that finally happened yesterday.  The idea that “what happens in China stays in China” was always nonsensical and to hear traders say they didn’t think the epidemic could be this bad makes me think that they have to get out of the trading pits once in a while – or maybe even once. Markets are efficient; but they don’t have to be rational. In this case, some fear should have been built in but it wasn’t.  Thus, this is likely a correction, adjusting prices to better reflect the uncertainty that has been there all along.  But when it comes to Jerome Powell, corrections are not viewed as price resetting.  They represent a challenge to growth that has to be met head on with all the power of the Fed.  Dumb?  Yes, but that is how he acted at the end of 2018.  The huge equity price gains were not supported by economic and earnings fundamentals and when the inevitable correction occurred, he turned into Chicken Little.  As the Fed members have been noting recently, there is not a lot of ammunition left and the Fed is going to have to resort to non-interest rate strategies if a major slowdown occurs.  The worry I have is that Mr. Powell will panic again and use up the last of his key weapon, lower interest rates.  Once you hit about one percent, the reaction function to further rate cuts largely disappears.  If you have to go to one, you are probably headed to zero and you only go to zero when there is a crisis.  So, why would businesses or individuals increase their borrowing or investing when rates get that low?  Go me, but the Fed Chair seems to think they will.  We have a long way to go before we get even close to correction territory and it is hardly clear that will even happen.  But given the Fed Chair’s history, I don’t have a lot of confidence the Fed will react in a manner that not only provides short-term stability but also allows for longer-term policy flexibility.

KEY DATA:  Sales: -1.3%; Over-Year: +9.6%; Median Prices (Over-Year): +6.8%

IN A NUTSHELL:  “The scarcity of existing homes on the market continues to limit sales.”

WHAT IT MEANS:   The meek have been leading way in the economy as housing has gone from okay to Tony the Tiger land: Grrrrrrrreat!  Existing home demand is generally following the pattern set by new homes and starts. Sales eased in January, which is not what I had expected.  I thought we would see a bit of a rise.  The drop was pretty much equal in both single-family and condos.  But remember, these are closings, compared to contract for new homes, so we may see a major pick up over the next couple of months.  Three of the four regions posted gains or were flat.  Only a sharp decline West kept the sales pace down.   Compared to January 2019, though, demand surged.  As for prices, they were still up pretty sharply over the year.  The key for both prices and sales is the inventory number.  It stands at 3.1 months.  That is, at the current selling pace, the number of homes listed would be depleted in a little over three months.  That is up slightly from the historic low set in December.  In other words, there are few homes to be bought so there are few sales to be made and with demand still decent, prices should be rising solidly.   

MARKETS AND FED POLICY IMPLICATIONS:  Existing home sales are a lagging indicator in that they represent purchase decisions made a month or more in the past.  That they are holding up pretty well is an indication that the sector is strong.  The level of home construction (housing starts) this quarter started off over 8% above the average in the fourth quarter and there is little reason to think that gain will tail off significantly.  So expect housing investment to be a key factor in growth this quarter.  But it would be nice if sales rose faster.  Home purchases translate into consumer demand for housing related goods, usually within about six month after the rise in demand.  We need something to offset the slowing in vehicle purchases if growth is to be sustained at 2% and fixing up a newly-purchased housing unit would be one source of that demand.  But homeowners seem to be entrenched and are unwilling to put their places up for sale, so don’t expect demand to rise sharply anytime soon.  Should investors worry about that?  Only if they care about economic fundamentals and I am not really sure where they stand on that.  Actually, I am not sure they really care that much.  But the Fed does and while no Fed member is out there saying there is irrational exuberance in the markets, they have to be wondering if the disconnect between economics, earnings and stock prices could create some real issues going forward.  Indeed, I think the recent spate of comments about how to manage in an environment of low interest rates is a warning that there is not much rate-cut ammunition left.  That, of course, is a problem created in part by last year’s rate reductions, which we know did nothing but hype the markets even more.  It should be an interesting spring and summer, when the full impacts of the coronavirus start showing up.      

KEY DATA:  Starts: -3.6%; 1-Family: -5.9%; Permits: +9.2%; 1-Family: +6.4%/ PPI: +0.5%; Goods: +0.1%; Services: +0.7%

IN A NUTSHELL:  “The strength in housing is a positive sign but let’s wait until the spring to see if it is real or weather-related.”

WHAT IT MEANS:  Housing had been improving at a nice, steady pace for a number of years but it suddenly broke out at the end of last year.  The January numbers seem to be supporting that stronger performance as housing starts fell relatively modestly.  There was a huge jump in December that was expected to be unwound by a sharp decline in January, but that was not quite the case.  To put things in perspective, construction activity was up by 21.6% over the January 2019 rate despite the decline.  That shows how out of control things are.  But there is an explanation: Warm weather.  Let’s wait until the spring, when new home starts would normally jump, before getting too pumped up about a potential home construction boom.  As for the details, there was a sharp decline in the Midwest, a moderate drop in the South and modest increases in the Northeast and West.  Looking forward, permit requests were up solidly across the entire nation.  The level was the highest in nearly thirteen years.  Given the really warm weather in February, we could see another pop in starts when we get the February data.

On the inflation front, producer prices jumped in January, led by a surge in services costs.   These include trade services (wholesalers and retailers) as well as hotels and financial services.  Energy and transportation prices were down.  On the goods side, besides energy, the pressures tended to be on the downside, with most components reporting declines.  Food costs were up moderately.  Looking outward, the coronavirus is slowing world demand and commodity prices are falling as a consequence.  Thus, expect wholesale costs to be soft as long as the epidemic persists. 

MARKETS AND FED POLICY IMPLICATIONS:  It looks like housing will form a base for growth in the first quarter.  But if, as I suspect, most of that increase was due to unseasonably warm weather, payback could be substantial in the spring.  I expect GDP to expand by somewhere between 1.5% and 1.75% this quarter even with a strong housing sector but if it makes it back to 2%, then we are likely looking at a really weak second quarter.  Indeed, the impacts from the coronavirus are likely to ramp up over the next few months as it will take time for China to ramp back up its manufacturing sector, when it actually can do that.  Supply chains have been disrupted and companies around the world are slowing production and sales due to the lack of supplies.  Industrial production is likely to be pretty weak across the globe and while the equity market investors may not realize it, what happens everywhere else actually does affect what happens here.  We don’t know how long this will last but the longer this goes on, the broader and deeper the effects.  The energy sector is retrenching and the last time that happened investment cratered and U.S. growth decelerated sharply.  We are not facing the same price collapse, but business investment has been weak and cut backs in the energy sector cannot help.  Thus, the first half of this year is setting up to be soft and if the epidemic lasts through the spring, don’t be surprised if there is a flat or even negative second quarter.       

KEY DATA:  Sales: +0.3%; Ex-Vehicles and Gasoline: +0.4%/ IP: -0.3%; Manufacturing: -0.1%/ Import Prices: 0%; NonFuel: +0.2%; Exports: +0.7%; Farm: +2%

IN A NUTSHELL:  “The start to the year was pretty mediocre for consumers and manufacturing.”

WHAT IT MEANS:  With the coronavirus and Boeing leading the way, the first quarter of this year is expected to be pretty slow and the first set of data seem to point to that being the case.  Take consumer spending, please.  Retail sales were mediocre in January and they reached that disappointing level only because people were able to get out and do some work around the home and visit their favorite restaurant.  Building materials and food services were up strongly.  There was a pick up in furniture demand but electronics and appliance stores did not do well.  Gasoline sales fell, but so did prices a little, so don’t look into that too much.  Clothing purchases, which had soared in December, came crashing back to earth in January.  There was really nothing pretty in this report.  The one thing that is keeping consumer demand strong is consumer confidence and the University of Michigan’s mid-month February estimate posted a gain. 

Industrial output fell sharply in January as both weather and Boeing did a number on production.  The warm weather (you notice I didn’t say global warming because we know that doesn’t exist) led to a sharp drop in utility production.  Boeing’s 737 Max assembly line halt created an equally massive decline in aerospace output.  The saving graces for this report were strong increases in vehicle, petroleum, plastics and computer production.  That kept the manufacturing decline from being really ugly. 

On the inflation front, there isn’t much.  Import prices were flat in January, though there was a moderate uptick in nonfuel costs.  Food import prices were up as were imported vehicle costs.  On the export side, agricultural prices jumped.  Chinese demand for pork is surging due to the swine flu and that is helping farmers.  It is unclear what the coronavirus will do to agricultural sales to China over the course of the year, but it is not helpful right now and that may wind up depressing U.S. food costs this spring.       MARKETS AND FED POLICY IMPLICATIONS:Estimates for the first quarter are running well below 2% and today’s data do nothing to change expectations.  The coronavirus impacts are just starting to show up and the longer this problem goes, the greater the impact.  Don’t forget that China is critical to large segments of the world economy including many non-industrialized and industrializing nations as well as the EU.  There are many countries that will be hurt significantly if this doesn’t end soon and there is little reason to expect it to do so.  The same can be said of the Boeing shut down.  The company wants to start back up before getting final approval but no one knows when that will be.  The first quarter for Boeing and their suppliers is lost and it is likely the same will happen in the second quarter.  Right now, most economists have not included a significant impact of the coronavirus in the second quarter (I am one of them), so there are hopes conditions will be a little better in the spring.  The best I can say about that is maybe.  With that in mind, it is hard to rationalize the exuberance in the equity markets, at least if you believe the economy actually matters.  The latest Blue Chip consensus has growth at or below 2% for every quarter in both 2020 and 2021.  That is not a forecast that says happy days are here again and that investors should go all in.  But they seem to be doing that so it should be interesting to see what happens if growth does disappoint.  Or, maybe investors actually like 2% growth.  Economists do, but that level of growth is hardly a prescription for strong earnings growth.