Weekly Jobless Claims and February Trade Deficit

KEY DATA:  Claims: 6.65 million/ Deficit: $39.5 Billion (down $5 bil.); Imports: -2.5%; Exports: -0.4%

IN A NUTSHELL:  “With some states, such as Florida, just discovering there is a pandemic, look for the unemployment claims to remain in the millions for a few more weeks.”

WHAT IT MEANS:  Last week, it was reported that new claims for unemployment insurance hit a record level that was five times the previous high.  We doubled that number in today’s report.  In just two weeks, ten million people have applied for unemployment insurance.  Have we topped out?  That is not clear, as it appears there are still a lot of new claims that could come in from the epicenter, New York, as well as other areas that are starting to see more and more shutdowns.  And, of course, those states that were living in denial are starting to wake up and face reality, so claims in those states should begin to skyrocket.  It is not unlikely that upwards of twenty million people will wind up applying for unemployment compensation and that total will not include those ineligible, for whatever reason, for the program. There is one really big and important difference this time: Under the CARES Act, some business owners who would not have been eligible under the old laws can now collect unemployment insurance. 

The trade deficit narrowed sharply in FebruaryThe sharp decline in imports point to what is likely to be continued significant cutbacks in U.S. purchases of foreign products.  As much of the February trade numbers reflect decisions made months before, the details really are not very relevant to the current or future economy.  But there was distressing news for farmers.  Sales of soybeans, which were expected to jump after the phase-1 China trade agreement, collapsed.  The idea that China will ramp up its purchases of U.S. goods this year is gone. Maybe next year.  We also sold a lot of energy products, but given the collapse in demand and price, that will not likely be repeated when the March data are repeated.  And vehicle sales, which also rose solidly, you can forget that for a while.  As for imports, fuel and computers were the chief products that saw less U.S. demand.   But to the extent that more computers are needed to support the remote economy, that could turnaround.

LABOR MARKET IMPLICATIONS:  We are headed toward double-digit unemployment rates that could breach 20%.  The CARES Act will soften that rise as it moves workers from the unemployment rolls to private sector payrolls.  One thing it does not do is necessarily create more output.  Businesses don’t have to have the workers do anything to get the money.  The intention is to create what I would call a “reserve army of the employed”.  These are people who are getting paid by the government but technically “employed” by businesses, no matter what they do or not do.  (Remind you of any other economic system?) 

For some firms, such as family run businesses, this is the greatest thing ever created.  They can hire their family members, to the extent that is legal (and according to some accountants I talked with, to some extent that is the case), and keep the income within the family.  That will allow them to subsidize the business and likely keep them from failing.  That may also be a rational strategy that firms that didn’t employfamily members might employ.  What that means for the unemployment rate is unclear.  If some of the family members hired were not part of the labor force previously, their hiring will not reduce the unemployment rolls.

Ultimately, the government payroll payments will have to end and private sector companies will have to start earning the money to pay those workers.  That is when demand will become key and for any economic recovery that results, the rubber will meet the road. When the upturn in the economy does appear, we could get a quarter or two of very strong growth, but only because we fell so far so fast.  It is the second and third and fourth quarters after the bottom is hit that matter.  Given that as well intentioned as the CARES Act is, and it is targeted more toward workers and small to mid-sized business than most previous so-called stimulus packages, it can only do so much.  

Thus, what we should really be calling the CARES Act is a stabilization plan, not a stimulus plan.  We need that desperately right now.  But it is just a start.  The lasting strength of the recovery will be determined by how well we wean businesses and households off the welfare state and return them to an economy based on capitalism. 

Weekly Jobless Claims, 4th Quarter GDP 2nd Revision and a Commentary on Planning

KEY DATA:  Claims: 3.28 million/ GDP 2.1% (Unchanged)

IN A NUTSHELL:  “The unemployment rate is like to go into the double-digits.”

WHAT IT MEANS: In large parts of this country the economy has essentially shut down and now we are starting to see the data that indicate the extent of that closing.  New claims for unemployment insurance, not surprisingly, skyrocketing to 3.28 million, the highest level on record.  The previous record was 695,000 in October 1982.  This is the not the only week we will see extraordinarily high claims numbers as not all shutdowns occurred at the same time.  So expect the unemployment numbers to rise by millions more.  It should also be remembered that many small businesspeople are not eligible for unemployment compensation if they are owners.  Thus, we are likely to be underestimating the true state of unemployment.  Regardless, we are likely to get to double-digits and how high that goes depends upon when the economy starts to reopen.

The final reading of fourth quarter 2019 GDP came in at 2.1%, which is unchanged from the previous estimates.  The economy ended last year growing at trend growth, which is what was expected, and started off this year on a fairly high note.  Part of that was weather driven, but at least economic conditions were not faltering going into the shutdown.       

Commentary: The Fed vs. the Government: Planning actually works!

The starkest difference in the reaction to the pandemic was between the Federal Reserve and the federal government.  The Fed has moved rapidly and strongly and there is a very simple reason: It learned the lessons of the financial market meltdown.  In 2008 – 2009, the Fed had no strategy to deal with what was happening.  The near-worldwide financial meltdown was not something that had been game planned.

But to its credit, the Fed has spent the last decade researching what worked, what didn’t and what needed to be done if there was another massive economic and/or financial crisis. It didn’t need anyone to tell it that a crisis was coming and it moved quickly and effectively to put in place the policies it had already identified as necessary.  The Fed had a game plan, it was not caught flatfooted and it moved to make sure the financial markets got the liquidity they needed.  There is still more to be done, but research and planning worked.  Kudos to past Fed Chairs Bernanke and Yellen, as well as current Chair Powell for getting the Fed as ready as possible for the current crisis.

And then there is the federal government.  It started first with denial that there was an issue, moved to disbelief that the problem could be large and finally to ragged, uncertain and uncoordinated reactions.  There doesn’t seem to have been a plan in place, despite warnings as recently as 2017 that a pandemic was possible and strategies had to be developed.

The implications of the failure of the federal government to have a plan to deal with a crisis similar to the current one are enormous.  Without a plan, policies to address the problems have lagged.  While other countries ramped up their testing, we are still well behind the curve.  Two nights ago, I was on a Zoom meeting and a senior manager at a major local hospital said that it was still taking four to six days to get test results back and that was for patients admitted because their symptoms mirrored those of Covid-19.  That required the hospital to treat the patients as if they had the virus and therefore critical, limited resources were wasted on patients that ultimately tested negative.  

In addition, the failure to ramp up testing and increase availability of critical medical supplies, as we saw in other countries, have created significant issues going forward.  Knowing who has the virus, who had the virus and who hasn’t had the virus is key if we are going to reopen the economy.  Otherwise, we don’t know the risk of potentially reopening early.  There is a debate going on that asks the question “when should we start reopening businesses?”  We all want the economy to reopen as soon as possible, but we also don’t want a relapse. 

If we are forced to shut down a second time, the attempts to stabilize the economy that have passed Congress will largely be wasted.  If we have to shut down again, it will come when the economy was greatly weakened and therefore less capable of handling the shutdown.  And if we have to shut down again, federal, state and local budgets will largely be busted.  And those are just the economic implications.  Clearly, the death toll will rise sharply if there is a relapse as it is not clear if the health care system could handle a second surge. 

My view is that it is better to err on the side of safety than on the side of speed.  We need to be as reasonably certain as possible that a relapse has a relatively low chance of occurring.  We will not be able to know with certainty, but that means this decision has to be made by experts.  The short-term economic costs of opening later may be greater but the longer-term economic and social costs are likely to be less.  That is my view.  Everyone needs to determine for themselves the risks of opening too soon and express those views, as this debate is raging right now.       And going forward, the federal government cannot be caught flat-footed again.

February Retail Sales and Industrial Production, March Builders’ Index, January Job Openings

KEY DATA:  Retail Sales: -0.5; Ex-Vehicles: -0.4%/ IP: +0.6%; Manufacturing: +0.1%/ NAHB: -2 points/ Openings: +411,000

IN A NUTSHELL:  “The economy was not doing particularly well before the virus hit, which is not good news.”

WHAT IT MEANS:  February data are still not reflective of where we are going, but it would be nice if they were strong enough to have formed some type of base.  That was hardly the case.  Take retail spending, which we know will be largely limited to online sales going forward.  Consumer demand faded in February, though that came on top of a strong January gain.  Together, though, the two months didn’t show much of an increase.  We can discount the sharp decline in gasoline because prices fell sharply, but people didn’t eat out, buy electronics, appliances, clothing or just about anything else.  All they did was shop online – which as I said, is what they will likely be still doing to some extent.  It will be interesting to see what the March retail numbers look like.  On the one hand, the last two weeks will be disastrous for anything but online sales.  But the panic buying may have made up for at least some of that.  So, the decline should be large, but maybe not as enormous as some fear.  April is when we could see the worst drop as it looks like social distancing will last at least the entire month. 

As far as manufacturing was concerned, output edged up in February.  Yes, overall industrial production soared, but it was all weather related.  Utility output was up over 7% after having declined by about 5% or more the previous two months.  What saved manufacturing was a surge in vehicle assemblies.  I suspect that not a lot of people are out kicking the tires these days, so that could reverse with a vengeance in the months to come.  Look for a truly ugly March manufacturing production number.

On the housing front, the National Association of Home Builders reported that its index edged down only relatively modestly in March.  All of the components, including traffic declined a small amount.  That was a pleasant surprise. 

The most meaningless, outdated number of the day was job openings, which were up sharply in January.  That is likely to change dramatically once we get the March numbers, in two months.  MARKETS AND FED POLICY IMPLICATIONS:Is a recession baked in the cake?  It is hard to see that it isn’t.  Whether the decline lasts four, six or eight months and is officially declared a recession is unclear, but we haven’t seen the really bad data yet.  The first time we get an employment report down massively, and we are going to get at least one or two, that will test the will of households.  How businesses continue to produce and stock the supply chain will be a challenge.  Europe is going into recession and China is just starting to recover, so at least one or two quarters of negative world economic growth is likely.  Second quarter growth could be sharply negative.  We will not shake the downturn until people can get back out to live their lives more normally.  And that requires largely ending the spread of the virus.  This country has been unprepared to even measure the extent of the problem as testing is way behind the rest of the world.  That is a failure of leadership and planning.  As testing ramps up, the numbers will surge.  But it is not clear when we will get things together as we are in a leadership vacuum that is being filled by governors and mayors making independent decisions but without the resources to meet the challenges they face.  The Senate is not even discussing an economic stimulus package, the President has just discovered there really is a problem and the administration’s economic brainless trust is either claiming we will not go into a recession or is proposing ideas that make little sense.  I was criticized for attacking the payroll tax proposal.  But if you are not working, you don’t pay the payroll tax anyway! Help is needed for those who are going to or have already lost their jobs, their businesses, their incomes, their health care and their ability to meet basic needs and pay bills and debt.  It seems our federal leaders in the administration and Congress just don’t get it. The result is that the downturn will likely be longer and deeper than necessary because of this federal-level leadership failure and it is why I and so many other economists now have a recession in our forecasts. 

February Employment Report and January Trade Deficit

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.   

February NonManufacturing Activity and Private Sector Jobs

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.       

Fed Emergency Rate Cut, March 3, 2020

In a Nutshell:  “The Fed’s emergency rate cut was supposed to boost confidence but it may wind up raising fears that the coronavirus is likely to cause a major economic downturn.”

Decision: Fed funds target range cut 50 basis points to 1.00% to 1.25%.

In an emergency action today, the Federal Reserve cut the fed funds rate by one-half percent.  The Fed noted in its statement that “…the coronavirus poses evolving risks to economic activity.”  In his press conference, Chair Powell indicated he knew that monetary policy would not change economic fundamentals, but he was acting to boost confidence. 

He was right in recognizing that monetary policy is limited in the current situation but may have been all wrong when he thought he was boosting confidence.

First of all, you cannot fight a virus with rate cuts.  The economy will slow because of the actions taken to fight the spread of the virus and those actions will not change because rates are lowered.  Indeed, it is hard to believe the Fed members actually think rate cuts will induce greater business or consumer spending.  I have no idea what the reaction function is that goes from rate cuts to better economic activity when the problem is an epidemic.

Instead, it looks like the Fed, as it did starting at the end of 2018 and all through 2019 when it reversed direction and started cutting rates, is targeting not the real economy but the financial economy.  For the past year, I have written that the Fed seems to have a triple mandate that includes not just growth and inflation but the equity markets.  This move seems to be targeted at the equity markets, as it is not likely to do anything to either growth or inflation. 

Since the late fall of 2018, I have argued that the Fed was wrong to consider cutting rates when the economy was solid and I continued that criticism all through the rate cutting process. 

My concern was that the actions were unnecessary to sustain the expansion and all it would do was make it difficult for the Fed to fight a real economic downturn.  In one respect, I was wrong: Investor confidence remained strong, even as growth moderated as most economists expected. 

But there were fewer arrows left to fire once the virus hit.  And after the current rate cut, which is once again occurring before the appearance of any weakening economic data, the Fed is largely out of ammunition.  Do the members actually believe that taking rates back down to zero will do anything more than it did in 2009? 

Even worse, the Fed may have botched the messaging.  If you cannot wait two weeks to cut rates, then why shouldn’t consumers, businesspeople and investors believe that the economy is on the verge of a recession?  An emergency cut means this is an emergency!

The message is that we are headed into real problems.  That is hardly the way to boost confidence.   

Where does the Fed go from here?  Once the softer economic numbers start coming in, and they we should start seeing them as we move through the spring, more cuts will be needed.  But there is only one percentage point left before we hit zero and that last percentage point is likely to do little. 

The Fed has botched it again.  When the markets tanked in 2018, the members should have looked at it as a resetting of overpriced markets because it was (my comment at the time was a correction is just that, a correction!).  Instead, they panicked and cut rates to support the equity markets.  They succeeded, but at a cost.  The markets surged and we were back into an overpriced situation, at least when you consider an economy that was growing by just 2.25%.  And the Fed wasted seventy-five basis points of ammunition. 

The only good thing to say is that it is a virus that is causing the economic problems and the only action that will turn things around is ending the epidemic.  This downturn was not caused by a bubble bursting or financial irresponsibility.  Instead, all it will likely require is people going back to living normal lives.  That may take a while, but once it does, we are likely to see a sharp recovery. 

January Income and Consumption

KEY DATA:  Income: +0.6%; Spending: +0.2%; Prices: +0.1%

IN A NUTSHELL:  “Households have money to spend, but with all that is happening, it is not clear they will spend it.”

WHAT IT MEANS:  The key to keeping the economy going is the reaction of households to all that is swirling around them.  It is not clear what people will do.  They have the money to spend, but for how long is the issue. Personal Income rose solidly in January.  But the details are a little questionable.  Wage and salary increases early in the year have been driven by increases in the minimum wage and while that is still happening, the gains are slowing down.  Thus, worker compensation did rise decently in January, but much less than it did in January 2019.  The biggest increase was in government transfer payments, especially for Social Security.  So, while the increase in income was large, it may have been only temporary.  In 2019, there was a surge in personal income but that faded as the first half of the year wore on.  I suspect the same will happen this year. 

As for consumer spending, it was moderate, at best.  Most of it came from a jump in durable goods demand – mostly vehicle sales.  The motor vehicle selling rate is trending down, though in a saw tooth pattern.  Thus, you get some ups even as demand fades.  When adjusted for inflation, which low, consumption rose modestly.  Indeed, we have started the quarter off growing at a 1% pace.  If the issues with the coronavirus and the markets affect consumer spending, we could see a very weak first quarter consumption number.   

MARKETS AND FED POLICY IMPLICATIONS:  In the midst of the stock market chaos/ panic, it is worthwhile to step back and ask the question whether the huge selloff makes sense.  If you look at it in the short term, the answer is yes.  The world economy is slowing and in many ways is shutting down.  Thus, some sectors are being clobbered because demand is just not going to be there anytime soon.  There is also the reality that it is likely to take some time, even when the all clear is given, for activity to ramp back up.  And since we have no idea how long before the epidemic is stabilized and dealt with and how long the process of returning to normal production and demand takes, the uncertainty has to factor greatly into pricing. 

But this situation is vastly different from the crash created by the financial crisis.  Then, there were real economic factors that drove the downturn.  The effects of a housing bubble bursting and financial system financial collapsing don’t disappear quickly.  In contrast, there is every reason to believe that travel and trade can be restored in a much shorter time once the restraints to activity are removed.  That is, the slowdown can be much more readily overcome.  Airlines will be flying again, manufacturers will be getting their supplies again, people will be interacting again, China will reopen and optimism will return.  It is just that we don’t know how long that will take.  And that means the markets will have problems pricing in the value of stocks, at least if you factor in earnings just for 2020.  For investors, the question is whether they are traders who are in it just for the short-term or are they investors.  We don’t know the bottom but we know that economic issues created by a virus are reversible. The Great Recession was long and deep and the recovery long and slow because there was so much damage to fundamental sectors of the economy.  This time is different and it is likely that the recovery will be swifter and stronger.  But getting to the bottom could be a very painful process. 

January Durable Goods Orders, Pending Home Sales and Revised Fourth Quarter GDP

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. 

January New Home Sales

KEY DATA:  Sales: +7.9%; Over-Year: +18.6%; Prices (Over-Year): +14.0%

IN A NUTSHELL:  “The warm weather has really heated up the housing market.”

WHAT IT MEANS:  Some may call climate change a hoax, but to builders, it is the greatest thing since sliced bread.  In January, new home sales skyrocketed to their highest level since July 2007.  Demand surged in the Midwest and West, was up solidly in the Northeast but fell in the South.  But once again, you have to look at the numbers with some caution.  First of all, the gains over the year were clearly impacted by the extremely warm weather.  The increases from January 2019 to January 2020 in the Northeast, Midwest and West were all between 45% and 50%.  Really, does anyone believe that weather didn’t play a huge part in those surges?  When there is little snow and the cold weather isn’t so cold, people can visit the construction sites and builders can build so it is a lot easier to sell homes under construction.  Prices jumped as a greater proportion of sales were for homes above $400,000.

MARKETS AND FED POLICY IMPLICATIONS: What worries me about the apparent exuberance in the housing market is that the demand is likely being pulled forward because of the weather.  The outsized gains from the previous year for so many indicators are warnings that the strength may not be sustainable.  Thus, while first quarter growth might be hyped by strong housing construction, it could be matched by a major turnaround in the spring and summer.  And if builders do what they often do, which is assume the good times are here to stay, then we could run into some real problems in the sector as we go through the second half of the year.  With the level of supply, as measured by months, low, I would not be surprised if builders continue to ramp up starts.  February has been another warm month and the construction data should be really good.  I just worry that the sector could be getting ahead of itself.  As for investors, the story remains the coronavirus. It is not clear how long it will take for a vaccine to be developed and become universally available.  The estimates I have heard range up to a year or even longer.  The implication is that this is not going away anytime soon and each time a new outbreak occurs, expect the markets to react strongly.  Thus, the efficient but often irrational markets could be volatile for quite a while.  The Fed is likely to continue to put out the word that it needs to watch and wait, not react.  Since interest rate changes don’t impact the physical health of the world, that makes sense.  As for the mental health of investors, well the Fed found the placebo effect worked well last year so it just might try it again this year. 

February Consumer Confidence and December Home Prices

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.

Linking the Economic Environment to Your Business Strategy