Uncategorized

July 28,29 ‘20 FOMC Meeting

In a Nutshell: “The path of the economy will depend significantly on the course of the virus.”

Decision:Fed funds rate target range remains at 0% to 0.25%.

The Federal Reserve made it clear today that there is no time limit on its intervention in the markets nor is there a limit on the amount of funds it can or will spend to keep the economy from faltering. That was expected and the Fed delivered.  But Fed Chair Powell also noted that the Fed can supply funds but cannot spend those funds.  Actually, the comment he uses is that the Fed “has lending not spending powers”.  Thus, its loan programs may not be right for all businesses.  Instead, Mr. Powell noted that additional direct funding on the part of the federal government might be needed.  In other words, he was hinting, quite strongly and clearly without saying so, that further fiscal stimulus is required.  As is usually the case with Fed Chairs, he declined to advise Congress and the president on what policies to continue funding or at what level.  He ain’t no fool!

What the Fed also tried to make clear is that the best economic policy is one that addresses controlling the virus.  He noted that the economy would not get back to previous levels until people feel comfortable being involved in all normal economic activities.  He commented that measures of consumer spending have softened since late June. The resurgence of the virus in June is having a real effect on household behavior and that is worrisome.  

So, what should we take away from the Fed’s actions?  First, the Fed is operating on the basis that this could be a long-term problem and is making it clear the monetary authorities are prepared to stay the course. That means interest rates will likely remain near record lows for an extended period.  The best way to look at this is in six-month increments, since we know little about the timing of vaccines or treatments.  So, rates will likely not be going anywhere for at least the next six months.  

But the reality is that the economy will not be getting back to where it was at the end of 2019 for eighteen to twenty four months, a point the Fed Chair made.  That implies the Fed is on likely on hold through next year and probably well into 2022.  The Fed will also continue its lending policies and much of its market intervention (bond and equity purchases) through next year as well.  When the Fed starts lowering its purchases, that will be a signal it is starting to see the light at the end of the tunnel.  

Ultimately, it is all about the virus and if we keep making mistakes that cause resurgences to occur, the economy will remain weak and support from both the Fed and Congress, will be needed.   

 (The next FOMC meeting is September 15,16 2020.) 

Uncategorized

June New Home Sales

KEY DATA:  Sales: +13.8%; Northeast: +89.7%; Prices (Over-Year): +5.6%

IN A NUTSHELL:  “The highest new home sales pace in thirteen years shows that at least one segment of the economy is back up and running.”

WHAT IT MEANS:  Housing has been leading the recovery and it continues to do so.  New home sales soared again in June.  The pace was the strongest since July 2007.  It didn’t matter if a house was completed, under construction or not even started, buyers bought.  The gains, though, were somewhat unevenly distributed across the nation.  There was a near doubling in contract signings in the Northeast, a region that was crushed by the virus and has just really started opening up.  Clearly, there is a lot of pent up demand in the states in that region and it is being met.  But when a section that usually comprises maybe five percent of total sales accounts for about twenty eight percent of the new demand, you know there was a special situation.  Still, sales were up strongly in the other three regions, so this is a real recovery.  On the prices side, the cost of a new home continues to rebound back toward where it was before the recovery.  With demand rising and inventories falling, builders have every reason to be happy and keep pumping out new homes.          

IMPLICATIONS:   Next week we get the first reading on spring GDP and it should show the largest quarterly decline on record.  With the economy starting to, the June data, which are the starting points for third quarter growth, were well above April’s horrendous shutdown numbers.  So we should expect the summer quarter to post possibly the largest rise on record.  But the virus resurgence has raised questions about the extent of that increase.  The V-shape recovery true believers were looking for a percentage gain equal to about two-thirds to three-quarters the size of the decline.  But that is looking like an overly optimistic outlook.  Yesterday’s rise in new claims for unemployment insurance is likely to be the first of many increases if the virus remains at its current level, let alone increases in those states that have managed to keep it somewhat in check.  The PPP is starting to run out and firms that will now have to make money the old fashioned way (by earning it), will likely start cutting their workforces in order to survive.  And it is likely that the next business and household payments plan coming out of Congress will be significantly lower than the last one.  That can only mean many people will see their disposable income decline – and their consumption follow suit.  Where we go from here is anyone’s guess, but I think the third quarter is setting up to show disappointingly strong growth.  Yes, that sounds ridiculous, but if you were expecting growth to be in the twenty-five percent range and it turns out to be closer to ten percent, then it is really not great.      

All that said, the Phillies open up tonight.  Yes, I know, they are a long-shot, but baseball is back and I am a huge baseball fan, so until they are eliminated, all I have to say is:

LET’S GO PHILLIES!

Economic Indicators

June Industrial Production, Import and Export Prices, Help Wanted OnLine and July New York Manufacturing

KEY DATA:  IP: +5.4%; Manufacturing: +7.2%/ Import Prices: +1.4%; Fuel: +21.9%; Export Prices: +1.4%; Farm: +1.4%/ HWOL: +5.2 points/ Empire State: +17.4 points; Expectations: -18.1 points

IN A NUTSHELL:  “Manufacturing continues to improve as the vehicle sector starts to return to normal production levels.”

WHAT IT MEANS:  One thing about math, you can get some very amazing changes when you start with very low numbers.  Industrial production soared in June as the manufacturing sector reopened.  Leading the way was the vehicle sector, which had shut down almost completely in April.  Plants started reopening in May and then ramped up production in June to such an extent that half of the total manufacturing production increases in those two months came from rising assembly rates alone.  It is not clear that sales will continue to jump, so don’t expect the July vehicle or manufacturing numbers to look nearly as strong as they were in May and June.  Still, the story was not just SUVs.  Every single manufacturing group posted a gain in June.  That rarely happens.  Warm, not hot weather led to a surge in utility production, but oil and gas drilling continued to shut down.

Import prices, which had also cratered in March and April, are starting to rebound.  But most of the gain came from the recovery of energy costs.  Few other sectors showed significant gains.  With imported food costs rising modestly, there could be some easing in the price pressures that we have seen in consumer prices.  On the export side, farmers got some decent increases, but their prices are still down sharply over the year.

Firms are starting to hire again and that means they need to advertise, at least a little more.  The Conference Board’s Help Wanted OnLine index rose solidly in June and was back to 2017 levels.  That said, it remains well below the peak posted in January.

Not surprisingly, the New York Fed’s Empire State Manufacturing Index jumped in July.  This is a diffusion index, which we know changes dramatically with the economy reopening.  So let’s look at not just the index, but for me the key number, those reporting “lower”.  For the general business conditions, employment, production and new orders indices, that number remains in the mid-20% range.  That is still high.  The jobs index itself was largely flat while hours worked were still falling, though modestly.  Worse, expectations are beginning to react to the surging virus and are falling.

IMPLICATIONS:We are at a crucial point in the recovery.  The virus is getting out of control in a number of large states and new cases are even beginning to rise in most states that didn’t reopen early.  School openings are unclear, sporting events are being run without spectators, downtown office building remain largely ghost towns in many major cities and our politicians cannot decide what is the best way to proceed.  With federal guidance limited, local decision making down to school district levels is predominating.  The resulting patchwork process of safety and reopenings is showing signs of faltering.  I wrote in April that I expected a major decline in the spring quarter and a sharp, but not nearly as large rise in the fall.  That is likely to still be the case, though the third quarter gain could be less than many had hoped for.  It will still be record-setting, but not the nearly twenty percent rise that many forecasters expect (Blue Chip consensus is roughly 18%).  Forecasting economic data these days is much more daunting than in the past.  Even then, I often just had my award-winning cat pick a number.  As an economist who is a member of just about every major forecasting panel, I have to come up with numbers each week.  But truthfully, most of us are largely guessing.  Thus, when markets move on results that are above or below expectations, those reactions are irrational since the numbers often are based on models that don’t work well under the current circumstances.So, try not to get too excited by what seem to be good numbers or too distressed by bad ones.  Over time, we might discover that they were neither that strong nor that weak. 

Economic Indicators

June Consumer Prices, Real Earnings and Small Business Optimism

KEY DATA:  CPI: +0.6%; Ex-Food and Energy: +0.2%; Food: +0.6%; Energy: +5.1%/ Real Earnings: -1.7%; Over-Year: +4.3%/ NFIB: +6.2 points

IN A NUTSHELL:  “Inflation is not an issue unless you eat, drive and/or cool your house (yes, that is an oldie but goodie, but it still works).”

WHAT IT MEANS:  Almost fifteen years ago, I used the comment above to criticize the Fed for saying that inflation was not an issue if you exclude food and energy.  That caught the eye of at least one member of the Fed, Janet Yellen, who kidded me about it at a program where I received a forecasting award.  Well, sufficiently chided, I stopped using the phrase, but it is worth trotting out again.  For the most part, inflation is quite tame, as we saw in the June Consumer Price Index report. But as anyone who buys food knows, the costs of eating at home continue to rise pretty sharply.  They jumped again in June and are up 5.6% over the year. Meat, poultry and fish costs are up double-digit over the year, but most other food prices rose sharply as well.  Being the one who does the shopping in the house, I can testify that costs are surging and the supply chain remains frayed as well.  As for energy costs, the rise looks high, but prices are coming off the shutdown lows and they are still at moderate levels.  What was most outrageous was the June surge in cake and cupcake costs. I just don’t know what to do.

Though real earnings, or income adjusted for price changes, fell sharply in June, the gain over the year remains extremely high.  But these data have to be put in context (as is the case with most of the numbers).  The average wage is a weighted by the numbers of workers in each category.  With the lower paid hospitality, retail and service firm workers bearing most of the brunt of the layoffs, the weighted average increased.  As the economy reopens and these workers return, the average wage should continue to decline.  Thus, this is one report that sometimes gets press coverage but these days it shouldn’t. 

Small business optimism improved again in June.  The National Federation of Independent Businesses’ index has increased for two months now.  Firms are starting to hire back their workers and hope to hire more and, not surprisingly, expect sales to improve in the future.  But this report also has to be viewed with some caution.  The economy is reopening and of course payrolls and sales are rising, as are hopes that will continue.  But this report does not tell us about the level of employment or demand.  It says things are getting better, which is good, but not how good things are.

IMPLICATIONS:  The June reports are looking a lot better, but they don’t include any impacts from the surge in the virus across the nation and the beginnings of the retrenchment in the reopening process.  It is not clear that the July employment numbers will reflect what is happening as they are collected the week of the 12th and it may take a few weeks before the layoffs get measured.  That raises questions about what the July employment report will actually represent.  So watch the weekly unemployment claims and continuing claims numbers, as they are closer to real time measurements. If they start to rise again, and I expect that to be the case, then that will be an indication the recovery is slowing.  Another labor market issue to consider is the reopening – or not – of schools.  The timing, especially of hiring for the new school year, may impact the August data.  What I am saying is that the numbers may be collected correctly but they could be largely irrelevant.  That is what happens when you have huge changes occur in short periods of time.  When you couple that with the indices, that reflect direction not magnitudes, it is clear that we are flying somewhat blind right now.  We know things are getting better, but there is likely to be some big bumps in the road coming.  But it is also hard to know how good – or bad – things are and we may not know that for months.  So, don’t take the headline number seriously.  Look for trends and study the details, which is something I argue all the time but I felt needed to be reinforced right now.      

Economic Indicators, Uncategorized

Weekly Unemployment Claims

KEY DATA:  Claims: 1.31 million (-99,000); Continuing Claims: 18.06 million (-698,000)

IN A NUTSHELL:  “The labor market has been improving, but the impacts from the virus resurgence could slow that progress.”

WHAT IT MEANS:  With the virus resurging across the nation, the focus of attention is turning toward determining how much of an impact it is having on the labor market.  Today’s unemployment claims report is not likely to contain very much information about that.  What it does is provide a baseline to compare to the next few weeks, when the effects of the shutdowns and slowing of the reopening will start to appear.  Whether the latest report is representative of that baseline is also in question as the July 4th holiday may have skewed the data somewhat. 

So much for the caveats.   Last week, the number of people filing new unemployment claims dropped solidly.  But as I remind everyone every week, the level is still incredibly high.  It is hard to say that 1.3 million newly unemployed people are a good number.  It is not.  Worse, it is high compared to the progress being made on the continuing claims front.  The number of people receiving unemployment checks dropped sharply last week.  However, the level was only half that the number that filed for unemployment.  It will be hard to sustain the solid declines in the unemployment rate and the strong job gains if that gap continues.  Since it takes time to go from claimant to recipient, the continuing claims numbers lag the new claims data, so don’t be surprised if the recent improvement slows.     

IMPLICATIONS:   Yes, the labor market is indeed getting better, but with states slowing and/or reversing their reopenings, the data could be nothing more than yesterday’s news.  I would be surprised if we don’t see new claims start to rise over the next few weeks.  More and more firms are warning of impending layoffs and that means many other firms are either ramping up more slowly or simply not filling open positions.  We have entered a period of rising uncertainty about the state of the recovery and companies are not stupid: Facing an inability to forecast future demand, the best thing to do is hire cautiously, if at all, or allow payrolls to decline organically.  Today’s data were good, but the see-no-evil markets need to look past those numbers and start asking the right question, which is: Where do we go from here?  Since the approaches to dealing with the virus are being made without central government guidance, the randomness of the approaches and the political undercurrents in which they are being made raise real concerns about their effectiveness.  Given the massive resurgence in the virus, it is hard to conclude otherwise.    

Economic Indicators

June NonManufacturing Activity and Employment Trends

KEY DATA:  ISM (NonMan.): +11.7 points; Orders: +19.7; Employment: +11.3 points/ ETI: +3.8 points

IN A NUTSHELL:  “Economic activity is coming back, but the jobs situation may not be as rosy as the employment report suggested.”

WHAT IT MEANS:  The reopening is picking up steam and spreading across many sectors of the economy (the impacts, if any, of the surge in the virus are not in most of the current data).  The latest report to show a huge gain was the Institute for Supply Management’s June Nonmanufacturing Index.   Orders surged, backlogs finally began to build again and overall activity skyrocketed.  But let’s remember, this is another diffusion index and that means we are getting direction not magnitude.  Still, in this case, up is always better than down.  But the employment index showed how changes in the indices could be misleading.  The measure jumped in June but is still showing that firms are cutting their workforces fairly sharply.  A quarter of the firms laid off workers while only sixteen percent added to their payrolls.  That is not good news for future employment reports.

Indeed, the Conference Board’s Employment Trends Index, while rising, remained extremely depressed in June.  The level was still down over fifty-five percent from the February reading.  The report included this warning, which I agree with: “In response to (the virus) resurgence, many governments have delayed or reversed their re-opening plans, which could lead to lower hiring. Given the possibility of less recruiting and the fact that layoff rates remain high (emphasis added), the upward trend in the number of jobs may not continue. The unemployment rate may plateau or even increase in the coming months.”

IMPLICATIONS:  Things are looking up when it comes to overall economic activity.  That is not surprising given that we really didn’t start reopening the economy until early to mid-May.  Investors are eating up every one of these good economic numbers, even if they don’t necessarily say the economy is in good shape.  Actually, none of them say that.  But they point to better times ahead.  The only thing that could slow that progress is a resurgence in the virus.  Oh, right, that is actually occurring.  So, how are the markets reacting?  Virus? What virus?  Investors are running around, hugging each other and partying, all without masks.  Will that lead to a further market sickness?  Only if you believe markets are rational.  The recent Congressional Budget Office update on the economy forecasted that GDP would not return to the fourth quarter 2019 level until spring 2022.  That is in line with what I suggested three months ago.  It will not get back to maximum sustainable GDP, which is the trend level of full employment activity, for nearly a decade.  At the end of 2019, the economy was running above that level.  As for the unemployment rate, the CBO expects it will not fall below 6% until the very end of 2024.  It was 3.5% in February.  In other words, for a lot of workers, happy days will not be here again for a very long time.  There are significant challenges ahead, even abstracting any additional virus-induced problems.

Uncategorized

June Private Sector Jobs, Manufacturing Activity and Layoffs and May Construction Spending

KEY DATA:  ADP: +2.37 million/ ISM (Manufacturing): +9.5 points; Orders: +24.6 points/ Layoffs: 170,219/ Construction: -2.1%; Private: -3.3%

IN A NUTSHELL:  “Tomorrow’s employment report should be good, though there are some real questions about the May one that creates confusion about how strong it will be.”

WHAT IT MEANS:  Our first reading of the pace that the reopenings are bringing back jobs comes tomorrow when BLS releases the June employment report.  Today, the employment services firm ADP released its estimate of June private sector payroll changes and it was pretty much as expected.  Large gains were recorded across all sizes of firms, while most industries added to their workforces.  The only weak areas were information services, mining and management companies.  But the confusion about tomorrow comes from ADP’s May numbers, which showed that the job losses, not gains, were even greater than expected.  In essence, they doubled-down on their estimate that the economy did not add jobs, as BLS reported, but actually lost over three million workers.  As I noted last month, the ADP and BLS numbers sometimes vary greatly, but it is not normal that they have a different sign.  Thus, it is unclear if the government’s May numbers will be revised significantly and if that is the case, what that means for the June data.  So, stay tuned.

In line with so many other reports, the Institute for Supply Management’s Manufacturing activity index popped in June.  Orders and production surged, which hardly was a surprise.  But also consistent with previous reports, employment and backlogs continued to decline, though at a slower pace.  That does not bode well for employment or production. 

Disappointingly, construction spending continued to decline in May.  The government did its part in trying to get the economy going, but private sector housing and most components of nonresidential construction were off. 

Layoffs continue at a huge pace, but at least the number of announced cutbacks slowed in June.  Challenger, Gray and Christmas reported that June’s number was down 57% from the May total.  Still, the second quarter total was twice as large as the previous record that occurred during the dot.com crash in 2001. 

IMPLICATIONS: Tomorrow is a big day as we get both the employment report and the unemployment claims data.  It looks like we could have another multi-million job gain, though who knows what the revisions to May will look like.  Regardless of what comes out, the claims numbers cannot be an afterthought.  They indicate the extent to which companies and governments continue to shed workers.  We need to get those number down dramatically as it is clear the reopening is not going as planned – or at least as planned by the early-openers.  That has forced the more cautious governors and mayors to slow the process down.  By the way, how come no one is talking about how the hot weather will slow the spread of the virus?  The sharpest increases in cases have largely been in the hot weather states of Florida, Texas, Arizona, and California.  But with investors, bad news on the virus front is viewed as good news and anything that points to some progress on the vaccine front is considered to be fantastic news.  As one investment advisor mentioned to me, the strategy is simple: Invest.  With the Fed backstopping the markets, that worked quite well in the second quarter. 

Uncategorized

May Spending and Income and June Consumer Sentiment

KEY DATA:  Consumption: +8.2%; Disposable Income: -4.9%; Prices: +0.1%; Over-Year: +0.5%; Ex-Food and Energy: +0.1%; Over-Year: +1%/ Sentiment: +5.8 points

IN A NUTSHELL:  “Households are spending again, but there is still a long way to go to get back to where we were.”

WHAT IT MEANS:  We are starting to see the impact of the economy reopening and the early signs are positive.  Consumption soared in May, led by a huge rise in durable goods i.e., vehicle sales.  Still, spending was up sharply in every category, a clear indication that people are ready and willing to keep spending more.  They have a long way to get back to where they were.  The number to compare is February spending and the May level is still off by over eleven percent.  In addition, the prospects for spending are somewhat cloudy.  It is all up to the federal government.  Disposable personal income fell sharply, but that was expected and that highlights the issue facing the economy.  Income gains and losses are being driven by massive changes in government social benefit payments.  They skyrocketed in April as the unemployment rolls soared.  As people are rehired, those income transfers will decline.  To put this in perspective, in April, government payments rose by $3 trillion, offsetting the $700 billion decline in wages and salaries.  In May, government benefits dropped by $1.1 trillion, but wages and salaries increased only $233 billion.  It is the government that is keeping spending going, not the private sector and that exposes the economy to the whims of Congress and the administration.  With incomes falling, the savings rate declined, but the 23.2% rate is still enormous.  As for inflation, prices stopped falling, but they are hardly rising. 

With the economy reopening, you would expect confidence to surge.  It is rising, but not once again, at a somewhat disappointing pace.  The University of Michigan’s Consumer Sentiment index was up solidly in June, but the level is still up only about ten percent from its April low, while it remains nearly twenty-three percent below the February high.  We are looking at 2014 numbers.  Both current conditions and expectations increased a similar amount.  One troubling element in the report was the final index being lower than the mid-month level.  The virus looks like it was the reason for that downturn.  The gains in the South and West, where the virus is surging, were significantly lower than in those areas where progress against the virus continues to be made. 

IMPLICATIONS:  The economy faces a dual threat: The resurgence of the virus and the vagaries of politics.  While the states suffering major jumps in new cases have not pulled back, some have slowed the reopening process.  That could be enough to cause people to become less willing to go out and spend at stores and restaurants or return to high-density work locations.  It is clear that large-group gatherings are not going to happen for quite some time.  That raises questions about the ability to repopulate office building and as a consequence, the ability of those firms that depend upon those workers to survive.  The summer should have been a time of reviving hope, but the virus operates on its own timetable.  And then there is Congress and the administration.  From the income numbers, it is clear that the major force in keeping things from falling apart is the enhanced unemployment compensation and to a lesser extent, the PPP.  Like it or not, the extra $600 per week is pumping massive amounts of money into the economy.  It is currently slated to end July 31st.   The PPP is not going to grow.  Put that together and the prospects are that without action, income could crater in August and spending will follow.  Consequently, something will have to get done, but the more the government is the income provider of last resort, the higher the budget deficit and the greater the issues will be on the other side.  The Committee for a Responsible Federal Budget forecasts this year’s deficit at $3.7 trillion using just current law, not any expected additional assistance.  Don’t be surprised if the deficit is well north of $4 trillion.  That is incomprehensible, but no one is giving it even a first thought. It is nice to look at the monthly data and think everything is beautiful and happy days are here again.  While the focus of attention must be on keeping the economy going, we also have to start thinking about what the economy may look like when we get through this.  That is what will ultimately determine the direction of the markets in the medium term.  Right now, few seem to be doing that.  

Uncategorized

Weekly Jobless Claims, May Durable Goods Orders, Revised First Quarter GDP

KEY DATA:  Claims: 1.48 million (-60,000); Continuing Claims: 19.52 million (-767,000)/ Orders: +15.8%; Ex-Transportation: +4.0%; Capital Spending: +2.3%/ GDP: 5% (Unchanged)

IN A NUTSHELL:  “The labor market is getting better at a disappointingly slow pace.”

WHAT IT MEANS:  The economy is reopening and people are being called back to work, but the improvement in the labor market remains a lot slower than expected.  Yes, new claims for unemployment insurance fell again, but the level remains near 1.5 million.  That is simply way too high.  The rate of decline largely flattened out in June, which is not a good sign given the acceleration in the reopenings.  The number of people receiving checks slipped below twenty million, but barely.  The decline over the week was reasonably high, but given the huge number of people receiving assistance, it was not as large as we should be seeing. 

Durable goods orders surged in May, but that came after two months of massive declines.  The number to compare is February’s and orders are still off 21% from that month’s level.  The biggest increase came in transportation.  The vehicle industry reopened and aircraft orders actually rose rather than declined due to cancellations.  Every major sector posted a gain, but given the previous declines, the increases were nothing to write home about.   Nondefense, nonaircraft orders, a proxy for capital spending, did improve solidly, but again, compared to February’s level, they are still off 5.6%.  In addition, order books were largely flat, not a good sign for future production.

First quarter GDP growth was unrevised from the previous estimate.  There were some changes in inventories, government spending and fixed investment, but the differences were nothing special.

IMPLICATIONS:I guess the best way to describe the unemployment numbers is disappointing.  The economy is reopening across the country yet layoffs remain at an unimaginably high pace.  If BLS finally figures out how to correctly categorize the unemployment data, it is possible that the unemployment rate will rise in June from the underestimated May level.  The number to compare is about 16.3%, though we cannot be sure since the misclassification adjustment was only estimated.  My rough estimate for the June unemployment rate is 15%.  That would be down from the number to compare but up from the 13.3% which was published.   The problem is that cut backs in companies and governments are offsetting some of the rehirings.  It looks like we will have about six million layoffs in June.  That means the reopening/expanding firms will have to hire back more than six million just to get back to even.  That is a tall order and it means June job gains will likely disappoint.  With the virus starting to run rampant in some early-opening states, it is becoming clear that the recovery will take longer than those who have the V-shaped economic growth pattern expect.  And many of those who believe in the exuberant growth theory are investors. 

Economic Indicators

May New Home Sales and June Philadelphia Fed NonManufacturing Index

KEY DATA:  Sales: +16.6%; Over-Year: +12.7%; Prices (Over-Year): +1.6%/ Phila. Fed (NonMan.): -3.6 (up 65 points); Business Activity: 7.3 (up 48.7 points)

IN A NUTSHELL:  “The leading light, housing, remains on a clear upward track.”

WHAT IT MEANS:  Yesterday, when the May existing home sales numbers came out lower than expected, I explained that the data were lagging in that they were closings of contracts signed in previous months.  I suggested we wait a few months to see how recent activity changes conditions.  Well, if the new housing sales numbers are any indication of the current state of the housing market, it looks like things are quite good.  Purchases, or at least contract signings, jumped in May with three of the four regions showing demand growth anywhere from 15% to 45%.  The only negative was in the Midwest, where sales fell.  It is unclear why demand was weak there, but it is also not unusual that one area differs from the others.  Still, there was one concern in the report: Inventory is extremely low and that could restrain sales, unless construction picks up.  As for prices, they rose, but only modestly.     

NonManufacturing activity picked up in the MidAtlantic area.  The Philadelphia Fed’s Index went from a record low to a nearly flat condition.  But remember, this is a diffusion index and it only shows direction, not magnitude of change.  Indeed, the negative index points to continued weakness in the economy, though the business index did show some gains.  That said, this was not a great report.  Orders are still falling sharply, order books are thinning and payrolls for both full-time and part-time workers continue to be cut.  Those details point out that changes in diffusion indices have to interpreted very carefully.    

IMPLICATIONS:  At least housing is in good shape.  With mortgage rates incredibly low and the Fed making sure there is plenty of money to go around (and around and around), as long as the virus doesn’t get totally out of hand, this sector should continue to do well.  For the next few months, as the reopenings continue, the darkest cloud is the virus surge in those parts of the country that didn’t have major problems early in the pandemic.  The virus sets its own conditions and even if areas don’t return to shut down status, a high level of cases would restrain a wide range of activities.  We still haven’t had a massive return of workers to downtown areas and high rises, especially in the hardest hit areas.  That could take months and it is unclear what will happen when they do return.  All those support businesses that depend upon office workers for their income are going to be stressed for a long time.  That means governments that depend upon tax revenues generated by those activities will continue to see shortfalls in income.  For example, the latest data from the City of Philadelphia has May tax revenues down 31.2% from the May 2019 level.  But investors see nothing but blue skies ahead and exuberance is hard to restrain.  In other words, equity prices are delinked from economics and the potential for earnings, and when that happens, forecasting the direction of the markets becomes even more difficult than forecasting the weather more than a few hours out. 

Linking the Economic Environment to Your Business Strategy