New Economic Data Paint a Picture of a World Emerging from Its Slumber--But It's a Cold Spring
Q2 US Gross Domestic Product Shows Continuing Recovery
As we've written here before, the primary factors that govern the performance of investment portfolios are growth, inflation and regime stability. While many different data points combine like a Seurat painting to describe the picture we see as growth, the primary indicator is Gross Domestic Product (GDP) growth. It is a measure compiled by the US Bureau of Economic Analysis, and it measures
[t]he value of the goods and services produced in the United States[...]. The percentage that GDP grew (or shrank) from one period to another is an important way for Americans to gauge how their economy is doing. The United States' GDP is also watched around the world as an economic barometer.
Coming in at 6.5%, the advance estimate of this value for the second quarter of 2021 was slightly higher than that recorded for the first quarter, 6.3%.
Now, if these were normal times, there would be dancing in the streets: average postwar productivity growth has been about 2%, and falling over the last several decades. However, market estimates given the depth of the slump from which the economy is emerging had forecast 8.5%. This two point difference surely came as a surprise on the downside.
Looking more closely at the data, it is clear that American consumers are doing their part to support economic expansion, and are generally in the best financial shape in years. They spent a lot on services, which makes sense in that restrictions to control the spread of the COVID-19 virus prevented them from doing so for about a year. They also bought a lot of stuff that is likely to last less than two years. It was largely businesses that reduced spending, as Total Inventories, Durable Goods Orders, Shipments and New Orders came in lower than forecast. This is reflective of the supply chain disruptions that we've discussed here before, as many of the countries through which parts and intermediate and finished goods transit are still suffering from low vaccination rates and high positivity rates. All in all, it was a number that showed that Americans are continuing to give the reins to the animal spirits that govern consumption, and are not yet dissuaded from consumption by the rise in COVID-19 positivity rates.
Consumer Sentiment Remains Strong
Consumer Sentiment, another important leading indicator of growth, showed that consumers feel pretty good about the economy and their prospects within it. The University of Michigan Surveys of Consumers didn't show the retrenchment that many in the financial media had feared, though the measures fell from June to July. The Index of Consumer Sentiment (-5%), Current Economic Conditions (-4.6%), and the Index of Consumer Expectations (-5.4%) were all modestly lower for the month of July, but were 12%, 2.1% and 19.9% higher year-over-year. While concerns about inflation are increasing, they have yet to dampen consumer attitudes toward the economy substantially.
Employment Gains Are Faltering
Last week we saw initial claims for unemployment benefits fall to 400,000 from 424,000 the prior week, a 5.6% improvement. While this means that fewer people lost their jobs this week than last, consensus estimates were for a drop to 380,000, so the rate at which the labor market was recovering has declined. This was also evident in today's ADP National Employment Report, which saw a change in US nonfarm private sector employment of 330,000. Although employers added jobs, the number of jobs added was less than half of consensus forecasts. It's unclear what the underlying cause is for the sudden drop in new jobs, and some in the financial rags are worried about declining economic growth. We think it's too early to say, but our opinion isn't so much that employers are reluctant to hire--all accounts seem to indicate that jobs are plentiful--but rather that employees are reluctant to take these new jobs. We see this in the wage increases that employers are finding necessary to offer to entice workers to accept open positions. When additional unemployment benefits expire this fall, we expect job growth to resume. More jobs data arrive on Thursday and Friday, so we will look to see this labor market deceleration continue.
PMI Measures Sit Atop Record Heights
Markit's Manufacturing Purchasing Managers' Index (PMI), a measure of manufacturing health in the US, showed that industrial companies continue to enjoy robust demand, although input prices and supply chain disruptions remain a concern. At 63.4, a record high, the index has showed accelerated expansion (a reading above 50) since November 2020. Similarly, the Institute for Supply Management's PMI confirmed this high level of activity, and an expansion that has continued for the past 14 months. We would expect that the US manufacturing sector should continue to outperform as long as the emerging economies to which manufacturing has migrated over the past twenty years continue to struggle with matters of public health. It turns out that infrastructure is more than just roads and bridges. At the same time, low raw materials inventories, low business inventories, longer shipping times, and hiring difficulties will throw sand in the gears for the foreseeable future.
As with the Manufacturing, Services PMI readings continue to strengthen, up 4% over the prior month, increasing in rate of growth, and expanding for the past 14 months. There the story is the same: increased costs, increased delays, increased worker shortages--leading to increased prices.
The Housing Market Takes a Breath
Rising housing prices may finally have given buyers pause. Pending Home Sales declined by 2% from May to June, while the Case-Schiller Home Price Index rose a considerable 18% in May, year-over-year. As housing stock remains too small to accommodate all buyers, we expect the Case-Schiller measure to continue to climb, especially as borrowing costs decline along with the US 10 Year rate. Cheaper financing -> more borrowing -> higher home prices. Thirty year mortgage applications declined by 1.7% nonetheless, despite the MBA 30-Year Mortgage Rate falling to an incredible 2.97%.
As in our last post on growth, we continue to see leading indicators provide conflicting signals as to the strength and direction of the market. We believe that the narrative of the two economies--one of white collar, work-from-home service workers, and the other of blue collar, work-on-site workers--continues to hold. The economy never really stopped for the former, while the latter experienced a catastrophic and life-altering disruption in work. It is folly to think that this dislocation can simply be bridged by the backfill of a couple of months of robust demand. Growth in the US should continue to be strong, but constrained by supply of labor, raw materials and parts, and logistics.
We'll check in with an update on growth in the rest of the world in our next post, as well as get a pulse on the general price level.