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Private sector jobs are up at a modest pace this year


June jobs numbers were somewhat disappointing. They are notoriously volatile, of course, so you can't read too much into one month's numbers. According to the establishment survey, the private sector created 83K jobs, but according to the household survey (which I think does a better job at picking up new jobs in the early stages of a recovery), 322K jobs were lost. Looking at the trend in both, using Dec. '09 as the low, the two surveys show a total of between 600K (establishment) and 1 million (household) jobs have been created in the private sector this year. The truth probably lies somewhere in between; jobs probably are up this year at an annualized pace of about 1.5%, and that's not very impressive. In good times, jobs rise 2-3% per year.

So this is a sub-par recovery so far (and that's old news), but it is a recovery and there are no signs in the data that I can see that suggest the economy is rolling over.

Car Sales up 14% from last year


Car sales in June were a bit weaker than expected, but they were nevertheless up 14% from year-ago levels. This series is notoriously volatile from month to month, so looking at the trend is the only way to make sense of it, and to me the trend is clearly up, and at a fairly rapid pace. That's not surprising given the depths to which sales fell—the rebound should be impressive. Nothing here to suggest the economy is "rolling over." I keep searching, but I can't find the signs that point to the double-dip recession that everyone seems to be expecting.

Economic illiteracy in Congress is simply frightening

Listen to Speaker Nancy Pelosi describe how sending out unemployment checks is the fastest way to create jobs, better than just about anything else. Let me hasten to add that there are plenty of Republicans that would flunk a test covering basic economic knowledge, but here we have one of the most powerful people in the world revealing an astonishing lack of economic knowledge and common sense. It is truly frightening and very disheartening.

In the decades that I have spent studying the interaction of public policy and economics in dozens of countries around the world, I have discovered time and again that most of the great economic tragedies can be traced back directly to misguided policies and an utter lack of understanding on the part of politicians of how businesses and economies actually work. The amount of pain, suffering, and economic losses incurred by hundreds of millions, if not billions of people around the world, due solely to the policy prescriptions of ignorant and arrogant politicians, is almost incalculable. And of course the depression of the 1930s is just one example, as related so well by Amity Shlaes in "The Forgotten Man." "FDR's Folly," by Jim Powell, is also excellent.

There are two solutions to this problem: only put people in power who really know how economies work (or who have advisors who do), or severely limit the ability of politicians to meddle with the economy. As a practical matter, the latter seems like the best choice. Or, as Rick Santelli put it the other day, "Just stop spending! Stop the spending!"

Speaker Pelosi: as noted in my previous post, the federal government has been sending out unemployment checks to almost 10 million people for the past year—an unprecedented number of checks—yet the unemployment rate has been stuck at a very high 10%. May I suggest that you have no idea what you are talking about?

The number receiving unemployment insurance is down 25%


This news has not received the attention it deserves. The number of persons receiving unemployment compensation insurance has dropped by 25% (2.8 million) since the high late last year, from 11.65 million to 8.82 million as of June 11th. According to the household survey of employment, we can surmise that 1.3 million of those no longer receiving compensation have found private sector jobs, while most of the remainder, for better or worse, have a stronger incentive to find a new job. I think the jobs situation continues to improve, albeit not by enough to result in a significant decline in the unemployment rate.

I'll be very interested to see the household survey tomorrow, since it has been registering a lot more jobs than the establishment survey, and that is typical in the early stages of a recovery. But whatever the numbers are, I suspect that they will be better than the market is expecting, since the market has had a very bearish bias towards everything of late.

Economic gloom and doom is good for homebuyers




30-yr fixed rate mortgages—whether for conforming loans or jumbos—have now fallen to their lowest levels ever. One of the main drivers of lower mortgage rates is the flattening of the yield curve (the 2-10 spread is down to 230 bps from a recent high of 290), that in turn is being driven mostly by declining bond yields. Lower bond yields are apparently the result of the market's recent conviction that a weakening economy will keep the Fed on hold for a very long time; the prospect of an extended period of very low short-term interest rates creates a very painful situation for anyone who has been betting on higher bond yields and a steeper yield curve because that trade has a significant cost of carry (i.e., the difference between short and long rates). So we have the perception of a weak economy to thank for giving us lower bond yields.

This presents a real opportunity for millions of homeowners to lock in some very attractive long-term financing. Not surprisingly, record-low mortgage rates have caused refinancing activity to surge, and refis are likely to be quite strong in coming weeks. (Even I am looking to refinance.) Locking in historically low rates of interest is surely a good thing, but it is also important to see that homeowners continue to respond to the incentive of price signals. Cheap mortgages coupled with the one-third drop in inflation-adjusted housing prices over the past several years (according to the Case-Shiller data) have made the average house a lot more affordable than it has been in decades. This is a powerful incentive for new buyers to bid for all of the foreclosed houses that are supposedly going to be dumped on the market over the course of the next year. I think it's premature to expect that there will be another big drop in prices, as so many seem to be predicting.

Weekly claims going nowhere


Weekly unemployment claims ticked up a bit in the recent week, but are essentially flat so far this year. I don't see anything here that would support an imminent double-dip recession, but neither do I see any impressive strength. I think these numbers are consistent with an economy that is recovering at a moderate rate.

Harpex shipping index looks very strong


In an attempt to give equal time to good news—there seems to be a bias towards the reporting of "bad" news these days—I show the latest version of the Harpex Shipping Index, which tracks the rates charged by container ships in the N. Atlantic. The very strong improvement in this index in recent months contrasts quite sharply with all the bad news coming out of Europe. On that score, I would note that Greek credit default swaps have dropped over 200 bps in the past week, the Euro is up about 5% from its early-June low, 2-yr Euro swap spreads have fallen 15 bps from their late-May high, and the DAX index of German equities has outperformed the S&P 500 by 13% since the end of April; those are some distinctly positive changes on the margin coming out of Europe that haven't received much publicity.

Construction appears to have stabilized


Residential construction spending has firmed somewhat over the past year, lending credence to the argument that the housing market has bottomed, but it is such a tiny (2.4%) part of the economy now that what happens there is almost irrelevant to the economy's growth outlook. Nonresidential construction, somewhat surprisingly, has firmed in recent months, but I don't see a reason for this strength to continue in any meaningful fashion. The best that can be said about construction at this juncture is that it is not collapsing.

The manufacturing sector continues to look strong


This market is determined to view the glass as half empty. This morning I saw headlines that said "factory growth weakens," followed by a story that says the "unexpected decline" in the ISM manufacturing index is a reason for the market's decline today. But as this chart shows, the index has merely dropped to a level that is somewhat less than spectacularly high. Based on past correlations, the index is now pointing to real GDP growth in the second quarter of about 5%, down from 6% a month ago. If Q2/10 GDP growth comes in anywhere near 5%, this market is going to be caught very short.


The same can be said for export orders. The June reading was a lot less strong than May, but May was one of the strongest levels recorded in decades; if things had continued at that pace the economy would have been on a moon shot. As it is, the June reading is unremarkable, and quite typical of what we see during recoveries. In fact, the June level of the index (56) is well above the average of the past 20 years (53.5), and is equal to the average of the index during the period June '03 through June '08, when real GDP growth averaged 2.7%.


Meanwhile, the employment index slipped only marginally, and remains at a level rarely exceeded at any time since the early 1970s.


Finally, the prices paid component of the ISM index registered a significant drop in June, but this is hardly bad news, and is most likely simply a reflection of the fact that energy prices have fallen of late (e.g., gasoline prices at the pump fell about 7% from mid-May through mid-June). In any case, a majority of those participating in the survey (57%) reported paying higher prices in June.

Overall, I would say the outlook for the manufacturing sector remains quite positive, and this strength is quite likely to "spill over" into strength for other sectors as well, thus bolstering the prospects for continued recovery.

Corporate layoffs remain very low


Announced corporate layoffs, as tabulated by the folks at Challenger, Gray & Christmas, remained at very low levels in June. No sign of the economy "rolling over" here. Indeed, the improvement in this series over the past year looks a lot better than it did in the year following the 2001 recession.

Fiscal and monetary policy are headwinds, not tailwinds


The yield on 2-yr Treasury Notes yesterday dropped to its lowest level ever. As this chart suggests, that means the market has never been so pessimistic about the economy's ability to grow. Short-term Treasury yields typically track the growth of nominal GDP, mainly because they present a risk-free alternative to having exposure to nominal GDP through investments in equities and/or corporate debt. That yields are under 1% for the first time ever suggests the market is expecting that an extended period of recessionary conditions and very low inflation are right around the corner. In other words, 2-yr. Treasury yields provide strong evidence that the economy is already priced to the double-dip recession that so many pundits seem to be calling for.

Let me explain. If nominal GDP is rising 5% a year, for example, then your baseline expectation for the growth rate of corporate cash flows should be something similar. After all, no business can have a cash flow growth rate which exceeds nominal GDP forever, because at some point that business would consume the entire economy. So it stands to reason that on average and over time, corporate cash flows, and profits, will tend to grow by a rate that is close to that of nominal GDP. You can capture that growth rate in your portfolio by holding equity exposure (in the hopes that growth will be positive and you will earn more than 2-yr Treasury yields), or by buying the 2-yr. Treasury if you're not sure and don't want to take any risk.

This chart is also instructive because it shows that yields tended to equal or exceed nominal GDP from the early 1980s through the early 2000s. That same period happened to be one in which inflation was generally falling and relatively low. It was also the same period during which the Fed almost always proclaimed that it was pursing a restrictive monetary policy (which involves pushing interest rates up relative to inflation so as to increase the demand for money). But beginning in 2002, the Fed began pursuing an overtly accommodative monetary policy, and this translated into yields generally being less than the growth of nominal GDP.

When 2-yr Treasury yields exceed the growth rate of nominal GDP, investors are naturally drawn to financial assets (e.g., cash, Treasuries), because they tend to outperform nominal GDP on a risk-adjusted basis. But when yields are less than nominal GDP, investors tend to prefer investments which are tied to the physical economy (e.g., commodities and real estate), since they tend to outperform the returns on financial assets. Corporate bonds and equities do especially well when money is tight and real yields are high, because in a tight money environment yields tend to fall and inflation stays low; falling yields make the return on equities look attractive, and so investors tend to bid up PE ratios; PE ratios tend to be highest when growth and inflation are lowest. Low inflation also tends to discourage investments in real assets (like real estate and commodities), and by doing so, low inflation discourages speculation and instead encourages investments in productive activities; low inflation thus tends to lead to stronger growth.

The fact that we've had easy money for most of the past 7-8 years helps explain why equities have performed poorly—with PE ratios declining of late—and corporate bond spreads are still historically wide. It also explains the strong performance of commodity prices, and—until a few years ago—the strong performance of real estate.

I have said this many times before and I'll say it again: the two most significant headwinds facing the economy today (and for the past year) are faux-stimulative fiscal policy and excessively "easy" monetary policy. (This of course flies directly in the face of the common perception that the economy has only managed to recover thanks to stimulative fiscal and monetary policy.) The huge expansion of government regulations and spending under the Obama administration, the fact that most of the spending took the form of transfer payments, and most of the tax cuts were temporary rebates, coupled with the Fed's $1 trillion injection of bank reserves via the purchase of MBS, have done almost nothing to increase hard work and risk taking, while greatly increasing investors' uncertainty regarding the future. How high will taxes have to rise to restore some semblance of sanity to the budget? How can spending be throttled back without creating even more pain and suffering? How high or low might inflation be in the future?

The great economist Allan Meltzer has an excellent op-ed in today's WSJ titled "Why Obamanomics Has Failed." Read it, since it adds a lot more substance to my sparse remarks on fiscal policy here.

It's important to note that these headwinds have been with us for some time, and they help explain why the economy has experienced a sub-par recovery to date. Business investment is improving on the margin, but as I have pointed out before, investment is severely lagging the rise in corporate profits, and a lack of confidence in the future surely helps explain why.

Does this mean we are doomed? No. It's always dangerous to extrapolate recent trends into the future, and that is especially the case today. There is a sea-change underway in the public's willingness to tolerate larger and more intrusive government, and this will very likely result in some huge changes to policy in the wake of the November elections.

Meanwhile, as the chart above suggests, the economy is moving in a positive direction, and the fears of a double-dip recession which have brought the equity market down may well prove to be unfounded. Holding cash or short-term Treasuries because one expects the economy to collapse may prove to be a very expensive hedge, not least because yields on risk-free investments are very close to zero, while yields on alternative investments (equities, corporate bonds, etc.) are historically high.

No signs of acute distress in the bond market



The equity market may be awash in expectations of a double-dip recession, but the bond market is saying there are few if any signs of acute distress. Those two conditions (recession in the absence of acute distress) are not mutually exclusive, but they are rarely found together in the wild.

The evidence for the lack of acute distress can be found in these charts. The TED spread (top chart) is a little elevated, but not unusually so. In fact, at today's 36 bps it is actually lower than its 20-year average of 49 bps. (The TED spread is a good measure of the degree of fear, uncertainty and doubt which inhabits the interbank lending market, and it tends to rise when the market worries about problems that may lead to bank failures.) 3-mo. T-bill yields are the world's standard for risk-free investing, and the fact that yields recently have risen to their highest level in almost one year is a sign that investors' risk aversion has declined somewhat.

I can only speculate as to why all this should be happening, but at the very least it is reassuring to note these developments at a time when the equity market seems to have fallen prey to the predations of the bears. I would venture to say that the end of the world as we know it is NOT the most likely outcome.

Corporate borrowing costs unchanged for five years


This chart shows the average yield on BAA corporate bonds over the past 5 years. The latest datapoint is 6.15% (as of June 28th), which is almost the lowest reading on the chart. Corporate bond yields spiked during the recession, when fear of massive corporate defaults was intense and it was difficult if not impossible for just about anyone to obtain credit. Spreads (the difference between corporate and Treasury yields) are about 100 bps wider today than they were in the tranquil 2005-2006 period, mainly because Treasury yields have collapsed. Borrowing costs for the typical large corporation have not risen at all in five years, but the widening of spreads indicates that expected default rates are much higher. It's not that there is a shortage of money in the system today, it's that fears of losses are still running fairly high. The market seems more preoccupied by fear than by reality.

Commercial real estate has taken a huge hit


One more chart to put the home price development in a broader context. This chart compares residential home prices to commercial property prices. Residential prices have fallen about 30% from their peak, while commercial property prices have fallen 40%. Those are serious, significant declines that reflect a huge amount of price adjustment, easily enough to absorb excess inventory. Both charts suggest that we may have found a new equilibrium price. Market participants still fret, however, that this is not the case. Everyone seems to be worried right now that asset prices are poised to decline to new lows, and that this will mark the start of a new depression. I don't believe it. I see too many signs of ongoing improvement: strong commodity prices, rising retail sales, rising incomes, strong manufacturing reports, rising rail shipments, rising container exports, etc.

The June decline in confidence is nothing to worry about


Can the June decline in this measure of consumer confidence (from 62.6 to 52.9) really be the cause of today's stock market plunge? I doubt it—it's more likely investors getting cold feet after seeing China's stock market fall to new lows. As this chart shows, confidence is a volatile thing and only takes on significance when a trend is apparent. If there's any trend in place over the past year, it is upward, so to me that says the June datapoint was just one of those random blips. And in any event, it's natural for consumers to be concerned and confused in the early stages of a recovery, especially this one, since the recession was unusually harrowing. Once burned, twice shy, as the saying goes.

Housing prices have been stable for over a year



The top chart shows real housing prices (deflated by the PCE deflator) based on the Case Shiller composite of prices in 20 large metropolitan markets. The second, which has a longer history, shows a composite of the 10 largest markets. Both send the same message: in inflation-adjusted terms, home prices have been stable for over a year, after a shocking plunge that lasted three long years.

Have prices achieved a new equilibrium? It looks that way to me. Take the second chart, for example. That shows that on average, home prices have increased about 1.5% per year in real terms over the past 23 years. That's consistent with other measures of home prices I've looked at, and could easily be a reflection of the gradually improving amenities and size of the average home over time. Consider also that real incomes have risen about 3% a year over this same period, so in terms of affordability, home prices are cheaper today than they were 23 years ago, not to mention the fact that financing costs are far lower than they were in the 1980s.

Yet the drumbeat of the pessimists has seemingly never been louder.

Credit spreads are still high, but not scary


Here's an up-to-date version of my chart showing 5-year credit default swap spreads on investment grade and high yield bonds, which in turn is a good proxy for generic credit risk in the bond market. Spreads widened in early May on the back of surging fears of a Greek default, but they have since settled back down. High-yield spreads are about 75 bps lower today than they were at the peak of the Greek crisis earlier this month. If I take this chart in the context of swap spreads that are now back down to a "normal" level (2-yr swaps today are 36 bps, after reaching a high of 64 bps on May 25th), I don't see any reason to believe that economic and/or financial fundamentals have deteriorated, much less that a double-dip recession looms large. The current level of credit spreads reflects the continuation of distress, to be sure, but spreads are not even remotely at a level which would suggest another recession.

Inflation is still within the Fed's target range


This index of inflation, the Personal Consumption Deflator, is arguably the best index of inflation from the individual's point of view. It also happens to be the Fed's preferred measure of inflation. Fed governors must be feeling pretty good that despite all the gyrations of the economy and Fed policy over recent years, both versions of this index (headline and ex-food and energy) are within the Fed's target zone of 1-2%.

I must admit that for about the past year I have been expecting inflation to move higher, and so far I have been dead wrong on this. I keep thinking that the Fed's huge addition of reserves to the banking system, coupled with the general weakness of the dollar, the strength in gold prices, the strength in commodity prices, and the steepness of the yield curve, all point to rising inflation, and it is just a matter of time before this occurs. But so far, those who believe that inflation is impossible when the economy is operating well below its full employment level have been right.

This is the kind of error I don't feel too bad about making, since higher inflation tends to have a very corrosive impact on the economy.

Chicago Fed Activity Index still strong


This is the 3-month moving average of the Chicago Fed's National Activity Index. With so many double-dippers out there, I thought it important to highlight an otherwise-obscure index such as this to show that there is very little, if any, data on which to base a recession call. Indeed, as of April this index "suggests that growth in national economic activity was above its historical trend."

HT: Calculated Risk, where you can find a long-term chart of the series as well as more detailed commentary.

Paragliding in Torrey Pines


Saturday I took a nice break from the routine and went down to Torrey Pines (just north of La Jolla in San Diego County) to try paragliding for the first time ever. It was a very nice present from my brother Dick, and one of the highlights of my life. This is a picture of me sitting in front of an experienced pilot. The views were breathtaking, and I won't even try to describe it. I'm told that the Torrey Pines gliderport is one of the best—and safest—places in the world to do this sort of thing, and I don't doubt it for a second.