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The consumer remains the engine of the American economy.
By Douglas A. McIntyre, 24/7 Wall St.
When Gallup asked people about the state of the economy this spring, as a recovery appeared to have taken hold, the polling company found “nearly half of Americans, 46 percent, still say the economy is in either a recession or a depression.” Only 40 percent said they thought a recovery was underway.
By the strictest measurements of economic data, economists said the Great Recession had ended. For a very large number of Main Street Americans, that opinion means nothing.
The public dialog about the economy has gone from “how strong will the recovery be?” to “why are we slipping back into a recession?” In a period as short as the past three months, economists have revised rosy forecasts that called for sharp increases in gross domestic product in the last quarter of 2012 and the entire year 2013 to worse predictions -- some of which now project there will be no economic growth in the United States at all over the next year. Some experts even believe that the so-called fiscal cliff at the end of the year could cause an economic catastrophe.
The tenor of the debate has turned negative for a fairly small number of reasons, but each has an overwhelming effect on the national economy. Most of Europe has fallen into recession. The European Union is the largest region by GDP. Consequently, American exporters rely on the region for revenue. The American employment market, which seemed so promising at the turn of the year when job improvement was 200,000 a month, turned to a market in which nearly no jobs are added at all. The hope of a housing recovery has dissolved as foreclosures rise. Consumer sentiment has reached lows not recorded in over a year.
The economy is similar to the way it was 18 months ago. Americans have returned to searching for signs of a recovery. The reasons for optimism are the same now as they were in late 2010. They rely on the ability of the economy to create jobs, which builds consumer confidence and leads to consumer spending. And consumer spending is still over two-thirds of U.S. GDP.
24/7 Wall St. examined the major factors that have traditionally driven American economic growth. Home sales cannot recover without jobs. Taxes can dictate what consumers are willing to spend. American companies that do well overseas are more likely to add new workers.
These are the 10 signs the recession is over.
1. GDP Improves
U.S. GDP starts to rise at 2.5 percent annual rate. The International Monetary Fund recently revised its forecast for U.S. GDP growth to 2.3 percent, down from its previous forecast of 2.5 percent in April. In addition, the agency projects that the gridlock in Washington, which could cause an increase in 2012 tax rates and automatic budget cuts, would cause GDP growth to fall below 1 percent next year.
In its World Economic Outlook Update, the IMF economists write: "In the extreme, if policymakers fail to reach consensus on extending some temporary tax cuts and reversing deep automatic spending cuts, the U.S. structural fiscal deficit could decline by more than 4 percentage points of GDP in 2013. U.S. growth would then stall next year, with significant spillovers to the rest of the world.” Other agencies, including the well-regarded OECD, have made similar comments.
Until most forecasts predict a solid growth of U.S. GDP at 2.5 percent or higher per annum, the economy will not hit an escape velocity that would enable it to increase employment, nor give a foundation to business and consumer spending, which in turn will increase tax receipts and erode the deficit.
2. Job Creation
Job creation hits 250,000 per month. Bureau of Labor Statistics data show that the U.S. economy added only 80,000 jobs in June, which was about on par with April and May. The news was a letdown. Jobs added had been above 200,000 a month in December 2011 and January and February of 2012. That spurred hopes that a recovery from the Great Recession had finally begun in earnest.
If job additions do not reach above 250,000 a month for an extended period, it will indicate that employers are not sanguine enough about the economy to risk new expenses. In addition, it will show that whatever modest stimulus the federal government may put in place after the election has been ineffective. With the erosion in the work force of the public sector due to austerity measures, additions in the private sector will need to be closer to 300,000 a month. Job creation figures are as important as any other set of information to signal a recovery.
3. Housing Market Stabilizes
National housing prices and foreclosures stabilize. There have been some positive signs about the future of the housing market recently. The Commerce Department announced that new home construction starts rose 6.9 percent in June to an annual pace of 760,000 -- better than any month since October 2008. The news was undermined a little by figures that showed permits dropped 3.7 percent to an annual rate of 755,000.
Although different housing measures have been described as mixed recently, they have actually been mostly negative. The carefully followed Case-Shiller Index showed that April prices were off in most of the top 20 markets year-over-year, with the average drop at 1.9 percent. On the basis of the same measurement, several cities had declines of 3 percent or more. Foreclosures remain high and may move higher. RealtyTrac reported that foreclosures rose for the first time since 2009 year-over-year during the second quarter of 2012. Just recently, The National Association of Realtors reported that sales of previously occupied homes fell 5.4 percent in June to a seasonally adjusted annual rate of 4.37 million homes. The number was the worst it had been since October.
The start of a housing recovery likely will signal several positive changes. One is that unemployment has started to fall and the pool of buyers has risen. Another is that the number of underwater mortgages has begun to drop, which means more people will have home equity for essential needs such as retirement. The housing market has caused such damage to the economy that an overall rebound in home prices should improve the national mood.
4. EU Recession
Recession ends in Italy, France and the United Kingdom. The European Union is the world’s largest economy by GDP. At $17.5 trillion, it is about $2.5 trillion larger than the U.S. The region is an essential export market for U.S. goods and services. A number of American multinationals have already posted second-quarter earnings that were hurt by EU sales. General Motors and Ford have announced that they expect losses in the hundreds of millions of dollars to be posted for the second quarter, partly due to weakness in the region. IBM recently announced a drop in sales in the region.
Some of the nations in the union have at least held their own. Germany’s unemployment rate has been stable around 5.6 percent. Recent figures from the U.K. put its unemployment rate at 8.1 percent -- similar to the U.S. But in Spain and Greece, the unemployment rates are well above 20 percent. In Portugal and Ireland, the number is about 15 percent. The weakest economies in the EU will not recover for years. But the large economies by GDP -- Germany, France, the U.K. and Italy -- will need sustained economic growth to drive demand of U.S. products and services. That will give a lift to revenue of American exporters, which in turn should create jobs.
5. China GDP Improves
China's GDP growth moves above 9 percent. China remains the factory for a huge portion of the world’s goods. It is also a major consumer of commodities. A slowdown in the Chinese economy is a signal that demand for both business and consumer products in the EU, U.S. and Japan is faltering. Chinese GDP growth rate was 10.4 percent in 2010, much closer to its traditional growth. The number dropped to just above 9 percent in 2011. But in the second quarter it dropped to a very modest 7.6 percent, signalling China is in trouble. That was the slowest growth since the first quarter of 2009 -- at the end of the Great Recession.
One way China contributes to global economic growth is with its rising middle class, which has become a relatively new set of consumers of imports from the U.S. Any decline in that appetite hits many American exporters. Another way China contributes to economic expansion is through its production activity. China remains the single best barometer of manufactured goods in the world. But China’s Purchasing Managers Index, a measure of factory activity, is unchanged or even contracting in recent months. When the People’s Republic government reports that PMI has moved sharply higher, and that translates into GDP growth of 10 percent or better, it will be another sign that an impressive global recovery is underway.
6. Tax Rate Stays Put
Current tax rate for individuals and businesses remains constant in 2013. The single biggest worry than many economist have about U.S. growth is the “fiscal cliff.” The “cliff” is a combination of government spending cuts and an increase in tax rates that would go into effect at the end of 2013. Federal Reserve Chairman Ben Bernanke recently warned Congress that the events would be deadly to the American economy.
The so-called Bush tax cuts were meant as an economic stimulus, and they remain so in the minds of some experts. Recently, Senator Tim Johnson said, “If Congress doesn’t act, middle class families will see their taxes go up by $2,200 on Jan. 1. Working families in these tough economic times should have the certainty of knowing their taxes won’t go up in six months.” Johnson’s sentiments are echoed by most Democrats. It is logical that lower taxes increase the chances of consumer and business spending, even though they may temporarily increase the deficit due to a drop in receipts to the Treasury. However, an extension of low taxes would prevent a drag on the economy and probably would boost consumer spending -- which is still two-thirds of GDP.
7. Retail Sales
Consistency of higher retail sales. Once again, the consumer is still the engine of the American economy. There are few better measures of consumer activity than retail sales. Yet, retail sales dropped three months in a row though June, mirroring to some extent the weakness in the job market. In June, sales declined by 0.5 percent compared to May. The trouble was widespread and included furniture, appliances and building materials. Most alarming, there was weakness in car sales, which have been one of the bright spots in the U.S. economy for over a year.
Retail sales should be getting a boost from lower interest rates, which are supposed to stimulate consumer borrowing, but that has not been the case. To augment the data on a national level, several of the largest chains turned in lackluster monthly sales. Macy’s missed expectations, and so did Costco. In the national pharmacy store segment, same-store sales at Walgreen were down sharply. The litmus test for retail spending will be the holiday shopping season, which now runs, based on industry measures, from the first of November through the end of December. Worry about tax hikes and jobs will damage revenue in a period during which many retailers make all of their annual profits. If holiday sales are good, one of the key components of the economy has begun to recover. If not, it may be until sometime in 2013, hopefully, when retail activity demonstrates a turn in the American economy.
8. Consumer Confidence
Consumer confidence rises sharply. The two primary measures of consumer confidence are from the Conference Board and the University of Michigan. According to an announcement on June 26, the “Conference Board Consumer Confidence Index", which had declined in May, fell further in June. The Index now stands at 62.0 (1985=100), down from 64.4 in May.” The other major measure -- The Thomson Reuters/University of Michigan index of consumer sentiment dropped to 72 this month from June’s 73.2 reading. That figure was the lowest so far in 2012.
Obviously, consumer confidence is tied to employment growth, retail sales and worries about taxes. They create a web of economic trends. A telling contrast to recent data is the reading from late 2006. Back then, when both GDP and home prices were rising, the University of Michigan index was near 100. The index would need to move back toward the high 80s or 90 for there to be a clear signal of a strong economic recovery
9. S&P Jumps
S&P quarterly earnings increase year-over-year on average. The AP recently reported: “Stock analysts expect earnings for companies in the Standard & Poor's 500 index to decline 1 percent for April through June compared with the year before, according to S&P Capital IQ, the research arm of S&P. That would break a streak of 10 quarters of gains that started in the final quarter of 2009.” But much of the recent gains came from cost cuts, including jobs. With companies worried about their sales, they tried to boost earnings through such measures.
Another reason for those gains was an actual recovery, especially when compared to depressed earnings levels in 2008 and 2009 caused by the financial wreckage of the recession. Revenue at many large companies, from banks to auto manufacturers, fell so fast during those two years that cost cuts could not keep up. Many large companies have now stripped their expenses down to the bone. Capital expenditures that could be delayed have been postponed. Layoffs have driven up productivity per employee. With capital expenditure and labor costs now so low, it will require substantial revenue improvements at most public corporations to push earnings higher.
The corporations most analysts will watch for a turnaround will be the largest in each industry, hoping to see a rebound in sales. Apple will be an exception, since its sales have been recession proof. A much better indication will come from improvement at General Motors, Microsoft, Citigroup, General Electric Walmart, Pfizer and AT&T. A broad rise in sales and earnings will be a sure indication that the economy has started to improve across multiple sectors.
10. Low Interest Rates
Fed announces it will shorten target period for low interest rates. Low interest rates have been at the core of the Federal Reserve’s efforts to revive the economy. The central bank has bought bonds through programs with names like QE2. But a promise to keep short-term rates near zero through 2014 is as close as the Fed can come to a blanket assurance that it will do nothing to undermine a recovery.
When the Fed first made this pledge early this year, Bernanke said, “It’s important for us to say what we think and it’s important for us to provide the right amount of stimulus to help the economy recover from its currently underutilized condition.” What more can the agency do beyond offering money at such extraordinary rates? Yet, some Fed governors believe that low rates through 2014 could cause inflation. A sudden snap back in the economy coupled with cheap capital could cause a bubble in assets like housing and stocks. Should the Fed believe there is such a risk, it would likely raise rates before 2014 to keep the U.S. economy from overheating and prevent asset inflation. Nothing would better signal that the central bank believes that an expansion is well under way.
