By Robert Hughes
The recovery from the historic plunge in economic activity resulting from the repressive lockdown policies implemented to slow the spread of Covid-19 has broadened significantly over the past month. However, ongoing restrictive policies, the inability to contain the spread of Covid-19, and shifts in consumer and business behaviors continue to challenge the nascent expansion.
AIER’s leading and coincident indexes rose sharply in September with the Leading Indicators index jumping to 67 and the Roughly Coincident Indicators index increasing to 33; the Lagging Indicators index, however, fell to zero. The sharp gain in the leading index suggests the recovery has broadened substantially and may signal the end of the recession (see chart).
Damage to the economy during the lockdowns has been massive. Gross domestic product plunged at a historic rate in the second quarter and more jobs were lost than at any other time in history. While the economy has begun to expand again and about half the jobs that were lost have been recovered, the pace of recovery appears to be slowing, suggesting a long time until complete recovery. Furthermore, there are a number of areas that continue to experience disruption, suggesting that while the recession may be over, the fallout is likely to continue.
AIER Leading Indicators index points to expansion
The AIER Leading Indicators index surged to a reading of 67 (on a scale of 0 to 100) in September, up from 21 in August, and the second-largest monthly increase on record. The September result is also the highest reading since November 2018.
Six leading indicators changed signals in September with all six turning to positive trends, five from a negative trend and one from a neutral trend. The real stock price indicator improved from a neutral trend to a positive trend based on data through August (the latest data available). However, nominal stock prices moved lower in September, suggesting this indicator could revert to a neutral trend if weakness continues.
The other five leading indicators to move to positive trends in September were housing permits, real new orders for nondefense capital goods excluding aircraft, real new orders for consumer goods, manufacturing and trade sales to inventories ratio, and average workweek in manufacturing. Housing has become one of the strongest areas of the economic recovery, supported by ultralow interest rates and a surge in demand for single-family housing as many consumers who were living in high-density urban areas decided to move to less dense suburbs (see more on housing below).
The four remaining leading indicators to turn to a positive trend were related to manufacturing. Unlike housing where many measures of activity have already returned or exceeded pre-pandemic levels, manufacturing activity remains mixed. A rebound off the lockdown lows has turned the AIER indicators to a positive trend but some measures of activity remain restrained (see more below).
The overall results among the 12 leading indicators show eight indicators in uptrends, four indicators still in downtrends, and none in neutral trends compared to two indicators in a positive trend, nine in negative trends and one neutral last month.
The Roughly Coincident Indicators index jumped to 33 in September following four consecutive months at the lower bound of zero. The last time the coincident indicators index spent multiple months at zero was in 2008-09 when the index spent a total of 11 consecutive months at the bottom. The index spent five months at zero in 1991 and four months there in 1981-82.
Two roughly coincident indicators changed signs in September: nonfarm payrolls and real manufacturing and trade sales both improved from negative trends to positive trends. The story for the labor market is similar to the manufacturing sector; while improvements off the lows that occurred during the worst of the lockdowns have turned the nonfarm payrolls indicator to a positive trend, the level of nonfarm payroll employment remains well below the pre-pandemic level (see more below).
Overall, two roughly coincident indicators had positive trends in September while four remained in negative trends and none were in neutral trends versus all six indicators trending unfavorably last month.
AIER’s Lagging Indicators index fell to 0 in September from 17 in August. Commercial and industrial loans fell from a positive trend last month to a negative trend in the most recent report. That change pushed all six indicators to unfavorable trends.
Overall, strong gains for both the Leading Indicators index and the Roughly Coincident Indicators index suggest that the end of the recession may have occurred or is imminent. However, the National Bureau of Economic Research is unlikely to declare an official end to the recession for some time as the risk of a double-dip recession is not insignificant. Some areas of the economy benefited from the initial push to reopen and posted sharp gains in recent months following massive drops in March and April. However, the latest data indicate that the rebounds may be starting to falter in some areas. Furthermore, with Covid-19 still out of control, restrictive policies still in place (and being reimplemented in some areas), and the potential for a rise in personal and business bankruptcies, the full fallout has likely not developed. The outlook for the economy remains highly uncertain and full recovery to pre-pandemic conditions is likely many quarters away.
Single-family housing recovery well underway
Housing activity – starts and permits – posted mixed results in August as declines in the multifamily segment offset gains in the single-family segment. Within the single-family area, there were gains in starts and permits with strength spread across most regions.
Total housing starts fell to a 1.416 million annual rate from a 1.492 million pace in July, a 5.1 percent decrease. The August decline followed three consecutive gains from an April low.
The dominant single-family segment, which accounts for about 70 percent of new home construction, rose 4.1 percent for the month to a rate of 1.021 million. Starts of multifamily structures with five or more units plunged 25.4 percent to 375,000. From a year ago, total starts are up 2.8 percent with single-family starts up 12.1 percent and multifamily starts down 16.9 percent.
For housing permits, total permits fell 0.9 percent to 1.47 million from 1.48 million in July. Total permits are 0.1 percent below the August 2019 level. Single-family permits were up 6.0 percent at 1.036 million, the highest rate since May 2007 while permits for two- to four-family units gained 17.8 percent and permits for five or more units decreased 17.4 percent to 381,000.
Permits for single-family structures are up 15.6 percent from a year ago while permits for two- to four-family structures are up 26.2 percent and permits for structures with five or more units are down 28.5 percent over the past year.
Sales of new single-family homes rose at the fastest pace since September 2006. Total sales rose 4.8 percent in August to a 1.011 million seasonally adjusted annual rate and are up an astonishing 43.2 percent from a year ago.
Total inventory of new single-family homes for sale declined 3.1 percent to 282,000 in August, the fifth decrease in a row, leaving the months’ supply (inventory times 12 divided by the annual selling rate) at 3.3 – a record low, down 8.3 percent from July’s 3.6 months, and 40.0 percent below the year-ago level.
Sales in the market for existing single-family homes rose 1.7 percent in August, coming in at a 5.37 million seasonally adjusted annual rate. From a year ago, sales are up 11.0 percent. The August pace is the highest since December 2006.
The existing single-family home segment saw inventory fall 2.3 percent to 1.27 million, pushing months’ supply to 2.8 from 3.0. Months’ supply for the existing single-family segment is also at a new record low.
Housing is one of the areas that may be experiencing structural change. If it is believed that higher density living represents a higher risk in future pandemics, then there may be sustained added demand for less dense suburban and rural housing, especially single-family dwellings. This trend could be boosted if businesses implement permanent work from home policies, to make employees happy but also to cut down on high-cost commercial real estate, especially in high-density, high-cost cities. Near-record-low interest rates are also a positive support for housing.
Labor market improvement is decelerating
U.S. nonfarm payrolls posted a fifth consecutive monthly gain in September, adding 661,000 jobs. However, the latest gain is the slowest so far in the recovery, and the five-month total gain of 11.42 million is far from offsetting the 22.2 million loss in March and April.
Private payrolls added a more impressive 877,000 jobs in September but was also the slowest of the recovery and brings the five-month total gain to 11.39 million versus a loss of 21.2 million in March and April. Total and private payrolls remain well below the February peaks.
The report suggests that the labor market recovery is continuing as restrictive government policies are lifted. However, the slowing pace of gain reinforces concerns that a sizable portion of the job losses may be very slow to return or may not return at all.
Within the 877,000 gain in private payrolls, private services added 784,000 while goods-producing industries gained 93,000. For private service-producing industries, the gains were led by a 318,000 increase in leisure and hospitality followed by retail with a gain of 142,000, and health care and social-assistance industries with a 108,000 increase. Within the 93,000 gain in goods-producing industries, durable-goods manufacturing increased by 46,000, construction added 26,000 jobs, nondurable-goods manufacturing rose by 20,000, and mining and logging industries added 1,000 jobs. Despite the gains over the last five months, every industry group had fewer employees in September than in February. The net losses range from a 0.8 percent drop in utilities workers to a devastating 23 percent plunge in leisure and hospitality.
The government sector cut 216,000 employees in September, with local government education payrolls dropping by 231,100, state government eliminating 49,400 education positions, and the federal government cutting 34,000 workers. Local government outside of education added 96,400 new employees.
The total number of officially unemployed fell to 12.58 million in September, a drop of 970,000 from August. The number of officially unemployed in February was just 5.8 million.
The unemployment rate fell to 7.9 percent from 8.4 percent in August while the participation rate ticked down to 61.4 percent from 61.7 percent. The participation rate was at a cycle high of 63.4 percent in January 2020 and fell to a low of 60.2 in April during the lockdowns.
The underemployed rate, referred to as the U-6 rate, fell from 14.2 percent in August to 12.8 in September; the peak was 22.8 percent in April.
The September jobs report supports the view that as government restrictions are lifted, payrolls are likely to rise. However, without a credible understanding of Covid-19 and with a flood of incorrect and misleading information drowning society, consumers may be reluctant to return to pre-pandemic behaviors. In addition, with enduring restrictions and heightened uncertainty surrounding government policies, businesses may be reluctant to return to previous levels of employment and investment. The longer these conditions continue, the more likely businesses are to shrink or close permanently.
New orders for durable goods posted a fourth consecutive month of rebound in August, rising 0.4 percent following a gain of 11.7 percent in July, 7.7 percent in June, and 15.0 percent in May. The gains followed drops of 18.3 percent in April and 16.7 percent in March. Durable-goods orders excluding aircraft and parts fell 0.8 percent for the month following gains of 8.3 percent in July and 15.8 percent in June. That puts the level of orders at $231.3 billion, within the $225 to $235 billion range they have been in since mid-2018.
New orders for nondefense capital goods excluding aircraft, a proxy for business equipment investment, rose 1.8 percent in August after gaining 2.5 percent in July, putting the level at $67.7 billion. This important category had been in the peak $65 to $70 billion range for several periods over the past 15 years before dropping to $61.3 billion in April 2020. The $61.3 billion pace was the slowest since August 2017.
Industrial production rose 0.4 percent in August following a jump of 3.5 percent in July, a surge of 6.1 percent in June and a gain of 1.0 percent in May. However, the four consecutive months of gains were not enough to overcome the back-to-back declines of 4.4 percent and 12.9 percent in March and April, respectively. Over the past year, industrial production is down 7.7 percent and 7.2 percent below the pre-pandemic level in February.
Manufacturing output, which accounts for about 75 percent of total industrial production, rose 1.0 percent after a gain of 3.9 in July, a record increase of 7.5 percent in June, and an increase of 3.9 percent in May. The four gains follow declines of 5.0 percent and 16.1 percent in March and April. The four consecutive gains still leave manufacturing output 6.9 percent below year-ago levels. With the manufacturing output index at 97.9 for August, output is 6.7 percent below the 2018-2019 average index level.
The gains in industrial production in August were generally widespread across nearly all major market and industry groups with two notable exceptions: energy and motor-vehicle production. Energy production fell 1.3 percent for the month after gains of 2.8 percent in July and 3.0 percent in June. From a year ago, energy production is down 10.9 percent.
Motor-vehicle production, one of the hardest hit industries during the lockdowns, fell 3.7 percent in August after gains of 113.9 percent in May, 119.5 percent in June and 31.7 percent in July. Motor-vehicle production had fallen by 80 percent in March and April.
High-tech industries output rose by 1.2 percent in August, the third monthly gain in a row and is up 4.9 percent versus a year ago. All other industries combined gained by a healthy 1.4 percent in August but are still 7.3 percent below August 2019. Compared to pre-pandemic levels, motor vehicles and high tech are above the December 2019 level while energy and the total production excluding energy, motor vehicles and high-tech index were still below.
Consumer and business balance sheets diverge
Despite the pandemic, restrictive government policies, and the worst economic contraction in history, household net worth rebounded in the second quarter to a new record. Household net worth rose to $118.955 trillion, up from $111.348 trillion in the first quarter and above the previous record of $118.576 trillion at the end of 2019.
The rebound was due to an increase in financial assets, led by a recovery in equities, and nonfinancial assets, led by a rise in real estate. Total assets rose to $135.4 trillion ($94.5 trillion of financial assets and $40.9 trillion of nonfinancial assets), a rise of 5.9 percent. On the liabilities side, total household liabilities were essentially unchanged at $16.5 trillion.
Two key measures suggest that household balance sheets are generally healthy. As of the second quarter, total household liabilities to assets were 12.2 percent, down from 12.9 percent at the end of the first quarter and near a four-decade low. Data for the second quarter also show the financial obligations ratio, household debt service plus other financial payments as a share of disposable income, was 13.6 percent, a record low back to 1980.
Nonfinancial corporate balance sheets appear far less healthy than households. Nonfinancial corporate liabilities have been rising rapidly over the past decade, generally posting annual increases in the five to ten percent range. As of the second quarter, nonfinancial corporate liabilities totaled $30.7 trillion, up from $28.9 trillion at the end of the first quarter and $28.5 trillion at the end of the second quarter 2019, a rise of 7.9 percent. Assets, meanwhile, posted a 4.1 percent gain from a year ago, totaling $46.5 trillion. Those results put the ratio of liabilities to assets at 66 percent, a new record high. While low rates make servicing debt easier, and Fed intervention in broader capital markets may ease some liquidity issues, high levels of nonfinancial corporate liabilities are a very dangerous condition given the state of the economy.
Of all the sectors in the domestic economy, the financial position of the federal government is the most troubling. Total public debt outstanding is up to 107.7 percent of gross domestic product as ongoing deficits run around $3 trillion.
Total debt across the entire economy rose to $59.3 trillion as of the second quarter. The increase was led by the federal government which saw a jump to $22.5 trillion from $19.6 trillion at the end of the first quarter, a rise of almost $3 trillion or about 15 percent. That follows a 2.8 percent gain in the first quarter. From a year ago, federal government debt is up 21.9 percent and since the end of 2015, debt has surged 48 percent. The federal government now accounts for 37.9 percent of all domestic debt outstanding, a record high.
Nonfinancial corporate debt is up 3.3 percent in the second quarter to $11 trillion following a 5.9 percent rise in the first quarter. From a year ago, nonfinancial corporate debt is up 11.1 percent.
Household debt was essentially unchanged at $16.1 trillion while financial sector debt fell to $17.3 trillion from $17.7 trillion at the end of the first quarter. Nonfinancial, noncorporate business, primarily small businesses such as partnerships and limited liability corporations, boosted debt by $245 billion to $6.6 trillion, a rise of 3.9 percent while state and local governments increased debt to $3.1 trillion. All government debt (federal plus state and local) accounts for 43.2 percent of domestic debt outstanding.
Managing debt has been a challenge for all sectors of the economy at different times in history. Inevitably, excessive debt creates instability and can drive or contribute to boom-bust cycles. Debt management across all sectors should be monitored carefully.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.