The dismal May jobs report on Friday sparked a stock market selloff based partly on concerns that the US could be facing a double-dip recession. The US data don’t in themselves warrant such fears. The real risk of a US recession comes from the deepening European crisis.
The May Payroll Data
The May nonfarm payroll increase of just 69,000 was below expectations of 150,000. It was unquestionably weak.
Other data components of the release were also weak. The average workweek dropped 0.1 hours to 34.4. If businesses are cutting back on hours, they aren’t about to hire a lot more people.
Hourly earnings rose just 0.1% for the second straight month. Wages rose at barely a 1% annual rate over April and May and are up just 1.7% from a year ago. That rate of wage growth isn’t keeping up with inflation and consumer spending power is therefore constrained.
There is a lot to be disappointed with in these data. The data don’t, however, suggest that a recession is imminent.
Here are the changes in nonfarm payrolls the past six months.
Payroll growth has slowed significantly the past three months. The percent change, however, is still near a 1% annual growth rate and hasn’t gone negative – yet.
Furthermore, the current trend of about 1% growth in payrolls the past three months is very much consistent with 2% real GDP growth or even more. That is because productivity gains typically boost real GDP at a faster pace than the rate of increase of the number of people employed.
A drop in stock prices was warranted given the weak data, but the data don’t indicate an imminent US recession.
Real GDP has averaged growth at a 1.9% annual rate since mid-2010. That trend is likely to continue.
Below are the recent annualized growth rates of the major components of real GDP.
|Q4 2010||Q1 2011||Q2 2011||Q3 2011||Q4 2011||Q1 2012|
The trends in the components do not signal an imminent recession. A quick comment on each category is presented below.
Consumer spending has been a major factor supporting real GDP growth. As noted above, wage growth isn’t going to boost spending, but there is at least some employment growth. That helps. Also, as the recent growth in consumer credit outstanding indicates, consumers are willing to take on a more debt given low interest rates. Consumer spending isn’t tanking. There is no sign here of an imminent recession.
Business investment can be a huge swing factor in GDP. In some previous recoveries, a sharp rise in investment has not only boosted GDP, but prompted a virtuous cycle that leads to more hiring and more consumer spending. Investment trends are mildly encouraging but are likely to be restrained by concerns over Europe. Nevertheless, with strong cash flow business investment is likely to continue higher. There is no sign here of an imminent recession.
The recent mini-boom in residential investment is intriguing. It has hardly been noticed, but housing starts have actually picked up recently, and from extremely low levels any gain has a disproportionate impact. (This category also includes home improvements.) The continued weakness in home sales and home prices has obscured the recent uptrend. Residential investment is so minimal now anyway that, even if it were to decline, it isn’t going to cause a recession.
Government spending, which includes state and local as well as federal spending, has been a drag on the economy for several years. It isn’t going to trend significantly higher, but state finances have improved and further declines will be limited. The trend won’t get any worse and thus won’t cause a recession.
Net exports have not been a major factor on GDP as the trade balance has leveled off in recent years. Exports have grown, but so have imports, and the net impact on GDP has been just +0.4% annualized.
Bottom Line GDP Forecasts
Our macro-economic model, based on the trends in the current data, suggest that real GDP growth will continue much as it has in recent quarters.
The trend of 1.9% annual growth since mid-2010 is likely to continue through the end of 2012.
The internal churnings of the US economy are steady, and there are not imbalances that would normally raise any concerns about an imminent recession. Even the slowdown in payrolls would only be a restraint on growth, not a growth killer.
The Real Problem
There are legitimate concerns that the US could enter a double-dip recession.
This could occur if overseas economies weaken significantly or cause an exogenous shock to the US economy.
Economic trends in China are not clear. A great deal of market emphasis has been placed on a private survey of purchasing managers. It has recently dropped below 50, suggesting that the manufacturing sector in China is contracting. Perhaps. But it is only a private survey and the market is overreacting to this one data series.
China economic growth is slowing, and that is a concern, but conditions have not clearly deteriorated to the extent that concerns about a US recession are warranted.
That brings us back, once again, to Europe.
The European Union is teetering on the edge of recession. Continued growth in the German economy has so far kept total growth positive.
The impact of a moderate decline in European GDP, however, wouldn’t impact US GDP sufficiently to cause a US recession. It could take off a couple of tenths of US real GDP growth, but the US isn’t sufficiently dependent on exports such that a decline would produce a large mathematical impact.
The real risk remains the dire credit and fiscal conditions in Europe.
There are fears that Europe is headed for a death spiral of a credit implosion involving bank runs, rising Italian and Spanish bond yields, worsening government fiscal imbalances, and countries leaving the euro.
That is a list of tangible problems and legitimate concerns, but the risks are almost impossible to quantify. This has created an understandable environment of “sell first, and ask questions later.”
Until there is a resolution of how Europe is going to address its banking problems, there is a real risk of contagion that impacts US banks.
Even drastic action such as European-wide bank rescues and deposit guarantees, however, won’t solve the severe fiscal problems that most European countries face. And the idea that their fiscal problems will be solved if governments simply switch from “austerity” to “growth” policies is absurd.
Italy, Greece, France, Spain, and many other countries need long-term reform of their social programs (retirement and health) to address the severe demographic problems they face in the years ahead.
The banking and government fiscal problems in Europe underlie the anxiety that caused the severity of the stock market sell-off on Friday, not the weakness in the employment release.
What It All Means
US economic growth trends, apart from global economic concerns, would be more than adequate to make stocks a strong “buy” given their very high relative value under normal conditions.
The May employment data Friday would have been nothing more than a minor disappointment on top of an otherwise modest growth trend. US stocks in the S&P 500 index sport an impressive 8.5% year-ahead earnings yield (a P/E of 11.8). The indicated year-ahead dividend yield on the S&P 500 is 2.22%, well above the meager 1.5% on the 10-year Treasury note. There is tremendous value.
If, that is, the European situation is managed sufficiently so as not to cause a credit shock that undermines US banks, the US economy, and US profits.
At this time, it is not clear that will be the case. Unfortunately, the outlook for US stocks now depends less on the US internal fundamentals and more on Europe's political developments.
Founder and Chairman, Briefing.com