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TrendTracker Update - May 2017

By Art Raymond

A Full Employment Economy?

As measured by Gallup’s Economic Confidence Index, America’s faith in the economy turned positive following the November 2016 elections and has remained in plus territory for the ensuing six months. That’s the longest streak in six years and indicates that more Americans are optimistic about the economy, than are pessimistic.

As evidenced by the weak gross domestic product and consumer spending numbers, that confidence has not translated into real economic activity. GDP for Q1 came in at an annualized growth rate of only 0.7 percent. More troubling was the 0.3 percent annualized growth in consumer spending, which accounts for 70 percent of the U.S. economy. That performance was its worst since 4Q2009.

In March, the Retail Sales component fell by 0.2 percent, led by slower vehicle sales which continued a three quarter losing streak, down 1.2 percent. Other weakness was experienced in furniture store, gasoline station, restaurant, and building material sales.

Over the past eight years, GDP has averaged only 1.0 percent in Q1 versus a 2.3 percent rate during the last three quarters. Some economists blame the Department of Commerce for the inaccurate seasonal adjustments. On that basis, many are optimistic for a Q2 improvement. However no one is arguing that the weak consumer spending data were incorrect.

Looking at the bright side, not all of the GDP components were weak in Q1. Residential investment jumped 13.7 percent – the second consecutive quarter for this important sector. Non-residential investment in buildings and equipment followed suit, with a gain of 9.4 percent.

With some measures up and others down, economists are wondering whether the economy is falling, stalling or growing. In any case, for a look at the direction of consumer spending in Q2, review the April Retail Sales report of May 12.

Sidebar: Longer-Term Implications of Low Growth
Simply stated, continuation of the last eight years of 2 percent GDP growth risks national bankruptcy. In recent history we’ve done much better. Between 1974 and 2001, GDP growth averaged 3.3 percent. The latest forecast from the Congressional Budget Office predicts that annual growth will average only 1.9 percent for the next 30 years. The predicted increase in federal spending to 28 percent of GDP, and the resulting rise in interest expense will drive our national debt to 150 percent of GDP over the next 30 years. As The Wall Street Journal said, “That is Greek territory…If weak growth persists, there is almost no combination of plausible spending cuts and tax increases that will get Washington anywhere near a balanced budget.”

Factoring in a 3 percent annual growth results in a brighter picture. By 2040, the economy would grow by $8.4 trillion to $38.3 trillion; by 2047, to $47.1 trillion. New tax revenues of $2.5 trillion would cover costs of government plus unfunded liabilities like Social Security. More importantly, the debt-to-GDP ratio would drop to 50 percent and thus reduce government’s need for debt re-financing. Ensuring that the economy grows faster than government spending is the answer.

Getting there will require a pro-growth agenda in Washington. Reduction in corporate tax rates, accelerated depreciation to encourage more investment, repatriation of the $2.5 trillion U.S. companies that have parked overseas, among other enlightened policies, would fuel a surge in new investment. And don’t forget policies that impact the individual taxpayer. Lower marginal tax rates proved their ability to fire up growth, during the 1980s and 90s.

Simply put, building a consensus on how to grow the economy faster than 2 percent is mandatory. The clock is running…

On the brighter side, a strong job market in April reversed March’s weakness by creating 211,000 jobs, and caused the headline unemployment rate (U-3) to fall to 4.4 percent. That’s the lowest number since May 2007, just prior to the last recession. Over the last 12 months, U-3 has fallen by 0.6 percentage points, and the number of unemployed has declined by 854,000. That’s a lot of paychecks being cashed and spent.

As a result, the pool of available workers fell to 12.8 million from 13 million, and the number of long-term unemployed persons stabilized at 1.6 million. The labor force participation rate of 62.9 percent has changed little over the past 12 months. The employment-population ratio also remained stable at 60.2 percent, but lower by 0.5 percentage points since December. The number of persons employed part time, but preferring full-time work, has fallen by 698,000. U-6, the total unemployment rate that counts those part-timers, has dropped to 8.6 percent from 9.3 percent a year ago. All these metrics point to a tight labor market and what economists call full employment. The Federal Reserve views 4.7 to 5 percent as sustainable over the long run in their meditations over interest rates.

With the reduced availability of workers in April, the average workweek rose by 0.1 hour to 34.4 hours for all workers, and by 0.1 hours to 40.7 hours for manufacturing workers. Average hourly earnings for all employees climbed by $.07 to $26.19. Over the year, the average hourly wage rate rose by $0.65, a 2.5 percent increase.

The trend in Jobless Claims continues down as shown on the graphic, below. Initial claims the week of April 29 saw a decline of 19,000, leaving 238,000 on the unemployed roles.

Gallup’s Job Creation Index read +36 in April, down slightly from the record all-time high of +37 in March. This metric utilizes random sampling of thousands of U.S. workers to provide an accurate assessment of their employer’s hiring activity. Companies are seeking more workers.

Overall, the employment situation is strong. The April Employment Situation report hopefully foretells an improved GDP and stronger consumer spending in Q2. Watch for the May report on June 2 for the latest news on the job market.

While the ISM Manufacturing Index fell by 2.4 points to 54.8 in April after seven months of beating expectations, many key components of this metric remain healthy: rising new orders, backlog, and export orders. Delays in delivery times and rising inventories are most likely the result of bottlenecks caused by higher demand. Remember, a score above 50 indicates a growing U.S. manufacturing economy.

One continuing concern of manufacturers and other businesses is poor productivity. In Q1, labor productivity across all businesses declined at a 0.6 percent annual rate, as output rose by 1.0 percent and hours worked climbed by 1.6 percent. For the last four quarters, productivity increased by only 1.1 percent.

In the manufacturing sector, Q1 productivity improved by 0.4 percent as output rose by 2.8 percent, but hours worked increased by 2.4 percent. For the last four quarters, productivity increased only 0.3 percent.

When the cost of hours worked increases by more than the value of output, productivity declines. The result is higher unit labor cost. In the manufacturing sector, unit labor costs rose by 4.3 percent over the four quarters since 1Q2016.

From 1950 to 1970, productivity in the U.S. averaged 2.6 percent growth annually. Over the next two decades, the average fell to 1.5 percent. Since 2010, annual productivity growth has leveled out at 0.6 percent.

Some economists contend that productivity data is difficult to capture and thus simply wrong. Others blame lower productivity on the dearth of transformative innovation and investment in labor-saving equipment. Indeed, the compound annual growth rate of non-residential investment plummeted from 12 percent to 3.3 percent since 1970.

The same call for pro-growth policies aimed at faster growth of GDP applies to the productivity challenge. Our standard of living depends on strong labor efficiency.

Housing Starts joined consumer spending on the negative side of the ledger by falling 6.8 percent in March. This weakness was equally shared by the single family and multi-family categories. As seen on the adjacent graphic, the trend remains upward and to the right. Over the last 12 months, the annualized rate of starts has increased by 9.2 percent.

New Home Sales in March rose by 4.9 percent to an annualized rate of 621,000, which with the exception of last July’s number, is the best performance of the recovery. Pricing was strong with the median price of a new home at $315,000. The supply of new homes on the market increased by 3,000 to 268,000 units, a 5.2 month inventory. The increase in mortgage rates shown in the graphic has not adversely impacted sales.

Existing Home Sales jumped 4.4 percent in March to an annualized rate of 5.71 million, the best since February 2007. Prices rose by 3.6 percent for the month, to a median of $236,400. Over the past 12 months, the median price climbed 6.8 percent. The inventory of homes for sale is tight at only 3.8 months. The average days on the market fell to 34 from 45 in February, and 47 a year ago.

At long last, the housing sector is showing signs of its importance to our economy. Total spending on housing averaged 19 percent of GDP over the past 60 years. In 2016, that number fell to 15.6 percent. New home construction and remodeling declined to 3.6 percent last year, only half its 2005 performance. Returning to the long-term average would add $300 billion to the economy.

In the 4Q2016 the homeownership rate was 63.7 percent, down from a high of 69.2 percent during the last boom. Economists claim that a sustainable level is 65 percent.

Household formation is a significant driver of home purchases and rentals. In 1Q2017, for the first time since 3Q2006, the number of new homeowners surpassed the number of new renters. Important keys to a vibrant market for homes are first-time buyers, and the availability of starter homes, both new and existing. First-time buyers made up 32 percent of the market in March, up from 30 percent a year ago. Builders are now putting up more starter homes in response.

Bottom Line: Along with the solid manufacturing and housing performances, the employment situation is an economic bright spot. Measures of employment are lagging economic indicators, those that perform best late in a recovery. Businesses typically delay hiring new workers until the capacity and capabilities of their current work force are maxed out. The current 4.4 percent unemployment rate and labor force participation rate of 62.9 percent evidence the scarcity of workers. At the end of the recession in 2009, over 15 million workers could not find employment. Today, that number is just over 7.1 million. Most of the best employees are already working. Finding qualified people is difficult.

This recovery is now 94 months old, well past the 59-month average since 1945. Without the implementation of pro-growth policies, the best outcome in the short term is a continuation of 2 percent GDP growth, and a slow decline in our standard of living as productivity fails to improve.

In the meantime, expect the tighter job market to drive wage rates higher, and workers to become more willing to change jobs. Your objective should be to offset higher labor costs with improved productivity. Be prepared to invest in labor-saving equipment. Focus on improving your processes. And remember that America has always survived and prospered.