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TrendTracker Update - August 2017

By Art Raymond

Dawdling Along

The economy continues to under-perform while Washington plays politics. In July, the U.S. economy posted a record 82nd consecutive month of creating jobs. That’s almost three years longer than the second-best stretch during the period 1986 to 1990. The 209,000 jobs added in July by employers, lowered the headline unemployment rate to 4.3 percent. That’s a 16-year low.

The good news for workers is the continuation of real wage increases. Over the 12 months ending in July, average hourly earnings have grown by 2.5 percent to $26.36. That’s solidly above the 0.3 percent inflation rate.

The brighter side of the July jobs report is also supported by Gallup’s U.S. Job Creation Index, which returned to its all-time high. In July, 47 percent of workers polled said their employers were hiring. That’s the highest rate since the survey was created in January 2008.

The June JOLTS Report, with 6.2 million job openings compared to only 5.4 million hires, substantiates the high labor demand noted in the Gallup report. Experts expect job openings to decline to 5.6 million in the near term, as employers struggle to find qualified workers. The larger the gap between hires and openings, the tighter the labor market, and higher the risk of wage inflation.

The latest Employment Situation Report was not all positive. Many of the new jobs were in sectors that pay relatively low wages such as health care, up 39,000 jobs, and food service, up 53,000. Also the number of persons working part time and who prefer full-time jobs remained unchanged at 5.3 million. That left the total unemployment rate, known as U6, at 8.6 percent of the civilian work force.

Gross Domestic Product
The last TrendTracker Update expressed concern about the inability of the economy to grow beyond the 2.1 percent annual rate experienced since mid-2009. GDP for 1Q2017 came in at an annualized growth rate of only 0.7 percent. In 2Q2017, GDP expanded by 2.6 percent, a nice rebound but not so hot compared to the 1960s and 1990s. Growth in the 10-year period of the 1990s averaged 3.6 percent and 4.9 percent during the 9-year span in the 1960s.

Many economists believe the performance of the economy is locked in low-speed cruise control. Inflation ran at an annual rate of 0.9 percent, well below the Fed’s target of 2 percent. Companies are reporting strong profits. Global economies are also contributing to our health through purchases of U.S.-made goods. And importantly, the consumer has kicked in with that sector’s spending rising 2.8 percent in 2Q, versus 1.9 percent in the prior quarter.

The consumer accounts for about two-thirds of our economy. Surveys indicate that Americans continue to view economic conditions positively in spite of the low growth rate. One such measure, the Gallup U.S. Economic Confidence Index, is a composite of answers to two questions: (i) what is your current view of the economy and (ii) is it improving or not. The resulting index for the week ending August 6 averaged a score of +7, the highest since mid-April, and the ninth consecutive month that respondents rated the economy more positively than negatively.

Some economists point to slow labor productivity growth as the primary factor in our poor GDP growth. Over the last year, that important metric rose by only 1.2 percent. That performance equaled the average growth rate since 2007, but remains stubbornly below the average of 2.1 percent since World War II. Everyone agrees that continuing at the recent rate will eventually translate into a lower standard of living for all Americans.

Last June, the ISM Manufacturing Index turned in its second-best performance since 2011 at 57.8. But July’s score of 56.3 remained solidly in positive territory. Remember that a score above 50 indicates growth in this sector. Important components of the index – new orders, export orders, and production – were strong.

As a result of this strength, manufacturers added 12,000 new jobs in June, and 16,000 in July. Getting these new hires productive is a critical issue. As noted above, labor costs are increasing at an annual rate of 2.5 percent while output per hour is unchanged. That combination eventually results in higher unit labor costs that ultimately squeeze profitability, or force higher prices.

The important residential construction sector has been up and down in 2017. Housing Starts in January came in at an annualized rate of 1.246 million. After a modest increase in February, that measure has steadily fallen to 1.092 million in May, a 12 percent decline from January. Thankfully, June starts rose 11.3 percent to 1.215 million, but not before leaving a negative impact on 2Q GDP.

June’s 7.4 percent jump in permits foretells continuation of the June bounce-back. Remember that monthly housing starts data can be volatile. Consequently you should watch the 5-month moving average line shown on the Econoday chart above for signs of a trend.

New Home Sales hit an annualized rate of 610,000 in June. The poor 2Q performance of this metric, which averaged 597,000 units sold monthly, hurt this sector’s contribution to 2Q GDP.

Boosting June sales were lower prices, down 4.2 percent for the median-priced house at $310,800. Supply of new homes for sale rose to 272,000 units, thus creating a 5.4 months inventory, a level considered tight by housing economists.

Existing Home Sales fell 1.8 percent in June to an annualized rate of 5.520 million. This sector has seen a year-on-year increase of only 0.7 percent. One reason: the median selling price is up 6.5 percent over a year ago at $263,800. The low inventory of only 4.3 months of supply is a primary contributor to high prices and slow sales.

Importantly, high prices are keeping first-time buyers out of the market. This group now accounts for only 32 percent of sales, versus 35 percent in 2016. Sales to first-time buyers enable sellers to move up market, and thus are critical to activity across the price spectrum.

Low supply, combined with high prices are resulting in quick sales. The median home sold in only 27 days in May, the shortest time in the six years this metric has been recorded.

Remodeling Market
With the combination of high prices and low inventories of homes for sale, people are remaining in their current homes. The same number of homes are for sale as in 1994, but the population is 63 million larger. And incomes have not kept pace. The result is a remodeling boom. According to Harvard University’s Joint Center for Housing Studies, Americans will pile a record $316 billion into home remodeling in 2017, versus $296 billion last year.

According to home renovation web site Houzz, about 60 percent of baby boomers are planning to remain in their current homes for the next five years. Another 20 percent is undecided. With the average home price increasing about 5.6 percent annually, it’s an easy decision to invest in renovations in lieu of relocating. At the other end of the age spectrum, millennials are buying smaller homes, many of which were built in the 1970s and badly need renovation and expansion. Adding to the problem is the growing practice of tearing down small 1970s homes and replacing them with much larger, million dollar plus houses.

This trend has no doubt limited new home construction. Housing starts in 2017 remains a quarter million plus below the annualized 1.5 to 1.6 million that many experts consider long-term market equilibrium. With remodeling a weaker economic driver than new construction, the residential housing market has lost some of its historic positive impact on the U.S. economy.

Breaking the 2 Percent Impasse
So, the headline unemployment rate has reached a 16-year low. But one has to wonder: how long can the economy continue to create sufficient employment opportunities when GDP remains just above 2 percent?

Yes, confidence is solid. Wages are rising; factories are humming; and consumer spending has perked up. The important housing sector, however, is lagging behind population growth in spite of low interest rates. First-time home buyers are staying out of the market due to high prices for starter homes. The rebound in remodeling can only partially fill the vacuum in new home construction.

GDP growth depends on an adequate supply of productive labor that enables expansion of the economy’s capacity to produce goods and services. The supply of manpower as measured by potential labor hours is driven by demographics. Since World War II, we have experienced three surges in potential hours: the entries of returning war veterans, baby boomers, and women to the work force. Since the early 1980s the number of potential hours has declined. With the U.S. fertility rate at an all-time low, reversal of that trend will require 20 years or so. A more liberal immigration policy could fill the population gap more quickly than a higher birth rate, if such a decision were palatable to the voting public.

To boost GDP, our labor resource must be properly educated and equipped to create goods and services efficiently. Those conditions require creation of innovative tools, effective capital investment, and training programs targeted on the right skills. Underlying those prerequisites must be government tax, regulatory, and research policies that support, rather than hinder, the efforts of the private sector. We are all in this predicament together.

Bottom Line: Pointing to the long lead time required to effect the needed pro-growth policies, many experts believe achieving 3 percent-plus GDP growth is impossible. But a program to fire up the economy is yet to be created, and the policies that can stimulate innovation, encourage capital investment, and train the work force are not on government’s agenda. Instead, the all-important engine that improves our lives remains broken. And our elected officials play petty politics, while leaving the tough issues unresolved.

It’s past time for you, the voter, to take charge of the asylum. We cannot continue to wait for creative solutions to our economic malaise. Let your representatives know your disappointment. Remember, just because you do not take an interest in politics doesn’t mean politics won’t take an interest in you …