Housing, Confidence & Richmond Fed
Over the last few days I have been discussing a variety of different data points as they have been released concerning the current state of economic growth. What is most concerning is the disconnect between the mainstream economist's, and analyst's, optimistic outlook which continues to diverge from the underlying data trends. (See here, here and here) The most recent releases of consumer confidence, non-seasonally adjusted housing data, and the Richmond Fed index provide further support of an economy that is continuing to "struggle through" rather than one that is gaining momentum to achieve "escape velocity."
The backbone of the economy is the consumer. Just a tad more than 70% of the GDP calculation is derived from personal consumption. Therefore, the confidence of the consumer is key to long term, organic, economic growth. Unfortunately, while consumer confidence has indeed improved since the depths of the last recession it remains at levels more often associated with recessions, rather than expansions, as shown in the chart below.
This is not surprising, of course, given that wages have remained relatively stagnant while the cost of living has continued to increase over the past several years. While the Fed's interventions have certainly created a "wealth effect" for the upper class - it is the burgeoning middle and lower class who benefit very little from a rising stock market. It is those individuals whose confidence continues to suffer from the effects of weak economic underbelly.
Consumer confidence is primarily driven by employment. Those that have jobs are going to feel more confident about spending money than those that are unemployed. With "real" unemployment remaining uncomfortably high the gap between those having difficulty finding work and those seeing jobs being plentiful remains at levels more normally associated with recessionary periods in the economy - not 5 years into a recovery.
The lack of confidence from the consumer is the real testament to the current state of the economic recovery. For most it still feels, looks and tastes like a recession - and they are acting accordingly. Frugality at home continues as the recent increases in payroll taxes, and spiking gasoline prices, consume more of the family paycheck. Such a situation doesn't bode well for increased confidence in the months ahead as the fiscal noose tightens further.
Housing Recovery Hype Ahead Of Fundamentals
The most recent release of new home sales sent the markets aflutter with excitement. The data showed that new home sales in January surged, from an upwardly revised 378,000 new homes sold in December, to 437,000 homes in January. That is all certainly very positive news. However, just viewing a single data point doesn't tell us much about the strength of the overall recovery. Therefore, we need to analyze the data within the context of its overall trends. The first chart below shows the "Total Housing Activity Index" which encompasses the seasonally adjusted data for new and existing home sales, permits and starts.
As you can tell housing has indeed recovered. However, when you consider all of the money that has been thrown at the housing market from settling with banks over outright fraud to bailing out underwater homeowners, we should be extremely disappointed with the result.
The seasonally adjusted data, however, tends to be a bit misleading. For example, in January there were not 437,000 actual new homes sold. In reality it was 31,000. In order to get to 437,000 new homes sold you must annualize the actual sales of 31,000. However, multiplying the January total by 12-months only gets you to 372,000 homes which is lower than what was seen in December. This is where fuzzy math is applied for seasonal biases - the seasonal adjstment to the January figute was an additional 65,000 sales (more than 200% of what was actually sold). As an aside - this was one of the largest seasonal adjustments for January on record. The reality is that when the data is adjusted in this manner it tells us very little about what is really occurring and what the impact on the economy will actually be.
Therefore, in order to understand what is really occurring within the real estate recovery we need to look at the actual data. For this I created a "Housing Process Activity Index" which uses the non-seasonally adjusted, actual, data for the entire new home building cycle - permits, starts, completions and sales. Since it is the construction process of a NEW home, versus the resale of an existing home, that has the greatest multiplier effect on the economy this index is most representative of the economic contribution that is likely to be made.
The index uses a 12-month average of the non-seasonally adjusted data to smooth out what is normally very volatile month-to-month data. As you can see in the chart below there has actually been very little "real" recovery in the housing market since the bottom post the last recession. Furthermore, the number of new homes sold has actually had very little relative recovery and remains well below historical norms which previously marked the bottom of a recession.
Last month I wrote an article on the "Real Housing Recovery Story" wherein I stated:
"The housing recovery is ultimately a story of the 'real' unemployment situation which still shows that roughly a quarter of the home buying cohort are unemployed and living at home with their parents. The remaining members of the home buying, household formation, contingent are employed but at lower ends of the pay scale and are choosing to rent due to budgetary considerations. Also, we should not discount the psychology of home ownership has dramatically changed since the crash as many of the "millennials" saw the financial damage their parents suffered and are opting out of taking such a perceived risk.
As I stated recently the optimism over the housing recovery has gotten well ahead of the underlying fundamentals. The overarching problem is that the housing market that is almost exclusively dependent on the continued push to artificially suppress interest rates combined with massive amounts of direct stimulus, and incentives, to bailout current homeowners and banks. This intervention is causing an artificial supply suppression which is likely to create a backlash in the future as the current supply/demand conditions are unsustainable.
While the belief was that the Government, and Fed's, interventions would ignite the housing market creating an self-perpetuating recovery in the economy - it did not turn out that way. Today, these repeated intrusions are having a diminished rate of return and the risk now is that interest rates rise shutting potential homebuyers out of the market."
Less Optimism In Richmond
I recently updated my Economic Output Composite Index for the data released through January. The most recent release of the Richmond Federal Reserve manufacturing survey, one of the EOCI's subcomponents, showed a positive bump from -12 reading in January to a +6 in February. There were improvements across the board in the survey which were very encouraging. However, where the headlines stop is where the trend analysis begins. The chart below shows the change in the survey from this time last year.
While the survey improved modestly in the latest report - attitudes have deteriorated considerably since this time last year. New orders have fallen to ZERO along with vendor lead time. Employment and the average work week have decreased as order backlogs continue to deteriorate. Inventories have continued to build up which is likely unwanted as end demand remains weak. The one bright spot is that wages have increased which is likely due to the need to maintain quality employees and staffing to meet current production needs. However, these higher employment costs translate in lower profit margins if those costs cannot be passed through to the consumer.
While the data has been volatile as of late due to the impact of Hurricane Sandy - the overall trend remains negative. This data confirms what we discussed in the EOCI index recently:
"For all of the debates it is clear that the impact of the liquidity programs have masked the underlying strength of the real economy. Unemployment remains high, wages remain weak and real consumption has slowed while debt still fills the gap between incomes and the current standard of living. It will likely not be much longer until we know for sure whether the economy can shake off this most recent bout of weakness and began a recovery. Analysts and economists have pointed to the rising stock market as an indication that this will happen. That would most likely be the case if the markets were functioning normally and reflecting increased expectations of economic growth rather than speculative risk taking based on a flood of liquidity. Maybe this time the economic data is telling the real story. If that is the case it is just a function of time before the financial markets figure it out."
Bottom Line Risks Remain
The series of articles over the last couple of weeks all describe the same thing - a financial market that is well ahead of the underlying economic fundamentals. The risk posed to the economy by rising gasoline and energy prices at the same time taxation has increased is not one that should be taken lightly. The consumer, already debt constrained, has little room to manuver.
While QE programs have lifted financial assets it has done little to boost the underlying economic environment. The temporary boosts given by Hurricane Sandy, along with a fairly mild winter which is positively skewing the seasonal adjustment data, will be quickly offset by the impact of higher taxes and reduced government spending. As we discussed in the past weekend's missive "Clarifying Over Bought, Extended and Bullish" the financial markets are currently at levels normally associated with intermediate term market tops rather than the beginning of a new bull market. Specifically I stated:
"With bullish sentiment and complacency at extreme levels it only further supports the idea that the current risk of investing new capital in the markets outweighs the potential reward. It is very likely that sometime within the next couple of weeks to couple of months that the markets will experience at least an intermediate term correction."
The wakeup call came on Monday with a 90% distribution day on heavy volume. While Bernanke & Co are still actively engaged in flooding the system with liquidity, which could provide near term market support, it is the economy that will drive the markets long term. Outside of a reduction in mortgage debt due to write offs, bankruptcies, foreclosures, short sells and settlements - there has been virtually no improvement in the average American's balance sheet. The major banks have done little to curtail the risks that almost sent them into bankruptcy last time as profitability still continues to be a function of taxpayer support and accounting gimmickry. The Eurozone crisis was put on hold temporarily but nothing has been done to actually resolve the debt issues that are the epicenter of their problem. The reality is that outside of the artificial supports of a global liquidity dump - the risks that nearly sent the world economies over a ledge into oblivion still remain. The only real question is when the next collision with that reality will occur.