For the second year in a row the economy, just as it was beginning to pick up speed, has smashed into a wall. And here we are again, wondering if the pieces can be put back together or whether we're really headed into a double-dip recession.
Last year, the problems were Europe's debt woes and the Greek bailout. This year, it's again about Greece. But it's also about $4-a-gallon gasoline, jobs, bad weather, government spending cuts and production setbacks out of Japan.
Optimism has once more faded into fear and disbelief. The Citigroup Economic Surprise Index, which tracks whether economic reports are better or worse than expected, has plunged to depths not seen since the worst of the financial crisis. Data on factory output, consumer confidence and jobs have all disappointed lofty expectations. Wall Street economists are frantically marking down their forecasts for the rest of the year.
Growth has slowed to a crawl, with first-quarter growth of gross domestic product at just 1.8%, below the economy's stall speed and well below the Street's 3.5% estimate from February. Unemployment has moved back over 9%. Stocks have fallen for five consecutive weeks, something that hasn't happened since 2004, as smaller, riskier stocks get hammered. Investors have tried to seek refuge where they can, but defensive stocks, Treasury bonds and even gold have all come under selling pressure in recent weeks.
Anthony Mirhaydari
This all sounds depressing, I know. I started warning of trouble for the economy and the financial markets a few months ago in my columns and blog posts, and we've certainly seen that trouble.
But here's the thing: The economy is already on the mend. And soon, that should translate into higher stock prices and a reacceleration in the economy -- enough to send GDP growth as high as 4.3% in the fourth quarter, according to Deutsche Bank.
I know that's hard to believe. But let me explain what I'm seeing and then offer some investments to help you take advantage of this nascent re-recovery.
The not-good-enough recovery will get better
If you're like most people, you're downright peeved at the state of things: A recent Newsweek/Daily Beast poll found that 81% of people say the economy is not delivering enough jobs. People are angry at the corporations, the rich, the government, gas prices and their "personal economic situation." Marriages are under pressure. People are losing sleep. There's a lot of nervousness out there.
The good news is that the outlook is improving.
For one, the short-term negative catalysts -- such as auto production shutdowns because of a lack of parts from Japan and a spike in gas prices -- are beginning to fade.
The Japanese are bouncing back, with the Markit/JMMA Japan Manufacturing Purchasing Managers Index a rare bright spot after jumping to 51.3 in May from 45.7 in April, which was the lowest since April 2009. (Any reading over 50 indicates month-over-month growth.) The output component of the index jumped to 51.5 from 35, the biggest gain since the data was first collected back in 2001. Only 24% of respondents noted longer lead times from Japanese suppliers, down from 55% the month before. And the new order component jumped 12 points, the best result since April 2009.
Because of this, U.S. auto production is poised for a big increase in the third quarter, according to newly released factory schedules from Ward's, an industry data provider. Output dropped to just 8.1 million units on a seasonally adjusted annual rate -- down from around 9 million in February. UBS economists estimate this output drop will slow GDP growth in the second quarter by 1%.
But over the next few months output is expected to average a 9.6 million annual rate, the sixth-largest production jump on record. That should be enough to add 1.25% to GDP growth in the third quarter, according to UBS. Toyota Motor (TM, news) has already announced that it intends to be back at full production by August.
And what do those numbers mean? Well, the surge in auto production back in 2009 -- as dealers restocked inventory in response to the cash-for-clunkers auto rebate program -- "helped lead us out of the Great Recession," in the words of Credit Suisse economist Neal Soss.
Relief at the pump
Gasoline prices have also cooled from their highs after crude oil dropped from its peak of nearly $114 a barrel in late April to trade below $100 earlier this week. According to Deutsche Bank economist Joseph LaVorgna, the 12.3% drop should translate into pump prices near $3.41 a gallon, compared with the $3.97 national average reported last month. That was dangerously close to LaVorgna's $4 a gallon economic tipping point -- a dangerous price level I warned of back in March.
Every 1-cent decline in gas prices adds about $1 billion to consumer spending on everything other than energy. So a 50-cent drop in gas prices early this summer would be a significant boost to the economy by keeping a big chunk of change in shoppers' wallets.
What's more, the decline in energy prices is likely to continue.
While the Oil Producing and Exporting Companies failed to agree on raising output quotas at a meeting this week, Saudi Arabia is reportedly preparing to increase oil production to the highest levels since the summer of 2008. Crude prices have stopped rising based on the dollar's problems, meaning that the market is moving on supply and demand rather than on the whims of currency traders. The fact that there's no oil shortage suggests lower prices. The energy futures market is indicating a gradual drop in prices.
Pay me, baby
Of course, you can talk about auto production and gas prices all day long, but jobs are what matter most to people.
For one, recent economic reports, such as the poor one last week from the Institute for Supply Manufacturing report still had a healthy employment component, suggesting the current slowdown isn't pulling down the job market. Clearly, managers view this soft spot as temporary.
And despite a recent increase in the unemployment rate and a slowdown in the pace of hiring, labor income continues to rise. More workers are working longer hours at higher wages, boosting overall labor income at a pace that's well above the rate of inflation. Hours worked over the first quarter rose at a strong 3.7% annual pace -- the best growth rate of the recovery to date.
I've used the product of hourly wages and aggregate work hours as a proxy for income in the chart above. Combined with higher household net worth and an easing of credit standards, these income gains should boost spending in the coming months -- setting the stage for a strong back-to-school shopping season. This should juice growth in the second half of the year; reluctant consumers provided a drag on first-half growth.
Over the horizon, hiring should get a boost from a combination of higher demand -- thanks to the rise in consumer spending I'm looking for -- and a slowdown in labor productivity. We've already seen a steady decline in output per worker as well as increased labor costs (higher wages). This is typical for this stage of the business cycle, and it's key to unlocking corporate hiring plans.
You see, in the midst of a recession and in the early stages of a recovery, employers have power over workers scared of losing their jobs. Many employees are sacked. Workers who remain have to take on extra work. At first, it's easier to pay them overtime than to hire and train new workers. Thus, productivity shows a big boost as the workers who still have jobs put their noses to the grindstone.
Eventually, economic activity reaches a point at which existing workers simply can't handle the increased load. New workers are hired. They are less efficient, and maybe not as smart or experienced. The fear of unemployment begins to fade for everyone -- maybe they add a few minutes to the coffee break, maybe they leave on time instead of waiting until the boss leaves, maybe they use up all their vacation days. Maybe they use up all their vacation days. All of these factors push down productivity. The more it drops, the more employers are forced to bring on new workers to keep expanding production and growing their business.
We're reaching that point now.
Digging into the numbers, Harris finds that employment in industries with above-average hourly earnings have finally started to outpace earnings in low-wage industries. This is a sign that the recovery is starting to gain traction and create a need for more high-skill, high-pay career-type jobs. As a result, growth in high-paying jobs is outpacing growth in low-wage jobs in a sustained way for the first time in three years.
