J.P. Turner Advisor Throws Lifeline to an Out-of-Work Client

Article by Taylor Smith

Last summer Clint Gharib got a frantic visit from a client. He was laid off by an auto-parts manufacturer and was panicked about not having enough cash to cover his living expenses, from mortgage payments to groceries.

The client’s goal was to raise $100,000 to fund near-term expenses, pay off some debt and keep him and his wife afloat in case of a protracted job search. His first impulse was to tap his IRA.

“I understand the anxiety that hits someone when a big change happens,” says Gharib, who is director of managed products and insurance at Atlanta-based brokerage and advisory firm J.P. Turner & Co. “The first thing I did was to calm him down.”

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WEEKLY ECONOMIC COMMENTARY
Stone & McCarthy Research Associates
WEEK OF DECEMBER 4, 2009

As they say in sports, sometimes it's better to be lucky than good. President Obama initiated a headline-grabbing jobs summit a day before Friday's release of the widely watched monthly employment report. Cynics may claim that the scheduling was done to defuse any negative reaction that might arise from another dismal reading on the jobs front, which many analysts expected. For the record, Wall Street had forecasted a decline of 125 thousand in nonfarm payrolls last month, sending the unemployment rate up another notch from its 26-year high of 10.2 percent. While that would still be consistent with a job market that is getting "less bad" by the month, it would be bad enough to fuel one of the most contentious issues that will dominate the political scene leading up to next year's mid-term elections.

Whether or not the scheduling of the jobs summit was deliberate or coincidental, the administration did not have to send out the troops on Friday to defuse a potential negative response to another bad report. Make no mistake, the agenda of the summit - to garner useful ideas from among economists, company executives, academics and labor officials on how to jump-start hiring - remains as relevant as ever; with roundly 8 million workers losing their jobs since December 2007 and a huge fraction staying unemployed for an interminable period of time, the plight of laid-off citizens will be front and center for some time to come. But instead of heightening the urgency of the issue, the latest employment report provided the administration with a rare opportunity to pat itself on the back.

For one, companies purged a much smaller 11 thousand from payrolls than the 125 thousand that had been expected. For another, the job losses over the previous two months were much smaller than originally estimated, as the revised numbers for September and October added back 159 thousand to payrolls. Finally, instead of increasing further into nosebleed territory, the unemployment rate actually posted a welcome decline, edging down from 10.2 percent to 10 percent in November. Simply put, while the employment report did not negate the significance of the jobs summit, it did provide confirmation that the ingredients for a sustained recovery in economic activity and a return to job growth are firmly in place.



Indeed, the surprisingly positive jobs report for November immediately raised two other issues that will no doubt dominate the economic debate in coming weeks - at least until the next set of monthly employment numbers is released. The first is whether the widespread concerns over another jobless recovery are now less relevant than before. Keep in mind that the experience following the 2001 recession is still fresh in the minds of policy makers, as companies continued to lay off workers for an additional 23 months after the recovery started. Secondly, with the economy on the mend and no longer purging jobs at an alarming rate, the question of whether more fiscal stimulus is needed to kick-start hiring will come under closer scrutiny, particularly in the face of the huge deficits that have become a political hot potato in Washington. A corollary issue is whether the Federal Reserve, already under attack for sowing the seeds of the real estate and credit market bubbles by keeping interest rates too low for too long, will consider rescinding some of its easy money policy sooner rather than later.

On the issue of a jobless recovery, if in fact the recession ended in June or July of this year, the nation has already experienced at least one-quarter of jobless growth. That's already longer than the usual one or two-month lag between the onset of a recovery and when companies start to beef up payrolls. But the odds of that lag being stretched out to any thing resembling the post 2001 experience have diminished considerably, in our view. True, the headwinds in the way of job creation are formidable, and studies indicate that it takes longer for the job market to recover following a financial crisis, much less one of such dire proportions that gripped the global markets in late 2008 and early this year. But the array of harbingers pointing to job growth that are now coalescing argue forcefully against an extended jobless recovery.

Perhaps the most consistent of these harbingers is the trend in one component of the labor force - temporary workers. It is a well-known dynamic that during turning points of a business cycle, these are the workers who are most immediately affected. For example, when sales begin to slide during the early months of a recession, companies let go of their temporary workers first, striving to retain senior, more skilled, workers in the hope that the sales downturn is only temporary. As the recession progresses, however, the productivity of these workers declines and they become too expensive to retain. At that point, the more permanent positions are extinguished, particularly as company executives become more convinced that the recession is real and will linger for an extended period of time.

Likewise, during the onset of a recovery, it takes time for company executives to believe that the upturn will be sustained. Instead of beefing up payrolls with permanent positions at the first sign of a revival, they will initially take on temporary workers who can be let go of more easily if the nascent recovery peters out. As the recovery shows signs of gaining traction, the next step will be to expand the hours put in by existing workers and, perhaps, converting part-time positions into full-term jobs. By relying more intensively on existing workers to churn out more output, companies derive the benefits of increasing productivity, which lowers unit labor costs and allows revenues to flow more quickly to the bottom line. At some point, however, it becomes more difficult to squeeze additional output from existing workers and the stage is set for an expansion in payrolls.

By all accounts, those elements that precede a pick-up in hiring are falling into place. In November, companies took on 51 thousand more temporary workers, the fourth consecutive monthly increase. Historically, the trend in temporary jobs leads overall payroll trends by six months. By this metric, job growth should turn positive around the turn of the year. Just as important, workers are putting in more hours. In November, the workweek increased by 0.2 hour to 33.2 hours, the highest since last February. The workweek in the manufacturing sector expanded by an even more impressive 0.3 hour to 44.4 hours, the longest shift in more than a year. Keep in mind that manufacturing is a highly cyclical sector that tends to lead the economy, both into and out of recessions. While factory jobs continued to be lost in November - declining by another 41 thousand following a 51 thousand drop in October - here too the losses are receding. Last January, factories purged 262 thousand jobs. What's more, about half of the temporary jobs created in November were in manufacturing even though the Labor Department classifies them in the services category. Hence, the manufacturing sector may be closer to generating net new jobs than the overall payroll numbers suggest.

To be sure, manufacturing plays a much smaller role in the overall economy than it did in earlier years. With a payroll of 141 million, factories are employing the fewest number of workers than anytime since 1941. But from a cyclical perspective, its influence is still important, as it reflects the trend in demand for more expensive durable goods by consumers, such as autos, as well as in the demand for capital goods by businesses, both domestically and from overseas. On this score, it is encouraging that the modest improvement in the payroll report is corroborated by some other measures, most notably from the Institute for Supply Management (ISM) manufacturing index. While the overall index did pull back somewhat in November, it remained above the 50 threshold that separates expansion from contraction for the fourth consecutive month. Over that period, the internal dynamics indicate sustained improvement in the manufacturing sector, as a number of components are participating in the advance, including new orders, production, employment and exports. Indeed, export orders have stayed above the 50 mark since July, suggesting that the dollar's decline combined with the improving global economy is having a growing influence here and will make a significant contribution to the recovery.



Unfortunately, the much-larger services sector apparently suffered a setback in November, according to the ISM's analogous index for the non-manufacturing sector, which slid to 48.7 from 50.6 in October. Since the economy is much more heavily dependent on services than goods producers, that setback is a harsh reminder that the nation is far from out of the woods. Conditions are getting better, to be sure, but the pace of improvement remains below what is needed to restore a healthy job market. Forget the admirable goal of restoring the 8 million jobs that have been lost since the onset of the recession in December 2007. That will take years to accomplish under the best of circumstances. The more immediate challenge for policy makers is to grow the economy fast enough to absorb the natural increase in the labor force - which is about 150 thousand a month - plus the deep pool of discouraged workers who will undoubtedly restart a job search once they sense an improvement in job prospects.

What this means, unfortunately, is that the unemployment data will continue to portray a picture of weakness, even as companies start to expand payrolls. Accordingly, we would not place too much emphasis on the surprising 0.2 percent decline in the jobless rate to 10 percent last month. In all likelihood, that was a quirk, which should be reversed in coming months as the labor force expands faster than the number of new job openings. But neither should that almost certain prospect be a source of pessimism, since the unemployment rate has a strong cyclical tendency to lag turning points in the business cycle. If anything, the case can be made that the unemployment rate will peak out at a somewhat lower level than was envisioned a few months ago, thanks to the rapid pace by which job losses are diminishing. The consensus view is that the rate will rise close to 11 percent before all is said and done, surpassing the previous post war peak of 10.8 percent set in 1983. Now, there's a strong chance it will peak out at 10.5 percent or even at a lower level.



That said, we do think it would be premature for policy makers to consider removing monetary or fiscal stimulus from the economy - and we highly doubt that they will. A case can be made against another major stimulus package, which has been gaining proponents in Congress and elsewhere in recent months. Aside from the pernicious consequences of a burgeoning budget deficit, the full effects of the $787 billion program put into effect last February have yet to play out. Only about one-third of those funds have been disbursed. But the November employment report, as encouraging as it was, does little to dilute the need for a targeted jobs program on a smaller scale that may still may very much come to fruition. The difficulty of the long-term unemployed to find jobs, the still-high unemployment rate that will likely head higher in coming months and the huge slack in the labor force as manifested by an "underemployment" rate that exceeds 17 percent are compelling measures of the fragile state of the job market. Nor will the Federal Reserve be influenced by the November jobs report to start raising interest rates. With so much idle labor resources, the prospect of an inflation flare-up ignited by outsized wage increases is far too remote to worry about. We suspect that the Fed will keep its key policy rate at its current near zero level for the foreseeable future.

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Talking to Clients About Your Transition

J.P. Turner's Al Pierantozzi, national sales manager, and Lois Cohen, transition manager, recently contributed to the article “Talking to Your Clients About Your Transition” which appears in the December issue of Transitions Magazine. Al and Lois provided practical information and helpful tips to help transitioning reps explain their move to clients. This is a good piece to add to your marketing process if you are actively recruiting reps into your branch.

Weekly Economic Commentary

WEEKLY ECONOMIC COMMENTARY
Stone & McCarthy Research Associates
WEEK OF NOVEMBER 27, 2009

If consumer surveys are any indication, retailers will not have much to be thankful for this holiday season. To be sure, shoppers are a notoriously unpredictable lot, and they may well behave differently from what they say to pollsters. What's more, the two most widely watched surveys of household intentions - taken by the Conference Board and the University of Michigan - have edged up from their depressed readings of earlier this year. But when you've been down so low for so long, a modest increase is not a meaningful sign of progress. Indeed, at 50, the Conference Board's confidence index in November is about twice as high as the level that prevailed in February and March, but it is still about half the average over the past 30 years.

As far as the near term outlook for the holiday season is concerned, the very same Conference Board took a separate survey this week, asking households how much they plan to spend on holiday gifts.
The response was anything but encouraging; U.S. households intend to dole out an average of $390 on friends and family, which is about 7 percent less than the $418 spent last year. What makes this particularly distressing is that the last holiday season was mired in a financial crisis and the economy was downshifting at a 5.4 percent annual rate, which, at the time, was the steepest quarterly drop in GDP since the early 1980s. That was followed up, of course, by an even steeper decline of 6.4 percent in the first quarter of this year, which explains why confidence sunk as low as it did in February and March.



But as we noted earlier, households can behave in unpredictable ways, and this season may provide another example of that independent streak. The clear message from past patterns is: don't listen to what people say, but watch what they do. So far, the results are not too discouraging. Early indications, based on hyped-up media reports, are that Black Friday is living up to its reputation. Shoppers swamped the malls the day after Thanksgiving, albeit no hit-and-run accidents by frenzied customers reminiscent of last year's Walmart incident was reported. That said, the typical huge price discounts offered by the chains and department stores were everywhere in evidence, and all indications are that the promotions will remain in place throughout the season.

However, there are a few departures from the usual holiday merchandising strategy worth noting. Apparently, a number of high-end retailers are employing the reverse tactic of keeping prices firm and inventories lean, warning customers that if they don't hurry up and buy now, the more desirable products will soon run out. The success of that strategy remains to be seen. The Wall Street Journal reported on Friday that customer traffic at discount shops appeared to be very heavy, while the purveyors of luxury goods are facing empty aisles. That discrepancy may reflect the growing inroads of online shopping during the holiday season, which tends to attract higher-income customers. Conversely, it could also reflect the shock effect of the stock market's sell-off on Friday, spurred by the headline-grabbing prospect of a debt default by Dubai World. The financial woes of that Gulf nation suggest to some that a second shoe of the credit crisis, which sent the global markets into turmoil last year, may be poised to drop.

Clearly, such a development would not bode well for households whose wealth is heavily linked to stock portfolios. There is little question that the stock market's meltdown last year - which helped wipe out $14 trillion of net worth and decimate the retirement nest eggs of millions of Americans - played a major role in the deep consumer-spending retrenchment in the second half of 2008. Conversely, the easing of the financial crisis and the astonishing rebound in stock prices since the spring, which restored about $4 trillion of value to stock portfolios, helped resuscitate spending this summer and fall. Any major reversal of the market's fortunes caused by another shock to the financial system could well send a signal to households that it's time to hunker down again. Needless to say, that would throw a major roadblock in the way of the still-fragile recovery.

Since Friday's trading was shortened by a 1:00 PM closing - and prices recovered from their worst early-morning losses - it would be premature to gauge investor sentiment until events play out. If the budding debt crisis is resolved over the weekend, bargain-hunters may return and put the market back on a firm footing. On the other hand, the tumult in recent days may simply reaffirm the uncertainty that still abounds regarding a host of issues about the economy, financial markets and government policies. About the only reasonable forecast we are willing to make is that the Dubai incident may serve as a catalyst for more volatility in the markets in coming weeks.

But whether asset values fluctuate up or down, there is little question that households are more inclined to rebuild wealth the old fashioned way - through higher savings. Recall that when stock and real estate values were rocketing higher during the 2005-2008 period, Americans were firmly convinced that they were on the road to retirement riches without having to put aside any savings. Hence, they collectively spent virtually every penny of their paychecks and borrowed extensively to finance their purchases. At the height of this overconsumption frenzy, the personal savings rate fell to under 1 percent and debt soared to a record 130 percent of disposable incomes. But the bursting of the stock and real estate bubbles exposed the fallacy of that strategy, leaving households with much-diminished asset values and a mountain of debt that still must be serviced. Consequently, a new norm for consumer behavior took over, one that is still evolving and coursing through the economy.

After the shock-induced retrenchment late last year, consumers have gradually reopened their wallets and purses, encouraged by ultra low interest rates, government incentives and a thawing out of the credit freeze that shut off the lending spigot during the financial crisis. But the step-up in consumption has been primarily for essential goods and services, as households put off discretionary purchases in favor of rebuilding savings. From a low of less than 1 percent, the savings rate gradually crept back to the 4 - 5 percent range late last year, where it has mostly stayed after adjusting for monthly gyrations related to rebate disbursements. Meanwhile, a renewed effort to restore a more normal relationship between debt and incomes is in progress. Consumer debt outstanding has been cut for a record eight consecutive months through September, and the overall debt-to-income ratio has receded by more than five percentage points from its peak reached in 2008.



No doubt, the process of repairing damaged balance sheets will continue for some time, but there are reasons to believe that much of the heavy lifting has already been done. True, by historical yardsticks, households still have a ways to go before a comfortable savings cushion is built up. For example, at the start of seven of the previous nine recoveries, the savings rate hovered between 8 - 11 percent, and many economists believe that it will climb back to that range before all is said and done. However, a climb that steep would surely sap the life out of consumer spending, assuring not only a subpar recovery but one that would be constantly susceptible to a relapse into recession. Our sense is that a more reasonable target is around 6 percent, which still implies that spending will grow more slowly than incomes but will not be held hostage to extreme frugality.

Keep in mind that even with the devastating wealth destruction during 2008, household net worth is still substantially higher relative to incomes than it was in the 1970s and 1980s when the savings rate actually soared well above 10 percent. In fact the current ratio of net worth to incomes is consistent with saving rates in the 5-6 percent range. What's more, after sliding for most of the past year, personal income bottomed out this spring and has been slowly recovering, posting increases in seven of the past eight months through October. It's important to note that when incomes are rising, households can increase both savings and spending, which is the welcome combination that appears to be developing. If the savings rate is pushed up gradually towards the 6 percent zone and income growth accelerates going forward, the seeds for a respectable spending increase would be sown.



Of course, the critical spur that would facilitate stronger income gains is still missing, namely a return to job growth. So far, the modest climb in personal incomes reflects a pick-up in average hourly earnings and weekly pay for the 90 percent of the labor force that is still employed. But if the economy continues to expand at its recent pace, that trend should accelerate and be reinforced by the long-delayed return of hiring by businesses. The latest plunge in first-time claims for unemployment benefits reported this week provides further evidence that layoffs are ebbing swiftly, as companies move closer to the point of beefing up payrolls. There is even speculation that such a development may occur before the year is out, which would end the longest hiring drought since World War 11.

One encouraging sign that hiring will resume is the rebound in economic activity now underway. True, the Commerce Department revised down the third quarter's growth rate this week to 2.8 percent from the original 3.5 percent estimate made a month ago. That was a disappointment, but not a fatal blow to the job market. For one, it was still a respectable performance for the period, and future revisions may lift the growth rate back above 3 percent. For another, the fourth quarter started off on an upbeat note, with real personal consumption posting a solid 0.4 percent gain in October. We are looking for healthy growth rate of about 3.5 percent in the fourth quarter. While that would still put the onset of this recovery on the weak side compared to past recoveries, it would be strong enough to generate job growth. Historically, the economy has never failed to produce net job creation when stringing together two or three consecutive quarters of GDP growth in excess of 3 percent. With all of the attention focused on the holiday shopping season, it is easy to lose sight of a brighter broader picture that may be developing.


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Weekly Economic Commentary

WEEKLY ECONOMIC COMMENTARY
Stone & McCarthy Research Associates
WEEK OF NOVEMBER 20, 2009
It was roller coaster week for the financial markets, reflecting growing investor jitters about an economy that has still not shown its true self. The solid 3.5 percent growth rate reported for the third quarter certainly buoyed spirits, if only because it highlighted how far we've come from the dark days of last winter when the economy seemed on the verge of the next Great Depression. Yet, as impressive as the summer reading on economic activity was, it came with a host of caveats that left most economists skeptical if it would continue. The cash-for-clunkers program and homebuyer tax credit were two particular influences that underpinned this skepticism, as they artificially inflated home and auto sales that contributed an outsized fraction of the third-quarter gain in GDP.

Interestingly, the expiration of the clunkers program in late August had a boomerang effect on both the economy and the mindset of investors. Car sales, as expected, tumbled in September from their inflated levels in July and August. Yet the payback was relatively brief and followed by a surprisingly strong rebound in auto sales during October, as manifested in the jump in unit car sales to a 10.4 million annual rate from 9.2 million in September. That turnabout, which was reported a few weeks ago, offered hope that households were more resilient than generally expected, and helped sustain the stock market's astonishing rally.

The October retail sales report out this week put a dollar figure on those unit sales, resulting in a 7.4 percent spike in revenues at auto dealers and parts makers. Even better, the auto strength, which accounted for about 85 percent of the increase in total sales, did not crowd out other purveyors of discretionary products. True, sales of building materials and garden equipment did decline sharply, but that may have been related more to the unusually cold and wet climate during October than anything else. On the plus side, general merchandise sales posted a solid 0.9 gain, including a surprisingly strong showing from department stores. Also encouraging, it was good to see a 1.2 percent jump in sales at restaurants and bars, a discretionary expenditure if ever there was one.

Since the retail trade data tend to be heavily influenced by volatile monthly changes in auto sales, a better picture of underlying trends can be gleaned by excluding autos as well a gasoline sales, which can be dominated by price changes. In October, that component increased by 0.3 percent, which is not compelling but marks the third consecutive month of steady gains. As the chart shows, spending on this core basket of goods has not increased for three months in a row since early 2008, when the Bush administration's tax rebates were fueling consumption. Back then, the recession had just started and the hemorrhaging in the job market had not yet taken hold. At the very least, households appear to be heading into the fourth quarter on a firmer footing than was the case earlier in the year, when fears of another Great Depression still weighed heavily on sentiment and jobs were being extinguished at more than three times the rate that is currently taking place.



It remains to be seen if the resilience shown by consumers holds up for the holiday season. If the recent actions of retailers are any indication, there is not too much optimism running through the aisles of department stores and other merchants. Inventories have been trimmed to the lowest level in nearly six years, and full-page ads announcing huge price discounts are filling newspapers a week before the traditional "Black Friday" push. While the general view is that holiday sales will not be a particularly festive occasion for retailers, the risk is that more consumers will be in a buying mood than stores are prepared to handle. If that's the case, inventories will be depleted even more heading into the new year, which could lead to a wave of new orders and provide a boost to factory output, giving the recovery much-needed momentum.

But even as the turnaround in auto sales inspired confidence in the recovery, the housing market is doing just the opposite. Indeed, the stock market, which has been rallying on the fumes of growing optimism towards the outlook, received a rude wakeup call following a disappointing housing report this past week. Like the auto industry, the housing market benefited from the administration's other targeted incentive program designed to prop up an ailing sector and help jump-start the overall economy. The first-time homebuyer tax credit is largely responsible for boosting home sales during the spring and summer months, enabling homebuilders to whittle down inventories that had been a major deterrent to new construction. The program had the desired effect, as homebuilding activity showed promising signs in the spring and summer months. After hitting a postwar low of 479 thousand units in April, housing starts bounced up to 593 thousand in July, where it hovered over the next two months.

That recovery in starts actually produced the first increase in residential outlays in fifteen quarters during the July-September period, encouraging Fed chairman Bernanke to claim that the residential sector should make a modest contribution to growth going forward. That still is likely to happen, but the latest housing report certainly threw some cold water on the progress this ailing industry seemed to be making. Instead of extending the rise from the spring lows, housing starts unexpectedly declined by a sizeable 10.6 percent in October, sliding back to a 529 thousand annual rate. It would be easy to blame bad weather for the relapse, but building permits - a barometer of future construction that is not affected by the weather - also fell by a corresponding amount during the month.



The most logical explanation for the surprising downturn in starts is that builders turned cautious about sales prospects that are tightly linked to the fate of the homebuyer tax credit. They understandably feared that once the scheduled expiration date on November 30 came and went, so too would sales, leaving builders again with unwanted inventories that would have to be marked down in price. As it turned out, Congress renewed the tax credit, and expanded the base of prospective buyers who are eligible to receive it, which may or may not restore builder confidence and promote some additional construction in coming months. More than likely, builders will take a cue from home sales. In this regard, next week's data on new and existing home sales for October will garner a good deal of interest; but like the housing starts data, they may well be distorted by the uncertainty over the fate of the tax credit that prevailed before it was renewed earlier this month.

We concur with Bernanke's assessment that the worst of the housing crisis is behind us, but would not be surprised if another leg down still lies ahead. What is particularly disturbing is the ongoing legacy of the housing bubble, when millions of families overleveraged themselves against their homes, believing that the rise in prices would never end and refinancing would always be available as an option to stay above water. Of course, the bursting of the bubble and the shutting down of the mortgage market exposed the fallacy of that logic and left households with a mountain of debt they couldn't handle, and banks with mountain of bad loans that almost brought down the financial system.

That woeful legacy was further highlighted this week with the report by the Mortgage Bankers Association that a record 14.4 percent of mortgages on 1-4 family homes were either delinquent or in the process of foreclosure in the third quarter, a fraction that has been rising with disturbing consistency as more and more homeowners lose their jobs. Of particular concern is the rate at which so-called "prime" mortgages are getting caught up in the delinquency/foreclosure crisis. While they may have started life as low-risk loans, the toxic cocktail of falling home values, tight credit conditions, and rising unemployment rates have compromised the quality of an increasing percentage of prime mortgages.

According to the MBA data, the delinquency rate on prime mortgages (30 days or more past due) jumped to a record 6.84 percent in third quarter from 6.41percent in the second and from 4.34 percent a year ago. Breaking the data down further, we see that 5.67% of prime fixed rate mortgages were delinquent in the latest quarter while 12.37% of prime adjustable mortgages were past due. To be sure, the delinquency rate on prime mortgages looks tame compared to the record 26.4 percent past due rate on subprime loans - the original bad boys of the housing crisis - but it is important to remember that prime loans account for roughly three-quarters of outstanding mortgages.



Continued increases in delinquency and foreclosure rates -- particularly in the prime mortgage universe -- are slowing the pace at which the housing market can recover. As foreclosed homes come on the market, they tend to depress home prices overall. Also, large inventories of foreclosed homes hamper the efforts of homebuilders to attract buyers. As the National Association of Home Builders reported earlier this week, "fully one-third of respondents indicated that they have recently lost sales due to low appraisal values. This is up from a quarter of respondents who indicated as much in a survey taken in July. Builders report that low appraisal values are often tied to the use of foreclosed and distressed properties as 'comps' in the appraisal process." Simply put, many economists believe that recovery in the broad economy won't be fully accepted until the housing market - the catalyst that brought the economy and financial system to its knees - is able to stand on its own two feet. If recent reports are any indication, that may still be a ways off.


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Weekly Economic Commentary

WEEKLY ECONOMIC COMMENTARY
Stone & McCarthy Research Associates
WEEK OF NOVEMBER 13, 2009

As we enter the midpoint of the fourth quarter, the economy appears to be ending the year in much better shape than envisioned just a few weeks ago. Sure, the eye-opening 3.5 percent growth rate in the third quarter was largely an artifact of special forces that pumped up auto and home sales. Without the sizeable contribution from housing and autos, growth would have come in at a much more anemic pace of about 2 percent, hardly a barn burning start to the recovery. Indeed, the common wisdom at the end of the period was that the removal of the props to those two sectors would suck the life out of the fourth quarter, leaving the economy vulnerable to a W-shaped recovery, one that could easily double-dip back into a recession.

But as the weeks progressed, signs of surprising vigor began to sprout. After the cash-for-clunkers program expired in late August auto sales tumbled as expected, falling to a 9.2 million annual rate in September from the 12.6 million average pace during July and August. But instead of staying in the doldrums, sales rebounded nicely in October, rising to over a 10 million annual rate. That surprised most analysts who speculated that the rebate-incentives would push forward enough sales to keep traffic at auto dealers at the depressed September level for another six months or so. Whether the October recovery was just a "dead cat" bounce that will be followed by another relapse in coming months remains to be seen. However, the fact that households have not gone into complete hibernation in the midst of a double-digit unemployment, high debt burdens and corrosive wealth destruction in recent years is an encouraging omen.



Indeed, the solid showing of nonauto retail sales in September and some encouraging signals from chain stores in October suggest that consumer spending in the fourth quarter will hold up better than expected. The increase in real personal consumption will likely not match the robust 3.4 percent growth rate posted in the summer quarter, but a respectable 2.5 percent gain could well be in the cards. Since consumer spending drives about 70 percent of GDP, that should underpin another decent growth rate in the fourth quarter. Similarly, a dramatic relapse in home sales that was expected in the wake of the expiration of the $8000 homebuyer’s tax credit is not likely to occur. Not only have lawmakers renewed the credit this week, the program has been expanded to include a smaller tax break for folks who already own a home and want to trade up (or retirees who want to trade down).

While the home-buying incentive by itself will not reinvigorate a deeply bruised housing sector, it should supplement other positive developments that point to a brighter near-term future for it as well as the broader economy. One of the most important is the improving financial environment, which is breathing more life into heretofore credit-starved households and businesses. The sustained low level of interest rates is a key component of this improvement. Mortgage rates on 30-year fixed rate loans, for example, slipped back under 5 percent this week for the first time in more than a month, touching levels not seen since the 1960s. Just as important, banks are easing their collective foot off of the credit brakes, indicating that the massive Federal Reserve/Treasury effort to restore a normally functioning financial system is finally bearing fruit.



The process is far from complete, of course, but it is heading in the right direction. According to the latest Federal Reserve Survey of senior bank lending officers, the percentage of banks that are tightening standards and terms for most loan categories continued to decline from the peaks reached late last year. That improving trend is more apparent for businesses than consumers, which should come as no surprise as the debt-servicing capacity of households has been much more compromised during the grueling recession and still jobless recovery than was the case for most companies. Indeed, with the mind-set of households focused on reducing debt burdens and repairing balance sheets, the lackluster demand for consumer loans is dampening the negative impact that restrictive credit conditions might otherwise have on household spending.

More important is the growing willingness of banks to extend loans to businesses. In the October survey released this week, the net fraction of banks that tightened standards for companies of all sizes fell to about 15 percent from over 30 percent for those reporting in the July survey. Last fall, more than 80 percent of banks said they were tightening the lending screws, meaning that the credit spigot was virtually turned off. That was not critical for large firms, as the capital markets opened up pretty quickly this year, facilitating a record volume of bond offerings by both investment-grade as well as less creditworthy companies. Their lofty yield spreads over Treasury issues, which have narrowed considerably since late last year, proved to be attractive to yield hungry investors in a Fed-induced low rate environment.

But small and medium sized businesses do not have access to the capital markets and are forced to rely heavily on banks to sustain, much less expand, operations. What’s more, many small business owners use their personal credit cards to obtain working capital, which left them vulnerable to the same restrictive practices that banks apply to households in general. Keep in mind that small businesses account for more than 50 percent of job creation, so their inability to borrow is one of the biggest headwinds impeding the recovery. But the latest loan officer survey indicates that the credit freeze is thawing dramatically for small businesses as well. In October, the net fraction reporting tightening standards had fallen to about 16 percent from 75 percent a year ago.

To be sure, small businesses will not rev up operations simply because banks are more willing to extend credit. Just like their larger brethren, these firms retain a healthy dose of skepticism regarding the demand for their products and services. What’s more, they are understandably confused over the healthcare reform proposals emanating from Capitol Hill. The House-passed version includes a provision that would force companies to either offer a health plan to workers or pay a hefty tax if they decide not to. The prospective bills circulating in the Senate do not carry such a mandate. It stands to reason that many small companies will simply refrain from taking on new help until the confusion is resolved in a final bill, something that may not be enacted for quite a few more months despite the more optimistic timetable projected by Senate majority leader Harry Reid.

Unfortunately, it is the job market where the rubber meets the road with regards to the economic outlook. On this score, there is still a yawning gap between the surprising strength in economic activity and the dormant state of labor conditions. Whatever is sustaining the spending pace of consumers in recent months, it will not continue to be a driving force unless more households receive paychecks. By all accounts, that prospect is still a ways off. True, the pace of layoffs continues to recede as manifested by the persistent decline in the number of laid-off workers applying for unemployment benefits. As the chart shows, first-time claims have fallen sharply from their peak levels seen during the spring. In the latest week, the number of new filings slid to 502 thousand, the lowest since the first week of the year, and the four-week moving average for this series is the lowest since last November. As encouraging as this trend is, the absolute numbers are still far too high for a recovery. A more normal pace of first-time claims would be around the 350-400 thousand level.



Indeed, the jobless claims metric tells us more about the plight of the unemployed than it does about the trend in payrolls. Even for the jobless, the story is somewhat distorted. True, the receding number indicates that companies are firing fewer workers than before. But those already on the jobless rolls are having a tougher time finding a new position than any time since the 1930s, as more than a third have been out of work for at least 27 weeks. Studies show that the longer a worker is out of a job, the more difficult it is for him or her to land a new one for a variety of reasons. And when they do, it usually is for a lower paying job than the one held before. That said, the slide in first-time claims for jobless benefits is happening at a faster pace than was the case immediately following each of the last two recessions, which suggest that a pick up in hiring may occur faster than is generally expected.

While the claims data are more correlated with firings than hirings, there is a relationship with the latter. According to some economic models, the current 502 thousand claims number is consistent with a 100 thousand decline in monthly payrolls, which is considerably smaller than what the Labor Department has been reporting in recent months. We suspect that a few more months of net payroll declines still lie ahead, but the inflection point leading to net job creation is close at hand. Up till now, the growth in the economy during the third and fourth quarters has been generated by productivity gains, which spurted to an astonishing 9.5 percent annual rate over the summer months. But companies can squeeze just so much output out of an ever-leaner labor force before hitting a ceiling.

We suspect that the productivity surge has reached its limit, and further output gains will soon have to be accommodated by increasing the workweek and expanding payrolls. In fact, the economy has never expanded by more than 3 percent for two consecutive quarters without an increase in payrolls taking place. It's still early, but another quarter of 3 percent growth is not out of the question for the fourth quarter, which would meet that two-quarter threshold for job creation. To be sure, there are some unusual forces fueling growth in the second half of the year, including a huge amount of Federal stimulus that will be fading at the start of the new year. If the economy falters in early 2010, so too might the hiring propensity of companies. That prospect is being given high odds by mainstream economists who are predicting a sub- par recovery through most of next year. But that seems to be a tendency at the start of most recoveries, particularly those that have followed harsh recessions. More often than not, the economy bounced back much quicker and faster than anyone expected. Given the headwinds that still prevail, a repeat of that scenario should be considered a long shot. Nonetheless, history suggests that it is wise to be prepared for upside surprises.


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Weekly Economic Commentary

WEEKLY ECONOMIC COMMENTARY
Stone & McCarthy Research Associates
WEEK OF NOVEMBER 6, 2009

Even the most die-hard optimist would admit the economy faces a number of headwinds that will keep it operating below its potential for some time to come. Forget the time-honored notion that the deeper the recession, the stronger the recovery that follows it. That notion has credibility only when recessions are caused by garden-variety cyclical forces, such as an overly aggressive monetary policy aimed at stamping out inflation, a steep inventory correction or a temporary shock that reduces the supply of a vital commodity, like oil. Once those growth-dampening forces are lifted, the pent-up demand suppressed during the recession can be unleashed, propelling the economy onto a rapid growth path. The greater the suppression during the downturn, the stronger is the ensuing catalyst the spurs a speedier recovery.

But the Great Recession that presumably ended in the second quarter was not initiated by garden-variety forces, but rather by a housing-related/ credit crisis that is still unwinding and impeding the recovery process. For too many years, the economy relied heavily on a housing bubble, overly easy credit and the willingness of households to borrow extensively against their burgeoning home equity to support spending. But the housing collapse and plunge in home values over the past two years have left households with a mountain of debt, inadequate savings and a shattered mind-set that will promote a much more cautious spending behavior until balance sheets are repaired, a process that may take years. Meanwhile, the surge in capital-eroding loan losses associated with the rising tide of foreclosures, bankruptcies and credit-card delinquencies have created a much more restrictive credit environment than typically prevails at the onset of a recovery.

History shows that the bursting of a housing-related asset bubble combined with a financial crisis leaves a severe hangover that suppresses economic activity for a considerable period after a recession. This time should be no different. Indeed, only the unprecedented intervention of monetary and fiscal policies together with a host of emergency measures to stabilize the financial system enabled the economy to overcome the powerful headwinds that drove it into the Great Recession. The financial system is healing, although still far from functioning normally, and households are slowly repairing their balance sheets - rebuilding a cushion of savings and paying down debt. Until the process is further along, however, the nascent recovery will be missing the early spark that has jump-started the growth engine in past cycles. If nothing else, these lingering headwinds mean that it will take longer than usual for the economy to make up the extensive ground lost during the recession.

Just how long it takes for the economy to reach its potential is open to debate. But one thing is clear: the trend in the job market will be a vital influence. Indeed, looking back over the post-war era, the strongest recoveries following recessions were accompanied by a fast revival in job creation. Conversely, weak recoveries were associated with weak job markets that lingered well after the recession ended. The most glaring example of the latter was the tepid recovery that followed the 2001 recession, the so-called "jobless recovery" when it took nearly two years before the economy started to generate net new jobs following the trough. We would be very surprised if it took that long this time, but assuming the recession ended around July, the wait so far is three months and counting. Considering that the recession extinguished more jobs both in absolute and percentage terms than any other since the late 1940s, the imperative to kick-start the job-creating engine is greater than ever.

The latest jobs report, released on Friday, reveals that the U.S. is edging closer to that point, but at far too slow a pace to satisfy the growing number of workers on the unemployment lines. Yes, the figures once again portrayed a picture that is getting "less bad" as the green shoot fans keep reminding us. In October, companies outside of the farm sector shed 190 thousand workers from payrolls, far less than what was taking place earlier in the year. What's more, the originally-reported job losses of 263 thousand in September and 201 thousand in August were revised down to 219 thousand and 154 thousand, respectively, resulting in 91 thousand more workers drawing paychecks than originally estimated. Hence, the trend is the friend of people looking for jobs. In the first quarter of the year, payrolls were being slashed by an average of 691 thousand a month, so the pace of job losses has been cut by two thirds since then.



True, the October reading was somewhat of a disappointment to economists who had forecast a smaller drop in payrolls of about 150 -170 thousand last month. That more optimistic expectation was based on a surprisingly large decline in initial claims for jobless benefits reported on Thursday and a relatively upbeat employment showing in the latest surveys of manufacturers and service sector companies taken by the Institute for Supply Management. But the disappointment was tempered by the upward revision to the prior two months, which solidified the improving trend underway since the beginning of the year.

Moreover, the forward-looking indicators are pointing to a continuation of that improving trend. As we have frequently noted in the past, companies tend to be highly cautious during the initial stage of a recovery, as they wait for firmer evidence that the recovery will be sustained. Hence, rather than immediately hire new workers at the first sign of a revival in demand, they first expand the workweek and hire temporary workers. The initial leg of that employment dynamic appears to be underway. The number of temp jobs increased by 34 thousand in October, the third consecutive monthly gain, and the workweek held steady at 33 hours; the manufacturing workweek actually edged up from 33.9 to 40 hours, the longest in a year. Historically, the trend in temporary workers leads overall payroll trends by about six months. Based on that metric, net job creation should commence sometime during the early part of 2010, which is about in line with our expectations.

But it will take a while before the pace of job creation is strong enough to absorb both the influx of people looking for jobs as well as the growth in the working-age population. What that means, of course, is that the headline-grabbing unemployment rate will look ugly for some time to come. As it is, this rate, which is tabulated from a survey of households rather than companies, is portraying a gruesome enough picture. The October rate spiked above the psychologically sensitive threshold of 10 percent, hitting a 26-year high of 10.2 percent. To be sure, it was only a matter of time before the 10 percent handle was pierced, and the fact that it happened so abruptly may, in fact, have provoked a sigh of relief in financial circles; instead of dreading the anticipation, investors can now take solace in the belief that the worst is over. That prospect, however, is far from baked in the cake, as many analysts believe that it will top 11 percent before all is said and done.



If it does hit 11 percent, it would exceed the 10.8 peak reached during the harsh 1981-82 recessions and set a new high for the post World War 11 period. But even if it doesn't, the current labor market is in many respects the weakest since the 1930s. One measure that is often cited as reflective of this weakness is the government's broad U-6 tally, which includes not only workers officially classified as unemployed but those who are working part-time for economic reasons and those too discouraged to look for a job but want one. In October, the U-6 rate hit an all-time high of 17.5 percent, up from 17 percent in September. This measure, unfortunately, only covers the period starting in 1994 and, hence, can't be compared with the 1982 recession. However, other employment barometers suggest that workers are in more dire straits now than then.

The most telling from our lens is the length of time it takes to find a new job after being laid off. By any stretch of the imagination, the job search couldn't be grimmer. In October, the average duration a laid-off worker remained on the unemployment lines was 26.9 weeks, well above the previous high of 21.2 weeks spent job searching in the early 1980s. To take another perspective, more than a third of unemployed workers - 35.6 percent to be precise - were out of a job for at least 27 weeks compared to a high of 25.7 percent in the early 1980s. The plight of the unemployed has not gone unnoticed in Washington, as a bill to extend unemployment benefits by 14 to 20 weeks was signed by the President on Friday.



Needless to say, the sorry state of the job market only reinforces the above-noted headwinds that will restrain the strength of the recovery. With households focused on paying down debt and repairing balance sheets, the major source of spending going forward will be income growth. But until companies start to beef up payrolls, wages and salaries will not increase nearly fast enough to support anything but modest spending increases. And, with existing workers fearful of losing their jobs amidst a still-climbing unemployment rate, they are likely to spend even less out of their paychecks than they would in more robust times.

That's the bad news. The good news - in a relative sense - is that the bad news is indeed becoming less bad and pointing towards a positive outcome in the not-too-distant future. Our sense is that by sometime in the early part of 2010, the job market will turn positive, with both the workweek and payrolls increasing. The unemployment rate lags the trend in payrolls, so that headline-grabbing metric will probably not start to recede until at least mid-year and will remain elevated well into 2011. For those speculating when the Federal Reserve will start lifting interest rates as the recovery progresses, keep in mind that it has never done so before the unemployment rate starts to decline. Given how high the starting point is and the absence of any inflationary pressures whatsoever, it is hard to believe that rate increases will be considered before the second half of next year. The prospect of a friendly Fed for an extended period of time is probably the major reason the financial markets did not respond negatively to the generally dour jobs report on Friday.


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