Posted by on 08.11.16
As the presidential political season approaches its climactic months, there is growing evidence that the U.S. economy is functioning far better than the headlines. At its foundations, however, the economy is showing cracks. Businesses have slowed the pace of hiring. Corporate earnings continue to decline. Uncertainty about the coming year, perhaps magnified by election rhetoric, seems to be dampening business investment. At the same time the underpinning of the economy, the U.S. consumer, seems to be clearly split about the health of his or her own household finances compared to those of the nation.
A survey by the Associated Press/NORC Center for Public Affairs Research showed that 42 percent of Americans felt the U.S. economy was in good health, while 66 percent judged their own financial condition to be strong. Behind the responses were concerns about another financial downturn, stock market volatility and especially the negative sentiments of the political trail. Only one in three respondents expressed confidence that they could quickly find employment in the event of a layoff.
The evidence of the dampening influence of the political rhetoric showed up in the disparity of responses of Democrats and Republicans. Among those identifying themselves as Republicans, only 34 percent described the economy as good, compared to 54 percent of the Democrats. The outlook was even more divided, with 38 percent of Republicans expecting the economy to deteriorate in 2016 compared to only 18 percent of Democrats.
Similar divergences existed in May between sentiment and data. Consumer confidence, as measured by the University of Michigan/Reuters and Conference Board surveys, has been in a slightly downward trend since the first quarter of 2015, yet consumer spending continues its multi-year pattern of outstripping gross domestic product (GDP). April’s retail spending jumped 1.9 percent and forecasts for the full year spending growth remain at or above four percent, even though GDP estimates for 2016 have been moderated to two percent.
Hiring had also been disconnected from sentiment until late spring. Surveys of business owners find that plans for investment have fallen off for 2016, including capital spending. Yet the pace of hiring remained brisk for a business cycle that is now in its seventh year of growth. May’s lack of job creation – employers added only 38,000 to the payrolls – was a warning sign that expansion is coming to an end, although other data reinforced the strength of the labor market. Jobless claims fell to 268,000 in late May. Even at the granular level the data is debunking myths about the health of the labor market. For example, unemployment among college grads is only 2.4 percent, compared to 5.9 percent of those with no more education than a high school diploma. The Labor Department’s data is at odds with the popular narrative that debt-burdened recent college grads aren’t finding jobs.
Figure 1: U.S. employers have added 14 million jobs during the past five years but payroll expansion may be reaching an end.
What is clear thus far in 2016 is that the behavior of individual businesses and consumers betrays an optimism that is not being expressed in the aggregate. Americans have gotten their finances in order and are spending, even as they express concerns about the near-term economic outlook. Businesses are hiring and investing in construction, even as business owners respond to surveys about the coming year in increasingly negative terms.
It’s unusual for sentiment and action to run in opposite directions for very long. As the economy rebounded from the financial crisis, a crisis in confidence kept both consumer and business spending muted right through 2013. With a presidential campaign that is likely to be toxically negative in the summer and fall, and a 24/7 news cycle to cover every word, it’s not hard to see faltering confidence turn to inaction. After a first quarter with 0.5 percent GDP growth, the U.S. economy can’t afford to have uncertainty chill activity.
According to the National Income and Product Account profit reports for the first quarter of 2016, earnings for the S&P 500 decline seven percent from the first quarter of 2015. The energy sector led decliners, with a drop of 107 percent year-over-year. Companies in the consumer discretionary sector saw the biggest gains, with an aggregate increase of more than 19 percent.
The slowing profit growth is one likely cause of the slowing wage growth. History has shown that decelerating profits and accelerating employment growth can coexist for an extended period of quarters, although eventually smaller profits will be addressed by reducing payrolls. To the extent slower earnings affects commercial real estate, the current state is likely to keep interest rates from being hiked and inflation in check at low levels. Continued weak profit growth does dampen demand for space, however, and the nearly ten percent increase in sublease space available – which bottomed out one quarter ahead of the peak for corporate profits in 2014 – is a reflection of that.
Through the first five months of 2016, however, data on the construction and real estate markets are still strong.
One segment of the economy that continues to show strength is the housing market. The National Association of Home Builders most recent survey again registers confidence from builders. Existing home sales were 5.45 million in April and new home sales were up steeply to 619,000, an increase of 100,000 units over the estimate.
Although the massive overhang of foreclosed homes that followed the mortgage crisis worked off several years ago, the supply of so-called “zombie” foreclosures lingered until recently. These were homes that were in the process of foreclosure but had no occupants. After banks moved too quickly to push homeowners into the foreclosure process, there was an overreaction in the opposite direction, particularly where no one occupied a home with a non-performing mortgage. Since the beginning of 2016, lenders have moved to close the books on these homes, discounting them to sell. The effort has reduced the total number of zombie properties to 19,187 by May 1, with 63 percent of those located in the five states that require court approval for foreclosure.
Inventories of new and existing homes are extremely tight. At the current pace of sales, the inventory of homes in the market would be depleted in 4.7 months. The short supply is reflected in pricing, as median existing home prices were up 6.3 percent year-over-year and new home prices spiked 9.7 percent from April 2015.
All of this good market news was reflected in April’s housing start data. Construction of new homes jumped 16.8 percent year-over-year in April to 778,000 single-family units (seasonally adjusted). In the June 1 U.S. Census Bureau of the Department of Commerce announcement, spending on residential construction fell 1.7 percent from March to April, but the $445.7 million was 7.7 percent higher than April 2015.
Figure 2: New home construction continues to recover even as pent-up household formation demand builds.
The Census Bureau report showed that construction spending during April 2016 was estimated at a seasonally adjusted annual rate of $1.134 trillion. The April volume was 1.8 percent below the revised March estimate but 4.5 percent above the volume in April 2015. During the first 4 months of 2016, construction spending amounted to $334.8 billion, 8.7 percent more than the same period in 2015.
Spending on private construction was at a seasonally adjusted annual rate of $843.1 billion, a year-over-year increase of 5.7 percent. The annual rate of public construction spending was $290.8 billion, a 2.9 percent decline from March and an increase of only 1.2 percent from a year earlier.
U.S. construction markets have thus far followed the playbook that nearly all economists forecasted for 2016. Those predictions were based on GDP growth that was in the range of 2.5 percent. While a strong second quarter could see the growth rate get back on that pace, most economists have moderated expectations for GDP growth to two percent or less.
Data on construction through May reflects demand for roughly six-to-eight percent more space and a similar rate of growth in dwelling units. Activity during the time periods measured thus far reflects decision-making that would have occurred early in the year, before the political situation and global economic picture were as clear. The true test of the strength of demand will come as decisions about expansion are made during the coming months. Should business owners and consumers be feeling more confident than public sentiment surveys are showing, the arc of construction growth should continue its climb at a rate above five percent. A falloff in construction activity during the summer months, however, will confirm the fears that uncertainty is ruling the market again.