The "less bad" economy that started on a technical bounce in March continues to find support from decelerating and up-ticking economic indicators such as consumer confidence, ISM manufacturing and non-manufacturing, new jobless claims, and durable goods. The most important of these is consumer confidence and the follow-through we need to see in retail sales (demand).
One of the first signs an economist looks for in a market recovery is a return of consumer confidence. Since 71% of our GDP comes from consumption, the health of the consumer is directly proportional to the health of the economy. The consumer confidence reading was released last week at 54.9 in May, a jump of 15 points, blowing out expectations. The rating has improved based on an improvement in expectations over business conditions, employment, and income.
Changes in expectations do not always correspond to changes in spending initially. Notice that retail sales have declined for the past three months on the chart above. While spending has not improved greatly, it has decelerated and that’s something that bulls are looking for. Below, the year-over-year percent change in expenditures hasn’t been lower than it was late last year, but the short-term trend is down.
Right now, it is quite clear that consumers are continuing to deleverage their balance sheet. The Consumer credit report came out last Friday, down .7 billion. On top of the absolute decline, there was a revision down from an .1 billion decline to .6 billion for March. Credit decreased at an annual rate of 7.5% in April—a slight up-tick from the annualized drop of 7.8% in March, but one tick isn’t a good measure of a trend. We’ll need another couple of readings to see if there is a trend establishing here.
Here is the debt to income ratio, reinforcing consumer deleveraging:
Why is the consumer still retrenching? Hard times are still here. We are either at the very worst of the economic downturn, and the point of inflection, or green shoots are going to die. The probability of a relapse is predicated on unemployment, interest rates, and a break in the recent stock market rally.
Employment nonfarm payrolls fell less than expected last week to a decrease of 345,000 jobs. Consensus had forecasted a decrease of 530,000 jobs. As a result of the decrease in jobs, unemployment climbed to 9.4%. This is the highest since 9.5% unemployment in August of 1983.
The unemployment rate is the number of unemployed as a percentage of the labor force. Discouraged laborers may leave the labor force because they are no longer actively seeking employment. This can understate the unemployment rate. At the same time, a large amount of teenagers and college graduates should be entering the workforce now and they may find a difficult time finding a job; and therefore, seasonally overstating unemployment. The unemployment rate for teenagers jumped 1.2% to a rate of 20.7% in May. In contrast, the rate of unemployment in adult men is 9.85 and 7.5% for adult women, up 0.4% each in May.
The decrease in employment is decelerating. It is possible to see the employment rate continue higher even at the absolute trough in the economy as discouraged laborers enter back into the labor force looking for a job. This is one reason why many feel it is a lagging indicator.
The other factor hitting the consumer is interest rates. As interest rates climb, so do mortgage rates. As mortgage rates climb, so does the cost of debt to buy new homes for borrowers and in adjustable rate refinancing. This year, mortgage refinancing is continuing at a feverish pace. Thankfully, most are switching from adjustable rate mortgages to fixed mortgages. On a positive note, according to the Standard and Poor’s, the percentage change in mortgage loan applications have gone from negative 31% in February, to positive 37.8% in March, and up 13.7% in April in comparison with a year ago. The month’s supply of new homes has been fluctuating between 10 and 11 months for a year. The same can be said with existing home month’s supply which has been fluctuating between 9 and 10 months for the past year.
Interest rates continue to rise on the 10-year Treasury bond since the start of the year. Many commentaries have been written in the past on www.financialsense.com that this is the next bubble to burst. I’m a believer. The 30-year rate is up an astonishing 29% in the first five months of the year.
These rates are having an ill-effect on mortgage rates. The 30-year fixed rate mortgage has turned up after taking a break in early Q2.
Overall, the trend has been down for some time. A chart of the average 30-year mortgage rate since 1971 shows the same interest rate mountain as the 30-year Treasury bond.
Higher interest rates could spell trouble in addition to unemployment for this economy. Short-term rates have been kept artificially low by central bank intervention, but the long end has been creeping higher. Eventually the long end will have enough pull to bring short-term rates up. Considering there was no mention of any more quantitative easing by Ben Bernanke last week, but instead pressure on Congress deficit spending, it will be very interesting to see what happens at the next Federal Reserve Bank meeting late this month in light of recent interest rate developments.
Finally, the stock market’s rally stands on the edge of a spring board, poised to reach the next echelon higher or doomed in an economic relapse. Technically, the market broke through very key resistance last week on Monday when the S&P 500 stepped above the 200-day average to take a peek at what a bull market looks like. As long as the stock market stays bullish, consumer sentiment and confidence should continue to improve.
Let me preface my commentary by first saying that I’m bullish on the stock market. There are some interesting developments currently. The first is declining volume since May 7th. While we should see rising volume with rising price, it is fairly common in a consolidation period to see volume dissipate. It did as such for two weeks before it broke to new highs on June 1st. The breakout should have been accompanied by volume, but it did not. There seems to be a little apprehensiveness since the breakout last Monday, but we haven’t broken down.
The S&P 500 finally caught up with the NASDAQ in breaking above the 200-day average. Despite the bullishness of this attribute, the average is still declining. A bull market is defined by a rising 200-day average. Before that can happen, the market must first be trading above it.
Despite the declining volume, the difference between advances and declining issues has been bullish in the recent run up last week. Here is a chart of the exchange’s advances to declining issues:
While the consumer’s confidence has improved over the past few months, they have decided to confidently be unconfident. The consumer has not reached the next step in coming to the economy’s rescue through consumption. Retail sales have recently declined and the consumer is continuing to deleverage. The probability of an economic relapse is predicated on unemployment, rising interest rates, and the stock market’s performance. Consumers are telling us they feel better about their future, but they’re not going to start shopping again until we see more of an improvement in the three areas listed above.
