– February 10, 2021 Reading Time: 11 minutes

AIER’s Business Cycle Conditions indexes were little changed in January with the Leading Indicators Index and Roughly Coincident Indicators Index both holding solidly above the neutral threshold of 50; the Lagging Indicators Index remained well below neutral. The Leading Indicators index came in at 75 for a fourth consecutive month and the fifth month above neutral. The Roughly Coincident Indicators index fell back to 83 after posting a 92 in the prior month while the Lagging Indicators Index rose to 25 from 17 (see chart). The results suggest continued economic expansion in the months ahead.

Despite five months of solid results from the Leading Indicators Index, economic data overall continue to show varied strength among the major sectors of the economy. Notable among the sectors is the strong performance of the housing sector. Sales and construction have been robust, especially for single-family units. Supported by low mortgage rates, demand appears to be getting a boost from urbanites moving to less densely populated areas. However, the period of strong demand is boosting home prices and the improving economy is pushing mortgage rates up slightly, both of which will likely contribute to some cooling of demand in future months. Wider distribution of a vaccine and confidence by urban homeowners and renters that urban living is no riskier than suburbia or rural living may also soften future demand.

Business investment also had a strong performance in the final quarter of 2020. Some strength may be related to Covid-19 retooling and some may be a result of labor difficulties. Regardless, business investment helped boost the economy in the final quarter of the year.

On the weaker side, consumer spending softened towards the end of the year as did some measures for the labor market. Better performances for both will be crucial for the economy in 2021.

For now, government policies continue to distort activity by consumers and businesses, and the number of new Covid-19 cases continues to attract attention. Looking ahead, vaccine success and lower numbers of new Covid-19 cases as well as the cessation of restrictive policies remain the most important factors for restoring pre-pandemic activity levels and growth rates for the economy.

Leading Indicators index remains solidly above neutral

The AIER Leading Indicators index remained unchanged at 75 in January. The January result is the fifth month in a row above the neutral 50 threshold and the fourth at 75. The results suggest continued overall economic expansion as three-quarters of the individual indicators are trending higher. In total, 9 of the 12 leading indicators maintained a positive trend in January, with 3 trending lower and none were neutral.

Positive (favorable) trends continued for the average workweek in manufacturing, real retail sales and food services, real new orders for core capital goods, real new orders for consumer goods, total heavy-truck unit sales, the ratio of manufacturing and trade sales to inventory, housing permits, debit balances in customers’ margin accounts, and real stock prices.

Downward (unfavorable) trends remained in place for the University of Michigan index of consumer expectations, initial claims for unemployment insurance, and the 10-year–1-year Treasury yield spread. All 12 indicators were the same for the fourth month in a row.

Overall, the Leading Indicators index remains above 50, indicating continued expansion is likely. However, government policies continue to distort economic activity and threaten future growth.

The Roughly Coincident Indicators index fell to 83 in January, following a 92 reading in December. This index has risen rapidly from a zero reading in August, with the last four months coming in above the neutral 50 threshold. Two indicators changed trend in January as the employment-to-population ratio improved from a neutral trend to a favorable trend while the consumer confidence indicator for the present situation dropped from a favorable trend to an unfavorable trend. Overall, five indicators were trending favorably while one was in an unfavorable trend and none were in a neutral trend.

AIER’s Lagging Indicators index rose to 25 in January following back-to-back readings of 17 in November and December and back-to-back zeros in September and October. Just one indicator changed trend in the latest month: real manufacturing and trade inventories improved from a neutral trend to a favorable trend. Overall, four indicators were trending lower, one indicator was trending higher, and one was in a neutral trend.

Real Gross Domestic Product Posted A Solid Gain in the Fourth Quarter, but Remains Below Trend

Real gross domestic product rose at a 4.0 percent annualized rate in the fourth quarter, down from a 33.4 percent pace in the third quarter, according to the Bureau of Economic Analysis. The two increases follow drops of 5.0 percent and 31.4 percent at annualized rates in the first and second quarters, respectively. Despite the two gains, real gross domestic product remains 2.7 percent, or more than $500 billion in real terms, below trend.

Measured from fourth quarter 2019 to fourth quarter 2020, real gross domestic product decreased 2.5 percent. For calendar year 2020, real gross domestic product fell 3.5 percent versus calendar 2019.

Real final sales to private domestic purchasers, a key measure of domestic demand, rose at a 5.6 percent pace in the final quarter of 2020 following a 39.0 percent annualized gain in the third quarter. This important gauge is still 3.1 percent, or more than $520 billion (in real terms), below trend.

Consumer Spending was moderate, with growth concentrated in services

Consumer spending decelerated in the fourth quarter, rising at a 2.5 percent pace following a 41.0 percent rebound in the third quarter. Durable-goods spending was unchanged for the fourth quarter, nondurable-goods spending fell 0.7 percent, and services rose 4.0 percent. Within services, housing services (a made-up number) rose at a 3.2 percent rate while health care services surged 12.4 percent. Consumer spending contributed 1.7 percentage points of the 4.0 percent real gross domestic product growth rate, with housing accounting for 1.35 percentage points and health care adding 1.33 points. Most other areas of consumer spending were lackluster in the fourth quarter.

Business investment performed well in the fourth quarter

Business fixed investment rose at an 18.4 percent annualized rate in the fourth quarter. At annualized rates, the gain was led by a 24.9 percent jump in equipment spending while intellectual property spending rose 7.5 percent and investment spending on structures rose 3.0 percent. Real business investment contributed 3.0 percentage points to overall real gross domestic product growth. Some of the strength may reflect retooling of work areas to accommodate Covid-19 requirements or efforts to boost labor productivity to offset absenteeism and/or labor shortages.

Core Capital-Goods Orders Hit A Record High in December, suggesting a positive outlook

New orders for durable goods posted an eighth consecutive gain in December, rising 0.2 percent following a gain of 1.2 percent in November. Total durable-goods orders are up 3.8 percent from a year ago.

Durable-goods orders excluding aircraft and parts rose 0.7 percent for the month following 1.1 percent gains in the prior two months. That is the fourth increase in a row and the seventh gain in the last eight months and puts the level of orders at $241.3 billion, a new record high.

New orders for nondefense capital goods excluding aircraft, a proxy for business equipment investment, rose 0.6 percent in December after gaining 1.0 percent in November, putting the level at $71.8 billion, a new record high. This important category had been in the $65 to $70 billion range for several periods over the past 15 years before dropping to $61.3 billion in April 2020. The $61.3 billion pace was the slowest since June 2017.

All but two of the major categories of durable goods shown in the report had a gain in the latest month. Among the individual categories, primary metals rose 0.3 percent, fabricated metal products gained 0.6 percent, machinery orders were up 2.4 percent, electrical equipment and appliances gained 0.1 percent, and the catch-all “other durables” category was up 0.5 percent. The two decliners were transportation equipment orders, down 1.0 percent and computers and electronic products, down 0.2 percent. Within transportation, motor vehicle and parts orders rose 1.4 percent, but the gain was offset by a 51.8 percent plunge in nondefense aircraft orders and a 5.0 percent fall in defense aircraft orders. Within the computers and electronic products category, computer-product orders fell 3.4 percent while communications equipment orders rose 0.3 percent.

Home construction remains a bright spot

Real residential investment (home construction) rose at a 33.5 percent pace in the fourth quarter compared to a 63.0 percent surge in the prior quarter. Home construction contributed 1.3 percentage points to overall growth in real gross domestic product in the fourth quarter.

Monthly data suggests continued strength

Single-family homebuilding posted another strong performance in December as housing starts and permits rose again while homebuilder sentiment eased back but remained at a very high level. Total housing starts rose to a 1.669 million annual rate from a 1.578 million pace in November, a 5.8 percent increase. The December gain is the seventh rise in the last eight months since hitting an April low. From a year ago, total starts are up 5.2 percent.

The dominant single-family segment, which accounts for more than eighty percent of new home construction, rose 12.0 percent for the month to a rate of 1.338 million, the highest since September 2006. Single-family starts are up 27.8 percent from a year ago.

Starts of multifamily structures with five or more units fell 15.2 percent to 312,000 and are off 40.0 percent over the past year.

For housing permits, total permits rose 4.5 percent to 1.709 million in December. Total permits are 17.3 percent above the December 2019 level. Single-family permits were up 7.8 percent to 1.226 million, the highest rate since August 2006 while permits for two- to four-family units fell 11.5 percent to 46,000 and permits for five or more units dropped 2.0 percent to 437,000. Continued gains in single-family permits suggest additional gains in home construction in coming months.

Builder sentiment eases but remains high

While current activity measures are very positive, the National Association of Home Builders’ Housing Market Index, a measure of homebuilder sentiment, fell slightly for a second consecutive month. The pullback is primarily due to surging materials costs, especially lumber, difficulty finding qualified labor, and resurging Covid-19 cases. Despite the decreases, overall sentiment remains relatively high.

The Housing Market Index fell to 83 in January, down from 86 in December but still very positive. All three components of the index had declines in the latest month but also remained at very high levels. On a regional basis, all four regions had declines in January but were also still at historically favorable levels.

Single-family home construction activity has recovered sharply since the April low as lockdown restrictions that impacted both construction workers and potential customers were eased. Furthermore, mortgage rates remain low by historical comparison (though they have drifted higher recently), providing support for the housing recovery while rising prices and tightening lending standards are headwinds for affordability and financing.

Labor Market shows some signs of weakness

Initial claims for regular state unemployment insurance totaled 779,000 for the week ending January 30, down 33,000 from the previous week’s revised tally of 812,000. Claims have eased back for three consecutive weeks since jumping in early January. Still, initial claims have continued to run in the 700,000 to 1 million range for 23 consecutive weeks and remain well above the pre-pandemic level of 212,000 in early 2020.

The four-week average fell slightly, off 1,250 to 848,250. The four-week average has drifted higher since hitting a low of 740,500 for the week of November 28, rising in eight of the last eleven weeks. Persistent initial claims at such a historically high level remain a threat for the labor market recovery and the economy.

The number of ongoing claims for state unemployment programs totaled 5.188 million for the week ending January 16, down 258,852 from the prior week. State programs had been trending lower since early March, but the downward trend has turned to a flattish trend since the week ending November 21. For the same week in 2019, ongoing claims were 2.076 million.

Continuing claims in all federal programs fell in the latest week following the prior week’s surge, coming in at 12.647 million for the week ending January 16, off 227,553.

The total number of people claiming benefits in all unemployment programs including all emergency programs was 17.836 million for the week ended January 16, down 486,405 from the prior week.

Two consumer surveys suggest short-term pessimism, medium-term optimism, and big partisan divides

The final January results from the University of Michigan Surveys of Consumers show overall consumer sentiment fell in January and remains well below pre-lockdown levels, though well above prior cyclical lows. Despite the small decline, the details show deep partisan differences, especially for consumers’ expectations.

Overall consumer sentiment decreased to 79.0 in January, down from 80.7 in December, a 2.1 percent decline. From a year ago, the index is down 20.8 percent. The sub-indexes both fell in January. The current-economic-conditions index dropped to 86.7 from 90.0 in December. That is a 3.7 percent decline and leaves the index with a 24.2 percent decrease from January 2020. The second sub-index — that of consumer expectations, one of the AIER leading indicators — sank 0.6 points or 0.8 percent for the month to 74.0 and is 18.2 percent below the prior year.

All three indexes remain well below the pre-pandemic levels, with the Current Economic Conditions index 22.9 percent below its 2018-2019 average and the Index of Consumer Expectations 15.2 percent below the recent average. Combined, the overall index sits 18.7 percent below the pre-pandemic average. All three are also well above the lows from the last recession: 55.3 for the overall index, 57.5 for the present situation index, and 49.2 for the expectations index.

According to the report, “The overall stability of consumer confidence has benefitted from wearing masks and social distancing, the quick substitution of home for office work, and the prompt distribution of generous federal benefits. These factors helped to absorb the pandemic’s negative impact on the economy as well as on personal finances.”

Regarding the partisan divide, the report goes on to add, “In contrast to the reduced levels but relatively stable trends in consumers’ economic expectations, partisan views have remained quite volatile. In the past three months, the Index of Consumer Expectations, the primary gauge for the future performance of the economy, has jumped among Democrats to 91.8 in January from 68.6 in October, and among Republicans it has plunged to 51.4 in January from 96.4 in October. This reverses the shift which occurred when Trump was elected and maintained throughout his term in office. The data also indicate that the weighted average across Democrats and Republicans (74.2) has closely followed trends for Independents as well as the all-household average. The sharp partisan differences have been effectively neutralized with respect to economic expectations, although still exerting a dominant force shaping public discussions.”

The Consumer Confidence Index from The Conference Board rose in January, increasing by 2.2 points to 89.3. The index is constructed so that it equals 100 in 1985. Overall consumer confidence remains well below the pre-pandemic level.

The two major components of the index had mostly offsetting performances for the month though the gain in expectations was slightly stronger than the decline in current conditions. The present-situation component – one of AIER’s Roughly Coincident Indicators – fell 2.8 points to 84.4 while the expectations component rose 5.5 points, taking it to 92.5 from 87.0 in the prior month. The report suggests that the resurgence of Covid-19 is weighing on consumers’ views of current conditions.

For the present situation component, The Conference Board report says, “Consumers’ appraisal of present-day conditions weakened further in January, with Covid-19 still the major suppressor.” The net of the percentage of consumers saying business conditions were good minus those saying business conditions were bad fell to -27.0 in January from -24.3 while the net percentage of consumers saying jobs were plentiful minus those saying jobs were hard to get fell to -3.2 from -1.9.

Regarding the expectations component, the report states, “Consumers’ expectations for the economy and jobs, however, advanced further, suggesting that consumers foresee conditions improving in the not-too-distant future.” Consumers’ expectations for business conditions in six months improved with the net percentage rising to 15.6 from 7.5 while the net percentage expecting better labor market conditions rose to 9.9 from 5.8 in December.

Outlook is cautiously optimistic

Overall, the economy continues to recover from the draconian lockdowns that began in 2020 though the results vary widely among the different sectors. The AIER Leading Indicators index suggests continued expansion in coming months.

Government restrictions on consumers and businesses remain a significant threat to the outlook for economic growth. The development and distribution of vaccines is a very positive development and should eventually lead to sharply less government restrictions. In the meantime, the longer the virus continues to spread (along with the possibility of mutations prolonging the outbreak), consumers remain restricted, and businesses remain closed or limited, the more uncertain a labor market recovery becomes and the higher the probability of a slow and drawn-out economic recovery.

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Robert Hughes

Bob Hughes

Robert Hughes joined AIER in 2013 following more than 25 years in economic and financial markets research on Wall Street. Bob was formerly the head of Global Equity Strategy for Brown Brothers Harriman, where he developed equity investment strategy combining top-down macro analysis with bottom-up fundamentals.

Prior to BBH, Bob was a Senior Equity Strategist for State Street Global Markets, Senior Economic Strategist with Prudential Equity Group and Senior Economist and Financial Markets Analyst for Citicorp Investment Services. Bob has a MA in economics from Fordham University and a BS in business from Lehigh University.

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