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May 12, 2022 Reading Time: 11 minutes

Summary

Volatility continues to impact the AIER business cycle indicators. AIER’s Leading Indicators Index fell back in April, posting an 8-point drop following an 8-point gain in March. The Leading Indicators Index continues to fluctuate around the neutral 50 threshold, with the average over the last seven months coming in at 51 (see chart).

Despite a weak headline from the GDP report, domestic demand in the economy grew at a decent pace in the first quarter and the outlook is for continued growth, but risks remain elevated. Persistent upward pressure on prices, labor shortages and turnover, fallout from the Russian invasion of Ukraine, and new lockdowns in China in response to outbreaks of COVID-19 are among the most significant forces impacting the domestic and global economies and represent potential risks. A new Fed tightening cycle has begun in response to elevated rates of price increase, raising the risk of a policy mistake. While the strong labor market provides support for consumer attitudes, incomes, and spending, it also has the potential to fuel a wage-price spiral.

Increased volatility should be expected to continue in capital and commodity markets, the economy, and economic statistics over coming months. Also expect continued volatility for the AIER business cycle indicators. Caution is warranted.

AIER Leading Indicators Index Falls Back in April

The AIER Leading Indicators index reversed course yet again in April, losing 8 points to 46 after gaining 8 points in March. The April level of 46 is back below the neutral 50 threshold following a 54 in March. Over the last seven months, the Leading Indicators index has been above neutral twice, below neutral twice, and exactly neutral three times, putting the average reading over that time at 51.

Four leading indicators changed signal in April, with three weakening and one improving: the manufacturing and trade sales to inventory ratio indicator moved from a neutral trend to an unfavorable trend as did the real new orders for core capital goods indicator while the real stock prices indicator dropped from a positive trend to a negative trend.  The total heavy-truck unit sales indicator offset the drop in the real stock prices indicator, improving from a negative trend to a positive trend. Among the 12 leading indicators, five were in a positive trend in April while six were trending lower and one was trending flat or neutral.

The Roughly Coincident Indicators index improved for a second consecutive month in April, rising to a perfect 100 following a 92 in March and four consecutive months at 75. One indicator showed improvement in April. The Conference Board Consumer Confidence in the Present Situation indicator improved from a neutral trend to a positive trend. Overall, all six indicators – nonfarm payrolls, employment-to-population ratio, industrial production, the real manufacturing and trade sales, real personal income excluding transfers, and The Conference Board Consumer Confidence in the Present Situation – were trending higher in April.

AIER’s Lagging Indicators index was unchanged for the third consecutive month, holding at 83 in April. February through April was the best three-month run since a four-month run at 83 from July through October 2018. No individual indicators changed trend for the month. In total, five indicators were in favorable trends, one indicator had an unfavorable trend, and none had a neutral trend.

Lingering materials shortages, labor shortages and turnover, and logistical problems continue to slow the recovery in production across the economy and are sustaining upward pressure on prices. Upward price pressures have resulted in a new cycle of Fed policy tightening, raising the risk of a policy mistake. Furthermore, the Russian invasion of Ukraine and recent lockdowns in China in response to a new wave of COVID-19 have launched a new wave of potential disruptions to global supply chains. 

The outlook is for continued economic growth, but risks remain elevated. Additionally, 2022 is a Congressional election year. Intensely bitter partisanship and a deeply divided populace could lead to turmoil as confidence in election results come under attack. Contested results around the country could lead to additional economic disruptions and government paralysis, again testing the durability of democracy. Caution is warranted.

Weak Headline Masks Underlying Resilience in First Quarter GDP

Real gross domestic product fell at a 1.4 percent annualized rate in the first quarter versus a 6.9 percent rate of gain in the fourth quarter. Over the past four quarters, real gross domestic product is up 3.6 percent, putting the level almost exactly on trend.

Real final sales to private domestic purchasers, a key measure of private domestic demand, rose at a more robust 3.7 percent annualized rate in the first quarter following a 2.6 percent pace in the fourth quarter. Over the last four quarters, real final sales to private domestic purchasers are up 4.4 percent, keeping the level slightly above trend. The trend growth in real final sales to private domestic purchasers is 2.6 percent since mid-2009.

Among the components, real consumer spending overall rose at a 2.7 percent annualized rate, beating the 2.5 percent rate in the fourth quarter, and contributing a total of 1.83 percentage points to real GDP. Consumer services led the growth in overall consumer spending, posting a 4.3 percent annualized rate, adding 1.86 percentage points to total growth while durable-goods spending rose at a 4.1 percent pace, contributing 0.35 percentage points. However, nondurable-goods spending fell at a -2.5 percent pace, subtracting 0.38 percentage points. Within consumer services, growth was broadly strong, led by financial services (6.3 percent growth rate), recreation (5.5 percent), and food services and accommodation (5.0 percent).

Business fixed investment increased at a 9.2 percent annualized rate in the first quarter of 2022, contributing 1.17 percentage points to final growth. That gain was led by a 15.4 percent jump in business equipment investment (adding 0.79 percentage points) while intellectual-property investment rose at an 8.1 percent pace (adding 0.40 points to growth). Those gains were partially offset by a decline in spending on business structures where spending fell at a 0.9 percent rate, the fourth decline in a row, and subtracting 0.02 percentage points from final growth.

Residential investment, or housing, rose at a 2.1 percent annual rate in the first quarter compared to a 2.2 annualized gain in the prior quarter. The first quarter was the second gain in a row following drops in the second and third quarters of 2021. The gain in the first quarter added 0.10 percentage points.

Businesses added to inventory at a $158.7 billion annual rate (in real terms) in the first quarter versus accumulation at a $193.2 billion rate in the first quarter. The slower accumulation reduced first-quarter growth by 0.84 percentage points. The inventory accumulation helped boost the real nonfarm inventory to real final sales of goods and structures ratio to 4.00 from 3.87 in the fourth quarter; the ratio hit a low of 3.75 in the second quarter.  This is still below the 4.3 average for the 16 years through 2019.

Exports fell at a 5.9 percent pace while imports rose at a 17.7 percent rate. Since imports count as a negative in the calculation of gross domestic product, a gain in imports is a negative for GDP growth, subtracting 2.53 percentage points. The fall in exports subtracted 0.68 percentage points. Net trade, as used in the calculation of gross domestic product, subtracted 3.2 percentage points from overall growth.

Government spending fell at a 2.7 percent annualized rate in the first quarter compared to a 2.6 percent pace of decline in the fourth quarter, subtracting 0.48 percentage points from growth.

Consumer price measures from the National Income and Product Accounts showed another sharp rise in the first quarter. The personal-consumption price index rose at a 7.0 percent annualized rate, up from a 6.4 percent pace in the fourth quarter. From a year ago, the index is up 6.3 percent. Excluding the volatile food and energy categories, the core PCE (personal consumption expenditures) index rose at a 5.2 percent pace versus a 5.0 percent increase in the fourth quarter. From a year ago, the core PCE index is up 5.2 percent.

Real Retail Sales Are Trending Flat

Retail sales and food-services spending rose 0.5 percent in March following an 0.8 percent gain in February. However, today’s retail sales data are not adjusted for price changes. In real terms, total retail sales were down 0.7 percent (adjusted using the CPI). Still, total retail sales are up 6.9 percent from a year ago while real retail sales are down 1.5 percent.

Core retail sales, which exclude motor vehicle dealers and gasoline retailers, rose 0.2 percent for the month, following a 0.1 percent decline in February. The decline leaves that measure with a 6.2 percent gain from a year ago. After adjusting for price changes, real core retail sales fell 0.2 percent in March and are down 0.3 percent from a year ago.

Categories were mostly higher for the month with ten up and three down in March. The gains were led by an 8.9 percent rise in gasoline spending. However, the average price for a gallon of gasoline was $4.40, up 19.8 percent from $3.68 in February.  General merchandise sales followed with a 5.4 percent increase while electronics and appliance store sales and sporting goods, hobby, and bookstore sales each gained 3.3 percent for the month.

Nonstore retailers led the decliners, down 6.4 percent, followed by motor vehicles sales, off 1.9 percent, and health and personal care store sales, down 0.3 percent.

Overall, total nominal retail sales rose in March, lifted by rising prices, especially for gasoline. However, in real terms, total and core retail sales fell. Furthermore, real total and real core retail sales are essentially unchanged from a year ago.

Durable-goods Orders Posted a Broad-based Rebound in March

New orders for durable goods increased 0.8 percent in March, rebounding from a 1.7 percent drop in February. Total durable-goods orders are up 11.9 percent from a year ago. The March gain puts the level of total durable-goods orders at $275.0 billion, the third highest on record.

New orders for nondefense capital goods excluding aircraft, or core capital goods, a proxy for business equipment investment, jumped 1.0 percent in March after falling 0.3 percent in February. Orders had risen for 11 consecutive months from March 2021 through January 2022 and have increased 21 of the last 23 months since April 2020. The results put the level at $80.8 billion, a new record high.

However, accelerating price increases have an impact on capital goods. In real terms, after adjusting for inflation, new orders for nondefense capital goods excluding aircraft – one of AIER’s Leading Indicators – were $41.2 billion in March, measured in 1982 dollars, a high level by historical comparison but well shy of the record high $49.2 billion in June 2000. The March result was a 0.8 percent gain for the month and is a 2.3 percent increase from a year ago. However, it is below the recent high of $41.5 billion in October 2021, putting the recent trend on a downward trajectory, resulting in a negative contribution to the AIER Leading Indicators index.

In nominal terms, every category in the durable-goods report showed a gain in March. Among the individual categories, electrical equipment and appliances led with a 3.9 percent increase, followed by computers and electronic products with a 2.6 percent rise, primary metals with a 1.5 percent gain, fabricated metal products, up 0.8 percent, and machinery orders, up 0.7 percent. Transportation equipment added 0.2 percent with motor vehicles and parts were up 5.0 percent, but nondefense aircraft was down 9.9 percent, and defense aircraft plunged 25.6 percent. From a year ago, every major category shows a gain.

Durable-goods orders continue to be strong, particularly the core-capital goods components, though a significant portion of the gain in nominal-dollar orders is due to price increases. Demand remains robust for the manufacturing sector, and the tight labor market creates incentives to substitute capital for labor. The pandemic may have accelerated structural changes to the economy, affecting labor, housing, manufacturing, and services.

Home Construction Remained Robust in March but Headwinds Are Gaining Strength

Total housing starts rose to a 1.793 million annual rate in March from a 1.788 million pace in February, a 0.3 percent increase. From a year ago, total starts are up 3.9 percent. Total housing permits also rose in March, posting a 0.4 percent gain to 1.873 million versus 1.865 million in February. Total permits are up 6.7 percent from the March 2021 level. Both categories were led by multifamily housing.

Starts in the dominant single-family segment posted a rate of 1.200 million in March versus 1.221 million in February, a drop of 1.7 percent and are off 4.4 percent from a year ago. Single-family permits fell 4.8 percent to 1.147 million versus 1.205 million in February.

Starts of multifamily structures with five or more units increased 7.5 percent to 574,000 and are up 28.1 percent over the past year while starts for the two- to four-family-unit segment fell 42.4 percent to a 19,000-unit pace versus 33,000 in February. Combined, multifamily starts were up 4.6 percent to 593,000 in March and show a gain of 26.2 percent from a year ago.

Multifamily permits for the 5-or-more group jumped 10.9 percent to 672,000 while permits for the two-to-four-unit category were unchanged at 54,000. Combined, multifamily permits were 726,000, up 10.0 percent for the month and up 29.4 percent from a year ago.

Meanwhile, the National Association of Home Builders’ Housing Market Index, a measure of homebuilder sentiment, fell again in April, coming in at 77 versus 79 in March, but still at a somewhat favorable level. Overall sentiment remains positive, but rising mortgage rates, elevated home prices, and higher input costs are major concerns.

Two of the three components of the Housing Market Index fell in April. The expected single-family sales index rebounded slightly, rising to 73 from 70 in the prior month, but the current single-family sales index was down to 85 from 87 in March while the traffic of prospective buyers index fell six points to 60.

Input costs are a concern for builders, with lumber coming in at around $915 per 1,000 board feet in mid-April, down from peaks around $1,700 in May 2021 and $1,500 in early March 2022 while copper was holding at just over $10,000 per metric ton. The high input costs will pressure profits at builders and may lead to more price increases for new homes.

Furthermore, mortgage rates have rocketed higher recently, with the rate on a 30-year fixed rate mortgage coming in at 5.00 percent in mid-April, nearly double the lows in early 2021. Higher home prices and higher mortgage rates are likely to be significant headwinds for future housing activity.

After a pullback in activity in the first three quarters of 2021, single-family construction has shown renewed strength. While the implementation of permanent remote working arrangements for some employees may be providing continued support for housing demand, ongoing home price increases combined with the recent surge in mortgage rates will likely work to cool activity in coming months. Threats to future demand combined with elevated input costs are weighing on homebuilder sentiment. The outlook for housing is becoming more guarded.

New Single-Family Home Sales Fell Again in March as Prices and Mortgage Rates Continue to Rise

Sales of new single-family homes fell in March, declining 8.6 percent to 763,000 at a seasonally-adjusted annual rate from a 835,000 pace in February. The March drop follows a 1.2 percent decline in February and a 3.0 percent drop in January. The three-month run of decreases leaves sales down 12.6 percent from the year-ago level. New home sales surged in the second half of 2020 but then slowed sharply in the first three quarters of 2021, hitting a low of 667,000 in October. Following the October low, sales posted two strong gains in November and December but have reversed some of those gains in the first quarter of 2022. Meanwhile, 30-year fixed rate mortgages were 5.11 percent in late April, up sharply from a low of 2.77 percent in August 2021.

Sales of new single-family homes were down in all four regions of the country in March. Sales in the South, the largest by volume, fell 10.2 percent while sales in the West dropped 6.0 percent, sales in the Midwest decreased 8.7 percent and sales in the Northeast, the smallest region by volume, sank 5.4 percent for the month. From a year ago, sales were up 12.8 percent in the Northeast and up 21.0 percent in the West, but are off 13.8 percent in the Midwest and off 24.7 percent in the South.

The median sales price of a new single-family home was $436,700, up from $421,600 in February (not seasonally adjusted). The gain from a year ago is 21.4 percent versus a 16.5 percent 12-month gain in February. On a 12-month average basis, the median single-family home price is still at a record high while the gain from a year ago in the 12-month average is 19.3 percent.

The total inventory of new single-family homes for sale rose 3.8 percent to 407,000 in March, putting the months’ supply (inventory times 12 divided by the annual selling rate) at 6.4, up 14.3 percent from February and 52.4 percent above the year-ago level. The months’ supply is at a relatively high level by historical comparison and is substantially higher than the months’ supply of existing single-family homes for sale. The relatively high months’ supply and surge in mortgage rates may be among the reasons for slowing gains in the median home price. The median time on the market for a new home remained very low in March, coming in at 3.0 months versus 2.9 in February.

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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