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August 12, 2021 Reading Time: 13 minutes

Summary

AIER’s Leading Indicators Index posted a fourth consecutive small decline in July, falling to 75 from 79 in June. While the pullbacks suggest that breadth of growth could narrow in the future, the July result remains at a level consistent with continued economic expansion in coming months. July also marks the eleventh consecutive month above the neutral 50 level.

The Roughly Coincident Indicators index held at 100 for a fifth consecutive month in July. The continued strength of the roughly coincident indicators is an important confirmation of the breadth of the current expansion. The Lagging Indicators Index held at 33 for the third consecutive month (see chart).

While the cessation of restrictive government lockdown policies and reopening of the economy remain the driving forces behind the economic recovery, difficult labor conditions, shortages of materials, and lingering logistical issues are pushing prices higher at an elevated pace. Furthermore, outbreaks of the Delta variant of the Coronavirus could worsen the supply issues or lead to some partial reinstatement of government restrictions or some retrenchment by consumers or all three. Despite the risks, the economic outlook remains tilted to the upside, but the threats appear to be becoming more significant.

Leading Indicators Index Suggests Continued Expansion, But Raises Some Concerns

The AIER Leading Indicators index posted another drop in July, coming in at 75 versus 79 in June, 83 in May, 88 in April, and a high of 92 in March. The July result remains solidly above the neutral 50 threshold and suggests continued economic expansion in the months ahead. However, the string of declines also suggests that sources of growth could start to narrow in coming months.

Among the 12 leading indicators, nine were in a positive trend in July versus three trending unfavorably while none were trending flat or neutral. Two of the leading indicators changed direction in July. Total heavy truck unit sales, a measure of capital investment, returned to a positive trend just one month after it fell to a neutral trend. Real new orders for core capital goods, a broader measure of capital investment, remains in a positive trend.

Housing permits was the second leading indicator to change direction in July, falling from a positive trend in June to a negative trend in July. Housing has been one area that has been heavily impacted by the pandemic. Lockdowns sent activity plunging (as they did for the entire economy), however, record low interest rates and a sudden shift in housing preference sent demand soaring. Demand far exceeded supply and sent prices rocketing higher. Those higher prices are now starting to soften demand as some buyers are priced out of the market, leading to falling activity (see below for more on housing).

Two leading indicators continued to show unfavorable trends: real new orders for consumer goods and the Treasury yield spread. The Treasury yield spread has been unfavorable for 19 months while the real new orders for consumer goods indicator has been unfavorable for three consecutive months.

Overall, the Leading Indicators index remained above the neutral 50 level for the eleventh consecutive month, suggesting continued expansion is likely. Over the last 11 months, the leading indicators index has averaged 78.8. Despite the recent pullbacks, that is still the highest level since January 2019. As government policies restricting consumers and businesses have been removed, economic activity has rebounded.  However, ripple effects from the lockdowns continue to disrupt labor supply, production, and logistics and transportation, resulting in scattered shortages of input materials and rising pressure on prices. These issues are likely to be resolved over time and are unlikely to result in a 1970s-style price spiral.

The Roughly Coincident Indicators index held at a perfect 100 reading in July with all six individual Roughly Coincident indicators continuing to trend higher. The fifth consecutive month of perfect results follow four months of readings in the 83 to 92 range and are the first five-month string of perfect scores since mid-2017. The Roughly Coincident Indicators index has been above the neutral 50 level for ten consecutive months, posting an average reading of 90, the highest since May 2019. The strong performance of the Roughly Coincident Indicators index reflects the broad strength of the economic recovery from the government-induced recession of 2020.

AIER’s Lagging Indicators index held a reading of 33 in July and is the ninth consecutive month in the 17 to 33 range. Those nine months follow back-to-back readings of zero in September and October 2020 and mark the 19th consecutive month at or below 50.  The average over the last 19 months is 28.5. Overall, four indicators remained in an unfavorable trend, while two indicators had favorable trends, and none were in a neutral trend.

Consumer Spending Drives Economic Recovery in the Second Quarter

Real gross domestic product increased at a 6.5 percent annualized rate in the second quarter, up from a 6.3 percent pace in the first quarter. Over the past four quarters, real gross domestic product is up 12.2 percent, putting the level almost back on trend.

Real final sales to private domestic purchasers, a key measure of private domestic demand, rose at a very robust 9.9 percent annualized rate in the second quarter following an 11.8 percent pace in the first quarter. Over the last four quarters, real final sales to private domestic purchasers are up 15.9 percent, putting the level above trend for the first time since the fourth quarter of 2019.

Growth in the second quarter was led by consumers. Real consumer spending overall rose at an 11.8 percent annualized rate, beating the strong 11.4 percent rate in the first quarter, and contributing a total of 7.8 percentage points to real GDP growth. The pattern of contributions to growth among the components of consumer spending in the second quarter was the mirror opposite of the first quarter as the second quarter was led by consumer services, followed by nondurable goods and then durable goods.

Spending on services grew at a 12.0 percent rate, contributing 5.1 percentage points to real GDP growth while nondurable-goods spending rose at a 12.6 percent pace, contributing 1.8 percentage points and durable-goods spending rose at a 9.9 percent pace, contributing 0.9 percentage points. Within consumer services, spending was particularly strong on food services (restaurants), travel, accommodations, and recreation services as consumers emerged from pandemic restrictions.

Business fixed investment increased at an 8.0 percent annualized rate in the second quarter of 2021, contributing 1.1 percentage points to final growth. That gain was led by a 13.0 percent jump in spending on equipment (adding 0.7 points to growth) and a 10.7 percent gain in intellectual-property investment (adding 0.5 percentage points). Those gains were partially offset by a decline in spending on business structures where spending fell at a 7.0 percent rate, the sixth decline over the last seven quarters, and subtracting 0.2 percentage points from final growth.

Residential investment, or housing, fell at a 9.8 percent annual rate in the second quarter compared to a 13.3 annualized gain in the prior quarter. The second quarter is just the second decline in the last 10 quarters (the other being the second quarter of 2020 during the height of government lockdowns). The drop in the second quarter reduced overall growth by 0.5 percentage points. Housing had shown resilience throughout the pandemic as extremely low interest rates combined with widespread remote working policies and the desire by some people to move away from virus epicenters has supported increased demand. However, limited supply and surging home prices are pushing buyers out of the market and leading to a cooling.

Businesses liquidated inventory at a $165.9 billion annual rate (in real terms) in the second quarter versus liquidation at a $88.3 billion rate in the fourth quarter, subtracting 1.1 percentage points from second-quarter growth.

Exports rose at a 6.0 percent pace while imports rose at a 7.8 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 1.1 percentage points. The rise in exports added 0.6 percentage points. Net trade, as used in the calculation of gross domestic product, subtracted 0.4 percentage points from overall growth.

Government spending fell at a 1.5 percent annualized rate in the second quarter compared to a 4.2 percent pace of growth in the first quarter, subtracting 0.3 percentage points from growth.

Housing Starts Rise but Permits Fall as Pandemic Pressures Continue to Unwind

Total housing starts rose to a 1.643 million annual rate in June from a 1.546 million pace in May, a 6.3 percent increase. From a year ago, total starts are up 29.1 percent. However, total housing permits fell 5.1 percent to 1.598 million in June from 1.683 million in May. Total permits are 23.3 percent above the June 2020 level. Both continue to trend down with starts 4.8 percent below its recent peak while permits are 15.1 percent below its peak.

The dominant single-family segment saw starts rise 6.3 percent for the month to a rate of 1.160 million and are up 28.5 percent from a year ago. Single-family permits however were off 6.3 percent at 1.063 million. Single-family starts and permits are also trending lower from peaks around the start of the year.

Starts of multifamily structures with five or more units rose 6.8 percent to 474,000 and are up 30.6 percent over the past year but starts for the two- to four-family-unit segment sank 18.2 percent to 9,000.  Combined, multifamily starts were up 6.2 percent to 483,000 in June.

Multifamily permits for the 5-or-more group fell 1.6 percent to 483,000 while permits for the two-to-four-unit category fell 10.3 percent to 52,000. Combined, multifamily permits were 535,000, down 2.6 percent for the month.

Homebuilder Sentiment Pulls Back as Activity Slows

The National Association of Home Builders’ Housing Market Index, a measure of homebuilder sentiment, fell again in July, to 80 from 81 in June and a peak of 90 in November 2020. Overall sentiment remains relatively high but elevated materials costs are pushing prices up and forcing some buyers out of the market, resulting in lower demand.

Two of the three components of the Housing Market Index fell in July. The current single-family sales index fell to 86 from 87 in the prior month and the traffic of prospective buyers index was off six points to 65 but the expected single-family sales index rose to 81 from 79.

New Single-Family Home Sales Fell Again in June

Sales of new single-family homes fell sharply again in June, decreasing 6.6 percent to 676,000 at a seasonally-adjusted annual rate from a 724,000 pace in May. That drop follows a 7.8 percent decrease in May and a 10.1 percent fall in April. Sales are down 19.4 percent from the year-ago level and are 31.9 percent below the 993,000 pace in January. However, sales are also about in line with the 677,000 pace from August 2019.

Sales of new single-family homes were down in three of the four regions of the country in June with the South, the largest by volume, off 7.8 percent, the West off 5.1 percent, and the Northeast down 27.9 percent. Sales in the Midwest were up 5.7 percent for the month. From a year ago, sales followed a similar pattern: sales were lower by 24.8 percent in the South, off 12.7 percent in the West, and down 40.4 percent in the Northeast.  Sales in the Midwest were up 7.0 percent from a year ago.

The total inventory of new single-family homes for sale rose 7.0 percent to 353,000 in June, the highest level since December 2008,  leaving the months’ supply (inventory times 12 divided by the annual selling rate) at 6.3, up 14.5 percent from May and 46.5 percent above the year-ago level. The median time on the market for a new home fell in June, coming in at 3.5 months versus 4.4 in May.

Recent headwinds for the housing market include somewhat higher mortgage rates and sharply higher home prices. The average rate of a 30-year fixed-rate conforming mortgage was 2.98 percent in June, up from 2.96 in May. The average rate is up from a low of 2.68 in December but lower than the 3.08 percent in March 2021. The average rate was as high as 4.87 in November 2018.

The median sales price of a new single-family home was $361,800, down 5.0 percent from the record high in May. The gain from a year ago is 6.1 percent. On a 12-month average basis, the median single-family home price is at a record high.

The combination of high prices and somewhat higher mortgage rates is forcing some buyers out of the market and contributing to a slowing in housing activity. It is likely that these conditions will continue to significantly impact the overall housing market, further reducing demand, easing the tight supply, and slowing future price increases.

Existing-Home Sales Rise as Prices Hit a Record

Sales of existing homes rose 1.4 percent in June, to a 5.86 million seasonally adjusted annual. Sales are up 22.9 percent from a year ago. Sales in the market for existing single-family homes, which account for about 88 percent of total existing-home sales, also rose 1.4 percent in June, coming in at a 5.14 million seasonally adjusted annual rate. From a year ago, sales are up 19.3 percent. Condo and co-op sales rose 1.4 percent for the month, leaving sales at 720,000 for the month versus 710,000 in May.

The median sale price in June of an existing home was $381,800, 16.1 percent above the year ago price and a new record high. For single-family existing home sales in June, the price was $386,600, a 16.7 percent rise over the past year and also a new record, while the median price for a condo/co-op was $347,200, 13.8 percent above June 2020.

The record-high prices are helping push up inventory. Total inventory of existing homes for sale rose 3.3 percent to 1.25 million in June, pushing the months’ supply (inventory times 12 divided by the annual selling rate) to 2.6, the highest since September 2020 though still a very low supply by historical measure.

For the single-family segment, inventory increased 3.8 percent to 1.08 million, the highest since November 2020. The months’ supply was unchanged at 2.5. The condo and co-op inventory fell 1.2 percent to 171,000, putting the months’ supply at 2.9, unchanged from the prior month. 

Durable-Goods Orders Rose in June as Core Capital-Goods Hit a Record High

New orders for durable goods increased in June, gaining 0.8 percent, the 13th rise in the last 14 months. Total durable-goods orders are up 40.7 percent from a year ago. The June gain puts the level of total durable-goods orders at $257.6 billion.

New orders for nondefense capital goods excluding aircraft or core capital goods, a proxy for business equipment investment, rose 0.5 percent in June after gaining 0.5 percent in May and 2.7 percent in April, putting the level at $76.1 billion, another 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 $59.9 billion in April 2020. The $59.9 billion pace was the slowest since December 2016.  Core capital-goods orders have been above $70 billion for eight consecutive months.

Gains among the categories in the report were generally broad-based though moderate in magnitude. Just one of the seven major categories of durable goods shown in the report had a decline in the latest month with five posting increases and one roughly unchanged. Among the individual categories, primary metals rose 0.4 percent, fabricated metal products fell 0.8 percent, machinery orders added 0.6 percent, computers and electronic products rose 1.0 percent, electrical equipment and appliances were roughly unchanged from the prior month, transportation equipment jumped 2.1 percent, and the catch-all “other durables” category was up 0.5 percent.  Within the transportation equipment category, motor vehicles and parts sank 0.3 percent while nondefense aircraft jumped 17.0 percent and defense aircraft increased 9.9 percent.

The report on durable-goods orders highlights the strength of the business sector. Capital spending reflects improving prospects for growth and rising confidence among business leaders. However, logistical and labor issues continue to hamper some areas of production, creating shortages of input material and putting upward pressure on prices. These pressures are likely to be temporary as issues are worked out and full production is resumed. The major risk over the short term is the resurgence in Covid from the Delta variant. The new outbreak may cause hesitation on the part of consumers or renewed government restrictions on economic activity.

Core Retail Sales Posts a Sharp Gain in June

Retail sales and food-services spending rose 0.6 percent in June, the fourth gain in the last six months.  The results over the last six months leave retail sales at the third highest on record and well above the most recent nine-year trend. From a year ago, total retail sales are up 18.0 percent.

Core retail sales, which exclude motor vehicle dealers and gasoline retailers, posted a 1.1 percent jump for the month, leaving that measure with a 15.8 percent gain from a year ago. Core retail sales are also up in four of the last six months, at the highest level on record, and well above the nine-year trend.

Gains were generally broad-based in June. The gains were led by a 3.4 percent increase in miscellaneous store retailers, followed by electronics and appliance stores (up 3.3 percent for June), clothing and accessory stores (a 2.6 percent rise), and gasoline stations (up 2.5 percent).

Only four categories had declines in June. Furniture and home furnishings fell 3.6 percent, motor vehicles and parts dealers were down 2.0 percent, sporting goods, hobby, musical instruments and book stores lost 1.7 percent, and building material and garden equipment and supplies dealers were off 1.6 percent.

Consumer Confidence Remained Strong in July

The Consumer Confidence Index from The Conference Board rose slightly in July, up 0.2 points to 129.1, the highest level since February 2020 and in a range consistent with strong economic growth.

The two major components of the index had small changes for the month, both remaining at relatively high levels. The present-situation component rose 0.7 points to 160.3, the highest level since March 2020.

The expectations component lost 0.1 points, taking it to 108.4. The details of the report suggest that consumers remain generally optimistic particularly as dwindling government restrictions boost economic activity.

Regarding current general business conditions, the percentage of consumers saying business conditions were good rose 1.2 points to 26.4 while the percentage of those saying business conditions were bad rose 0.2 percentage points to 19.3. Those results left the net business conditions percentage at 7.1, up 1.0 from the prior month.

For the labor market, the net percentage of consumers saying jobs were plentiful gained 0.2 points to 54.9 while those saying jobs were hard to get was unchanged at 10.5. The net percentage for current labor conditions comes in at 44.4 for July, up from 44.2 in June and well above the -15.7 in April 2020.

Regarding consumer expectations, consumers’ expectations for business conditions in six months, the percentage expecting good conditions fell 0.3 points to 33.4 while the net percentage expecting bad conditions fell 0.3 points to 10.5. The net percentage for business conditions six months ahead was unchanged at 22.9.

Net consumer expectations for the labor market were also unchanged, as the percentage expecting more jobs added 1.1 points to 27.7 while the percentage expecting fewer jobs also added 1.1 points to 16.8. The net percentage for the outlook for jobs was unchanged at 10.9.

Expectations for future income improved with 20.6 percent expecting an increase while 8.6 percent expect a decrease, leaving the net percentage at 12.0 percent. That positive result helped support future buying plans as percentages for buying a home, auto, or major appliance all rose in the latest month.

Outlook Remains Positive, But Risks Are Growing

The U.S economy posted a strong gain in the second quarter with real gross domestic product now back on its pre-pandemic trend. Details in many economic reports as well as surveys and anecdotal evidence show various sectors and industries within the economy are grappling with lingering fallout from the lockdowns as well as the resurgence of Covid cases due to the Delta variant. 

Fading government restrictions have boosted economic activity. However, the rebound in demand continues to outpace the recovery in supply as ongoing labor difficulties including a lack of qualified workers, absenteeism, temporary shutdowns, and inability to retain talent, have led to production shortages and logistical and transportation problems. These shortages are putting upward pressure on prices, but a 1970s-style price spiral remains unlikely.

The emergence of the Delta variant could worsen the supply issues and lead to renewed government restrictions on consumers or businesses. It could also lead to some retrenchment by consumers if the perception is that the Delta variant represents a significant health risk.

The AIER Leading Indicators index posted its eleventh consecutive month above the neutral 50 threshold but also posted its fourth consecutive small decline. The results suggest continued expansion in coming months but also reflect the possibility that sources of future growth could narrow in coming months. The Roughly Coincident Indicators index posted a fifth consecutive 100 reading, confirming a wide base of current sources of growth. Overall, the outlook remains favorable but the threats to future growth may be growing.

Research-Reports-August-Cream

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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