July Business Conditions Monthly

Indicators at a Glance
Capital Market Performance
Consumer Finance Rates
Leading Indicators (1950–2018)
Roughly Coincident Indicators (1950–2018)
Lagging Indicators (1950–2018)
AIER’s Leading and Coincident Indicators Fell in June but Remain Very Strong; Debt Levels are Growing but Do Not appear to be a Threat Yet

AIER’s Business Cycle Conditions Leading Indicators eased back in June, registering a 92 following three straight 100s. The Roughly Coincident Indicators index also registered a 92 following three consecutive perfect 100s. The Lagging Indicators index held at 92 for the third consecutive month (see chart below). Despite the drops, the AIER business cycle indicators signal economic strength and suggest a positive outlook with a low probability of recession.

Economic activity remained robust over the past month, providing further evidence that real GDP growth likely reaccelerated after a weak first quarter. Consumer price increases accelerated a bit further in May. However, ongoing trade disputes including escalating tariffs remain a major source of concern. In addition, with the prospect of interest rates continuing to drift higher, there are some concerns over debt levels in various sectors of the economy. However, only one sector raises a red flag: government.

Leading indicators pulled back in June, but economic conditions remain favorable
A trifecta of 92s in June for the AIER business cycle indicators provide solid evidence that the U.S. economy remains on an expansionary path. The Leading Indicators index dropped 8 points to 92 following three consecutive 100s. As noted over the past few months, the Leading Indicators index has reached 100 on 16 separate occasions, holding that level an average of four months. The longest run of perfect scores was nine months. Consequently, the Leading Indicators index was not expected to hold the perfect score for very long. The June results vindicated that expectation.

Ten of the 12 indicators continued expanding in the latest month while two, real stock prices and housing permits, turned to a flat or neutral trend. None of the leading indicators were in a down trend. The last time any of the leading indicators was in a down trend was February 2018.

The Roughly Coincident Indicators index came in at 92 in June after posting perfect 100s in 12 of the past 15 months. Five indicators continued to expand in the latest month while one, The Conference Board’s Consumer Confidence indicator on the present situation, turned to a flat trend. Historically, the Roughly Coincident Indicators index has shown more persistence than the Leading Indicators index, hitting 100 on 22 occasions, with the average duration of runs at 100 at 12.5 months. Despite the persistence, the Roughly Coincident Indicators index held the perfect score just three months in this latest run.

AIER’s Lagging Indicators index held at 92 in the latest month, its third month at that level. Overall, five indicators are trending higher, none are trending lower, and one is neutral. However, two indicators posted offsetting changes in the latest month. Real manufacturing and trade inventories moved from a positive trend to a neutral trend while commercial and industrial loans improved from a neutral trend to a positive trend.

The three AIER business cycle indicator indexes showed slightly lower but still strong results in June, suggesting a continued favorable economic outlook with a low probability of recession in the coming months.

Economic activity is growing at a moderate pace
Consumer spending was notably weak in the first quarter and a primary reason for the weak gain in real GDP growth. Over the course of the first quarter, real personal consumption expenditures fell in the first two months but posted a strong 0.6 percent increase in March. That gain was followed by a 0.3 percent increase in April and an essentially flat month in May. Even if June comes in flat again, second-quarter real PCE is likely to show a rise of more than 2 percent, better than the 0.9 percent pace in the first quarter, though still below the average pace of the past few years.

Retail sales are a key component of consumer spending and have shown somewhat stronger performance in recent months than overall real consumer spending. Retail sales jumped 0.8 percent in May, the third strong monthly gain in a row following weak performances in January and February. Over the past year, they are up 5.9 percent, the strongest yearly gain since November 2017 and the second-highest 12-month gain over the last six years.

Gains in retail sales in May were widespread among the components. Strong gains were posted by miscellaneous store retailers, building-materials and building- supplies stores, clothing stores, restaurants, and general-merchandise stores. Online retailers and consumer staples such as food stores and health and personal- care stores had modest growth in May. The only major components to show declines for the month are furniture and home-furnishings stores as well as sporting-goods, hobby, music, and book stores.

Unit vehicle sales picked up in June, an early sign that retail sales overall may show another solid rise for the month. Unit sales came in at 17.5 million units at a seasonally adjusted annual rate, up from 16.9 million in May. For the second quarter, however, unit sales are 1.4 percent below the first quarter. Unit vehicle sales continue to be driven by light trucks (pickups and SUVs), which posted a 12.0 million-unit annual rate, up from 11.5 million in May, while car sales have languished, selling at a 5.46 million rate versus 5.43 in May. Light trucks comprised a record 68.8 percent of total light-vehicle sales in June.

On the investment front, new orders for capital goods increased 0.2 percent in May, pushing the year-to-date increase versus last year to 14.7 percent. Excluding defense-related capital goods, orders fell 2.0 percent in May, dragged down by a 7.0 percent drop in nondefense aircraft orders. Nondefense capital-goods orders excluding aircraft, a proxy for business capital investment, fell 0.2 percent for the month following a 2.3 percent increase in April. Overall, high levels of new orders for nondefense capital goods excluding aircraft suggest businesses remain willing and able to invest in productive capacity.

On the labor front, the June jobs report was strong. Payrolls in the United States rose by 213,000 in June, solidly beating an expected gain of 195,000. The private sector added 202,000 jobs. Gains were widespread among the private sector industries in June.

The strong labor-market conditions attracted a very substantial 601,000 more people into the labor force in June, pushing the labor-force participation rate to 62.9 percent, up from 62.7 percent in the prior month. The unemployment rate also moved higher, rising 0.2 percentage points to 4.0 percent in June, after hitting a new low for the current cycle of 3.8 percent in May.

Average hourly earnings rose 0.2 percent in June, holding the 12-month change steady at 2.7 percent. The length of the average workweek also held steady at 34.5 hours. Combined, the gains in payrolls and hourly earnings along with steady hours worked resulted in a 0.4 percent increase in the aggregate-payrolls index in June and a 12-month rise of 5.1 percent. This index is a proxy for take-home pay and has been growing in the 4 to 5 percent range for most of 2011 to mid-2018, providing a solid base to support consumer spending.

Consumer price increases accelerated in May
The consumer price index rose 0.2 percent in May, the fourth 0.2 percent increase in the past six months. From a year ago, the CPI is up 2.8 percent, the fastest pace since February 2012. The pace of rise in the CPI has been drifting higher since registering a 0.2 percent decline for the 12 months ended April 2015. However, much, though not all, of that acceleration has been due to energy prices, a famously volatile category.

Energy accounts for about 7.8 percent of the total CPI, and for the 12 months through May, the CPI for energy rose 11.7 percent. Excluding energy, the CPI is up 2.1 percent for the 12 months ended May.

Food prices overall are up 1.2 percent over the past year. However, that number hides a stark contrast between food bought for home (i.e., groceries) and food away from home (i.e., restaurants). Grocery prices, which account for about 7.3 percent of the CPI, are up just 0.1 percent over the past year while restaurant prices, about 6 percent of the total index, have risen 2.7 percent.

Core consumer prices, which exclude food and energy and comprise about 78.9 percent of the CPI, are up 2.2 percent from a year ago. Within the core, goods prices, 19.9 percent of the total, are down 0.3 percent over the past year while services, 59 percent of the CPI, are up 3.0 percent.

A few key areas account for a major portion of the rise in core-services prices. Shelter, particularly owners’ equivalent rent, is a major driver of core-services prices. OER accounts for 23.6 percent of the CPI and has risen 3.4 percent from a year ago, up from a 3.1 percent increase for the year ending in November 2017. This number is particularly noteworthy because it is a contrived number. It represents what home owners would pay to rent their homes to themselves. There is no actual transaction behind the number. It is estimated based on what actual renters are paying for their housing. A variety of housing services and household- operations services such as water, sewer, and trash collection as well as domestic services, gardening and lawn care, and repair services, together accounting for a total of about 2 percent of the CPI, are all showing 12-month price increases above 3 percent.

Finally, hospital services, about 2.3 percent of the CPI, and motor vehicle insurance, 2.4 percent of the CPI, are posting 12-month increases of 4.7 percent and 8.3 percent, respectively.

In sum, while consumer price increases in aggregate are accelerating, six areas—energy, restaurants, OER, housing-operation services, hospitals, and vehicle insurance—totaling 44 percent of the CPI, account for most of the upward pressure.

Debt levels are rising across the economy
Domestic nonfinancial debt rose 7.2 percent to $49.8 trillion in the first quarter. Among the major private sectors, household debt increased 3.3 percent with mortgage debt up 2.9 percent and nonmortgage debt up 4.2 percent. Nonfinancial corporate-business debt rose 4.0 percent.

For both households and corporate business, the increases in debt appear moderate in the context of their overall balance sheets. For households, asset growth has exceeded debt growth, pushing net worth to a record $100.8 trillion. For nonfinancial corporate business, total net worth is also at a record high, reaching $23.7 trillion; the ratio of liabilities to assets is 46.3 percent, about where it was in 1990 and near the middle of the range over the past 30 years.

The most indebted sector is the federal government. Total debt outstanding was $21.2 trillion as of June 29, 2018, according to the Treasury. As of the end of the first quarter, the debt-to-GDP ratio stood at 105.7 percent. The latest Congressional Budget Office projections show debt held by the public (a subset of total federal government debt) exceeding 150 percent of GDP by 2048. Without significant changes to fiscal policies, the federal debt burden could precipitate the worst financial crisis in many generations.

Indicators at a Glance
Capital Market Performance
Consumer Finance Rates
Leading Indicators (1950–2018)
Roughly Coincident Indicators (1950–2018)
Lagging Indicators (1950–2018)

Robert 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.