– by New Deal democrat

The long leading indicators: on the cusp of turning negative?

A “long leading indicator” is an economic metric that reliably turns a year or more before the onset of a recession.

Geoffrey Moore, who for decades published the Index of Leading Indicators, and in 1993 wrote  Leading Economic Indicators: New Approaches and Forecasting Records identified 4:

• housing permits and starts
• corporate bond yields
• real money supply
• corporate profits

A variation of the above is Paul Kasriel’s “foolproof recession indicator,” which combines real money supply with the yield curve, i.e., the difference in the interest rate between short and long term  treasury bonds. This turns negative a year or more before the next recession about half of the time.

Another long leading indicator has been described by UCLA Prof. Edward E. Leamer who has written that “Housing IS the Business Cycle.”  In that article he identified real residential investments as a share of GDP as an indicator that typically turns at least 5 quarters before the onset of a recession

Several other series appear to have merit as long leading indicators as well.

Real retail sales in several forms also has value as a long leading indicator.  Doug Short has identified real retail sales per capita as another important metric.  In a similar vein, Steven Hansen of Econintersect has flagged retail employment vs. real retail sales as turning significantly in advance of recessions.

It also appears that the Fed’ Labor Market Conditions Index also turns negative serves as a long leading indicator, typically turning negative at least one year before the onset of a recession.

Finally, the tightening of credit conditions also appears to have merit as a long leading indicator.  Two measures, the Senior Loan Officer Survey, and the TED spread, are worth noting.

That gives us a total of 9 varieties of long leading indicators.  All of these economic series have a long term history of turning a year or more before a recession.

I haven’t examined these in detail since the beginning of July.  Then, I found them just slightly positive on balance.  In light of recent interest rate moves, now is a good time for an update.

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by New Deal deomocrat

JOLTS, Labor Market Conditions index consistent with late 2017 recession
 

I continue to be unimpressed with the Job Openings and Labor Turnover Survey (JOLTS), as showing post-mid cycle deceleration for over a year.   I have found what I hope is a better way to present my argument, so that you can see why the report is less than heartening.

First, here is a comparison of job openings (blue), hires (red), and quits (green, right scale).  Because there is only one compete past business cycle for comparison, lots of caution is required. But in that cycle, hires and quits peaked first, while openings continued to rise before turning down in the months just prior to the onset of the Great Recession:

Through today’s report for August, 2016 looks very much like 2006, or even early 2007.

To better show you my concern, let’s look at this same data as expressed in YoY% changes:

Figure 2

Although there’s lots of noise in the squiggles, the pattern of maximum growth at mid cycle gradually declining under zero prior to the onset of the 2008 recession is evident.  Here is a close-up of the years 2005-08 to show you the deceleration of quits and hires from their peaks in late 2005, and the flatness of hires before declining in the months just before the recession:

Now let’s look at the same time frame up until this month’s release:

You can see similar peaks of quits and hires in late 2014, and the general flatness in hires over the last year. The rates of YoY change are equivalent to those at the end of 2006.
If the same pattern as the last economic cycle were to hold for this one, JOLTS would show continued deceleration before rolling over into an actual recession about 12 months from now.

Meanwhile the LMCI has been slightly negative virtually all this year.  As shown in the graph below, this is consistent with slowdowns (as in 1985 and 1995) as well as prior to recessions:

Still, the LMCI has not declined nearly as much as it typically has prior to most of the recessions in the last 50 years.  At the same time, note that the LMCI does a pretty good job forecasting the direction of the YoY change in employment (red).  So the YoY trend in the monthly jobs report is likely to continue to decelerate.

While I’m not forecasting any actual negative monthly job reports in the near future, the YoY payrolls graph still shows continued deceleration. Here is a bar graph of the monthly gain in jobs for the last 3 years, minus 150,000, better to show the deceleration from the peak of nearly 2 years ago:

The 4th quarter of last year showed job increases of over 250,000 per month.  It is a virtual certainty that the job reports for this quarter are going to average much less.

In summary, both the LMCI and the JOLTS reports have been adding to the accumulating evidence that we are getting late in the expansion, if we only go by these two metrics, and we follow the 2001-07 template, a recession could begin within about 12 months.  Which means that this month’s housing data, as well as the long leading business profit and residential investment data in the first Q3 GDP estimate will take on added importance.

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New Deal Democrat

writing from The Bonddad Blog On Monday I gave what I think is a reasonable roadmap to the next recession. I want to follow up on this a little.

The post from nearly 10 years ago was entitled, Are Hard Times Near? The great decline in interest rates is ending.” The theory is right in the title. Since the 1970s, real average hourly earnings had declined. Average Americans coped by spouses entering the workforce, by borrowing against appreciating assets, and by refinancing as interest rates declined.

By 1995 the spousal avenue peaked. Borrowing against stock prices ended in 2000. Borrowing against home equity ended in 2006. When interest rates failed to make new lows, the consumer was tapped out, and began to curtail purchases. A recession began – and its effects have lingered and lingered. Hard Times were indeed near.

Here is a graph from 1981 of mortgage rates and 10 year treasuries:

In that article in 2007, I wrote that the consumer might yet have one more chance to refinance debt. In fact after the recession it turned out there were two: in 2009 and again in 2013. Ten year treasuries made a 60 year+ low in 2013 at 1.50%. Even if treasuries, and mortgage rates tied to them, make a new low, the floor is somewhere north of 0%. That -1.5% decline in a mortgage payment on a $250,000 house would be $3750 a year, or a little over $300 a month. That’s the most extreme case. Even if interest rates make new lows, households that refinance are likely to see more on the order of $100 or $200 per month of freed up cash — not enough to power much consumer spending.

Yesterday Molly Boesel of Core Logic confirmed this, writing in her blog

Because a refinance isn’t free, a simple rule of thumb is to add 100 basis points to the current market mortgage rate as the rate at which borrowers would have an incentive to refinance…. According to the chart [bleow], most borrowers hold mortgages with rates up to 4.50 percent, with 62 percent of mortgages and 72 percent of UPB in this range.

If mortgage rates rise as predicted, we will certainly see refinancing volumes fall in 2016. Note there is a small share of outstanding mortgages with interest rates of about 300 basis points or more above the current market rate.

Currently nominal wage growth is running at about 2.5% YoY. Real wages have been boosted in the last 2 years by collapsing gas prices. Once that is over, what happens next? Even 2% YoY inflation eats up nearly all of consumers’ wage growth. A 3% YoY inflation rate means real wages decline.

So the bottom line is, we are already in a period – a period that I expect to last an entire generation – where real gains by average Americans won’t be available from financing gimmicks, but must come from real, actual wage growth. At the moment I see little economic or political impetus to make that happen, even though average Americans understand via their wallets the issue all too well. Eventually it will happen, but I believe between now and then is another recession, one that I fear is likely to be worse than the 2008-09 recession because it is likely to include a spasm of wage-price deflation.

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by New Deal democrat

Why hasn’t increased household formation led to increased housing construction?

Tim Taylor has an interesting article about “What was different about housing this time?”  Specifically, why has housing in both building terms and as a share of GDP risen so slowly since 2009.

To cut to the chase, he writes that while prices have been increasing:

There are two possible categories of reasons for the very low level of residential building since 2009. On the supply side, it may not seem profitable to build, given what was already built back before 2008 and the lower prices. On the demand side, … the demand for housing is tied up with the rate of “household formation”–that is, the number of people who are starting new households…..  The level of household formation was low for years after 2009 ……..
Together, the declines in household formation and homeownership contributed to the decline in residential expenditures as a share of GDP.

As an initial matter, I again note that it is important not to overlook the surge in all-cash purchases of large houses by foreigners – who are hedging their bets and/or shielding financial assets – since 2009.

But what caught my eye was Taylor’s graph showing household formation:

It certainly *was* low after 2009 – until 2015, when it rose sharply, to an annualized rate of 1.750 million.

And now look at housing starts for the last 10 years:

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by New Deal democrat

Aside from a shortage in starter housing for Millennials,there is NO inflation

Yesterday’s CPI report seems to be read as potentially justifying an interest rate increase in June.  For example, here’s Professor Tim Duy, on Fed hawks:

Inflation rose on the back of higher gas prices. Headline CPI gained 0.4 percent, although core rose a more modest 0.2 percent. Core CPI inflation is hovering just above 2 per cent….Fed hawks will be nervous that rising gas prices will quickly filter through to core inflation; doves will remind them that the Fed’s target is PCE inflation, which remains well below 2 percent.

As to his own opinion, he says:

I don’t think June is a go; the data isn’t quite there yet.

And here is Yian Mui of the Washington Post:

The solid [consumer inflation] data helps bolster the case for the Federal Reserve to raise binterest rates at its next meeting in June…..Fed officials have long said that they expect inflation to pick up once the effects of the stronger dollar and low oil prices dissipate. Although the central bank relies on separate data to calculate price increases, Wednesday’s report on consumer costs appears to support the central bank’s claim.

Whether or not the Fed is listening, the fact is that yesterday’s inflation data does no such thing.

Consumer prices less shelter are only up +0.1%. Not month owner month, but Year over Year! This is one of the lowest rates in the entire 75 year history of the series:

Here’s a close-up of the last two years just to drive home the point:

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Yves Smith at Naked Capitalism has just pointed to The unfairness of housing purchases through time.     New Deal democrat and Barkley Rosser (at Econospeak) have pointed to problems with rental prices.  NDd continues with this post, also pointing to Bill McBride at Calculated Risk…

by New Deal democrat

Rents are going through the roof!

Rent increases appear to be out of control.  Median asking rent rose from $850 to $870 in the first quarter of 2016, and is up $71 from $799 YoY, an increase of 9%!  This sets yet another record for rents.

Here is the graph of nominal median asking rents by the Census Bureau:

Here is an updated look at real. inflation adjusted median asking rents, which also set a new record:

 
Vacancies remain extremely tight:

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by New Deal democrat

Consumer Expenditures Survey: incomes rose sharply from June 2014-June 2015
A major piece of data came out last week that has been totally unreported in the media and econoblogosphere:  the Consumer Expenditures Survey (CES) for June 2014- June 2015.

This is the first CES report to include the period of rapidly declining gas prices. And at least on initial examination, to my nerdy eyes, it’s a stunner.

The CES income data has been the source of most of the reporting over the last few years indicating that the vast majority of workers have seen a real decline in wages.  For example, using the CES data, the NELP reported last August that real wages had declined across the board since the end of the recession in June 2009:

And in a report just a few weeks ago, the Pew Foundation showed the inflation-adjusted  CES income and expenditures through June 2014 into this graph:

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by New Deal democrat

The best measure of labor market recoveries: March 2016 update

In my opinion the best measure of how average Americans are doing in an economic expansion isn’t jobs, and it isn’t wages per hour.  Rather, it is real aggregate wage growth.  This is calculated as follows:

• average wages per hour for nonsupervisory workers
• times aggregate hours worked in the economy
• deflated by the consumer price index

This tells us how much more money average Americans are taking home compared with the worst point in the last recession.

Why do I believe that this is the best measure of labor market progress?  Let me give you a few examples.

First, compare an economy that creates 1 million 40 hour a week jobs at $10/hour, with an economy that creates 2 million jobs at 10 hours a week at $10/hour.  If we were to count by job creation, the second economy would be better.  But that’s clearly  not the case.  The second economy is paying out only half of the cold hard cash to workers as the first.

Next, let’s compare two economies that both create 1 million 40 hour a week jobs, but one pays $10/hour and the other pays $12/hour.  Clearly the second economy is better.  It is paying workers 20% more than the first.

Finally, let’s compare two economies that create 1 million 40 hour a week jobs at $10/hour.  In the first economy, there are 3% annual raises, but inflation is rising 4%.  In the second, there are 2% annual raises, but inflation is rising 1%.  Again, even though the second economy is giving less raises, it is the better one — those workers are seeing their lot improve in real, inflation-adjusted terms, whereas the workers in the first economy are actually losing ground.

In each case, the economy creating more jobs, or more hourly employment, is inferior to the economy  that pays more in real wages to its workers,  In other words, the best measure of a labor market recovery is that economy which doles out the biggest increase in real aggregate wages. In short, at the end of the analysis, people generally work not for hours, and not for jobs themselves, but for the cold hard cash that is put in their pockets.  That’s why I believe that real aggregate wage growth is the best measure of a labor market recovery.

With that introduction, here are real aggregate wages for the entire past 50 years: IMPORTANT NOTE:  This graph shows *aggregate* real wages.  It is not divided by households or per capita, so this measure doesn’t try to convey how much improved individuals’ lots might be.  It conveys how much more income has become available to the middle/working class as a whole.

For that, we can divide by population to see real wage growth per capita:

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by New Deal democrat (Bondadd blog)

One long term indicator changes to Yellow
 

One long leading indicator has turned from green (positive) to yellow (caution): mortgage rates.

Since middle class wages peaked in the 1970s, the ability to refinance debt at lower interest rates has been an important coping mechanism.  Particularly since the 1980s, whenever

• real wages have stagnated,
• the effects of refinancing debt have dwindled, and
• the ability to cash in an appreciated asset has stalled,

the middle class has retrenched by curtailing its debt load, thereby bringing about a recession.

(You can read a post from me on this, dating from the blogosphere’s primitive era, here.)

As the below graph shows, each of the last 3 recessions has occurred after a period of 3 years (red) where mortgage rates have failed to make a new low:

The failure of mortgage rates to make a new low is not the *signal* for a recession.  Rather, it has been a necessary predicate.

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– by New Deal democrat      

Forecasting the 2016 election economy, first forecast: the long leading indicators

Last week I showed that, going back 160 years, roughly 3/4 of all US Presidential election results correlated positively with whether or not at the time of the election campaign, the US was in a recession or not. More than 2/3 of the time, it accurately predicted the Electoral College winner, and 80% of the time, it accurately showed the winner of the popular vote.  In fact, if we simply go by the metric of whether or not the US was in recession during the 3rd Quarter of the election year, then 84% of the time the winner of the popular vote was from the incumbent party if the economy was expanding, and from the opposition party if the economy was in recession.

We now have enough information to make a good forecast as to whether or not the US economy will be in recession in Q3 2016.  That means we can make a reasonable forecast as to which party’s candidate will win the popular vote.

Prof. Geoffrey Moore, who for decades published the Index of Leading Indicators, and founded the Economic Cycle Research Institute (ECRI) in 1993, wrote  Leading Economic Indicators: New Approaches and Forecasting Records describing and explaining what he called “long leading indicators,” that is, economic metrics that reliably turn a year or more before the onset of a recession.  He identified 4:

– corporate bond yields

– housing permits and starts

– real money supply

– corporate profits

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