The week's economic reports

Following is a summary of last week's economic reports. While job creation reported by the BLS remains steady and the rebound in manufacturing continues, the housing market showed more signs of weakness. Stocks and bonds ended the week with the S&P 500 Index up 1.8 percent at 1,530, now up 7.9 percent on the year, and the yield of the 10-year U.S. Treasury Note up 16 basis points to 5.19 percent.


ISM Manufacturing Index: The Institute for Supply Management reported stronger manufacturing activity in June, the ISM manufacturing index measuring 56.0, the fourth increase in the last five months after bottoming in January at 49.3. Strength was seen in production (up from 58.3 to 62.9) and new orders (up from 59.6 to 60.3) while prices paid declined (down from 71.0 to 68.0) but remained at elevated levels due to higher commodity prices.

The increase in production is an indication that manufacturers are anticipating stronger demand in the months ahead, but as Asha Bangalore at Northern Trust(.pdf) notes, "Consumer spending grew at an annual rate of 4.2% in the fourth quarter of 2006 and the first quarter of 2007. Incoming data point to below 2.0% growth in consumer spending in the second quarter and projections for the rest of 2007 do not show robust gains. Given this deceleration in consumer spending, why would factories undertake to raise production?" Good question.

ISM Non-Manufacturing Index: After bottoming in March at 52.4, a four-year low at the time, the ISM non-manufacturing index has surged over the last three months to breach the 60 level for the first time in a year. April's reading of 56 was surpassed by May's 59.7 level, which was topped by the most recent reading of 60.7 in June.

This index averaged in the low 60s during 2004 and 2005 and then settled into the high 50s for most of 2006 before plunging earlier this year. The recent improvement is consistent with other ISM data and regional manufacturing reports indicating a pronounced improvement in recent months leading to a widely expected rebound in second quarter economic growth.

Pending Home Sales: The pending home sales index published by the National Association of Realtors declined for the fourth time in the last five months, further evidence that housing is not likely to rebound anytime soon. Falling 3.5 percent in May after declining about the same amount in April, the index is now down 13.3 percent on a year-over-year basis.

The chart below, also from Northern Trust(.pdf), shows the relationship between pending home sales and existing home sales with the clear message that further weakness in home sales should be expected over the summer.

Employment Situation: The Bureau of Labor Statistics reported 132,000 new jobs created in June and a huge upward revision to the data for prior months. The original April estimate of 80,000 was revised upward to 122,000 and May's increase of 157,000 rose to 190,000. Strength was seen in the usual areas - health and education services added 59,000 jobs, leisure and hospitality (mostly food service) added 39,000 positions, and government employment rose by 40,000.

Surprisingly, construction added 12,000 jobs and manufacturing lost 18,000. Both the gains in construction employment and the losses in manufacturing are inconsistent with nearly every other economic report for these two sectors of the economy. With homebuilding in a virtual freefall and a significant rebound in manufacturing underway during the second quarter, these two figures would make much more sense if they were reversed. This only adds to the continuing doubt regarding both the accuracy and the relevance of the monthly nonfarm payrolls data from the BLS.

The unemployment rate held steady at 4.5 percent, hourly earnings increased by 0.3 percent as expected, and the workweek was flat at 33.9 hours. The long-term picture in the chart below paints a picture of stability and of a leveling-off after employment rebounded in 2004 following the technology and stock market induced slowdown earlier in the decade, but the reality of the labor market will likely not be known for some time to come, due to the extraordinary difficulties in divining meaning from the real-time BLS data.


In addition to the outsized impact that the declining teenage labor participation rate is having on the unemployment rate and the reality that, more than ever before, workers are facing dramatic reductions in income when changing jobs (e.g., auto workers), there are additional factors involving the birth-death model adjustment and benchmark revisions that could make the current stream of jobs data all but meaningless.

Analogous to the 800,000+ increase seen in the benchmark revision reported earlier this year (applied to the March 2005 to March 2006 data), next year's revision for the March 2006 to March 2007 period is likely to show an adjustment in the opposite direction, in large part due to falling construction employment that has yet to show up in a meaningful way in the monthly reports. Recall that the Bureau of Labor Statistics uses the birth-death model to estimate the formation of new businesses (and hence new jobs) for its monthly reports and then, once a year, they go back and update their prediction model based on actual business "births" and "deaths" and the entire dataset for the year is revised.

Back in 2005 when both the economy and the housing market were booming, employment was underestimated as a result of using models based on previous, weaker trends. Similarly, as the economy slowed in 2006 and as homebuilding continued to decline in 2007, it will likely be revealed early next year that employment was overestimated in 2006 and early 2007 as a result of using models based on previous, stronger trends.

All of this, when combined with the routinely large revisions to prior month's data (nonfarm payrolls for April and May were revised upward a combined 75,000 in this report) makes the employment report from the BLS not nearly as respected or as relevant as it once was.

Summary: The manufacturing rebound continues and housing shows no signs of a turnaround anytime soon. This has been pretty much the same story for about the last three months and there is no indication that anything is going to change anytime soon. It seems more likely that the manufacturing rebound will level-off or falter before the housing market picks up, simply due to the many more forward-looking indicators for housing, all of which remain dim.

The employment data thrilled those observers looking for good economic news amid all the subprime and housing woes, however, employment has always been a lagging indicator and, given the recent history of revisions, this indicator now lags by as much as two years (i.e., the January 2008 benchmark revision will tell us what the employment situation was really like between early 2006 and early 2007).

The Week Ahead: Economic reports in the week ahead will be highlighted by retail trade on Friday, a report that will be heavily scrutinized for continuing signs of a consumer retrenchment. Also scheduled for release are reports on consumer credit on Tuesday, international trade on Thursday, and both consumer sentiment and import/export prices on Friday.