Now for some good news about the economy. I see four positive signs in employment, lending, residential construction, and the global economy. They come with a few caveats, but they have the potential to lead the United States out of the recession.
1. Employment is improving
I am seeing three important positives:
First, temporary employment hiring is rising at the fastest rate ever, 28.7% on a three-month annualized basis.1 This is one of the key leading indicators for the U.S. job market. Why? Because it says that companies are seeing an increase in demand for their product or service. To meet that demand they need more workers. Companies aren’t 100% positive that the demand is sustainable, so they’re hiring temporary workers. If the demand continues, these employees may become permanent.
Second, overtime and total hours worked in manufacturing are rising. In the past, that’s been the first sign that the labor market is starting to improve. Again, it’s all about demand. When demand for a product increases, manufacturers add extra shifts to produce more. These extra shifts lead to more overtime hours and total hours worked. This does two things: it signals that the reservoir of extra labor that the company can draw from is falling, and that employees should be able to build their confidence as their income rises and the prospects for further layoffs recede.
Third, initial unemployment claims are falling. There’s always a natural creation and destruction of jobs in the economy. We’re seeing movement in both: improvement in new jobs and job destruction receding.
Right now only 41% of industries are seeing month-over-month rises in employment.2 Manufacturing, construction, and retail, which account for a quarter of the total labor market, remain weak. Over the past two years, the U.S. economy has lost 7 million jobs, including 2.1 million in manufacturing, 1.6 million in construction, and 1 million in retail.3
Going forward, it appears that some of the critical drivers of these three key pieces of the labor market are showing signs of recovery. The leading indicators in the manufacturing sector have turned positive. In retail, we’re beginning to see consistent increases in consumer spending, which can eventually translate into hiring. The news is somewhat better in construction. Public construction spending has been a constant positive this year and it appears to be continuing this uptrend with the fiscal stimulus program out of Washington. In addition, the housing market appears to be reaching a new, fragile equilibrium. Pending, new, and existing home sales are all rising and excess inventory of housing is beginning to fall. The drag in the construction sector is still in private nonresidential construction, which currently represents over a third of total construction spending. Here activity over the coming year is likely to continue declining dramatically.
2. Loans to businesses are rising
Over the past two quarters, the percentage of loan officers tightening their lending standards has fallen from its extreme level in the first quarter, according to a survey of senior loan officers conducted by the Federal Reserve. This can begin to help credit reenter the private sector. For example, in many small business start-ups, many owners finance their enterprises by taking a second mortgage. With the problems in the mortgage market, this form of small business financing is all but closed. Another venue is credit cards and bank loans, but these have also become much harder to come by. If a small business can’t find the start-up funding, it may never make it, and this is a drag on both economic activity and job creation.
While the lending to small businesses is still very subdued, the loan officer survey has begun to show some easing. Perhaps an even more powerful sign that credit is returning to the business sector comes from the non-bank side of the financial world. Commercial paper and corporate bond issuance have been making a huge recovery. In the past, bank loans have typically followed the tightening or loosening trends of nonbank loans.
Small businesses are still hurting from poor sales, not credit conditions. At the highest level ever recorded, 33% of businesses surveyed by the National Federation of Independent Businesses said their biggest problem is poor sales. Only 5% said that their biggest problem is financing and interest rates.
3. Homes are affordable, price declines are slowing, and housing activity is set to rise
The big stories in housing are the substantial slowing in price declines and extremely high home affordability. As a result of the high affordability, year over year pending home sales are up 31.8%,4 new home sales are up 5.1%,4 and existing home sales are up 23.5%.5 At the same time there’s a more manageable inventory of homes on the market because housing starts are down 47% since the start of the recession.6 Just as with autos, the need for new housing is rising; the catalyst of high affordability and price stability appears to be in place.
There’s a shadow inventory of homes out there—those that aren’t yet on the market, but will be. It includes homes off the market because their owners are waiting for an improved market, as well as those who are in the midst of the foreclosure process. These homes may go back on the market in 2010-2011 and could be a long-term headwind for any type of robust recovery in housing.
4. The global economy is recovering
As of October, the leading indicators of 39 of the largest economies in the world are all signaling growth. This is the first time in 20 years of data that we’ve seen this breadth of recovery. It is also a dramatic reversal from the start of the year, when none of the 39 largest economies saw their leading indicators rise.
To me, this is an extremely strong signal of a global economic recovery. And as the economies of other countries improve, demand in those countries will increase. This should translate into demand for U.S. exports. Indeed, U.S. exports are rising at a 25% three-month annualized rate as of October.7 Improved U.S. exports should translate into improved employment trends for exporters and a boost to U.S. gross domestic product (GDP.)
What this all means for investors
I am increasingly focusing on industries that have the potential to benefit from revenue growth. The early cyclicals—sectors and companies that tend to do well in the early stages of an economic recovery—are indicators of the start of a market rally. As the economy moves to full expansion, I’m focusing on industries that might see sales running ahead of average and that could benefit from strong global trade and a recovery in capital spending: industrials, semiconductors, software, and some consumer staples. I also see signs the recovery is just starting in consumer durables, so I still like homebuilders, appliances, furniture, and autos. The stabilization in the employment sector could mean that the days of an extremely lenient Fed may be coming to an end in 2010, so I’m more cautious on financials and commodities.