How Are the Green Shoots Doing? Well . . . .

Back in early May, we gave an overview of the stock market and the economy. We left open the question at the end whether some signs of life in the economy – so called "green shoots" of spring – marked the beginnings of recovery. Some six weeks later, we still have no conclusive evidence. But here are some factors.

Jobs, Spending and Housing Are Not as Weak
Retail store sales seem to have turned upward. After notable weakness in March and April, the May figures picked up by 0.5%, a quite respectable one-month gain. Most of it was higher gas station sales owing to the higher prices we've begun to suffer again, but even aside from that, other stores showed net gains. Not big, but encouraging.

Employment was still down in May, but that report surprised with the smallest decline since last September; while jobs still fell by 345,000, they had declined an average of 605,000 each of the prior seven months. It feels odd to express pleasure over 345,000 jobs lost, but we'll take what we get here. Construction and service sector job losses moderated, with retailing actually increasing the number of its employees, one of the few non-government sectors to do that.

Housing activity has stopped falling. New construction "starts" on one-family homes, that is, ground-breakings, increased for three consecutive months through May. Sales of these houses were still weak through April (latest known today; more data due later this week) but are up from a January low. The levels of these starts and sales, at 350,000-400,000, remain near record lows for the 50-some years the U.S. Census Bureau has collected these data; a healthy volume of starts has been about 1.5 million. Extraordinarily low mortgage rates, below 5%, gave some hope that activity might pick up. Historically, a recovery in housing has been one of the main forces pulling up the entire economy. But then, around June 1, mortgage rates rose sharply, surpassing 5% for the first time since early March and reaching 5.59%, the highest since last Thanksgiving. Last week, they retreated a bit, but such a sudden upshift is troublesome if the fragile sector is to develop a full-blown recovery.

But Higher Mortgage Rates and Gas Prices Raise Concern
So we've identified two concerns as we ruminate on the economy's fortunes: higher mortgage rates and higher gasoline prices. Both of these can act like weeds among the green shoots, choking them off just when they might be developing into nice plants. Fortunately the very latest moves in both show some easing; besides last week's easing in mortgage rates, gasoline prices were flat to down very slightly. And food prices remain moderate. The grain and meat prices that were so high and distressing at this time last year have largely given way; chicken is an exception, but beef, pork and even turkey prices are considerably lower now. This helps offset the pressure on tight consumer incomes from the recent surge in gasoline.

So compared with our last assessment, we're probably mildly more optimistic that outright recovery can come soon. Our hesitation seems to be joined by stock market investors, who push stock values higher, but then get nervous and push them back down. This happened yesterday with a 200-point drop in the Dow Jones average. One reason the press cited for the drop was a downgrading of the world outlook by the World Bank. That highlights an important aspect of the likely pattern of news going forward. The economy and the markets are in fact much improved over their chaotic states last fall. But bad news about the repercussions of this entire meltdown scenario will continue for some time. In our view, a poorer outlook for developing countries, while sad, is still to be expected in this chain of events. Further, and closer to home, we are likely for many months to have bad news about jobs and unemployment. Traditionally, companies wait quite a while after sales begin to turn up to commit to a larger workforce. In this age of instant information, we will be impatient to have better news right away, but don't fret. If the economy's improving trend is sustained, that will come in due course, but not next month or the month after that.

Uncle Sam Giveth and Uncle Sam Taketh Away
Two other issues. We've repeatedly promised further comments on the auto industry, especially in the wake of General Motors' bankruptcy filing three weeks ago. Prospects for these companies depend crucially on auto sales themselves. These were up in May from April, but at 9.9 million vehicles, they remain more than 30% below a year ago. Still this was the best level since December, and a recent statement from the CEO of GM indicates that company is experiencing firm sales in June as well. This is significant, since it means their customers are not scared off by the bankruptcy proceeding and have faith that the company will be around for awhile to service and maintain the cars. The General Motors reorganization plan appears to take better care of "secured" creditors than Chrysler's did, but these are both unprecedented situations and taxpayers, of course, will have a majority interest in GM.

Which brings us to a final topic, the role of the federal government in current business and financial markets. The upturn in mortgage rates we talked about earlier stems in part from an upturn in U.S. Treasury rates that began back in the winter. Yields on 10-year Treasury notes have risen from 2.27% in mid-January to 3.63% today. Some argue that these rates have risen because of expectations of higher inflation; this view has some validity. But the cause is simpler, we think: in the last six months, the Treasury has issued more than $900 billion in new bonds and notes. With tax receipts weakened by the economy and spending increased by stimulus efforts, that's about twice as much debt issuance as the volumes that had prevailed for several years through last September. This topic is one that will take at least a whole article itself, but its importance for the moment is that since mortgage rates tend to follow Treasuries, the government's "stimulus" has come with a higher cost for new housing credit. We don't think it will totally undo the relief that mortgage and housing markets have already seen, but it doesn't help. And it's one more reason we're still skeptical about the strength of any recovery in the months ahead.