The Economy Springs Ahead -- But then Falls Back

We haven't talked to you for a long while about the state of the economy, and as spring arrives, we see some signs of life that finally might be suggesting a break out to more vigorous times.  But, similar to this spring's weather thus far in the New York region, the gains are hesitant and a bit erratic, but they still point to the development of more economic strength.

A Better Stock Market Helped by Low Interest Rates

First, while very erratic itself, the stock market is hovering around new highs.  The last couple of days, the Dow Jones and the S&P 500 have both been down, but just on Monday, they closed at new record levels.  The S&P finally beat its October 2007 peak on March 28 and advanced more on Monday, April 1; the Dow pierced its 2007 peak just on March 5.  This week's subsequent declines were fairly sharp, but even so, the Dow is up almost 9% over the last three months and the S&P more than 6%.

These moves in stocks seem to us mainly generated by low interest rates, rather than genuine optimism.  People with cash to invest in financial instruments can choose stocks or bonds.  If an investor is cautious, bonds might be the choice, but the Federal Reserve has conducted monetary policy with a goal of keeping long-term interest rates low, and they are.  A 10-year Treasury note pays a mere 1.7% in today's market and high quality corporate bonds with roughly that maturity pay just over 3%.  As we'll see, such low rates are helping spur growth in interest-sensitive parts of the economy, but they don't provide investors much return.  So by comparison, if there is much reason at all to believe the economy could grow, stocks, which should rise with it, may be the better choice.

Home Sales and Prices Helped by Low Interest Rates

Second, the low interest rates are helping the housing market.  Mortgage rates are at 50-year lows – really.  Home sales and house prices are rising.  These moves have not been strongly resurgent, but they mark upturns from the protracted declines during and after the financial crisis.  Sales of existing home were 7.1 million in 2005 and they dropped to a low of 3.5 million in the fall of 2010; last year, they averaged 4.66 million, and they advanced through this February to a 4.98 million annualized rate.  Home values dropped from April 2006 through February of last year by a total of 26% and they have since recovered by 10%.  While those values are still well below their 2006 highs, at least the decline in that wealth cushion for homeowners seems to be over.

These improvements, more home sales and firmer home values for homeowners are helping support consumer spending, giving further lift to the overall economy.  People are also borrowing somewhat more.  This is a relative shift as well; we paid off debt from 2008 through much of last year, and home mortgage obligations were actually still edging lower through the end of 2012.  But credit card and other consumer borrowing has picked up.

Aging Cars Lift Sales of New Cars

One area of greater demand is cars.  As with homes, vehicle buying dipped very low for a long time during and after the recession; the average age of vehicles on the road reached 11.2 years in 2012, up from 9.4 years in 2007.  Cars, SUVs and small trucks can go this long because they're made better now than, say 10 years ago, but clearly, car owners have also been getting their old rattle-traps repaired more before they decide to trade them in.  Improving economic conditions and greater credit availability are helping them make that trade-in decision, and since November, car and light truck sales have been noticeably stronger, above 15 million (annual rates).  For those concerned that this only benefits auto plants overseas, these recent gains have come almost entirely in domestically produced vehicles.

Purchases of home furnishings have also increased noticeably just the last few months, logically, with increased home sales and new home construction.  People are also eating out more and spending more on cell-phone, cable TV and internet service and air travel, just to name some scattered items where expenditures have risen over the last few months.

Business Finally Put Their Cash to Work

Business spending is also a source of growth at present.  Expenditures on structures, particularly power and communications installations and even manufacturing facilities, contributed marked growth in the fourth quarter of 2012.  Installations of information and communications equipment added as well.  During and after the recession, businesses pulled in their expenditures on such assets greatly.  This occurred in particular despite a substantial improvement in their internal cash flow and they finally began during 2012 to move their investment outlays closer in line with the profits and other funds generated by their operations.  Until early last year, the post-recession period had seen companies stash away their cash flows in financial assets – and quite properly – paying off or restraining their use of bank debt.  The move away from short-term debt was also accompanied by a shift to corporate bonds; this is a healthy development and also more sensible with the current 50-year-plus lows in those borrowing rates.

But Major Uncertainties Get Hinder Momentum

These consumer and business spending and borrowing patterns are constructive for growth, but several forces stop us from getting too excited about economic prospects.  You've probably seen the headlines today about March's jobs report, with businesses adding just 88,000 new jobs and still more people withdrawing from the job market altogether.  Prior months' new hiring was actually revised higher from previous reports, so the trend over the last six months is no weaker, but job growth is still unacceptably low and uninspiring.  Surveys of consumer confidence bear this out; those surveys and the job counts are both above recession lows, but well below levels 10-15 years ago.

We also continue to worry about gasoline prices.  At $3.50 to $4.00 a gallon for regular at the moment, these amounts mean consumers have to spend noticeable portions of their incomes just to fill up their cars.  This doesn't bode well for spending on other things, especially as the summer driving season gets going soon.  At the same time, these stubbornly high prices are evoking more structural responses – more hybrids, more Fiat 500's, other energy-saving efforts.  The recognition that cheap energy will not return can spark efforts at more innovation.

Finally, continuing heckling and haggling in Washington mean no one knows what to expect about taxes and government regulations.  Delays in formulating the structure of ObamaCare arrangements adds to these woes.  Recent surveys of small business owners by the National Federation of Independent Business highlight their concerns; the largest share of that group in 20 years reports that government requirements are their biggest business problem.  Their plans for expanding their businesses and for hiring are also restrained well below amounts that prevailed for decades before the recession.

So we see fundamentals reasserting themselves in ordinary demand for cars and houses.  Innovations in energy and business investment can also support further growth.  But uncertainty remains intense, holding back the outburst of self-reinforcing growth we're all looking for.  More, we didn't even mention continuing financial stress in Europe, and who knows what's going on with North Korea . . . .

Up next for Ways of the World:  Earth Day in just over two weeks brings attention to another force that interacts with all of this: sustainability and business efforts to practice it.  Those two words, "sustainability" and "business", can appear in the same sentence, as we'll see.

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Our comments about spending are based on Commerce Department data associated with the GDP accounts.  Housing data come from the National Association of Realtors, and home prices from First American Core Logic.  The Federal Reserve uses the latter source to value all homes for the balance sheets it compiles for the total economy.  Our comments about borrowing are based on accompanying tables from the Fed's Flow-of-Funds Accounts.