I see both dark clouds and rays of hope.
I’ll get to today’s seriously stinky employment report in a moment, but let me start with a bit of good news. Calculated Risk, who to my knowledge has never been wrong, called the bottom to the decline in both house construction and prices last February, and sees considerable confirmation of that prediction since then:
- housing starts are increasing
- residential construction spending is up 17% from its low
- new home sales are up 17% so far this year relative to the previous 18 months
- Case-Shiller and
Core Logic house price measures may have started to rise modestly. Moreover, a broader perception by home owners and buyers that prices have stopped falling would itself be a significant positive.
Autos are another bright spot for the economy. June sales of cars manufactured in North America were up 31% over the previous year, and up 24% so far for the first 6 months of 2012 compared to 2011:H1.
Year-over-year domestic light truck sales were up 18% for June and 11% for 2012:H1.
Tim Duy asks how a recovery in housing could make that much difference. Here’s my answer. The graph below plots the shares of total spending on final goods and services that are attributable to autos and residential construction. These sectors are indeed small relative to the whole economy, with autos and housing between them on average accounting for only about 8% of GDP. That means that if the economy were growing at a 3% annual rate, and housing and autos were doing the same, their contribution to the annual growth rate would only be 0.24 percentage points.
But the key point is that housing and autos hardly ever grow at the same rate as everything else. As housing dropped from about 6-1/4% of GDP at the top of the housing boom in 2005 to its value around 2-1/4% today, it took about 4% away from the level of real GDP. The table below summarizes the drop in real GDP during recent recessions. In an average recession since 1970, real GDP fell at a 1.34% annual rate, of which housing alone accounted for 0.74 percentage points, and autos another 0.27 percentage points. I’ve also argued that hits to the auto sector make an important contribution in the quarters just before a recession begins; see also Ana Herrera’s interesting paper on this last point.
And autos and housing can also make a key contribution to the economic recovery that we hope would follow after a recession. In the robust growth that came the year after the 1970, 1974, and 1982 recessions, these two sectors alone contributed 2 percentage points to the total real GDP annual growth rate. And in other recessions where there was a weak recovery, weakness in housing and autos was an important feature. For example, in the first year of the current recovery, autos and housing contributed a mere 0.17 percentage point to the 3.3% real GDP growth rate. In the 3 years since the recovery began, autos and housing contributed 0.24 percentage points to the meager 2.4% annual GDP growth rate.
But referring back to my first graph above, there is much more that we could still expect these sectors to do. For example, if autos were just to get back to 3% of GDP– a share exceeded in 94% of the quarters prior to 2005– and housing to 4%– a share exceeded 87% of the time prior to 2005– that could add another 2% to GDP right there. Note this makes no reliance at all on any kind of pent-up demand, and uses what seem like quite pessimistic assumptions about the size of the permanent hit absorbed by these sectors. Obviously if we instead did get something like a more typical post-recession boost, these sectors could make a much bigger contribution.
I was recently asked by a portfolio manager what a scenario that came out on the upside of everybody’s GDP forecast might look like, and this was my answer– a robust recovery in housing and autos could easily help produce a 4% real GDP growth rate.
Unfortunately, the rest of the economy so far is not cooperating. On Monday we received the disturbing news that the ISM manufacturing index slipped below 50, meaning that more manufacturing facilities are reporting that conditions worsened in June than reported gains. One month by itself is not terrifying, but there are plenty of other disturbing developments.
Chief among these was yet another disappointing report from the Bureau of Labor Statistics. The BLS estimated that nonfarm payroll employment grew by only 80,000 jobs on a seasonally adjusted basis in June. That’s not much help when there were 157,000 new Americans entering the labor force in June to add to the 12.7 million others who are still unemployed and actively trying to find a job.
Could housing and autos be enough to turn all that around? Before you answer yes, take a look across the Atlantic. Reports in the financial press on the European situation seem to have a boom-bust cycle all of their own. Last week we supposedly shifted back into the optimistic phase of the reporting cycle. But the long-run challenges facing Europe remain as daunting as ever. I have a hard time seeing how that story could be written so that it has a happy ending. And if we do see a dramatic turn for the worse in Europe, it becomes harder yet to get that upside surprise to work out for the U.S.