U.S. Stock Rally Takes a Breather as Housing Concerns and Continued Joblessness Hamper Economic Recovery
Posted by Eric Anderson on July 20, 2011
After delivering the strongest first quarter in 13 years, stocks paused during the second quarter as most of the equity indices gave back a little ground, taking a break from the rally which had begun in August of last year. On a year to date basis, the best result came from the Dow Jones Industrial Average which rose 8.6%, while the Russell 2000 (small caps) and S&P 500 were quite close at 6.2% and 6% respectively. The NASDAQ’s return was a little lower at 5%. The MSCI EAFE index gained back some ground it lost earlier in the year during the second quarter, but is still only up 3.7% for the first six months of 2011, and continues to be influenced by the weakness in Japan and several southern European economies.
Of the ten S&P 500 sectors only the Financial sector delivered negative absolute returns through the second quarter. On a relative basis, three sectors underperformed the S&P 500’s 6% gain. Along with the Materials sector’s gain of +3.7%, the laggards include the two largest sectors, Financial -3%, and Technology +2.1%, with the Technology sector continuing its underperformance which was the case for much of 2010. Of the remaining seven sectors that all did better than the S&P 500, some of the strongest results were delivered by two of the weakest sectors last year, Healthcare and Utilities which rose 13.9% and 9.1% respectively. The Energy sector continued to benefit from the increase in crude oil prices, rising 11.4% so far in 2011.
U.S. GDP growth in this recovery is being hampered by housing which usually is a strong engine of economic growth and job creator. The financial system was brought to its knees in 2008 / 2009, still has not fully recovered, and continues to work its way through the many excesses of the last housing boom. As a result banks and mortgage brokers are not making credit / loans available as easily as they normally have in past recoveries given reduced levels of capital, current backlog of defaults and foreclosures, and tighter underwriting standards. In fact, residential construction normally makes up about 4 – 5% of total GDP, at the peak in 2007 /2008 was 6%, and now is down to around just 2%, or less than half of its normal contribution to economic activity.
Cars bigger than houses?
Another important component of GDP that also has been operating below its trend line is the auto industry. This area is normally about half as large as housing in terms of contribution to GDP at around 2.5%, but now with the housing issues it is actually more of a driver of growth to U.S. GDP than housing. The March 11th earthquake / tsunami in Japan that caused so much loss of life, property damage, and radiation from the four Fukushima Daiichi plant reactors, also created a major disruption in the supply chain of a host of electronics, autos, and auto parts which has continued to affect the worldwide production of many products. The impact on the U.S. auto part supply chain was quite pronounced and the production disruptions are only now beginning to recede with the planned July build schedules of the domestic plants owned by Honda, Nissan and Toyota.
Used car buyers have noticed higher sticker prices, while new car buyers have reported a lack of incentives or deals basically because available inventory was not being replenished, but instead being drawn down and depleted. For example, new U.S. car sales in April were 13.1 million, fell to 11.8 million in May, and declined again to 11.5 million in June. In the month of June Toyota and Honda saw their sales fall 20% from prior year levels, while GM and Ford posted unit gains of between 5 and 10%. Honda, Nissan, and Toyota collectively account for 40% of U.S. auto production and 20% of light duty trucks, and during the second quarter output at their U.S. plants slowed considerably and even came to a halt at Toyota during the early part of June. As a result the second quarter GDP will be held back by weak auto production, some economists estimate that as much as ¾ of one percentage point of GDP growth, but GDP should regain strength in the third quarter as auto production ramps back up and as some of the other drags on the economy in the first and second quarters appear to be subsiding, specifically weather / floods, as well as receding gas prices.
We talked about jobs at length in our year end review and what it will take to meaningfully lower the unemployment rate. Unfortunately, the latest news to report is not encouraging, as job creation continues to lag, as exemplified by the recently released June employment report which showed that average weekly hours worked and wages fell. More importantly a very disappointing 18,000 jobs were created, as new hiring was nearly halted and the unemployment rate unexpectedly rose to 9.2% from 9.1% in May. Furthermore, the prior two months were revised and restated lower with a net reduction of 44,000 jobs; therefore, since the recovery began, the U.S. has only regained 20% of the 8.8 million jobs lost over the last recession, and the U.S. needs to add at least 150,000 jobs each month just to keep up with population growth.
The official number of unemployed rose to 14.1 million, but this number excludes discouraged workers (250,000 people were removed from the June total) who have reportedly given up looking for jobs, and unfortunately this group keeps increasing each month as 44% of the unemployed have been off the job for at least 6 months and the average length of unemployment hit a new high at just under 40 weeks. The “underemployment rate,” which includes those who would like to work full-time but who can only find part-time work, rose to 16.2%, its highest level since December of 2010. Economists had counted on state and local government job losses, but few were predicting that private employers would pull back so much, as they added just 57,000 jobs in the month, which was the weakest showing since May 2010. Earlier in the year, private employers were adding around 200,000 jobs per month, but the June results marked the weakest month since September of 2010 when employers were still shedding jobs. Small businesses that are the engine of U.S. job creation just do not seem to have the confidence to hire any more than they can not get by without.