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The US Economy and the Great Muddle

By David Dittman on October 11, 2011

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Statistics Canada reported last Friday that Canadian employers hired 60,900 new full-time workers in August, nearly six times the consensus estimate. Canada’s unemployment rate is now down to 7.1 percent, from 7.3 percent in August. The unemployment rate hasn’t been this low in Canada since December 2008.

In the 12 months ended Aug. 31 employment grew by 1.7 percent, or 294,000 jobs, concentrated in Ontario and Alberta. Full-time employment rose by 2.5 percent, or 344,000 jobs, while part-time work declined by 1.5 percent, or 50,000 positions. Total actual hours worked increased 2 percent.

The September 2011 Labour Force Survey is yet another sign of Canada’s strength relative to other developed economies. For example, the Organization for Economic Cooperation and Development (OECD) unemployment rate for August was 8.2 percent. And it set up an easy comparison with the US, where the unemployment rate still stands at 9.1 percent.

The US Economy: Still Growing

It was a midsummer’s nightmare for stocks after Jul. 7, when the S&P 500 closed at 1,353.22, within striking distance of the 2011 closing high of 1,363.61 established Apr. 29. From there until Oct. 3’s 1,099.23 the most widely followed index in the world shed nearly 19 percent. The S&P/Toronto Stock Exchange Composite Index, meanwhile, gave back more than 23 percent.

Much of this wealth destruction was the result of an unseemly debt-ceiling debate in Washington, DC, and an obtuse, ill-timed credit downgrade of Uncle Sam by Standard & Poor’s. But there are legitimate issues in play the maladroit handling of which could result in chains of events that tip vulnerable economies into recession.

Fears of a European sovereign debt contagion persist, and there’s no assurance a deal will be reached that adequately recapitalizes vulnerable institutions, prevents the spread of debt contagion and staves off the onset of another global financial crisis, particularly in a political system where a libertarian faction in Slovakia can hold 17 other EU members hostage.

The kind of financial shock that spreads to and takes out Italy and Spain and threatens to undermine the flow of credit in the US could result in a recession. But at this point the market isn’t pricing this risk; there doesn’t appear to be the kind of stress in the financial system that suggests a crisis is imminent.

The HSBC Financial Clog Index measures the aggregate level of stress in the financial system based on four factors: interbank stress, measured by the TED Spread and the LIBOR-OIS Spread; financial institution default risk, measured by US financial credit-default swap spreads; mortgage agency credit spreads, measured by credit spreads for Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE); and equity volatility, measured by the Chicago Board Options Exchange Volatility Index, or VIX.

Source: Bloomberg

Although clearly elevated, the Clog Index is nowhere near the levels we saw at the height of the financial crisis during the winter of 2008-09. A precipitating event–failure of negotiations with Slovakia and over the extension of commitments first made in July 2011 that are now insufficient to deal with Greece’s rapidly accumulating shortfalls could qualify–could push it there.

But even in that event, there can be no crisis where credit isn’t absolutely necessary. We buy businesses, and the businesses we cover–particularly those we recommend in the Canadian Edge Portfolio-have taken steps to protect themselves from the potential impact of a 2008-style crisis by paying down debt and refinancing at historically low rates over the last three years.

There is also concern about China and a “hard landing” and what this would do to global growth. It’s important to note that the emerging market industrial production slowdown is policy enforced, due to concerns about inflation. Emerging market growth on average is still strong, forecast to be around 7 percent in 2012. And if things slow to an uncomfortable level policymakers can reverse prior decisions and get less restrictive, particularly in China.

The concern with legs is that of a slowing US economy, particularly to the extent that this concerns Canada, with which it still forms the biggest bilateral trade relationship on the planet. But evidence that the world’s biggest economy is still expanding–albeit at a sluggish pace insufficient to absorb long-term unemployed, for example–continues to mount.

The Federal Reserve Bank of Chicago National Activity Index (CFNAI) is a weighted average of 85 previously reported monthly economic indicators; these indicators are drawn from four broad categories of data: production and income; employment, unemployment, and hours; personal consumption and housing; and sales, orders, and inventories.

The index has an average value of zero and a standard deviation of one. Because economic activity tends toward trend growth rate over time, a positive index reading corresponds to growth above trend and a negative index reading corresponds to growth below trend. Through August the three-month average stood at -0.28.

The US Economy: Not Quite Chooglin

Usually readings like this on the CFNAI indicate an economy already in a recession. But contributing numbers for September–data for jobs created, in particular–have been better than August and suggest recession fears are overblown.

The Institute for Supply Management’s manufacturing Purchasing Managers Index was 51.6 in September, up from 50.6 in August. A value above 50 indicates that more responders reported improvements than reported deteriorations, so we’re still on the positive side. But the average historical value for manufacturing PMI is 52.7, so we’re continuing with the jagged, slow and inadequate theme. September was better than a poor August, but it was still suboptimal.

Source: Bloomberg

Non-manufacturing PMI for September, meanwhile, was 53, 0.3 percentage point lower than the 53.3 percent registered in August but still showing growth for the 22nd consecutive month. Light vehicle sales, among the 85 CFNAI indicators, increased 9.8 percent over September 2010 but were down slightly from August. Sales of domestically manufactured light trucks were up 16.9 percent over September 2010 and even up slightly over August 2011.

The key number, however, is employment. The more people get back to where, the more they can service their mortgages and start consuming again. But combined with the upward revision to August’s jobs created number from zero to 57,000, the September data establish a trend that isn’t consistent with a rise in unemployment back to 10 percent.

That’s not to say great progress will be made getting 14 million long-term unemployed back to work; the rate of job growth is still insufficient to accommodate new labor force entrants as well as those who’ve lost jobs since 2007. And job creation will likely remain below the critical 150,000 per month level well into 2012.

But we’re simply not seeing the job losses that would define a new US recession. Because the unemployment rate will remain stubbornly high, it’ll be difficult to distinguish–as has been the case throughout this recovery–between a stalling economy and one that’s just gathering momentum.

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