After a relentless stream of disappointing reports, it's nice to receive a dollop of good news for a change.
Make no mistake; nothing that came out of Washington's data mills this week can be considered a game-changer. But at least the negativity that has been overhanging the economic landscape in recent weeks has been lifted a bit, offering a kernal of hope for optimists who believe that the softness portrayed in some key indicators is nothing more than a temporary blip on the road to better times.
To be sure, we are not factoring in the European debt quagmire, which seems to sink into deeper quicksand with each passing day and is no doubt playing havoc with investor psychology. If the new Greek government, whenever it is formed and whatever shape it takes, continues to play chicken with Europe's policy makers, dominated by Germany, and is willing to rupture the single-currency union to achieve debt relief, then all bets are off. Under those circumstances, it would be almost impossible to guess what the financial fall-out in the U.S would be, and the knock-on effects it would have on investor and public confidence. That said, we have seen this tug-of-war drama before; each new tremor causes the financial markets to buckle but not break, reflecting perhaps the tenacious view that rational minds will eventually prevail and arrive at a sensible compromise.
Absent a confidence-shattering blow from oversees, the U.S. is showing signs of emerging from its latest soft patch. Paradoxically, there is a good chance that the first quarter's growth rate, initially pegged at a sluggish 2.2 percent, will be revised lower when the second tally is released at the end of this month if only because of a slower than expected pace of inventory restocking by wholesalers in March reported this week. But that's looking through the rear view mirror at conditions ending more than a month ago. Of more relevance is what's happening now and what the forward-looking indicators tell us will happen in coming months. Here's where this week's reports - admittedly a slim package - come into play. Put simply, the signs of an improving labor market, business and consumer sentiment and credit conditions were clearly on display.
Let's start with small businesses, the backbone for job creation, which have been severely hampered throughout the recovery by an array of forces, some unique to smaller firms and some shared by the general business community. In April, the National Federation of Independent Business (NFIB) small business optimism index recovered 2 points to reach 94.5, regaining its upward movement after briefly dipping lower to 92.5 in March. The April reading equaled the 94.5 in February 2011, which was the highest since December 2007 - the last month of the previous expansion. Contributing to the April rise were solid gains in earnings and increased plans for hiring and capital expenditures, as well as improved expectations for the economy and credit conditions.
As the chart shows, the NFIB index also got off to a good start in 2011 before getting derailed by a series of disruptions -- natural disasters and geopolitical events - that restrained growth in the broader economy and increased uncertainty in the outlook. Although the divisive political environment in the US remains and financial conditions in Europe are volatile, the US economy appears to be more stable. Without the drag from a series of natural disasters here and abroad, prospects for growth in 2012 are more upbeat. It appears that the March dip in the index reflected primarily the spike in gasoline prices, which receded in April and continues to slip in May. With the easing of this immediate pressure on budgets, businesses are able to once more allocate spending for payrolls and infrastructure improvements.
The largest change in the components of the index was in the earnings trend, up 11 to -12% in April - the highest reading since prior to the onset of the recession. This is a hopeful development, and suggests that businesses may be both more able and more inclined to hire new workers and to invest in infrastructure for their operations. Possibly contributing to higher earnings were higher prices. In April, 23% of respondents reported plans to increase prices, up 2 points from March. This index has been rising steadily since January, along with gasoline prices. The next largest change was in plans to increase employment, which was up 5 to 5%. This was a return to a modest upward trend after the neutral reading in March. Although the index remains below its pre-recession levels, the general direction is for modest, steady gains.
There was also a decent rise in plans to make capital outlays of 3 points in April to 25%, the highest reading since 26% in June 2008. The April number was not far off the levels seen in the early stages of the recession. This component has been hovering between 20% and 25% for over a year. Plans for capital spending remain fairly steady, but could accelerate if the earnings trend remains firmer. Finally, the expected credit conditions component rose 3 to -8%, which was consistent with levels seen at the start of the recession and before the credit crunch took hold in earnest. Significantly, The availability of loans is returning to levels generally prevailing during periods of expansion.
To be sure, the recovery will not gain much traction unless the big guys start to do more of the heavy lifting. Thus far, the large corporations have shown a willingness to replace ageing machinery and software and rev up operations in response to solid gains in exports. But investment spending in general has not been as much of a growth catalyst as it usually is during upturns. Instead, companies are hoarding their ample cash inflows, holding a record $2.23 trillion in liquid assets at the start of the year. However, the nascent revival in small business prospects could be a positive omen that ultimately unlocks the cash trove and spurs stronger increases in capital spending. That's because the behavior of small business owners mirrors that of households in general. If household demand picks up, business investment will follow.
Granted, the behavior of households has been anything but decisive, as the 2.2 percent growth rate in real personal consumption expenditures over the eleven quarters of the recovery is more than a percentage point below the long-term average dating back to 1960. But recent signs have been promising. One of the bright spots of the first quarter's disappointing GDP report was the sturdy 2.9 percent increase in personal consumption expenditures. While the quarter ended on a weak note, households may have regained their mojo in April. At the very least, they are spending the second quarter in a much better mood than was the case during the earlier months of the year.
According to this week's reading by Reuters/ University of Michigan, the consumer sentiment index took a surprisingly upward turn, rising to the highest level since January 2008 in early Mary. The 1.4-point increase to 77.8 included a much more upbeat feeling about current conditions, whereas the expectations component actually slipped from April. The divergent paths probably reflected some relief from the drop in gasoline prices (the current conditions component) and rising trepidation over how the looming political battle over expiring tax cuts will impact the economy next year (the expectations component). However, perceptions of current conditions correlate more closely with spending, so the nice bounce there will hopefully presage stronger consumer spending in April and May.
We will be getting retail sales figures for April next week and it will be interesting to see if the solid 0.8 percent gain posted for March will hold up in light of the expected weather-related payback (the weakness in overall personal consumption in March reflected primarily soft spending on services). One promising note that is shared by the small business segment is the easier access to credit that households appear to be enjoying. What's more, they are showing a much stronger willingness to take on new debt. That is strikingly illustrated in this week's consumer credit report, which revealed an astonishing $21.4 billion surge in credit in March, the strongest monthly increase since a $28 billion rise in November 2001. Nor was the March increase a one-off event, as credit growth has been accelerating since last fall. Indeed, the $48 billion gain in the first quarter was the largest for any quarter since 2000. No doubt, some fraction of the borrowing increase is being taken to plug the shortfall in income growth, enabling households to maintain living standard. But restrictive credit conditions have been a major growth impediment throughout most of the recovery and the reopening of the credit spigot should be regarded as a welcome development.
