Posted by Joseph Y. Calhoun, III

The economic data released this week continues the pattern we’ve seen for months. Manufacturing is leading the recovery while consumption continues to lag. This pattern is actually quite normal for recovery from recession and is consistent with economic theory. The mainstream view that the economy can’t recover without a rise in consumption is exactly backwards. This recession - and almost every other recession for that matter - was not caused by a lack of consumption. The recession was caused by a drop in investment, specifically a drop in residential investment. During the housing boom, practically the only investments we were making were in real estate so when it fell, the entire economy, unsurprisingly, did a header.

The incoming economic data support this view that it is investment that is leading us out of recession. Last week’s data started with personal income and outlays which showed a small rise in income and spending. Personal income rose 0.1% month over month and 1.1% year over year. Wages and salaries were up nicely (0.4%) but that was offset by a reversal of the strong increase in farm income last month (what the heck was that about?). Spending was up 0.5% but most of that was due to a rise in gasoline prices. Durable goods spending was only up 0.1%. Real disposable income fell slightly on the month, possibly due to the expiration of extended unemployment benefits. The savings rate fell slightly to 3.3%. Income and spending will only really pick up when employment recovers but as bad as this recession has been, income and spending have held up surprisingly well throughout.

By contrast, the ISM manufacturing survey, also released Monday, showed continued expansion in the manufacturing sector, although it did ease a bit from last month to 56.5. The employment component was strong for the second month rising to 56.1 (Friday’s employment report showed a rise of 1000 jobs in manufacturing; not much but a start). New orders and backlogs were also strong at 59.5 and 61.0. Further confirmation of the strong ISM report came Friday when factory orders were reported up 1.7%. The backlog reading looks like future jobs to me. Manufacturers have squeezed about as much productivity out of the current work force as they can and hiring will have to pick up soon if new orders keep coming in at this pace.

Construction spending fell 0.6% in January, but that was a bit less than expected and maybe a bit surprising considering the snowstorms. Most surprising was a 1.3% rise in residential construction. The overall drop was due to a drop in non residential and public construction.

The ISM non Manufacturing report was released Wednesday and rose to 53.0 it’s highest reading since April of 2008. The employment component rose strongly but is still below 50 at 48.6. New orders rose to 55 the highest since August 2007. It makes sense that the non manufacturing survey lags the manufacturing survey coming out of recession so I expect the non manufacturing report to continue to surprise to the upside in coming months.

Chain stores reported quite good same store sales on Thursday. Overall same store sales rose 4% with Macy’s, Dillard’s, Aeropostale, Gap, Abercrombie and Fitch, Banana Republic, Old Navy and Limited Brands, to name just a few, all reporting better than expected numbers. This is six straight months of rising same store sales so this isn’t a fluke. The death of the American consumer has been greatly exaggerated.

Jobless claims fell on the week to 469,000, slightly less than expected but still much higher than I’d like to see. I think we can see some job growth at this level but in a healthy economy claims would be at least under 400,000 and preferably even lower. On a brighter note, productivity and unit labor costs were both better than expected. The drop in unit labor costs (-5.9%) is particularly important since a reduction in labor costs will have a direct impact on hiring. One of the hesitations about hiring is that the future cost of an employee right now is a giant unknown due to the ongoing debate over health care reform and other policy measures. Those things will ultimately be resolved though and when they are, labor costs will have fallen in the meantime.

Pending home sales, reported on Thursday, confirmed the ongoing weakness in the housing market. Contracts signed were down 7.6% in January which the NAR blamed on the weather but this is one more in a string of weak reports so I don’t think that is the whole explanation. We had a burst of activity as we approached the end of the first time home buyers tax credit in November that sucked sales forward. We might see a similar effect as we approach the extended expiration in April, but unless the subsidy is extended once again we’ll have to wait for further confirmation of economic recovery before sales pick up again.

Friday brought the employment report which showed a loss of 36,000 jobs on the month, a bit less than expected. Of course, the administration had prepared everyone for this by blaming a weak report on the weather well in advance, but the truth is that the snowstorms probably had a minimal effect on this report. The big loser - again - was construction with a loss of 64,000 jobs but this is just a continuation of what we’ve been seeing for many months now. And it should be pointed out that these reports are seasonally adjusted and last I checked winter happens every year. Okay, the snow was worse than normal but construction won’t come back for some time regardless of the weather.

The glimmers of hope in these employment reports are getting brighter and this one was no different. Temporary help was up again, rising by 48,000 jobs. Service jobs were up 42,000 and government jobs, despite census hiring, fell by 18,000 (yes, I put that in the positive category). The labor force and the participation rate were both up and the number of employed expanded by 308,000 while unemployed rose 34,000 (this is from the household survey). There were some bad stats too though; those working part time due to economic conditions rose 475,000 reversing some of last month’s positive change. There are still significant problems with the labor market. Long term unemployment is a major problem and there are a lot of people who have dropped out of the workforce. As the economy recovers these people will re-enter the workforce so even when the economy starts producing jobs again, the unemployment rate will likely stay high for a while. But things are improving and I expect next month’s report to start showing overall growth.

The economic recovery is, as I said last week, on a pretty normal path with manufacturing leading. Consumer activity will pick up when employment picks up and with new orders and backlogs rising and retail sales surprisingly strong, we might be on the verge of exatly that. Jobless claims are the key metric over the next few weeks; if they start falling again I think we can expect a very strong employment report next month.