LP L FINANCIAL R E S E AR C H

Weekly Economic Commentary

June 1, 2009

Will the Auto Sector Turmoil Detour the

Economy’s Road to Recovery?

John Canally, CFA Last week, global financial markets braced for the bankruptcy of GM, cheered
Economist for a quick end to Chrysler’s bankruptcy, all while trying to gauge the impact
LPL Financial of the automakers’ meltdown on the U.S. economy. The news on housing last
week suggested that the bottoming process in that sector continued, while
the release of the regional manufacturing surveys offered hope that the pain
ECONOMIC CALENDAR of the auto bankruptcies may be contained.

Monday, June 1 ISM Non Manufacturing This week, markets will digest the details of the GM bankruptcy, which
Personal Spending Index will allow market participants to begin to more accurately assess what the
April May impact to the economy will be. As the week progresses, attention will turn
to the employment picture in May, with the release of the ADP employment
Personal Income Factory Orders
April April report on Wednesday, the jobless claims data for the week ending May 30 on
Thursday, and the May nonfarm payroll jobs report on Friday.
ISM Mfg Thursday, June 4
May Productivity Also of great interest to the market, will be the release of the weekly chain
Q1 store sales data for the week ending May 30 on Wednesday, the chain
Construction Spending
April Initial Claims store sales data for the month of May, due on Thursday, along with the April
wk 05/30 personal spending report, which was released as this publication was being
Tuesday, June 2
Domestic Car/Light ICSC- Chain Store Sales written. This data will provide a sense of the pace of consumer spending
Vehicle Sales (YoY) (two-thirds of gross domestic product) in the early-to-mid part of Q2 2009.
May May Spending rose at a 1.5% annualized clip in Q1 2009 versus Q4 2008, but we
Pending Home Sales Friday, June 5 expect spending to fall in Q2 versus Q1, but only by about 1.0%.
April Unemployment Rate The news on the housing market last week continued to suggest that the
May
Wednesday, June 3 long-suffering housing sector may be in the bottoming process. Why?
ADP Employment Nonfarm Payrolls
May May „ Existing house sales have been moving sideways since last Fall, rising to
a better than expected 2.9% in April versus March
Challenger Job Cut Consumer Credit
Announcements April „ New house sales have been moving sideways since early 2009, rising
May 0.3% in April versus March
„ The inventory of existing and new homes for sale has dropped
dramatically, with existing home sales inventory down 18% from their
July 2008 peak, and new home inventories down 48% since peaking in
July of 2006 [Chart 1]
Soaring affordability (falling prices, historically low mortgage rates, relatively
stable incomes), along with the government’s foreclosure mitigation program
have all helped. We still have a long way to go before housing can be a plus
for GDP growth, but at least it has stopped getting worse.
GM and Chrysler passed each other in bankruptcy court, with Chrysler likely
to emerge this week from a month long stay in receivership after filing on

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 W E E KLY E CONOMIC COMME N TAR Y

1 Housing Market Bottoming Process Continues May 4, and GM filing on June 1. The question for the market is, what impact
the bankruptcies will have on the broad economy over the next few months.
Existing 1-Family Home Sales: United States (left scale)
SAAR, Thous First some background. U.S. auto and light truck output is now just 1.5%
New 1-Family House Sold: United States (right scale)
SAAR, THous of GDP, after accounting for roughly 3.5% of GDP on average since 1970,
6400 1400
and accounting for as much as 4.5% of GDP for much of the early 1970s.
6000 1200 Thus, the bulk of the auto sector’s pain has probably already been felt in the
5600 1000 economy over the past several years. [Chart 2] In terms of jobs, auto related
employment accounts for roughly 2% of all employment. Thus far, the impact
5200 800
of the Chrysler bankruptcy has been negligible on a national scale. First,
4800 600
jobless claims stood at 605,000 the week Chrysler filed for bankruptcy on
4400 400 May 4, and in the latest week (May 23) claims stood at 623,000, an increase
4000 200 of 18,000. While, unwelcome, a rise of that magnitude suggests that the
99 00 01 02 03 04 05 06 07 08 labor market outside of autos is not experiencing any further deteriorating due
Source: Realtor/Census Bureau/Haver 06/01/09 to the Chrysler bankruptcy.
In addition, the Institute for Supply Management’s Survey of Manufacturing
Index rose to 42.8 in May from 40.1 in April, beating expectations of a
42.3 reading; a reading below 50 signals contraction, while an index above
2 Auto Sector Share of GDP has Already Declined
50 signifies growth in manufacturing. A reading on the ISM in excess of
Markedly
41.2, over a period of time, generally indicates an expansion of the overall
Motor Vehicle Output as a Percent of GDP economy. Therefore, the May ISM indicates growth in the overall
5.25 economy in May following seven months of decline, but continuing
4.50 contraction in the manufacturing sector. Note that the impact of the GM
3.75
bankruptcy (and related plant shutdowns) will also impact the June ISM data,
as will the lingering effects of the Chrysler plant shutdowns.
3.00
Regionally however, the impact has been quite large, judging from the big
2.25
drop in the Chicago Area Purchasing Managers Index in May versus April.
1.50 Much of the nation’s auto production occurs in the Midwest. Notably, it was
0.75 the only regional manufacturing survey to deteriorate between April and
70 75 80 85 90 95 00 05 May, thus we can conclude that in May, the impact of the auto sector turmoil
Source: Haver 06/01/09 hasn’t spread to other sectors of the economy. [Chart 3]
Overall it’s unfortunate that auto bankruptcies will muddle the economic
picture, just as the markets are trying to assess when the recession will end
3 ISM Suggests the Economy is Emerging from and how robust the recovery might be. Our view is that the bankruptcies
Recession; Little Impact from Chrysler at GM and Chrysler will cloud the economic picture over the summer, but
Bankruptcy won’t do enough damage by themselves to run the economy off the road
to recovery. The question is can markets look past the auto impact to the
ISM Manufacturing: PMI Composite Index
SA, 50+ = Increasing underlying health of the economy?
80
As the week progresses, markets will begin to focus on the labor market
70 Above 41.2% Economy Expanding
reports for May, which include:
60
„ The ADP and Challenger layoff data for May on Wednesday, which often
50 provide an “early look” into the government’s jobs report
40 „ The jobless claims data for the week ending May 30 on Thursday. As
Below 41.2% Economy Contracting noted above, the impact of the Chrysler bankruptcy on the claims data
30
has been muted, with the impact from the GM shutdowns looming
20
75 80 85 90 95 00 05 „ The nonfarm payroll jobs report on Friday, which provides the most
Source: Institute for Supply Management/Haver 06/01/09 comprehensive look at the nation’s labor market in May

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 W E E KLY E CONOMIC COMME N TAR Y

Our view is that the bankruptcies As we point out often in these pages, the labor market is, at best,
at GM and Chrysler will cloud the a coincident indicator of the economy. As a result, we expect the
unemployment rate to continue to rise, and the monthly nonfarm payroll job
economic picture over the summer,
count to remain negative, long after the recession ends.
but won’t do enough damage by
themselves to run the economy off However, there are several aspects of the jobs report that are predictive of
future labor market trends, and we (and the market) will be watching these
the road to recovery.
indicators closely. Those indicators include:
„ Overtime hours
„ Employment at temporary help firms
„ Employment in early cyclical sectors like Technology and Retail
„ The diffusion index—the number of industries adding jobs versus the
number of industries shedding jobs in a given month
The May jobs report is also likely to be influenced (again) by the hiring of
workers for the 2010 Census. The key for the May jobs report (and indeed for
most economic reports due out over the next few months) is whether or not
the financial markets can look beyond the impact of the auto sector in the
report to gauge the underlying strength (or weakness) of the broad economy.

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This research material has been prepared by LPL Financial.

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