Jobs and manufacturing point to continued growth

In my estimation, the market continues to underestimate the health of the U.S. economy. To be sure, this recovery still ranks as the worst in modern times. The unemployment rate remains very high. The labor force participation rate remains very low. The number of people working today is still 3 million less than at the peak in early 2008. It's no secret that the economy should be doing a whole lot better. However, the most important thing is what is happening on the margin. The bad news is that the rate of improvement has been disappointing; the good news is that the economy continues to add jobs at a decent pace, and there is no sign of any deterioration. The market is braced for a recession, but there is no sign of a recession; the economy continues to grow, albeit at a disappointingly slow pace.

For the past two years, the private sector has been adding jobs at a 2% pace: about 190K per month on average. That's the same pace as during the 2004-2006 period. According to this chart we are growing just as fast today as we were when the economy was reasonably healthy about 8 years ago. The difference, of course, is that given the depth of the recession we should have been growing much faster.

Both employment surveys show that the private sector of the economy has added a little over 6 million jobs in the past three years. At this pace, jobs will reach a new high within a few years. That will still leave many millions of people unemployed, so it's nothing to cheer. But things are nevertheless improving, not deteriorating. That's critically important, since the markets and the Fed are worrying that the economy is clinging to growth by the skin of its teeth. It's not. It's doing much better than that. Economies are not like airplanes: they don't have a "stall speed." Economies don't collapse if they grow too slowly, they just keep growing slowly.

The January ISM manufacturing report was a good deal stronger than expected (53.1 vs. 50.7). As the above chart suggests, it is reasonable to think that the economy is growing at a 2-3% pace given the health of the manufacturing sector. Things could be a lot better, but they are not getting worse.

As the above chart shows, manufacturing conditions in both the U.S. and the Eurozone are improving on the margin. To be sure, although the survey suggests that Eurozone manufacturing is still shrinking, the pace of deterioration has slowed. On the margin, the outlook is improving both here and in Europe.

Even in Japan the outlook is improving. The Nikkei 225 is up almost 30% since mid-November, thanks to declining deflation risk courtesy of a weaker yen. As the second chart above shows, the January manufacturing surveys in Japan, like in the Eurozone, show a reduction in the rate of deterioration.

It's never smart to let the perfect be the enemy of the good. The economy should be doing better, but it is improving, and that is a far cry from being at risk of recession. Things are likely to continue to improve, albeit slowly.

Markets (and the Fed and most other central banks) are too worried about how things should be better, when they should be encouraged that the outlook is slowly improving.