Although the broad economy has grown steadily since the beginning of 2009, the construction sector remains mired in a state of recession. Construction employment peaked at the end of 2006 as the housing bubble began its collapse. Currently, the unemployment rate of the construction sector stands at 21.8%. This is primarily contingent upon the fact that residential construction is at its lowest annual rate since records began in 1959. Unfortunately for the construction sector, there is little indication that residential construction will pick up in the short term. The National Association of Realtors is forecasting that new housing starts will slowly increase from its current annual pace of approximately 500,000 to 900,000 in the second quarter of 2012, which is substantially less than the historical annual average of 1,500,000.

At the current sales pace of existing homes, there is 8.6 months of supply on the market. Most industry analysts consider 6 months a healthy supply of homes. When taking into consideration the shadow inventory of homes (homes in the early stages of foreclosure process not currently listed) the condition is much worse. Additionally, approximately 40% of sales in the past month were either foreclosures or short sales which drive down the median price of existing home and make new homes (new construction) look less attractive from a price point. The road to recovery in the construction sector will be a slow one, but at least there has been some stabilization in the number of construction jobs (5,500,000) since the midpoint of 2010.

As investors raise questions surrounding the prospects of both stocks and bonds as we head into the Summer, a useful exercise can be looking at the historical valuation of the two asset classes in relation to one another. A variation of Dr. Ed Yardeni’s Fed’s Stock Valuation Model can be used as a simplistic gauge of the relative valuation between the two asset classes. Working under the premise that investors must choose to allocate a limited amount of capital between stocks and bonds, the model subtracts the yield to maturity of the 10-Year U.S. Treasury Note from the earnings yield on the S&P 500 Index to develop a spread between the two.

For much of the 1990’s the spread was negative, suggesting that stocks were expensive relative to bonds. Following the burst of the tech bubble that proved stocks were in fact overvalued, the spread turned positive and has remained so ever since. It is thought that when the spread is positive stocks represent a better investment than bonds due to the higher yield. This is not necessarily the case, in an absolute sense, as one must take into account the additional risk equity investors bear. The reasoning that because stocks are inexpensive relative to bonds does not necessarily suggest that stocks are about to experience a period of positive returns. Keeping in mind that this model represents a relative valuation spread between the two assets classes, a positive spread could suggest that both assets classes are overvalued in relation to other investments – stocks just less so than bonds. Thus, while the model cannot pinpoint the overall outlook for either asset class, trends in the magnitude and direction of the spread have proven useful in the past when predicting the relative movement of stocks and bonds.

The unemployment situation in the U.S. has been a major concern for economists when considering an economic recovery from the “Great Recession”. This week’s chart examines the peak employment level (total number of people working in the U.S. labor force), along with the time taken to return to that peak level after a recession. The chart looks at peak employment in percentage terms, so 100% indicates the U.S. is at a peak employment level, while anything below 100% indicates the employment level is lower than the previous peak employment.

The U.S. hit a peak employment level in November 2007, and has yet to make much progress towards reaching that peak again. Since 1948, this is the longest time period the peak employment level has remained under its previous high after a recession. Growth in the U.S. labor force (total number of people working or seeking work) has leveled off over the last few years while more than 1.7 million civilians have dropped out of the labor force since mid-2008. The nearly 14 million unemployed people that remain in the labor force average nearly 37 weeks of being unemployed.

Several economists, including those that authored a working paper at the San Francisco Fed, have noted that the natural unemployment rate, long considered to be 5%, may have increased over the last several years to stand as high as 6.9% today. After examining variables such as labor market skill mismatches, extended unemployment benefits and growth in productivity, these studies have concluded that the increase in the natural rate of unemployment is most likely temporary, though may last for several years.

As commodity prices around the globe continue their steady march upward, convention would suggest that inflation in the U.S. isn’t far behind. However, as many developing nations have already felt the sting of rising costs, inflation in the U.S. remains largely absent. Headline CPI rose only 1.6% in December over the previous year despite surging costs for oil, gold, cotton and many other commodities.

The cause for the divergence is a split between the pace of increases in the prices of goods and those for services. Producers, largely unable to absorb further increases in input costs, have begun to signal to consumers that price increases are inevitable. Thus the red line on the graph, which represents the cost of goods, has recently risen and is above its long term average, therefore adding inflationary pressure to the economy. Goods included in this metric include commodities and non-durables, less food and beverages. Meanwhile, the costs for many services (such as rent, electricity, and medical care) in the U.S. have grown at a much slower pace since the beginning of the crisis as high unemployment has stifled wage growth. The cost of services is shown by the blue line on the graph; the most recent values sit well below the long term average, therefore lessening inflationary pressure on the economy. At the end of January, inflation for goods registered an increase of 2.2% over the previous year while prices for services only advanced 1.2%. On average over the past 20 years, prices for services have grown 1.75 times faster than those for goods, but cheap labor from developing nations has kept prices for goods in check. So while rising commodity prices can be a driver of inflation here in the U.S., it will likely take acceleration in the prices of services before headline inflation can take off.

This week’s chart shows the relative economic size (measured as a percentage of U.S. GDP) of the top nine countries during each time period compared to the U.S. economy. Back in 1980, the economic giants of the world were Japan and developed Europe, with only two emerging nations near the top (China and Argentina). Moving ahead 30 years to 2010, China surpassed Japan as the second largest economy in the world, and a few more emerging nations (India and Brazil) are now considered two of the largest economies. Japan and the European nations lost relative economic size to the United States from 1980-2010, while Canada remains the same relative size. Projecting out to 2020, China jumps off the chart, with GDP equal to 99% of the U.S economic output. Japan and the developed European nations are estimated to lose more relative size to the United States while more emerging nations will be considered among the largest economies, most especially Russia and Korea. Clearly, the unprecedented growth in emerging economies is a trend expected to continue through the next decade.