KEY DATA: Consumption: 0%; Disposable Income: -0.1%/ Construction: -1.3%; Private: -0.1%/ ISM (Man.): -1.5 points; Orders: -3.1 points; Employment: -2.0 points
IN A NUTSHELL: “The consumer may be slowing down but that has yet to have a major impact on manufacturing.”
WHAT IT MEANS: The economy rebounded nicely in the spring, but the first half of the year was the same as it has been for the last seven years. Now that we are in the second half, the question is: Will the second quarter rise in activity be sustained or will we fall back into the usual pattern? If the consumer has any say, don’t expect any major improvement in growth. Consumption, when adjusted for inflation, was flat in June. A modest rise in services demand was offset by declines in durable and nondurable spending. The broad based moderation in consumption is a concern, especially when you consider that incomes are just not improving. Real disposable income, which is the best measure of spending power since it adjusts for taxes and prices, fell slightly. That is not as much of a concern as it might appear since the drop was due to a major cut back in interest and dividend income. This is a wildly volatile component. Wage and salary gains were good but still nothing spectacular. Households are trying to maintain their lifestyles and they are doing that by cutting their savings rate.
Despite tepid consumer demand, the manufacturing sector is in good shape. Yes, the Institute for Supply Management reported that the activity index fell in July. Actually, just about every component was off. So why do I say conditions remain strong? The levels of the overall and component indices are still pretty high. New orders are increasing strongly, just not robustly. Firms are adding to payrolls at a solid pace, even if it is slightly less rapidly than in June. And order books continue to fill, providing hope that production will continue to increase. Indeed, the overall index seems to be pointing to GDP growth closer to 4% than the 2% we have seen so far this year.
The June construction report was released and it showed that building activity fell sharply. A major reduction in public sector activity made the numbers look really bad, though the lack of increase in the private sector was a real disappointment.
MARKETS AND FED POLICY IMPLICATIONS: Until I see differently, I am going with my headline from last week’s GDP report: Same as it ever was. The consumer is spending but is hardly exuberant. Income growth is just not strong enough to pull us out of this 2% economy. Yes, manufacturers are saying things are good, but with vehicles sales trending downward compared to last year, it is likely there is little room for further improvement. And construction is going nowhere. All this points to another quarter of maybe 2.50% growth, give or take a quarter percentage point. So, why are investors so buoyant? Earnings are holding up and as long as that continues, the party could keep going and going and going.