KEY DATA: Starts: -14.4%; 1-Family: -2.4%; Permits: -5.4%; 1-Family: -0.8%/Claims: 280,000 (down 36,000)
IN A NUTSHELL: “Home construction keeps bouncing around but with builder confidence soaring, it is likely the August slump will be followed by a September surge.”
WHAT IT MEANS: Housing starts cratered in August but the Alfred E. Neuman in me holds strong: I am not worried. July’s level was revised up to the highest rate in nearly seven years. A 31.5% decline in buildings of five units or more was the major reason for the August drop and this component is extremely volatile. For the first eight months of the year, starts are up by nearly nine percent, keeping up hopes that we could see another double-digit rise in construction activity. I think that is likely for two reasons. First, permits are still running above starts. That points to an acceleration in construction. Second, the National Association of Home Builders/Wells Fargo Housing Market Index surged in August to its highest level since November 2005. Builders can get irrationally exuberant at times, but that is usually when construction activity is surging. So look for a rebound when the September numbers come out.
With the Fed still focusing on labor, the sharp drop in the weekly jobless claims number was eye opening. We are about as low as can be expected. Don’t be surprised if this number soars soon. The closing of three casinos in Atlantic City will likely mess up the data for a short time. Also, the Philadelphia Fed’s Business Outlook Survey showed that activity grew at a somewhat slower pace in September. Nevertheless, orders were strong, backlogs grew and hiring jumped. Those details point to continued strength in the manufacturing sector.
MARKETS AND FED POLICY IMPLICATIONS: Housing continues to improve even if the gains are inconsistent. Builders are a pretty confident bunch and that can only be because they are seeing activity pick up. Thus, the fall off in construction activity should not be viewed as any sign of weakness. With the labor market tightening, Janet Yellen may be repeating her point that if the data are stronger than expected, the Fed is prepared to act sooner than whatever the term “extended period” means. Indeed, if housing starts do bounce back and manufacturing continues to grow strongly, that is precisely what the Fed will have to do. Regardless, investors may be a bit confused by the inconsistencies of these numbers but that has never stopped them before.
A further thought on the Fed’s leaving in “extended period” in the statement. Given her weird comments about the meaning of the phrase, that it was not calendar based but data based, I can only conclude that the Fed members would like to remove the words but only when they think the markets will not overreact. They don’t want another 100 basis point gap up in rates. I suspect that as soon as there are consistently robust job gains and the unemployment rate drops below 6%, which could happen by the end of the year, the phrase will be removed. December is my guess.
KEY DATA: Pending Sales: +3.3%; Year-over-Year: -2.1%/ GDP: 4.2% (from 4.0%); Corporate Profits: +8.0%/ Claims: 298,000 (down 1,000)
IN A NUTSHELL: “If the housing market really is getting better, then there are every reasons to believe the strong growth seen in the second quarter can be repeated.”
WHAT IT MEANS: Housing took a big hit in the winter and the spring was better but not great. However, it appears that conditions are beginning to really improve. We saw that existing home sales hit their highest sales pace this year in July, housing starts surged and builder Confidence continued to pick up. Today’s report showing pending home sales increasing just added to the impression that housing has thrown off its winter-induced lethargy. While these are contracts not closings, they do point to more home sales ahead. Granted, the level is still slightly below what we saw in July 2013, but they are coming back nicely. The only recent negative housing report was new home sales and that looks like an aberration. Developers don’t develop and builders’ confidence doesn’t rise if demand is weak.
In other reports, the economy grew even more strongly than initially estimated and the robust increase in activity led to a jump in corporate profits. The good news is that firms are using some of the money to invest in equipment, software and even new plants. What they are still not doing is paying their workers more and they will continue to do that as long as they can get away with it. But the time to pony up may be getting near. Unemployment claims eased last week and seem to be settling into a range that puts it at the lowest in history if you adjust for the size of the workforce. The level points to a potentially very strong August employment report, which we get at the end of next week. I would not be surprised if job gains around 275,000 and we could even see the unemployment rate at 6%.
MARKETS AND FED POLICY IMPLICATIONS: Today was a good day for economic numbers, which should mean a good day for investors. Of course the economy often takes second place to geopolitical concerns and the situation in Ukraine continues to be worrisome. Vlad the Invader seems to be at it again and that is not good news. But domestically, the economy is in good shape and getting better. If the August employment report is as good as I believe it could be, the screeches coming from the hawks will get awfully loud. Janet Yellen
conceded that conditions may improve faster than expected. While a robust gain in payrolls and a drop in the unemployment rate will not likely cause the Fed Chair to come out and make that admission just yet, it will likely give her pause. The interesting question is how will investors react to the Fed moving closer to hiking rates? Since tightening will only come when Chair Yellen and her band of merry low-raters think the economy is really strong and the labor market is becoming an issue, a rate hike should be viewed positively. But that is just an economist talking.
KEY DATA: Home Sales: +2.4%/ Leading Indicators: up 0.9%; Claims: 298,000 (down 14,000)
IN A NUTSHELL: “It looks like the economy is approaching escape velocity.”
WHAT IT MEANS: There were a lot of numbers released today and they all were really good. First, there was existing home sales, which rose solidly in July. The pace of demand is back to October after having posted four consecutive increases. While the level is not spectacular, it is probably within ten percent of a solid market. The huge levels posted during the mid-2000s should be viewed as aberrations not targets. Increases were in all regions except the Northeast, which was flat. As for prices, they continue to moderate. After peaking last August at a 13.4% rise over the year, the gain is now under 5%.
Looking forward, the Conference Board’s Index of Leading Indicators popped in July. This measure is accelerating as there were 0.6% increases in both May and June. Gains in both the coincident (current conditions) and lagging indicators support the view that the economy is in really good shape. And then there were the weekly jobless claims number, which got back to “normal”, that is, below 300,000. Last week’s pop was a surprise and assumed to be due to a non-seasonally adjustable pattern of vehicle production shutdowns. That we moved back to such a low rate is an indication that the labor market is really in good shape.
There were two other reports released that also point to a strengthening economy. The Philadelphia Fed’s Business index surged in August, as did expectations. Supporting the view that manufacturing is really cooking was the Markit flash August number which jumped to its highest level in 4.5 years. The report noted that “robust manufacturing growth momentum has been sustained through the third quarter”.
MARKETS AND FED POLICY IMPLICATIONS: Janet Yellen speaks tomorrow morning and that is the focus of attention. Her talk takes on even more importance given the growing indications that the economy is beginning to break out of its sluggish growth mode. While waiting for wage gains is not exactly the equivalent of sitting on a bench waiting for Godot, it is not really the best way to run monetary policy. Wages is a lagging, lagging indicator and monetary policy needs to look forward. The economic data are pointing to stronger growth than the Fed has been forecasting, which is hardly a surprise. I always use the Fed’s numbers as a lower bound for growth. Of course, I have been aggressively optimistic this year and seeing the possibility that my forecast could actually turn out to be correct makes me a bit giddy, so I will limit my criticism of the Fed. That said, I have argued that wage gains are coming sooner than later and that the Fed will be compelled to raise rates earlier than many have expected. Today’s data reinforces that view. These data should make investors happy, but only when they realize that it’s the economy not the Fed that should be driving prices.
KEY DATA: ECI (Private, Year-over-Year)): +2.0%; Wages: +1.8%; Benefits: +2.5%/Claims: 302,000 (up 23,000)
IN A NUTSHELL: “Wage and benefits pressures are barely starting to accelerate even as the labor market continues to strengthen.”
WHAT IT MEANS: If the labor market matters to Fed members and the concern centers around employment costs, then the quarterly Employment Cost Index should be an important number. Whether it is or not for others, for me it is another critical part of the picture and right now businesses are still controlling workers costs but maybe not as well as they had been. Private sector compensation costs rose at a solid pace in the second quarter though that came after an aberrant nonexistent increase in the first quarter. Both wages and benefits jumped. Looking over the year, though, the increases in total compensation, wages and benefits were all at the top of the range we have seen for the last couple of years but not above it. Public sector costs are rising at the same pace even though wages and salaries are barely budging. Looking across occupations, service workers are doing the worst, which is not surprise. Whatever gains in compensation we have seen have been centered in the professional and construction worker ranks.
Jobless claims jumped, but that was expected. Last week’s report was assumed to be a bit too low due to the random nature of vehicle sector summer shutdowns. The four-week moving average, though, was the lowest in over eight years and that is without adjusting for labor force size. If the claims numbers relate in any way to job gains, and I believe they do, then the July employment report which comes out tomorrow should be good. Given the robust June gain, I expect July’s to be lower but we could easily average between 260,000 and 275,000 for the two months. That would be impressive. The unemployment rate could also decline. I would not be shocked if it breaks 6%, though that is not in the forecast for this month.
MARKETS AND FED POLICY IMPLICATIONS: So far, so good, at least when it comes to controlling employment costs. Yes, the second quarter number was hotter than expected but the first quarter rise was strangely minimal. Average them out and there was not any major change in the rate of worker cost increases. Benefit expenses have accelerated a touch and wages seem to be moving upward, but the pressures do not look great. But the Fed has to look at least six to twelve months down the road and if the unemployment rate keeps declining, unless the law of supply and demand has been repealed for the labor market, compensation pressures simply have to increase. The issues are when and how fast. Most members of the Fed appear to believe it will be a lot later and not very rapidly but I am not that sure. Tomorrow’s jobs report will give us another piece of the puzzle and hourly wages should be watched carefully. Workers need more income to spend more and power growth to a higher level. That does not seem to be happening just yet but I think we will be seeing signs very soon.
KEY DATA: Sales: down 8.1%; Jobless Claims: 284,000 (down 19,000)
IN A NUTSHELL: “The labor market may be getting better but wage gains are not and until that happens, families will not be buying new homes at any great pace.”
WHAT IT MEANS: When it comes to economic numbers, today’s data were the best of times and the worst of times. First the good news. Jobless claims dropped to their lowest level in over eight years. And when you adjust for the size of the labor force, you have to go back to 1999. Clearly, the labor market is tightening, but we have to be a little cautious about the July claims numbers. The vehicle makers don’t close plants in the same pattern that they used to when July was standard changeover to new model time. Thus, the seasonal adjustments may be a little out of whack and it wouldn’t be surprising if the number gaps upward next week. It will still be low, but not as eye-catching as today’s number.
While the job market may be getting better, the housing market is not, at least when it comes to new home sales. Builders saw demand plummet in June and the decline was across the entire nation. The largest fall off was in the East, where sales plummeted 20% while the West saw demand decline by just under 2%. The supply of homes for sale is continuing to rise and that growing inventory could lead to improving sales as buyers have more options to choose from.
MARKETS AND FED POLICY IMPLICATIONS: While the declining housing sales are troubling, they really didn’t make a lot of sense. It is hard to believe that builder confidence is jumping, as we saw with the jump in the Home Builders’ index, while sales are falling. So I am a little suspect about these data. Meanwhile, the jobs numbers are just getting better and better and for me it is all about the labor market. Not to sound too much like the broken record that I am, the missing link in this recovery continues to be solidly growing worker income. We saw this week that in June, earnings were flat again and adjusting for inflation, they declined. It is hard to make a commitment to buy a house when you don’t have increasing funds. But that is likely to change. The low levels of claims points to another solid jobs report and we could see the unemployment rate decline to 6% or even lower when the July data are released next Friday. Now there are many who simply do not believe that worker compensation will accelerate any time soon. But unless the law of supply and demand has been repealed for the labor market, the tightening of conditions will force firms to start bidding for workers. There may be resistance to doing that and the appearance of wage pressures may take longer to show up as a result, but it is coming and probably sooner than most think. When household incomes start rising, they will be better able to qualify for mortgages while the resulting increase in confidence will likely also encourage more home purchases. The Fed will likely wait to until wages are actually rising before any decision to increase rates is made. The old saying that “if you wait to see the whites of inflation’s eyes before tightening you have waited too long” seems to have been discarded by the Yellen Fed. As for investors and business owners, they dismiss the warning signs about growing wage pressures at their own peril.
KEY DATA: Starts: -9.3%; 1-Family: -9%; Permits: -4.2%/Claims: 302,000 (down 3,000)
IN A NUTSHELL: “We thought that home construction would surge this spring but instead it has fizzled, despite improving labor market conditions.”
WHAT IT MEANS: I know this will probably date me but does anyone remember the Vanguard rockets that were supposed to launch our satellites into space? No? Not surprising, since most of them went up and the fell back right to earth. Well, the home construction sector, which was supposed to rocket us into stronger growth looks more like a Vanguard than the Atlas V that successfully sent our men to the moon. Yes, I miss the space program. Housing starts posted a second consecutive big decline in June. After rebounding sharply in April from the winter weather, builders seem to be getting more cautious. This is a real surprise. First of all, permits, while down in June as well, have been running about five percent above starts for the last two months. Builders are not paying for permits unless they expect to build those units. The number of homes authorized but not started also jumped. And finally, builder confidence soared in June, according to the National Association of Home Builders. So what is going on? I am not certain but the nearly thirty percent decline in starts in the South has to be suspect. I could understand it if there was just a huge decline in the volatile multi-family sector, but the single-family component also dropped sharply. In the rest of the country, activity was up. So let’s wait a while before we jump to any conclusions about the state of the housing market.
The good news today was the drop in jobless claims. We are looking at levels not seen since 2007 and when you adjust for the size of the labor force, we are approaching record lows. The monthly surge in the number of jobs being created and the continuous drop in the unemployment rate is no fluke. The July jobs report is setting up to be another really good one.
MARKETS AND FED POLICY IMPLICATIONS: Home construction is a critical component of any strong economy and right now, activity seems to be faltering. But I just don’t believe that the headline number is telling the whole story. The huge fall off in the South makes no sense, especially given that starts rose everywhere else and other indicators point to rising activity. So my suggestion is that we feel disappointed by the report but don’t get too worked up about it. What I think investors should focus on is the jobless claims data. The labor market is tightening. Firms are not cutting workers and people are finding jobs. Don’t be surprised if the unemployment rate dips below 6% by the fall and with full employment at around 5.5%, it is hard to believe that labor shortages will not start appearing across industries, occupations and regions. The real question is: When will businesses feel compelled to raise wages to attract workers? I have said this before and I will keep saying it, that time is coming, likely before the end of the year, and once the wage dam breaks, retention issues will arise and compensation costs will become the main topic of discussion at the Fed. But Fed Chair Yellen is content to wait until she actually sees that happen so rate hikes are still well into the future.
KEY DATA: ISM (Non-Manufacturing): -0.2 points: Orders: +0.7 point: Hiring: +2 points/Claims: 315,000 (up 2,000)
IN A NUTSHELL: “The service sector remained solid in June and with orders strong, that should continue.”
WHAT IT MEANS: Normally, the Institute for Supply Management’s surveys take center stage, but on a day where we got a huge employment report, this is probably a tree falling in the forest: It makes noise but few hear it. The service sector grew in June but not quite as strongly as it had been over the previous few months. Still, two key components of the index, new orders and employment, rose solidly. Indeed, the orders index is quite high, indicating that not only has there been no slowdown in demand, but activity should accelerate in the months to come. Firms are gearing up for that as their hiring is increasing. We saw that in the payrolls number. This bodes well for job gains going forward. But this was not a uniformly strong report. Business activity eased and backlogs grew more slowly, so we may not be seeing a rapid pick up in activity.
Also lost in the employment report was the weekly jobless numbers. Claims inched upward but the level is still consistent with payroll increases in the 225,000 to 250,000 range. I suspect we will stay at that job gain pace during the summer and accelerate in the fall and winter.
MARKETS AND FED POLICY IMPLICATIONS: It was a good day for economic numbers. The economy is indeed as strong as I have been arguing but not as strong as we want. But that time is coming and sooner rather than later. The equity markets should be focusing on the better growth not the coming jump in interest rates, but rationality and efficiency are two vastly different things. Markets are efficient, not necessarily rational. That said, we have been sent into the July 4th weekend with lots of things to celebrate, so let me end by simply saying:
Have a Great July 4th Weekend!