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Revised Third Quarter GDP and November Consumer Confidence

KEY DATA: GDP: 3.9% (up from 3.5%); Year-over-Year: 2.4%; Corporate Profits: +2.1%/Consumer Confidence: down 5.4 points

IN A NUTSHELL:   “The economy really is growing solidly, which makes the decline in confidence very strange.”

WHAT IT MEANS:  Is the economy accelerating?  It sure looks that way.  The upward revision to the summer economic performance was a surprise, but it was not caused by anything that could be considered strange.  Both consumer and business spending was a bit better, but the changes were not large.  Similarly, government spending was cut, but also by a modest amount.  The trade deficit turned out to be wider than initially thought but businesses stocked up for the holiday shopping season at a greater pace, offsetting the negative impact of trade on growth.  All-in-all, the changes came in all the right places.  Inflation remained in check, which was expected, but there was a downgrade to personal income growth.  That is not good news for employees.  Corporate profits rose at a modest rate as well. 

Meanwhile, in the face of declining gasoline prices, improving economic activity, strong job gains and a lower unemployment rate, consumers suddenly turned sullen.  The Conference Board’s Consumer Confidence Index dropped sharply in November after having risen solidly in October.  There was an especially large decline in expectations as the labor market outlook seemed to dim.  These results were quite a surprise and given all the positive economic news, are hard to explain. 

Meanwhile, the slowdown in home price appreciation continued in September. The S&P/Case-Shiller national index fell slightly and the year-over-year gain came down again. It is hardly a surprise that the huge increases we had been seeing have disappeared but it is disturbing that we are not seeing some continued monthly gains.

MARKETS AND FED POLICY IMPLICATIONS: If the consumer confidence numbers had come in as expected, I would be talking about the economy being off to the races.  But the sharp decline does raise some questions, though I am not sure what they are.  Basically, there is every reason but one to believe that people should be feeling better about things.  That reason is wages, or lack thereof.  Nothing else should be standing in the way of this economy really picking up steam.  But businesses have done a great job of keeping worker demands for higher wages at bay and until the pendulum swings back to employees, firms will continue limiting pay increases to their workforces.  The Fed members are likely to take these reports in stride, as they really do not change anything.  But investors have to start wondering what shoppers are really thinking.  I believe this will be a really solid holiday season, but we need happy consumers for that to happen. 

October New Home Sales, Pending Home Sales and November Consumer Confidence

KEY DATA: New Homes: +0.7%/Pending Sales: -1.1%/Consumer Comfort: up 2.2 points

IN A NUTSHELL:   “The housing market is marking time but improving consumer confidence may be coming at just the right time.”

WHAT IT MEANS:  The housing market has been adding to growth since the winter wipeout but the impact has slowed.  That trend may be continuing.  New home sales did increase a touch in October, but only because the September pace was revised downward.  Builder confidence has been rising so the small gain, though better than some thought, was a surprise to me.  The level of purchases has been in a tight pattern for the past three months and it is still below 500,000 a month, annualized.  Strong sales would be around one million, so the sector has a long way to go.  Demand was strong in the Northeast and Midwest but off in the South and West.  Prices, however, did surge.  The high end of the market looks like it may be coming back.

Pending home sales, which are signed contracts for existing homes, dropped in October.  There were declines in all regions except the Northeast, which posted a modest rise.  This does not bode well for existing home sales, which are likely to rise minimally, if at all,

On a positive note, The Thompson Reuters/University of Michigan consumer sentiment index rose in November.  That was in sharp contrast to the large decline posted by the Conference Board’s confidence index.  There was a small fall off from the mid-month reading, but sentiment hit a level not seen in more than seven years.  Both current conditions and expectations were up.  This report is also supported by an increase in the Bloomberg Consumer Comfort Index to its highest level since December 2007. 

MARKETS AND FED POLICY IMPLICATIONS: Housing is just not improving very much at all.  But while it is critical that this market get going, for the holiday shopping season, the consumer numbers are what really matter.  I had mentioned in my commentary on the Conference Board’s confidence number that the decline made little sense.  That two other reports point to improving confidence is more in line with logic.  But logic and household perceptions don’t necessarily go hand-in-hand so we have to be a little uncertain about what people are thinking.  If confidence is rising, which I tend to think it is, then we could be in for a very good fourth quarter spending number.  That is what we really need.  So on that note, let me say to everyone:

Have a Happy Thanksgiving!

October Existing Home Sales, Leading Indicators and November Philadelphia Fed Index

KEY DATA: Home Sales: +1.5%; Leading Indicators: +0.9%; Phila. Fed: up 20.1 points

IN A NUTSHELL:   “It is looking more and more like the economy is accelerating.”

WHAT IT MEANS:  Where should I start?  How about the outlook for the future?  The Conference Board’s Index of Leading Indicators jumped for the second consecutive month, and the stock market didn’t even help this time!  If this measure has any predictive capacity, and it does, then it is pointing to a lot stronger growth in the months to come.  A second indication that growth may be picking up was the huge increase in the Philadelphia Federal Reserve Board’s Business Outlook Survey’s activity index.  This index does bounce around but the enormous rise points to a clearly improving manufacturing sector.  There was a special set of questions asked about employment and almost 56% of the respondents say that they expect to hire in the next twelve months.  That is up about ten percentage points since January and the major reason is that firms expect sales to rise.  The positive sales outlook should not be a surprise given that only 1.7% of the respondents expect growth to slow over the next six months.

For the economy to really hit its stride, we need the housing market to at least hold up its part of the deal.  Existing home sales rose in October and demand has finally clawed back above where it was when rates spiked.  For the first time since October 2013, the year-over-year change was positive.  The increases across the nation were solid but there was a decline in demand in the West.  Prices seem to firming again, in part because of the inventory is shrinking.  Rising prices is critical if homeowners are to have enough equity to sell their current houses and move into different ones.  That churn has been missing from the market.

MARKETS AND FED POLICY IMPLICATIONS:  What a day for the economic data.  While overall inflation may be restrained, we saw that services inflation is coming back and the level of jobless claims points to additional strong employment reports.  Now it appears that housing is picking up, albeit slowly, while manufacturing may be poised for a large increase.  When you add those numbers the jump in the leading indicators, you really have to feel optimistic about the economy.  The Fed is debating the use of the term “considerable time” when it comes to keeping rates low.  But the members may dump that phrase as early as the mid-December FOMC meeting if the economic numbers continue to show increasing economic and labor market strength.  They may also have to start talking about services inflation, something that really needs to get the attention that has been missing.  But investors like to focus on the positive and the latest numbers only feed the bullish beast.

October Consumer Prices, Earnings and Jobless Claims

KEY DATA: CPI: 0.0%; Excluding Food and Energy: +0.2%; Real Hourly Earnings (Year-over-Year): +0.4%/Jobless Claims: 291,000 (down 2000)

IN A NUTSHELL:  “Stable inflation is keeping spending power up as wages continue to go nowhere.”

WHAT IT MEANS:  The Fed’s focus of attention appears to be turning to inflation and labor compensation as the members are indicating that the labor market is tightening.  At least that is what it seems.  It is hard to really know what the policy indicator du jour is at the Fed.  I guess if you keep changing the target, your aim is irrelevant.  Enough of my poking fun at the Fed.  Consumer prices went nowhere in October, which was actually a surprise.  It was expected that the decline in energy costs, which were off sharply, would lead to a fall in the Consumer Price Index.  It didn’t, even though food costs were more restrained than they had been.  There was a sharp drop in meat and poultry prices and that helped since most other components continued on their inexorable rise.  While clothing and used vehicle costs fell, new vehicle and especially services prices rose.  Meanwhile, medical costs, both services and goods, are about as well contained as we have seen them in decades. 

With inflation flat, a small rise in hourly wages allowed inflation-adjusted earnings to increase over the month.  If you want to see why consumption remains muted and so many people think we are still in recession, look at the hourly earnings numbers: They have grown by only 0.4% over the past year.

Will wage gains improve?  Eventually, as the labor market keeps firming.  Jobless claims have settled in the 290,000 a week range, which is consistent with solid to strong payroll increases.

MARKETS AND FED POLICY IMPLICATIONS: The talk is all about deflation, but the data provide little support for that view.  Excluding food and energy, the 1.8% rise over the year is not that far from the Fed’s desired 2% range.  The deceleration that occurred in the late spring and summer has turned around.  Why?  While few were watching, services inflation has rebounded, settling into a 2.5% annual range.  That is above the Fed’s target.  Services, excluding energy, is the key component in the index, making up over 57% of the total and 75% of the core.  If 2.5% is the base for services inflation, the prospects for deflation seem slim.  Meanwhile, commodities less food and energy, has been falling for over a year.  If this component starts rising even slowly, the core will exceed 2%.  My expectation is that core inflation will move above the target level early next year, keeping the Fed on course for raising rates this spring.  As for investors, the headline should be encouraging, though my analysis argues it should be a warning that inflation is not all it is not cracked up to be.

October Housing Starts and Permits

KEY DATA: Starts: -2.8%; 1-Family: +4.2%; Multi-Family: -15.4%; Permits: +4.8%

IN A NUTSHELL:   “Home building is holding in and with permits rising, it looks like additional construction could be on the way.”

WHAT IT MEANS:  Builders have become quite optimistic, but the real question is: Are they translating that good feeling in action?  In October, at least, that just didn’t happen in all segments of the market.  Housing starts fell, but that was due to a huge drop in the very volatile multi-family segment.  That is not that unusual.  Single-family construction rose to its second-highest level since spring, 2008.  Of course, the housing bubble had already burst by then, but at least we are moving forward.  We still have a long way to go, though, before we get back to solid levels.  Still, so far this year, starts are up by nearly 10% compared to the first ten months of 2013.  In any event, permit requests are running a little ahead of starts causing the number of units permitted but not started to jump.  That permit excess implies that building activity should start ramping up in those areas not covered with snow or ice.

MARKETS AND FED POLICY IMPLICATIONS: The jump in the National Association of Home Builders index signaled growing confidence in the housing sector and low rates are leading to growing mortgage applications, so it is just a matter of time before builders start putting more shovels in the ground.  That permit request are outpacing starts just reinforces that view because builders stopped speculating a long time ago.  That doesn’t necessarily mean we will a large increase in November.  The massive snowstorms and deep freeze will probably temporarily slow things down.  But housing is moving forward and that is what is important.  For the Fed members, this type of report allows everyone to sit around and do nothing.  The starts numbers are neither weak, nor strong, nor not even just right.  They are just another sign of an economy that has yet to truly break out to the upside.  As for investors, I guess if you don’t set a new record on any given day, it is a disappointment so maybe record setting is the key driving force.  It cannot be that the U.S. economy is so strong and the world economy is looking so good that happy days are here again.

October Producer Price Index and November Home Builders’ Index

KEY DATA: PPI: +0.2%; Goods: -0.4%; Services: +0.5%: Food: +1.0%; Energy: -3.0%/NAHB: up 4 points

IN A NUTSHELL:  “While wholesale inflation remains modest, what energy is giving, food is taking away.”  

WHAT IT MEANS:  The economy is solid, jobs are being created and the unemployment rate is nearly at full employment, so the Fed has to shift its attention to something else if it is to come up with the next rationalization of why it is keeping rates low.  Right now, the FOMC seems to be locked into low compensation gains, but there is also the issue of inflation, or its lack thereof, to fall back on.  Some members have already expressed that concern.  When it comes to current and future consumer costs, wholesale prices seem to be telling a confusing story.  The Producer Price Index rose a little more than expected in October.  The large drop in energy costs was supposed to cause the index to decline but there were offsetting increases.  In particular, food prices continue to rise sharply and over the year, they are up a whopping 6%.  In addition, the index presents a variety of services prices, a key differentiation.  Since services comprise 63.5% of the index, this break down better mirrors the economy. The category called “final demand trade services”, which looks at retailing and wholesaling, surged.  As a result, the services component rose strongly.   Excluding energy, wholesale costs have increased by a moderate 2% over the year.  That said, the inflation pipeline is not showing any major problems ahead, even when energy is excluded.

On the housing front, home builders are smiling again.  The National Association of Home Builders’ Housing Market Index jumped in November.  The sales conditions, future sales and traffic components were all up.  The only weakness was in the Midwest.  It will be interesting to see if the current bad weather changes things.

MARKETS AND FED POLICY IMPLICATIONS: The Fed is suffering from wandering-eye syndrome.  First the members were worried about growth and jobs.  When those issues dissipated, they started focusing on the unemployment rate.  When that blew through their target they started talking about wage inflation.  Worker compensation remains muted but even if it starts to move up, there are rumblings that low inflation could become an issue.  In other words, if the Fed wants to keep rates low, they will find something out there that would defend their stance.  However, inflation is inching upward, even as it remains below its desired level.  The rise in producer prices points to a further modest uptick in household costs, but as I have said many times, the pathway from wholesale to consumer prices is hardly straight.   Meanwhile, the economy looks really good and the increase in the Homebuilders’ Housing Market Index reinforces the view that conditions are getting even better.  Thus, I am sticking to my belief that the Fed will start raising rates this spring.  Meanwhile, in the land of make believe, investors may look at the data and say there isn’t enough inflation for the Fed to do anything in the near term and with the economy improving, it is pedal to the metal, or whatever they say.

October Industrial Production

KEY DATA: IP: -0.1%; Manufacturing: +0.2%; Mining: -0.9%

IN A NUTSHELL:   “The manufacturing sector remains the rock on which the improving economy is being built, but it needs some help.”

WHAT IT MEANS:  The U.S. is the one shining economy in the universe of soft industrial nations.  The manufacturing sector has been critical to the continued growth and that remains the case as output rose in October.  There was a small decline in overall industrial production as mining and natural gas utility production fell sharply.  I guess no deed goes unpunished.  Cratering energy prices may be helping consumers but they are hurting producers.  Still, we cannot complain since the additional money left in wallets rather than pumped into gas tanks is coming at the best time possible – the holiday shopping season.  On the manufacturing front, output gains were pretty much across the boardThe biggest weakness was in transportation.  Vehicle assembly rates have come down with the stabilizing sales pace.  Demand may be quite solid, but it was in the 16.3 million units range for three of the past four months and that stability may be causing vehicle makers to build more cautiously.  There was also a cut back in aerospace, but I doubt with Boeing’s backlog, that will be sustained.  Improvements in technology may be helping consumers but the tech companies are having issues selling computers and output in that sector remains weak.

A second positive manufacturing report released today was the New York Fed’s Empire State survey, which showed that activity rebounded in early November after having declined in October.  The October drop was strange, having come after nine consecutive months of solid gains, so the return to growth was hardly a surprise.  It reinforces the view that the manufacturing sector is still growing solidly.    

MARKETS AND FED POLICY IMPLICATIONS: Kermit complained that it was hard to be green, but the greenback is having no problems these days.  That is occurring, at least in part, because the rest of the industrial world is not in great shape.  Indeed, Japan slipped back into recession.  Neither the Fed nor investors will likely take that news very well, especially since the rise in manufacturing activity was nothing great.  We are not talking about robust industrial output growth here.  Given the headwinds from the rest of the world, we need energy prices to stay low – despite its negative impact on output in the energy sector.   Lower energy costs feed into consumer spendable income and a really good holiday shopping season would keep the economic acceleration going.  The Fed looks at energy costs more as an economic issue than an inflation factor.  So the easing in top line inflation will not matter very much but any jump in consumer spending will.  Still, there are Fed members who are uncertain about the sustainability of a strong U.S. expansion and softening world growth and moderating manufacturing production is likely to add to those concerns.

October Employment Report

KEY DATA: Payrolls: 214,000: Revisions: +31,000; Private Sector: 209,000; Unemployment Rate: 5.8% (down from 5.9%); Hourly Wages: +0.1%; Year-over-Year: 1.9%

IN A NUTSHELL:   “Though people are coming into the workforce and finding jobs, we still need hiring to be stronger before we will see wage gains accelerate and worker confidence improve.”

WHAT IT MEANS:  The results are in and the labor market is close to being healthy but it is not there yet.  While there was little bad news in the October employment report, we really cannot say that workers should feel great about conditions. While job gains were less than hoped for, the August and September increases were revised upward solidly, bringing net gains to 245,000.  That is pretty solid.  The revisions are critical because they are showing better growth than first reported.  The initial job gain for August was 142,000, a disappointing performance.  But that now stands at 203,000, a pretty decent number.  It is likely that the upward revisions will continue, which means we have to focus on the previous months, not just the current month’s numbers.  Over the past three months, job gains have averaged just under 225,000, a strong but not yet robust pace.  Gains were across the board, including manufacturing, construction, retailing and even local government. So much for fiscal austerity.   The problem remains wages.  They rose modestly once again and the only thing that is keeping people afloat is the even slower rise in prices.

The unemployment rate declined to its lowest level since July 2008.  All components were strong as the labor force grew, unemployment dropped and the labor force participation rate rose.  One detail popped out: The teenage unemployment rate was 18.6%.  Teens comprise only 3.7% of the labor force but 12.1% of those unemployed.  The unemployment rate for those 20-years and older was 5.3%.  To make a big dent in the unemployment rate, we have to cut the teenage rate a lot more.  However, when it comes to labor shortages, teenagers are not the target hiring group, so we should keep a closer eye on the over-20 unemployment rate.

MARKETS AND FED POLICY IMPLICATIONS: Almost all the economic numbers point to an improving labor market and economy.  So, why did the electorate throw the Democrats out on Tuesday?  They blamed them for a “weak” economy and they were not really wrong.  The economic number that matters most to the average worker is income, not GDP or labor force participation rate.  Politicians and economists can debate those other data all they want, as long as wage gains are minimal, people will feel sour about the economy.  So let’s stop talking about jobs and start talking about income.  If anyone has any idea how to grow workers incomes other than reaching a point of labor shortages, let me know.  Thankfully, we are getting there and the unemployment rate is nearing full employment.  Wage gains will have to follow, but getting businesses to accept that reality may take a lot longer now than in the past.  That time frame is something the Fed members will be puzzling over, as it holds the key to Fed policy. 

Third Quarter Productivity and Weekly Jobless Claims

KEY DATA: Productivity: +2%; Year-over-Year: +0.9%; Unit Labor Costs: +0.3%; Year-over-Year: +2.4%/Jobless Claims: 278,000 (down 10,000)

IN A NUTSHELL:   “As the labor market continues to firm, there are growing hints, but still just hints, that wage pressures are starting to build.”

WHAT IT MEANS:  Okay, the election is over and we will have to wait until January for the new Congress to start creating whatever chaos they want to create, so let’s get back to economic reality.  Businesses are doing what they can to keep labor costs down and in the summer, they pretty much succeeded.  Third quarter productivity gains almost completely offset labor compensation increases.  That led to a modest rise in labor costs, which is good news for prices.  These data are wildly volatile, so it is worthwhile looking at the changes over the year.  Since the third quarter of 2013, productivity rose modestly while labor costs were up fairly solidly.  And, for the first three quarters of the year, productivity increased by less than 1% while, labor compensation rose by 3.1%.  Even adjusting for inflation, compensation is up by 1.3% so far this year.  It is possible that inflation-adjusted earnings could rise at the fastest pace since 2007.  That is a clear sign that the tightening labor market is forcing firms to pony up a little more money. 

There were other data on the labor market, but they were more mixed.  Weekly jobless claims dropped solidly and the four-week average remains at historically low levels.  However, The Challenger, Gray and Christmas layoff announcement report jumped in October to its second highest level this year.  It was noted that October and November tend to be big months for layoffs as firms set business plans, so we should probably wait and see how the rest of the year plays out.  Also, we really don’t know where those cuts will come or if they will even take place.  That said, layoff notices are down by over 4% so far this year.

MARKETS AND FED POLICY IMPLICATIONS: Firms keep pushing their workers harder and harder as they hold back both their hiring and compensation.  But the dam seems to be breaking.  Productivity gains this year will probably be in the one percent range, making it four consecutive years of modest increases.  With compensation rising, there is pressure on margins and firms are worried about paying workers even more.  But it’s the tightening labor market that will likely be the driving force in 2015 and that means either firms will have to start raising prices or shrinking margins.  Most likely we will see a little of both.  But that doesn’t mean earnings have to weaken.  If economic growth is above 3%, as I believe it will be, companies will have to make it the old fashion way, through volume.  Are investors thinking about the implications or modest productivity gains and rising labor costs?  Probably not, as the headlines don’t shout rising wage pressures.  But the Fed members know the devil is in the details and they say a lot.  Regardless, tomorrow is Employment Friday and we will see what happened with October payrolls and the unemployment rate.  I expect job gains to be well north of 250,000 while the unemployment rate remains at 5.9%.

October Supply Managers’ Non-Manufacturing Survey, ADP Payrolls and Online Labor Demand

KEY DATA: ISM (Non-Manufacturing): -1.5 points; Employment: +1.1 points/ADP +230,000/Help Wanted: +11,700

IN A NUTSHELL:   “The electorate may be disappointed with the economy but the numbers are pointing to accelerating growth and a tightening labor market.”

WHAT IT MEANS:  The Democrats got shellacked yesterday and massive discontent with the economy was a key reason for the rout.  But politics is politics and it often has little to do with reality.  In this case, there are reasons voters are correct and reasons they are wrong.  First, the wrong.  Basically, economic activity continues to rise.  The Institute for Supply Management’s Non-Manufacturing Index fell in October, but it remains at a level that is consistent with solid to strong growth.  Importantly, especially with the October employment report coming out on Friday, the employment index continues to break out on the upside.  Few firms are cutting back and more are hiring, a good sign for workers.  New orders continue to grow, but a little less briskly, while production has come down from outer space to the stratosphere.  In other words, everything is moving ahead quite strongly, though maybe not at break neck speed.

Where the electorate was right, was their feeling that their own economic conditions are just not great.  As I have said, ad nauseam, it is hard to spend, or feel good about things, if your income is going nowhere.  But that could change soon.  The labor market is tightening at a rapid pace, and it looks like we get confirmation of that on Friday.  ADP’s estimate of private sector payroll gains came in higher than their number for September and that could mean we will see a very strong October job increase.  The strong rise occurred despite an almost nonexistent rise in large-business hiring.  This sector had been strong for quite some time, so I don’t know what went on.  A firming labor market was also supported by a solid rise in the Conference Board’s Help Wanted OnLine Index.  Firms are looking for lots of people and I suspect they are also hiring a lot more workers. 

MARKETS AND FED POLICY IMPLICATIONS: The sour view about the economy expressed by voters makes sense when you consider that few have seen their wages rise and many have seen their benefits cut and their copays surge.  The only thing that will change that situation is a labor market that forces firms to bid for workers.  Each month, we see more and more signs that labor shortages are starting to appear.  We are approaching full employment nationally, but in some areas, industries and occupations, that condition already exists.  It’s just that shortages need to be more widespread before wage gains will accelerate and benefit cuts will be reversed.  I suspect by the spring, the intransigence toward paying more will fade as job openings become so great that firms have no choice but to start raising offers.  We are not there yet, but the Fed members need to recognize that a rising wage environment is not that far away.  As for investors, any euphoria over the election results may have to be tempered by the simple fact that being in power means you have to actually try to govern, something that neither party has bothered with lately.