March Retail Sales and Producer Prices

NAROFF ECONOMIC ADVISORS, Inc.

Joel L. Naroff

President and Chief Economist

215-497-9050

joel@naroffeconomics.com

KEY DATA: Sales: +0.9%; Excluding Vehicles: +0.4%/ PPI: +0.2%; Goods less Food and Energy: +0.2%

IN A NUTSHELL: “Consumers are picking up the shopping pace but they can spend a whole lot more.”

WHAT IT MEANS: It finally looks a lot like spring but that doesn’t mean the winter weather still isn’t with us, at least when it comes to economic data. Retailers took a hit because of the cold and snow and the March data seem to indicate that as conditions moderated, consumers started venturing out to the stores again. Retail sales jumped, helped by a sharp rebound in motor vehicle purchases. Indeed, vehicle purchases jumped 5.5%, though dollar sales were up less. There was also strong demand for furniture, clothing, building supplies and general merchandise. People also ate out a lot when they shopped. But not every segment got some additional loving by consumers. Sales of electronics and food for home fell and we also didn’t do a lot of shopping online. There was also a strange decline in gasoline purchases. Gasoline prices were up over 10% but sales, which are not adjusted for prices, were down. That doesn’t make much sense.

On the inflation front, wholesale costs rose moderately in March. Rising energy costs helped, though even excluding energy, producer prices increased a touch. Goods prices had been falling for several months, but no matter how you sliced or diced the data – and the report does that in a wide variety of ways – costs were up in March. That, actually, is a good sign as it indicates demand may be coming back. Services inflation, which has softened recently, moved back into the positive range. We had not been seeing much there as lowered transportation costs kept services prices under control. Looking down the road, the price increases in intermediate and unprocessed products generally fell only modestly. That points to a possible further slowing in the wholesale disinflationary process.

 

MARKETS AND FED POLICY IMPLICATIONS: March was a transition month as the weather eased, but not everywhere and not as much as most of us would have liked. The solid, though not spectacular, retail sales numbers point to a consumer that is finally venturing out. The rapidly improving April weather should lead to another solid rise in spending, though we will not know that for another month. This is the first indicator that supports the view that it was the weather, not a general economic slowdown, that led to the weak first quarter reports. That would normally make investors a little more comfortable, but we are in the midst of earnings season, so the hits and misses coming from companies will likely be the driving force in the markets. Since the Fed members try not to react to any given monthly number, the retail numbers should remind them that the April and May data, which will be out before the June FOMC meeting, could be telling. However, inflation remains quite subdued, so the Fed doesn’t have to be impatient. In other words, the April 28,29 FOMC will likely be non-event as there will be few non-weather-impacted data points that will be released before then that could cause a change in the statement.

 

March Import and Export Prices

KEY DATA: Imports: -0.3%; Nonfuel: -0.4%; Exports: +0.1%; Farm: -1.7%

IN A NUTSHELL: “Declining import prices provide fuel to the argument that the Fed doesn’t have to worry about inflation, at least for now.”

WHAT IT MEANS: The debate over when the Fed should or will raise rates continues to rage as the hawks and doves weigh in on an almost daily basis. If you believe the Fed members, rates should either be increased in June or next year. I guess that is a tight shot pattern when it comes to Fed policy. Just kidding. In any event, since the Fed claims to be data driven, what do the numbers tell us about potential Fed actions? Well, on the inflation front, there doesn’t seem to be much to worry about. Import prices fell in March and once again, fuel was not the driving factor. Indeed, for the seventh month in a row, nonfuel import costs declined. Every major category, included food, was down. Nonfuel import prices are of by 1.9% over the year, a clear restraint to any attempt by U.S. firms to raise prices. As for our exports, the farm sector continues to be battered by lower prices – they are down 13.5% since March 2014. Only fish prices are up.

MARKETS AND FED POLICY IMPLICATIONS: Controlling inflation while keeping growth solid is the Fed’s dual mandate. With the dollar strong, import prices are likely to be well contained, limiting to an extent domestic inflation. That can allow the Fed to focus more on growth, at lest that is the argument that the doves are making. The hawks simply say that the stronger dollar and low energy prices are transitory factors keeping prices low. Continued trend or above trend growth, coupled with a tightening labor market, improving worker incomes and the eventual turnaround in the dollar and energy prices imply that rising inflation is not that far off. Who will win the debate? My view is the data will firm sharply over the next two months. That may come too late for a June increase, but not for a July or September one. What worries me about the public discussion, especially by non-Fed commentators, is the apparent broadening of the perceived Fed mandate. Those that worry about the dollar argue the Fed cannot raise rates because it would further increase the dollar, lowering exports and restraining inflation and growth. Those that are focused on the equity markets argue that a rate hike would shock the markets, causing a correction so the Fed has to make equity prices a concern. The bond market gurus say that negative interest rates around the world make it impossible for the Fed to raise rates or limit its capacity to do so, implying that the bond market should control Fed actions. So now the Fed seems to actually have a quintuple mandate: Control inflation while keeping the economy solid, equity prices high, the dollar from getting too strong and limiting the impact on bond markets. Huh? People, we are approaching the six-year mark for this expansion. The post-World War II average is 5 years. The last three expansions averaged almost 8 years, with the longest being 10 years. In other words, one other thing the Fed has to consider is that the next recession could occur within a few years and if rates are not up by then, it will be forced to resort, once again, to non-traditional policies. The Fed has to raise rates back to more normal levels and the longer it waits, the faster it will have to act.

December Consumer Prices, Real Income and Industrial Production

KEY DATA: CPI: -0.4%; Excluding Energy: 0%; Food: +0.3%/ Real Earnings: +0.1%/ IP: -0.1%; Manufacturing: +0.3%

IN A NUTSHELL:   “Falling prices may worry some but households are ecstatic and manufacturers are gearing up to meet the growing demand.”

WHAT IT MEANS:  Horrors of horrors, energy prices are falling.  If you watch the business news, that is what you would think.  With another sharp drop in gasoline, the Consumer Price Index posted its largest decline in six years.  So, should we worry?  Not really.  Excluding energy, prices were flat and over the year, non-energy costs were up nearly 2%.  That is not deflation.  The December report was really odd.  There were a large number of components that posted outsized changes.  Apparel and used vehicle prices fell by over 1% while medical goods and energy services rose 1%.  Just about every major category was either up or down by 0.2% or more and that is not a normal pattern.   As for deflation, don’t tell that to people who have to spend a lot of their money on food and utilities.  Those costs were up solidly.  My suggestion: Stop looking at the headline number because when oil turns around, and it just might be starting to do that, the sign will simply change even if the magnitude doesn’t.

Real earnings rose modestly in December and that is distressing.  When prices fall sharply, if all you can get is a small rise in spending power, there are real problems out there.  This economy would be a lot better off with a little more money going to workers.

It will take additional quarters of strong growth to get to the point in the labor market where businesses will have to start raising wages faster and that growth is likely to occur.  Industrial production fell in December but a warm December (hoorah!) caused utility output to tank.  Meanwhile, manufacturing production rose solidly once again, despite a small pull back in vehicle assembly ratesThe University of Michigan’s mid-month reading of consumer sentiment rose to its highest level in eleven years.  It’s almost as if happy days are here again. The lower gas prices are going to wind up in the economy and better wage gains could trigger robust consumption.

MARKETS AND FED POLICY IMPLICATIONS: The economy is growing solidly and households are a happy bunch of campers once again, so it looks like 2015 should be a really good year.  Strong growth, coupled with oil price stability or even increases, will make people forget the idea of deflation and turn to the more important issue: When will the dam that is holding back wage gains break?  Normally, labor shortages lead to rising wages, which begin slowly once the inability to find workers starts appearing.  That is not happening this time.  Instead, we are creating the next “bubble”, which is the pent-up demand for higher wages.  The longer we go without slowly raising wages, the greater the surge will be.  The Fed may think it has time because labor compensation growth is largely non-existent.  But if my view is correct, when the capitulation occurs, wages will jump, catching the Fed with its rates down.

December Retail Sales and Import Prices

KEY DATA: Sales: -0.9%; Gasoline: -6.5%; Internet: -0.3%/Import Prices: -2.5%; Nonfuel: -0.1%; Exports: -1.2%; Farm: -0.7%

IN A NUTSHELL:  “It doesn’t look like consumers shopped ‘till they were tired, let alone ‘till they dropped in December.”

WHAT IT MEANS:  In the critical holiday shopping season, it doesn’t look like the urge to splurge took hold.  Retail sales fell in December, but that was not a shock.  We knew that vehicle purchases had come down from unsustainable heights to more reasonable levels and gasoline prices had crashed.  These data are not adjusted for prices, so the decline in gasoline purchases was likely a price issue.  But there were weaknesses in other categories.  Electronics and appliance demand, which had been largely going nowhere, turned negative.  You mean everyone didn’t go out and buy a curved screen TV for a couple of grand?  Prices were low but there are no affordable new products that have caught peoples’ attention.  Phone sales seemed to be solid, but I guess not good enough.  The milder winter, at least compared to last year, probably helped create the sharp drop in Home Depot/Lowes type stores.  Households bought less clothing, sporting goods and general merchandise as well.  But we did spend more money on food – both at home and away – as well as on furniture.  That was it.  Not a lot of shopping went on.

On the inflation front, there is none.  Import prices fell sharply as energy drove the decline.  Excluding fuel, costs were off modestly.  Consumer and capital goods costs edged downward while vehicle prices were flat.  Unfortunately, food costs keep rising and that is not good news for the consumer.  On the export side, prices were down pretty much across the board, led by a huge drop in energy and a sharp decline in agricultural prices.

MARKETS AND FED POLICY IMPLICATIONS:  Rising consumer optimism, more jobs and lower energy costs were expected to create a really good holiday shopping season.  It doesn’t look like that happened.  I guess for all those workers who didn’t see any increase in incomes, buying a whole lot more was not in the cards.  We need better wage gains so the 147 million people employed have more money in their paychecks.  That still is not happening, so business people who are disappointed by the economy should keep in mind that if they don’t pay their workers more, their workers cannot spend more.  The other thing to remember is that the additional money left in peoples wallets when they leave the gas station is relatively small.  It takes time for the impact to build up.  Thus, while spending should rise, don’t expect it to surge. So, what do these reports mean for the markets and the Fed?  Investors will not like the retail sales report as it relates to earnings.  But a solid but not robust economy, coupled with no inflation means the Fed can be very patient.  That should assuage some of the angst.  Regardless, I have no idea what is driving investors at any given moment these days and given the volatility, I don’t think anyone does.

November Job Openings and December NFIB Small Business Survey and Employment Trends

KEY DATA: Openings: +142,000; Hires: -111,000/NFIB Optimism: +2.3 points/Employment Trends: +0.5%

IN A NUTSHELL:   “Though small businesses are becoming more optimistic and job openings are increasing, hiring has yet to hit its full stride.”

WHAT IT MEANS:  The December jobs number was a lot better than expected with firms of all types hiring people with all kinds of skills.  But we can and likely will do better.  The Bureau of Labor Statistics reported that in November, the number of job openings rose solidly.  The rate of openings has now reached the highest point in nearly 14 years.  Basically, there are an awfully lot of open recs for positions, despite the fact that hiring has ramped up.  But with the number of openings surging by over 20% over the past year, the 9% increase in hiring could not keep up.  Part of the problem may be the continued unwillingness of workers to leave their jobs.  While the number of people quitting was up nearly 7% over the year, the quit rate is not much different than where it was during the early part of the recession.

If job gains are to accelerate, the small business sector will have to play a major role and that is a real possibility.  Small Business optimism jumped in December to its highest point since October 2006.  The percentage of owners thinking it is a good time to expand soared and is finally approaching more typical expansion levels.  Similarly, hiring and compensation plans are nearly at normal levels as well.

Finally, the December Conference Board Employment Trends Index was released yesterday and it rose sharplyOver the year, the index increased a robust 7.5% and the gains accelerated in the fourth quarter.  That too points to better job growth ahead.   

MARKETS AND FED POLICY IMPLICATIONS: The likelihood is that the strong job gains we have been seeing will continue and may even ramp up.  Ultimately, those openings will have to be filled.  Right now, hiring, despite the solid payroll increases, is not as strong as it can be.  Small businesses are saying that they cannot find qualified workers, but they are at a point where they will have to either raise wages more and/or expand their employee search activities.  Meanwhile, if you talk to employment services firms, you discover that large companies are still dithering over their hiring decisions.  They haven’t figured out that the longer the wait the more candidates they lose.  Many companies still think they are living in a world of unlimited supply where they can pick and choose employees as they please.  That reality is disappearing, as witnessed by the huge number of openings, but clearly not enough to change behavior significantly.  It is only a matter of time.  And time is what the Fed seems to think it has.  I still believe that wage pressures are being artificially dampened and when they break out, the increases will be rapid.  But I have been saying that for a while now and it has not come about.  That only tells me that the pressures may be even greater than I thought and if they are, the Fed will once again find itself behind the curve.

December Employment Report

KEY DATA: Payrolls: +252,000; Revisions: +50,000; Private Sector: +240,000; Unemployment Rate: 5.6% (down 0.2 percentage point); Hourly Wages: -0.2%

IN A NUTSHELL:   “Firms may be hiring like crazy but they are not paying up for those workers, at least not yet.”

WHAT IT MEANS:  Today I get to be a true economist: There is both good news and bad news in the December employment report.  Let’s start with the positive.  The economic jobs machine has shifted into high gear.  Payrolls rose strongly in December and both the October and November gains were revised upward.  On average, employment increased by an average of nearly 290,000 per month over the past three months.  For all of 2014, almost 3 million new positions were added, the most since 1999, the peak of the Y2K/dot.com boom.  Job gains were across the board, with construction, manufacturing, finance, health care and especially restaurants adding workers solidly.  We are eating out again and that is a great sign.  Also, the public sector has finally started to help out with state and local governments hiring as their revenues continue to rise.  While the federal government, excluding the ever-shrinking postal service, is not hiring very much, at least it is no longer cutting workers.

There was also a very sharp drop in the unemployment rate.  We hit the lowest level since June 2008.  Okay, the labor force declined as did the participation rate, but by now, everyone should know what I think of those numbers.  The labor force growth in 2014 was disappointing but it did pick up quite sharply in the second half of the year.  As for the participation rate, it was down only 0.1 percentage point from December 2013.  It has stabilized recently.

The disappointing aspect of the report was the decline in the hourly wage and a downward revision to the November increase.  While the labor market continues to tighten, firms seem to be able to put off raising wages. 

MARKETS AND FED POLICY IMPLICATIONS:  This was a really good report but the wage numbers keep it from being a great one.  I am just not sure what to make of the hourly earnings data.  For example, there were hourly wage declines in manufacturing, education and health care, finance, information services and utilities.  These are not your typical low pay sectors where you would expect worker pay to fall, especially when demand is rising.  While retail wages were off, they were flat in hospitality and leisure.  Basically, I am not so sure we should make any judgments about worker compensation from these numbers.  That is important since the Fed is watching inflation closely, especially since some members are concerned that inflation is too low.  More rapidly rising wages would ease those concerns.  Still, with the job market firming, it is only a matter of time before we see consistently better wage increases.  The dam holding back the wage gains may be higher and stronger than expected, but it is not unbreachable and with the unemployment rate near full employment, we will likely see the cracks appearing very soon.  Until they do show up, though, Fed Chair Yellen can remain “patient”.   

December ADP Jobs, Conference Board Help Wanted Online and November Trade Deficit

KEY DATA: ADP: 241,000/Help Wanted Online: -79,200/Trade Deficit: $39 billion ($3.2 billion narrower)

IN A NUTSHELL:   “A solid labor market coupled with a narrowing trade deficit points to continued strong growth ahead.”

WHAT IT MEANS:  Employment Friday is this week and the first guess at the private sector number comes from ADP, which estimated that employers added workers solidly in December.  That said, the government’s data and the ADP numbers sometimes diverge widely.  For example, ADP estimated that private sector payrolls rose by 227,000 in November while the government put it at 314,000.  But the 3-month trend has tended to be fairly close and that raises a question about Friday’s jobs report.  For the fourth quarter, ADP puts total private sector job gains at 710,000.  After two months, the government has it at 550,000, a difference of 160,000.  Could December’s increase be below 200,000?  Possibly, though I think it will be between 225,000 and 250,000.  Companies of all sizes are adding jobs and that should mean continued solid payroll gains.  I remain optimistic about the job market.

Helping drive the economy forward, regardless what investors might think, is a rapidly narrowing trade deficit.  Exports are beginning to suffer from the weakness around the world, but that is being offset by declining petroleum imports.  The drop in exports is not a major concern as most of the decline came from Boeing shipping were planes.  That is likely just a timing issue.  Vehicle shipments were off as well and that may reflect slower world growth.  On the import side, the only category that posted a sharp gain was cell phones.  Thanks Apple.  Adjusting for prices, it looks like the trade deficit will be fairly stable.  There have been concerns that trade would slow growth in the fourth quarter but right now that is not the case. 

The Conference Board’s Help Wanted Online Index plunged in December after having soared in November.  Actually, this one month up and one month down pattern seems to be a routine that is odd given the consistently strong payroll increases.  These data are supposed to be seasonally adjusted, so I guess I will simply say that the decline in online want ads is a concern that should unwind in a month.

MARKETS AND FED POLICY IMPLICATIONS: The recent data have been disappointing but the ADP and trade numbers were better than expected.  Indeed, today’s reports raise more questions than they answer.  Friday is only two days away so we will have a better picture of the labor market soon enough.  What investors will make of these reports is anyone’s guess.  I don’t even think investors know what they are thinking.  The markets are reacting emotionally so it’s best to simply step back and not make too much of the doings there.  And don’t forget that Wall Street and Main Street have been delinked for a long time so making a judgment about the economy based on stock movements is silly.  As for the Fed, the focus is still on wages but the issues in Europe and the continued low inflation rate are complicating things.

January Supply Managers’ Non-Manufacturing Survey, November Durable Goods Orders and Home Prices

INDICATOR: January Supply Managers’ Non-Manufacturing Survey, November Durable Goods Orders and Home Prices

KEY DATA: ISM (Non-Manufacturing): -3.1 points/Employment: -0.7 point/Orders: -0.7%; Capital Spending: 0%/Home Prices (monthly): +0.1%; Over-the-Year: +5.5%

IN A NUTSHELL:   “The economy hardly ended the year with a bang, but only because the recent pace was not sustainable.”

WHAT IT MEANS:  It would be great if we could get a string of five percent growth rates, but the likelihood that the third quarter pace will be duplicated anytime soon is not great.  What would be good is if the economy eases only modestly and that looks to be the case.  The Institute for Supply Management’s December index of non-manufacturing activity fell solidly, but there is no reason to worry.  Yes, just about every component posted decent declines, but the levels also matter and they are still pointing to decent growth.  That is, the services sector is coming down from extremely high levels to more sustainable and solid levels.  Indeed, hiring continues to be strong and dropped the least of all components.  The one change that does cause a little concern is the sudden shrinkage in order books.  The thinning was modest, though.

As second indication that the summer’s breakneck pace is cooling was the drop in durable goods orders in November.  Interestingly, while these data are usually really volatile, there was no sector, except defense aircraft, that posted either a large change.  As for business spending, executives continue to be cautious, as capital goods orders were flat after having dropped the previous two months.  I guess a strong economy is not enough to get firms to invest in the future.

Housing prices look like they have finally stabilized.  The year-over-year increase had been slowing for quite some time but we the latest data are indicating the drop is largely over.  CoreLogic’s November index showed a rise in both the monthly change and the yearly increase.  Every state and 96 of the top 100 metro areas posted increases since November 2013.

MARKETS AND FED POLICY IMPLICATIONS: The quarterly GDP growth rates always bounce around even when conditions are great.  The summer’s 5% pace was way above expectations but we really are not sure what trend growth will look like.  I think we can expand at or above 3.5% this year.  Consensus is around 3%.  As long as energy prices don’t spike, consumers will have lots more income to spend and the likely gains in wages will only add to purchasing power.  Ultimately, businesses will recognize that the U.S. economy has turned the economy and investment will rise with that epiphany.  Think about it.  The Conference Board’s CEO Confidence Index declined in the third quarter even as the economy was soaring.  So who knows what drives thinking in the corner office?  Maybe executives are more worried about the rest of the world, which is clearly a concern.  But the U.S. is hardly a problem.  Regardless, we get the December employment numbers this Friday and that is what will likely drive investor and Fed thinking.  Don’t expect another job gain number anywhere near 300,000, but it should be decent and the unemployment rate could decline even if the participation rate rises.

December Supply Managers’ Manufacturing Index and November Construction

KEY DATA: ISM (Manufacturing): -3.2 points; Orders: -8.7 points; Employment: +1.9 points/Construction: -0.3%; Private Residential: +0.9%

IN A NUTSHELL:   “Manufacturing’s robust growth rate has slowed to only a strong pace.”

WHAT IT MEANS:  I hope everyone had a wonderful New Year.  The manufacturing sector surged in the fall and it was likely that the robust pace would moderate.  Well, it did in December.  The Institute for Supply Management’s Manufacturing index dropped fairly sharply, but that hardly signals the sector is in trouble.  First of all, the level is still consistent with solid growth.  Indeed, it is hard to believe that firms ramped up hiring if they were worried that conditions were weakening significantly.  Thus, the moderation in order growth, including imports and exports, as well as production doesn’t seem to be viewed with much alarm.

Construction activity eased in November, but here too the details are not pointing to a major slowdown.  Private sector construction rose, especially for residential projects.  That was really good news since this segment had been one of the weaker links.  Nonresidential construction was off.  The big drop was in public sector power projects.  That may be reflective of the falling energy costs, though given the long lead times on these activities, it is unclear exactly what is happening.

MARKETS AND FED POLICY IMPLICATIONS: The economy continued to expand nicely at the end of last year but we will have to wait until next Friday to see how many jobs were created and a few more weeks to find out fast GDP grew.  The early signs are that consumers spent money like crazy and manufacturing during the entire quarter was strong.  Most economists expect that we will come down sharply from the 5% mountain that we got to in the third quarter.  It is hard to think we will be anywhere near that number in the fourth quarter.  But I still believe that barring a huge reduction in inventories, growth could once again be near if not above the 3.5% pace we have seen for four of the last five quarters.  That is well above consensus.  Still, for investors to remain exuberant, we need the data to show that the economy is hitting on all cylinders.  Today’s numbers don’t show that, though they also don’t indicate a major slowdown.  As for the Fed, the next FOMC meeting is January 27, 28.  The members will know the December employment numbers but I am unsure how much they will know about fourth quarter growth, which is scheduled to be released on January 30th.  Regardless, the “considerable time” phrase is being replaced by patience and the members have to start indicating what that means.  I guess we will find out then, maybe.

December Consumer Confidence and August Home Prices

KEY DATA: Confidence: 92.6 (up 1.6 points)/National Home Prices (Year-over-Year): 4.6%

IN A NUTSHELL:   “The consumer is smiling and there is every reason to think the era of good feeling will continue next year.”

WHAT IT MEANS:  If 2015 is to be the year of that the consumer makes a comeback, it will have to start with people actually feeling good about things – and they do.  The Conference Board’s Consumer Index rose in December led by a surge in the current conditions measure.  People viewed the labor market more positively with jobs becoming more plentiful.  The perceptions of business conditions also improved.  As a consequence, the Present Conditions Index hit its highest level since February 2008, which was at the start of the Great Recession but well before the banks collapsed.  The only concern in the report was that the outlook for the future faded a touch.  It is hard to understand how the present economy is clearly improving but optimism is not when there have been few factors that have raised concerns about the future.  I guess record stock prices and soaring job gains are problems.  Or maybe it was the election results.  Or more than likely, it was just one month’s numbers.

As for housing, price gains continue to slow.  The latest S&P/Case-Shiller report showed that the deceleration in year-over-year price increases continued in October.  While the monthly change was negative, on a seasonally adjusted basis, the national index continued to post a solid rise.  That holds out hope that we are reaching a bottom on the price appreciation decline.  Nevertheless, it is not looking like we are in for a sharp rise in prices anytime soon.  Looking across the country, none of the twenty metro areas identified posted a double-digit rise from October 2013.  Similarly, none posted a decline over the month, when you look at the seasonally adjusted numbers, so that is something positive to work with.

MARKETS AND FED POLICY IMPLICATIONS: The year is coming to an end and the good news is that people are feeling positive about economic conditions.  All signs point to strong growth in 2015 and while optimism is great, households still need the wherewithal, i.e., income, to follow through on those thoughts.  That is the big unknown entering 2015 and how wage and salary gains play out will determine the strength of the economy.  I believe that job gains will be robust and by spring, labor shortages and with them, higher wage increases, will follow.  That is my wish for the New Year, but as the saying goes, “if wishes were horses, beggars would ride.”  In other words, we shall see.  On that note, let me say:

Have a Happy and Healthy New Year!

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