August Supply Managers’ Manufacturing Report and July Construction Spending

KEY DATA: ISM (Manufacturing): +1.9 points; Orders: +3.3 points; Employment: -0.1 point/ Construction: +1.8%; Private: +1.4%; Public: +3.0%

IN A NUTSHELL:  “Manufacturing activity is soaring and construction is starting to boom, so why are people doubting that the economy is finally switching gears?”

WHAT IT MEANS: I hope everyone had a wonderful weekend but summer is unofficially over and it is time to get really serious about the economy.  While some may think I am suffering from heat stroke, I really do think we are closing in on escape velocityManufacturing activity continued to accelerate in August, according to the Institute for Supply Management.  The most eye-opening part of the report was another surge in new orders.  We are talking about really strong order growth here.  As a result, companies ramped up production, also to a high level.  Despite the growing output, order books filled and that means production levels could continue expanding.  About the only negative component of the report was the employment index.  It eased a smidgeon.  However, there is still a lot of hiring going on.  Despite the problems in Europe, export orders grew, a sign of that U.S. firms finally get it when it comes to world trade.

We got another indication that construction will be adding to growth this quarter.  Construction spending soared in July.  The increases were spread across much of the economy.  In the private sector, nonresidential activity jumped even more than residential.  But for me, it was the pick up in public construction activity that was most noteworthy.  Government has been the biggest roadblock to growth, restraining spending and hiring.  That is clearly changing.  We saw an increase in state and local government activity in the second quarter and hiring is starting to grow again.  Now we see that governments are back in the building business and they are even investing in schools again.  Amazing.

MARKETS AND FED POLICY IMPLICATIONS:  It is the week that contains Employment Friday so anything that comes earlier tends to be downgraded.  But the robust manufacturing report, one that was well above expectations, makes it clear that the economy is hitting on almost all cylinders.  It also provides some substance to my expectation that we will get really strong numbers on Friday.  My payroll increase is just north of 275,000 and we could see a gapping down of the unemployment rate to 6%.  Neither are consensus numbers but that is my story and I am sticking to it.  If my forecast does indeed happen, there could be some real screaming at the Fed.  There are a number of very anxious inflation hawks out there waiting for the right time to show their talons.  But right now, that is just conjecture.  We still have three days before E-Day.  As for investors, the improving economic environment should be good for sales.  But it also may mean a sooner than expected rise in rates and growing pressure on wages.  Which trend will rule is a good question and I am not sure anyone can answer that right now.  We will have to wait and see.

July Income and Spending

KEY DATA: Inflation Adjusted Disposable Income: +0.1%; Inflation Adjusted Consumption: -0.2%

IN A NUTSHELL:  “The lack of wage gains is keeping consumers from spending more money.”

WHAT IT MEANS: The constraining cycle of minimal wage gains leading to minimal consumption increases continues.  Households saw their incomes rise modestly in July as the increase in wages and salaries was the slowest this year.  Adjusting for inflation, the rise was barely perceptible.  Real disposable personal income has increased by 2.6% over the year, enough to drive decent but not great consumer spending.  In July, households decided to go on a shopping vacation.  They spent little but some of that may be due to the relatively mild winter that reduced air conditioning needs.  Utilities are part of services spending and that component, which is two-thirds of all consumption, was flat.  Also, while vehicle sales were strong, they did not come close to the robust pace posted in June so spending on durables was off sharply.

Will consumption rebound?  The likelihood is yes as the University of Michigan’s Consumer Sentiment Index increased in August as households are more optimistic about their economic conditions.  However, they remain somewhat uncertain about the future.  A sharp rise in the Chicago Business Barometer adds to the indicators showing that the manufacturing sector is improving.  That is likely being led by better consumer spending, even if the government is not yet finding that is happening.

MARKETS AND FED POLICY IMPLICATIONS: We need better consumer spending but we cannot get it until wages actually rise.  This is the trap we are in and it is not resolving itself quickly.  Indeed, businesses remain convinced they can get the perfect candidate at the price they think they should pay despite the growing number of job openings.  The disconnect in this economy is between what an employer wants to pay and what an employer needs to pay to get the worker they want.  In the business community, which is a firm believer in the market economy, there is a belief that the labor market doesn’t follow the laws of supply and demand.  In economist’s parlance, employers think that the labor supply curve is flat so they can pay a constant price for any number of workers they want.  The high unemployment rate of the past six years allowed that concept to take hold since it was basically accurate.  But with excess labor supply diminishing, a normal shaped labor supply curve is reappearing and that means to get more workers, you have to pay more.  If you don’t, the opening will go unfilled.  Markets work, even the labor market, and while wages may be sticky downward in a recession, as we approach full employment, they will go up.  The longer businesses take to recognize that wages need to be increased, the faster they will likely rise when that recognition sets in.  On that positive note for workers let me say:

Have a safe and enjoyable Labor Day Weekend!

July Pending Home Sales, Revised Second Quarter GDP and Weekly Jobless Claims

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.

August Consumer Confidence, July Durable Goods Orders and June Home Prices

KEY DATA: Confidence: +2.1 points: Current Conditions: +6.7 points; Expectations: -1 point/ Orders: +22.6%; Excluding Aircraft: +1.6%/ Home Prices (Monthly): 1%; Year-over-Year: 8.1%

IN A NUTSHELL:  “Consumers are getting some real smiles on their faces and that should help propel spending, but only if wage increases improve.”

WHAT IT MEANS: There were a number of key reports released today and maybe the most interesting one was the Conference Board’s Consumer Confidence numbers.  Overall confidence rose solidly again in August, the fourth consecutive increase.  The level hasn’t been this high since October 2007.  The eye-opening component was the Present Situation index, which surged.  There was a sharp rise in the percentage of respondents who thought that jobs were plentiful and a modest decline in those who felt it was difficult to find a position.  Strangely, fewer believe job openings will rise in the near future.  Rationality may not be at work here.  The other key finding is that people are not overly optimistic about their incomes increasing going forward.  That, even more than their general view of the world, could keep households from spending briskly.

Orders for big-ticket items skyrocketed in July, but when civilian aircraft orders rise 318%, you know that the headline is largely meaningless.  Excluding private and defense aircraft, orders did jump and that was due to strength in the vehicle sector, which was up over 10%.  Otherwise, the numbers were largely off, with only communications posting a nice gain.  Business capital spending eased, but quite modestly compared to the jump posted in June.  Backlogs are building nicely and that should mean expanding production going forward.

Home prices continue to rise, but the rate of increase is decelerating.  The S&P/Case Shiller 20-city index was up decently in June and has moved back to fall, but the gain over the year was down in all twenty cities.  The price index is back to where it was in fall 2004.

MARKETS AND FED POLICY IMPLICATIONS: Consumers are feeling a lot better about economic conditions, but they are not exuberant about their income possibilities.  That is holding back spending and until the labor market tightens further, wage increases will remain limited.  That is why the debate over the slack in the workforce is so important.  In addition, home price gains are slowing.  While that may help affordability, it hurts the churn in the market as fewer homeowners will see their equity levels rise to where they can once again sell their homes.  That said, the jump in orders does point to continued decent overall economic growth but until we get the consumer going, strong growth will remain a wish not a reality.  Investors should understand that, even as they bid up prices.  But these reports only add to the divisions that exist at the Fed.  It’s still the labor market and we don’t get the August employment report until the Friday after Labor Day.

Fed Chair Yellen Talk at Jackson Hole Conference

In a Nutshell: “… if progress in the labor market continues to be more rapid than anticipated by the Committee, then increases in the federal funds rate target could come sooner than the Committee currently expects … Of course, if economic performance turns out to be disappointing … then the future path of interest rates likely would be more accommodative than we currently anticipate.”

If you don’t like two armed economists, you will truly dislike the talk that Fed Chair Janet Yellen gave today at the Federal Reserve Bank of Kansas City’s Economic Symposium in Jackson Hole, Wyoming.

The greatly anticipated speech delved into the details of the labor markets, the impact of wages on inflation and the way that monetary policy should react.  Of course, being a good economist and academic, Chair Yellen discussed all sides of the issues.  For example, is the decline in the participation a result of changing structural factors such as the aging workforce or is a cyclical decline due to frustration that will unwind once the labor market firms more?  The answer is, of course, yes.  That is, it could be one, or the other or even both, which it likely is.

Similarly, there were discussions about wage pressures, how long it could take for wages to rise faster and when rising labor costs would actually translate into rising inflation.  As any economist will tell, the answer is hardly clear since there are multiple competing factors.  Thus, wage pressures could ignite quickly or be delayed.  Rising wages could signal future increases in inflation, or maybe not.  The Fed should react quickly to rising wages or maybe wait if the wage increases are temporary.  In other words, the answer is any or all of the above.

So, given the talk, is there anything to take away from the speech?  Yes.  First, the Fed members recognize that we are a lot closer to their desired goals than they had projected.  Second, the lack of wage inflation is not necessarily a good sign for future inflation.  The apparent current slack in the labor market could disappear more quickly than expected.  In the past, the Fed Chair had generally been on the side that current labor market conditions argue for keeping rates low for an extended period.  Now, those same conditions need to be watched more carefully.

If Janet Yellen was viewed believing the labor market had plenty of slack and wage pressures would not build anytime soon, that perception has to change.  She recognizes that the risks are more balanced.  That means she will be more willing to move rapidly if the economy continues to improve surprisingly quickly.  Thus, investors should not assume any time frame for Fed rate hikes.  It is easy for economists and market analysts outside the Fed to pick a date.  But today’s talk makes it clear that if the Fed has to move sooner or deems it necessary to wait longer, the Fed Chair is totally prepared to go in that direction, whatever it may be.

July Existing Home Sales and Leading Indicators, Weekly Jobless Claims

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.

August National Association of Home Builders Index

KEY DATA: Housing Market Index: 55 (up 2 points)

IN A NUTSHELL:  “Builders may not be irrationally exuberant but the rise in confidence is an indication that the housing market is getting better.”

WHAT IT MEANS: The housing market has been adding to growth but the recent data have not created any great feeling that the sector will lead the way toward much stronger economic activity.  That still seems to be the case but at least it now appears that residential construction should continue adding to growth.  The National Association of Home Builders/Wells Fargo Home Builders Index rose in August, making it three consecutive months that builders’ optimism increased solidly.  The level is not yet back to where it was last August, when it hit a nearly eight year high, but it is getting close.  The three components, current sales, future sales and traffic, were all up.  Only the traffic measure remains at a low level, which is clearly a concern.  Apparently, the limited traffic is turning into sales, though.  Regionally, optimism was mixed.  Gains were posted in the Northeast and especially the Midwest, but were down somewhat in the South and West.  The weakest link remains the Northeast, where builder confidence may be rising but it still is in the “not very good” range.

MARKETS AND FED POLICY IMPLICATIONS:  The housing sector has been sending mixed messages since the winter weather cratered activity.  Sales have been improving in fits and starts while construction has wandered aimlessly.  The trend may be up, but not with any vigor.  The Home Builders seem to be saying that activity could start picking up again.  Of course, that is only one voice.   Fannie Mae’s economists toned-down their view of the housing market for the second half of the year, indicating that “With respect to housing’s contribution to growth this year, we have downgraded our outlook following the disappointing housing activity seen during the first half of the year“.   I guess the simplest thing to say is that housing will add to growth but not be the driving force behind any major upturn in economic activity.  Anything that implies less than stellar growth helps those at the Fed who want to watch and wait, and that includes the Fed Chair.  As for the markets, the Home Builders and Fannie Mae reports will probably just add to the view that rates are not going up anytime soon.  Of course, there are geopolitical concerns that seem to ebb and flow, as well as Chair Yellen’s talk on Friday in Jackson Hole.  Past Fed Chairs have used this forum to send messages about the future direction of policy.  It is fervently hoped that we will get some idea about Yellen’s thinking on how a tightening in the labor market translates into inflation issues and the need to raise rates.  Wage pressures only matter to the extent they create inflation concerns and we have no idea about the speed of that transmission process and what that may mean for Fed policy.  In other words, the era of “better communication” continues with very little good communication.

July Industrial Production and Producer Prices

KEY DATA: IP: +0.4%; Manufacturing: +1%; PPI: +0.1%; Goods less Food and Energy: +0.2%

IN A NUTSHELL:  “With manufacturers ramping up production, it is clear the economy is accelerating, but it is doing so without any major inflation pressures.”

WHAT IT MEANS: Consumers may not be spending a whole lot of money but that doesn’t seem to matter to manufacturers.  Production surged in July and the increases were across the board.  Every durable goods and five of the eight nondurable goods sectors raised output levels.   On the consumer side, vehicle assemblies jumped 13% as sales remain strong.  But it wasn’t just what’s left of Detroit.  Output of electronics, appliances and furniture also increased solidly.  Even clothing production was up! There were some soft spots, such as food and energy, but that doesn’t change the picture.  Business goods production rose as a lot more business equipment and construction supplies were churned out.  The manufacturing capacity utilization rate hit its highest level since February 2008. 

While production may be jumping, costs are not.  The Producer Price Index rose modestly in July, helped along by a shape drop in energy costs.  Services costs rose a touch faster but than goods prices but they are still not rising sharply.  There appears to be only one area where wholesale costs are worrisome: Consumer foods.  Finished consumer food goods jumped one percent in July and are up nearly six percent over the year.  Those increases show up in the supermarket and with wages largely flat, households will have less left over after buying food to purchase other goods.

MARKETS AND FED POLICY IMPLICATIONS: Rising output and modest inflation pressures: Who could ask for anything more?  The increase in production is the result of improving economic conditions and that implies hiring should continue to improve and the unemployment rate decline.  Those are necessary conditions to shift the excess of supply in the labor market to an excess of demand and ultimately higher wages.  With producer costs tame, inflation should also continue to be fairly modest, allowing purchasing power to rise once compensation gains pick up.  The Fed members who want to keep holding the economy’s hand will look at the tame inflation numbers and say that policy can remain untouched.  The inflation hawks will say the industrial production gains argue that conditions are changing and the Fed needs to get out in front of any potential inflation pressures.  In other words, nothing will change at the Fed.  These reports, coupled with geopolitical pressures subsiding, at least a little, should put some smiles back on investors’ faces.

July Retail Sales

KEY DATA: Total Sales: 0.0%; Excluding Vehicles: +0.1%

IN A NUTSHELL:  “The consumer has taken a holiday from shopping.”

WHAT IT MEANS: Remember the phrase “shop ‘till you drop”?  Well, forget about it.  Consumers are not shopping very much at all.  I often argue that we shouldn’t expect a major return to the malls (or Internet) until incomes started growing.  Since incomes are not growing, it is not a major surprise that retail sales would be sluggish.  But this is getting ridiculous.  For the second consecutive month, households skipped the trip to the store.  July retail sales were flat after rising modestly in June.  We knew that vehicle purchases eased from the robust June sales pace but that is hardly a concern as they are still at a very strong level.  The real worry is weakness in electronics and appliances, which has been faltering since they surged in the first quarter.  A similar trend was also seen in furniture sales.  It looks like a new vehicle is the only big-ticket item people are buying.  Sales at department stores were down sharply, indicating a trip to the mall was not something a whole lot of households did.  Not every retailer hit the skids in July.  Supermarkets, restaurants, sporting goods, health care, building materials and clothing stores all posted gains, though they were nothing special.   

MARKETS AND FED POLICY IMPLICATIONS:  People just don’t seem to be into shopping right now.  Undoubtedly, income is an issue.  But six years of economic uncertainty may be changing spending patterns, at least for a while.  Consumers are finding they can live without a lot of the stuff they used to buy automatically.  Our consumption society bought an awful lot of things that we probably didn’t need but thought it might be nice to own.  Just as the Great Depression scarred a generation of consumers, the Great Recession may be modifying the need for things.  How long that “I don’t need that” attitude may last is unclear.  We will not really know until incomes start rising strongly for an extended period.  But there is a good possibility that the savings rate during this expansion will be higher than during the housing bubble-driven spending boom in the 2000s.  Savings as a percent of disposable income was on a clear downward trend from 1975 to the beginning of the recession in early 2008.  Fear and financial necessity drove the rate up.  It is down somewhat this year but it is still above the average posted from 2000 to 2007.  Regardless, right now people are just not parting with their hard-earned funds and that is a concern.  For the Fed, though, softer retail sales mean more moderate economic growth so there is less need to raise rates.  That should make investors happy, even as it raises questions about earnings.

June Job Openings and Labor Turnover Survey

KEY DATA: Openings: +94,000; Hires: +92,000; Quits: +48,000; Layoffs: -32,000

IN A NUTSHELL:  “Businesses are hiring and people are quitting, two clear signs that the labor market is firming.”

WHAT IT MEANS: There no longer is a question that the labor market is getting better.  The focus of attention has shifted to how quickly, since that will determine the speed at which worker compensation increases.  One report that has taken on more intense focus is the Bureau of Labor Statistics’ Job Openings and Labor Turnover survey.  This report is starting to flash red.  Job openings are surging and were the highest since early 2001 – over thirteen years ago!  Meanwhile, hiring is also improving and that is back to spring 2008 levels, about six months before the banking meltdown.  But maybe the most important number in this report, at least as far as I am concerned, is the quits component.  People are actually leaving their jobs, something that has been unheard of over the past five or six years.  True, the number of people telling their employers to take the job and, well you know what, is still not very high.  But that is changing, maybe the clearest indication that the labor market is getting back to normal.

MARKETS AND FED POLICY IMPLICATIONS: Firms are looking for new employees but they are also having trouble filling the positions: Over the year, openings rose nearly twice as rapidly as hiring.  That point was also seen in the National Federation of Independent Business July survey which found that 24% of the respondents had trouble filling openings.  Firms are also starting to face the problem that a growing number of workers are simply leaving.  I have been warning about this likelihood for over six months now and the data are starting to support the view that six years of treating workers as if “they are just overhead” is going to be paid for by much faster increases in wages and/or benefits than most business leaders have been expecting or planning for.  And my argument that the decline in the participation rate is due to longer-term demographic and social issues, i.e., it is structural not cyclical, also implies that labor supply will not keep up with demand and wages will have to rise.  The Fed can continue on its current course without creating massive problems for a while.  But those who think that rates don’t have to rise until the second half of next year are underestimating the rate of tightening in the labor market.  I have the Fed beginning to raise rates in the first quarter of 2015 – my forecast since last December – but for that to happen, the FOMC has to start outlining when it will start reducing its reinvestment of assets and then actually raising rates.  Quantitative easing is history.  Now is the time for Janet Yellen to tell us where we go from here and how she is going to get us there.

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