June Retail Sales

June Retail Sales

KEY DATA: Sales: +0.5%; Ex-Vehicles: +0.4%; Ex-Vehicles and Gasoline: +0.3%

IN A NUTSHELL: “The consumer spent heavily in the spring and that implies second quarter growth should be quite strong.”

WHAT IT MEANS: Wages might not be rising very quickly but that is not stopping households from spending money. Retail sales rose solidly in June after surging in May. The May level was revised upward sharply, so the two months together point to really good demand. Looking at the June report, vehicle demand led the way, which we pretty much knew from the sales data. But there was another strong month of sales at building materials and garden stores, as homeowners seem to be improving their properties. And while they are doing that, they are going out to eat like crazy once again. Restaurants had been seeing modest sales gains for quite a while by that seems to be changing. People shopped online and bought lots of furniture and health care products, indicating that sales were spread between big-ticket and smaller purchases. Rising gasoline sales also helped. Declines in purchases at supermarkets, sporting goods stores and department stores restrained the gains. It should be kept in mind that these data are not price adjusted, so some of the ups and downs may be due to price changes.

In a different report, the New York Fed’s Empire State Index, which measures local manufacturing activity, declined slightly in early July, but it remained at a very high level. Almost every component of the current conditions and futures indices was down, but not significantly. Essentially, manufacturing in the New York region remains solid. Of course, this area is not a huge industrial area, so not much should be made of the changes, on way or another.

MARKETS AND FED POLICY IMPLICATIONS: The first reading of second quarter GDP growth will be released on July 27th and right now it looks to be a really good one. It would not be surprising if it had a 4-handle, which would mean that the economy expanded by about 3% during the first half of the year. That is pretty much in line with expectations. The robust growth is also not a surprise given the massive tax cut and the beginnings of additional government spending. When you implement one of the largest fiscal stimulus’s on record, you better get strong growth at least for a while. Which means we should see solid growth, at a minimum, for the rest of the year. But, as I keep asking, what happens when the sugar high wears off? Will businesses keep investing at higher rates or settle back into previous capital spending levels? Right now, they are not shopping for new equipment ‘till they drop by any means. And once the tax cuts increase consumer spending to a higher level, how can households increase their spending levels without any significant change in purchasing power? It is great that 2018 should be a great year, but what about going forward? That is always the worry when you hype things and it is no different right now. For example, after the Obama stimulus package hit, growth accelerated. In the second quarter of 2010, it hit 3.9%, but faded afterward. With inflation heating up and wages not following, with businesses spending lots of money on mergers and acquisitions, stock buy backs and dividends but little on new capital, and with trade becoming a major uncertainty, it is not a lock that strong growth will be sustained.

June Producer Prices

KEY DATA: PPI: +0.3% Over-Year: +3.4%; Goods: +0.1%; Services: +0.4%

IN A NUTSHELL: “Wholesale cost increases are accelerating and with more tariffs being announced, it is hard to see how consumer inflation will not accelerate as well.”

WHAT IT MEANS: Is inflation a problem? Maybe not yet, but it is hard to see that it will not be a real issue very soon. Wholesale prices rose solidly in June even with a sharp decline in food costs. Excluding foods, it was up at a concerning rate. I point out foods because a large part of the trade war is being fought over agricultural products and a loss of foreign markets would create surpluses in the U.S. and price declines. To the extent the price increases were due to bumper crops, those declines would likely be temporary. So, we should focus on the goods excluding foods and those were up pretty much across the board. Energy prices are rising as well and that is not good news for consumers, especially since they are helping drive a sharp rise in transportation costs.

Over the year, producer prices are up the fastest since December 2011. That is a warning and if we look into the pipeline to see if cost pressures will accelerate of slow, it is clear that they are likely to worsen. At the intermediate level, non-food and energy goods costs are soaring. Processed materials less food and energy were up by nearly five percent over the year and much of that will likely be passed through to finished goods. And the sharp rise in energy costs we saw in June is likely to be as great this month.

MARKETS AND FED POLICY IMPLICATIONS: Wholesale costs are accelerating and now we have threats of further tariffs on China that can only ramp up inflation fears. Of course, they are only wholesale costs. By that I mean the pathway from producer to consumer price increases is hardly straight. But we are getting to wholesale inflation levels that will be hard to absorb without materially reducing earnings. That is a warning for investors that the sugar high from the tax cuts may start wearing off, as businesses have to show increases that are not simply tax related. Higher producer costs, regardless of the source of the cost pressures, are not good news for the markets. If earnings come under pressure, it is likely that at least some of those cost increases will start showing up in the consumer price measures. That cannot make the Fed happy. So, today’s report is not good news as it provides warnings that inflation is likely to rise further and corporate earnings could weaken as we go through the second half of the year.

June Non-Manufacturing Activity, Private Sector Jobs, Layoffs and Weekly Jobless Claims

KEY DATA: ISM (NonManufacturing): +0.5 point; Activity: +2.6 points/ ADP Jobs: 177,000/ Layoffs: +37,202/ Claims: +3,000

IN A NUTSHELL: “With the economy booming, it is becoming harder and harder to find workers to hire.”

WHAT IT MEANS: Boy, are businesses in good shape. Earlier this week we saw that manufacturing activity rose again in June and today the Institute for Supply Management indicated that the nonmanufacturing portion of the economy might be in even better shape. Business activity surged and it was already strong. New orders were robust. But hiring eased a touch, though it is still quite strong. Despite soaring production, orders books are still filling at a pretty rapid pace. It is getting harder to meet the strong demand and that has led to deliveries slowing further. Will firms start allocating demand by raising prices? That might be coming.

Tomorrow is Employment Friday and it looks like job gains will be solid. ADP’s measure of private sector employment increases pointed to a very good but not great increase. There was limited hiring in the small business segment, which usually leads the way. If there is going to be problems hiring, it is likely to show up here as larger businesses can pay more and provide better benefits. That may be the case already.

Job layoffs remain low, even if they did pick up in June. Challenger, Gray and Christmas reported a jump in layoff notices and we are starting to see a rise from last year. The report noted that “in the wake of announced tariffs, we may be entering a period of increased cuts going forward”. Interestingly, retail is stabilizing and it was also pointed out the firms are already looking into creating a suitable workforce for the holiday shopping season. On the other hand, other sources indicate that firms have been scrambling to find any worker possible to fill positions and many are just not working out. That could be leading to more turnover.

Jobless claims increased last week and are running a touch higher than they had been. Still, the level remains pretty low.

MARKETS AND FED POLICY IMPLICATIONS: Tomorrow’s payroll number could be a head scratcher. Clearly, firms are looking for workers and have become somewhat desperate. But if they cannot find them, then job growth could be lower than the consensus of roughly 200,000. I would not be surprised if it is closer to 150,000, even if the labor force participation rate rises. A disappointing number would not be a sign of weakness, other than in labor supply. As I have argued all year, the key number is the hourly wage change. If we get the expected pop in wages, it will be taken as a warning that the labor market tightness is finally creating higher wages. This is a terrible measure, but it is closely watched nonetheless. I don’t like it because it is a weighted average, so it is possible that the average wage rate can fall even if all wages rise. In addition, it doesn’t include benefits and firms are upping their use of non-wage compensation packages in order to attract workers while not locking in higher salaries. Investors, though, seem to be willing to shrug off just about any and every hurdle placed in their way so a weak employment number may – or may not – affect the markets. Rationality is not the same thing as efficiency.

June Supply Managers’ Manufacturing Index and May Construction Spending

KEY DATA: ISM (Manufacturing): +1.5 points; Orders: -0.2 point/ Construction: +0.4%; Residential: +0.8%/ Ads: -51,000

IN A NUTSHELL: “Robust industrial activity should keep the economy strong for quite a while.”

WHAT IT MEANS: With trade issues starting to slowly, but steadily spiral out of hand, we need to know if the key sectors can withstand the potential problems that a trade war could bring.  Last week we saw that household income, especially wages and salaries, was not growing significantly. Today, though, it became clear that the industrial sector is in very good shape. The Institute for Supply Management reported that its manufacturing index rose in June. Orders continue to increase sharply, though not quite as quickly as they had been. Still, the expanding demand was large enough to force production to rise and order books to continue to fill (though also less rapidly). Both producer and customer inventories are low and that bodes well for future production. Finally, hiring continues at a very solid pace as well. All in all, it looks like the manufacturing sector should be able to lead the way for the rest of the year.

It is also looking like construction is starting to accelerate. Activity jumped in May, led by a surge in residential building, both private and residential. Office construction was also up sharply. However, excluding office, nonresidential construction was weak, which is something that needs to be watched. The economy needs a broad based strong construction to help offset any weakness that the trade battles may create.

MARKETS AND FED POLICY IMPLICATIONS: Can the U.S. economy withstand the counter-tariffs being put on by Europe, Canada, Mexico and China as well as the higher costs created by our tariffs? Right now, given that the level of the tariffs is not huge, it looks that way. That is not to say some industries will not be hurt badly or that growth will not slow, but unless things deteriorate further, a recession will not likely follow just from the current trade skirmishes. However, the longer the tariff mini-war continues, the greater the damage and the slower the economy will grow. That is causing investors to lose some of their exuberance and maybe even creating some caution in the market. But this week contains Employment Friday and some of the concerns about the future course of the economy could be either dispelled or heightened, depending upon the size of the report. The consensus is for strong gain in the 200,000 range. I don’t think that is likely. However, I do think the wage number could be hotter than expected. That would create worries. Regardless:

Have a wonderful and safe July 4th!

May Consumer Spending, Income and Prices and June Consumer Sentiment

KEY DATA: Consumption: +0.2%; Disposable Income: +0.4%; Prices (Over-Year): +2.3%; Excluding Food and Energy (Over-Year): +2.0%/ Sentiment: 98.2 (up 0.2 point)

IN A NUTSHELL: “Inflation to Fed: We have a liftoff.”

WHAT IT MEANS: There is a famous saying from the Apollo 11 mission, when we put the first people on the moon: “We have a liftoff!” Well, it looks like that is the case when it comes to inflation.   Consumer prices rose moderately in May, whether or not you include the more volatile food and energy components. But the real issue is that over the past year, both the headline number and so-called core numbers rose by at least 2%. The Fed’s target has been reached.

But we are just starting to see the impacts of the tax cuts hit. Indeed, consumer spending increased fairly modestly in May and when you adjust for inflation, it was flat. That is likely to change, hopefully, during the second half of the year. Moderate May weather kept utility spending down and that helped restrain consumption. Energy costs were up sharply, though. Meanwhile, household income expanded at a somewhat better pace. But even here, there are some warning signs. Wage and salary gains were fairly limited. What created the solid increase was a sharp rise in dividends. For the average household, if they hold stocks at all, their dividends wind up mostly in retirement accounts, so it is not going to be spent. That raises questions about how strong consumption will be going forward. So far this quarter, consumption is growing at a 2.3% pace, up quite nicely from the 0.9% rate posted in the first quarter. A likely decent gain in June could push the increase to the 3% range. That would point to much better second quarter growth.

The University of Michigan’s Index of Consumer Sentiment edged up in June, though it receded from its mid-month reading. Importantly, households are becoming more concerned about future economic activity. Respondents think the economy is in very good shape, but the trade issue is weighing on optimism. A growing share of people believe more trade is better than less.

MARKETS AND FED POLICY IMPLICATIONS: Right now, the extended period of strong growth that so many are predicting is just a wish and a hope. The numbers on wages continue to disappoint. In addition, households seem to taking their tax cuts and saving them, as the savings rate has risen recently. And while business capital spending is strong, it hardly matches the massive spending on dividends, stock buy-backs and mergers and acquisitions. I am not saying that the tax cuts are having no impact on growth, they are. But as of now, I think the added spending has been disappointing. That may or may not worry investors, but in a perverse way, should provide some comfort to the Fed. The members’ worse fear is a surge in growth that triggers even faster inflation. How long the Fed would be willing to allow the economy to “run hot” is not clear, but with backlogs building and labor shortages of critical workers, such as truckers, at crisis levels, the ability and need to raise prices is also increasing. Inflation may not be high yet, but the Fed has to be concerned that it will exceed its target by more and for longer than expected. It hard to think that we will not see another two rates hikes this year and the possibility we will get four more next year cannot be dismissed.

Revised First Quarter GDP and Weekly Jobless Claims

KEY DATA: GDP: 2.0% (from 2.2%)/ Claims: +9,000

IN A NUTSHELL: “A disappointing first quarter expansion is likely to be followed by robust second quarter growth.”

WHAT IT MEANS: Is the economy weak or strong? Did the tax cuts add to growth or do little? The answer to both those questions is, of course, yes. The third estimate of first quarter growth came in a little less than expected. The economy grew decently, but consumers did not spend a whole lot of money, especially on big-ticket items, restraining the expansion. Indeed, consumption grew at the slowest pace in five years. But the major reason for the downward revision to GDP came from less inventory building. Firms added to stocks at slower pace than previously thought. That, though, actually is a positive for second quarter growth. The data are indicating that both businesses and households picked up the spending pace in the spring. With less stock in the warehouses, production had to rise even more to meet the emerging jump in demand.

Corporate profit estimates were also revised and they grew robustly, to say the least. When taxes and certain adjustments are taken into account, profits were up nearly 17% over the level posted in the first quarter of 2017. Look for those numbers to get even bigger as we go through the year. Now if we can only get businesses to invest even more of those dollars, the economy would be in great shape.

Jobless claims jumped last week but that is hardly unusual. Smoothing out the ups and downs, the level remains extremely low. Conditions are so tight the firms are once again hiring teenagers. Challenger, Gray and Christmas reported that teenage hiring in May was up 73% over May 2017 levels.

MARKETS AND FED POLICY IMPLICATIONS: The economy does not grow in a consistent manner. Some quarters are disappointments while some exceed even the most optimistic forecasters’ estimates. So don’t make much of the first quarter number. Indeed, we could see second quarter growth at double the first quarter pace. Of course, averaging those two out would put us at where most economists expect growth to be this year: roughly 3%. Given the huge tax cuts, the massive surge in after tax profits, large increases in government spending and an already solid economy, that pace would be a disappointment. Three percent growth is what the president’s economists say is the sustainable level over the next ten years. That is in their forecasts. But if we can only get roughly three percent when you hype the economy at a pace maybe never seen before, you have to be concerned. The impacts of the tax cuts will wear off over the next twelve to eighteen months, so where do we go from there? Businesses may be at a much higher level of activity, but they still have to grow from that level and that means consumer spending will have to be a lot better. And that will require wage growth to accelerate sharply. But we have had no sign that will happen and if it does, what will happen to inflation and interest rates? If you are wondering why so many economists are raising their probability that a recession could start in late 2019 or the first half 2020, that is why.

May Durable Goods Orders and Pending Home Sales

KEY DATA: Orders: -0.6%; Excluding Aircraft: -0.5%; Capital Spending: -0.2%/ Pending Sales: -0.5%; Over-Year: -2.2%

IN A NUTSHELL: “The manufacturing sector is still growing, but maybe at a less robust pace.”

WHAT IT MEANS: One of the highlights of the current expansion has been the rebound in manufacturing. Well, that upturn may be moderating. Durable goods orders fell in May, marking the second consecutive monthly drop. Declines were pretty much across the board as the vehicle, civilian aircraft, computer, electronic equipment and metal sectors all were off. Demand for machinery, communications equipment and defense aircraft did increase. Still, backlogs rose sharply, indicating that production will continue to be strong for quite some time. Slowing vehicle sales and building inventory is not good news for the auto sectors. Finally, capital spending also slowed a touch. While the tax cuts provided the means of invest, firms have not done so consistently as spending has been up and down like a yo-yo this year.

The National Association of Realtors reported that pending home sales were off in May. Weakness in the South, the biggest region, offset gains in the other three regions. Housing’s big problem is not demand, as prices are up sharply. It is a lack of inventory that is restraining sales and that is likely to continue to be an issue for quite a while.  

MARKETS AND FED POLICY IMPLICATIONS: The housing sector is being buffeted by a lack of homes on the market, rising interest rates and soaring prices. That combination does not make for a stable market. The recent moderation in rates should help, but if growth is as strong as most economists expect, inflation and longer-term interest rates should continue to filter upward over the course of the year. And the Fed has made it clear that short-term rates will be rising as well. So, don’t expect this sector to lead the way. In addition, the rising costs to manufacturers from tariffs is just starting to bite and while initially, those costs might be absorbed, there is only so much some of the businesses can stand. We could see them raising prices as long as those tariffs are maintained. As for U.S. firms facing tariffs put on American made products, those impacts are also in the beginning stages. Thus, while the economic fundamentals are strong, some cracks are beginning to appear. Ultimately, investors will have to decide how much of the threats are real and how much bluster. They cannot keep getting whipsawed. Until then, volatility is likely to continue.  

May Leading Economic Indicators, June Philadelphia Fed Manufacturing Survey and Weekly Jobless Claims

KEY DATA: LEI: +0.2%/ Phil. Fed: -14.5 points/ Claims: -3,000

IN A NUTSHELL: “Strong growth this quarter should be followed by another quarter of solid growth.”

WHAT IT MEANS: The economy is strong, but will it continue that way? It looks likely. While the Conference Board’s Leading Economic Index rose somewhat modestly in May, it is still pointing to better growth ahead. The gains were in most components of the index, which indicates the economic expansion remains broad based. Still, as the report states, “the current trend, which is moderating, indicates that economic activity is not likely to accelerate.”

Manufacturing activity in the MidAtlantic region moderated in early June, but that is really not a surprise. The index is wildly volatile and it soared in May. Orders continued to expand, but not as robustly. Hiring remained very strong and employees are being asked to work longer. Surging shipments led to a thinning of order books, which does need to be watched. Looking forward, optimism continues to fade. While it is still high, it is coming back to more normal levels. That said, the special question this month was on production and respondents indicated current output has been rising sharply and activity is expected to accelerate going forward. Hiring should be strong in the summer, if firms can find the workers.

Jobless claims fell modestly last week, indicating the labor market remains tight. Given how low there are, it would be hard to see them drop much more.

MARKETS AND FED POLICY IMPLICATIONS: There may be some headwinds forming. Clearly, the tax cuts have created a huge amount of stimulus that will carry us through the rest of the year and well into next, but what do we do once the impacts fade? That is when confidence about the future sets in and there is a lot of chaos in Washington that is causing optimism to moderate. Of course, that just means we are backing down from the exuberance that has gripped the consumer and business community since the passage of the tax changes. Nevertheless, issues regarding trade and immigration, which directly affect businesses, are not viewed as being helpful. Growth will likely come in above 3% this quarter and next, but to keep growing at that pace, firms have to invest and an uncertain world is not a desirable one to make big capital spending decisions.

May Housing Starts and Permits

KEY DATA: Starts: +5%; Year-to-Date: +11%; 1-Family: +3.9%; Permits: -4.6%; Year-to-Date: +8%; 1-Family: -2.2%

IN A NUTSHELL: “The rebound in home construction means the sector might actually add to growth this quarter.”

WHAT IT MEANS: Home construction had been lagging this quarter, which was a bit of a surprise. And with mortgage rates rising, there was concern the sector could falter. Instead, housing starts rose solidly in May. But the data were all over the place. For example, construction in the Midwest surged by over 60%. Multi-family building activity nearly doubled and single-family starts jumped 45%. Those changes came after large declines in April. We are talking huge changes that are usually seen in the winter, not the spring. Meanwhile, starts were down in the other three regions, with the Northeast posting a double-digit decline. So we need to step back and see what happens in June before we make any major conclusions about the strength of the home construction sector. Looking forward, permit requests moderated, but they had been running well above the pace of construction and it was inevitable there would be a pull back. A massive increase in the Northeast and a more moderate decline in the Midwest were more than offset by weakness in the West and especially the South. For the last three months, permit requests ran higher than starts, so there is a reasonable expectation that the large jump in construction will be sustained, at least for a couple of months.

MARKETS AND FED POLICY IMPLICATIONS: Second quarter growth looks like it was solid and the remaining question is how big a number will print. Estimates range up to 4% or even more and that cannot be ruled out. I am more in the 3.5% range (actually, a touch below that), but there is still a lot of data to come that could change that. The strong housing number could push up GDP estimates. Regardless, the economy is in good shape, which just about everyone understands. Broad based growth would support the Fed’s expected four moves this year while not spooking investors too much. It is hard to argue that the economy will falter from a fairly modest one-half percentage point increase in short-term rates if the economy is expanding robustly. Indeed, if or when the current trade war fears fade, investors will get back to watching economic variables and those look good.

May Industrial Production and June Consumer Sentiment

KEY DATA: IP: -0.1%; Manufacturing: -0.7%; Motor Vehicles: -6.5%/ Sentiment: +0.8 points

IN A NUTSHELL: “A fire may have disrupted vehicle production in May, but that has already turned around, so don’t worry about the drop in output.”

WHAT IT MEANS: I often mention that it is foolish to look at the headline number for one month and assume it tells what is going on. Nothing shows that more than the May industrial production number. The decline in overall output and the sharp drop in manufacturing activity were largely due to the fire in Ford’s main parts supplier. Vehicle and parts production cratered. That is already turning around, so while the May number was temporarily low, the June number should be temporarily high. Put the two together and you get the trend. That said, manufacturing output still declined mildly in June as most industries were down. Six of the eight non-durable goods industry groups posted falling output, while only three of the eleven durable goods industries were up. Why the sudden drop in output is unclear, so I think it is best to just file this report away and see what the next couple of months have to offer.

Household confidence picked up during the first half of June. The University of Michigan’s Consumer Sentiment Index increased modestly, led by a sharp increase in the view about current conditions. However, and maybe more importantly, respondents were more pessimistic about the future. And they are beginning to notice the pick up in inflation. Anchored inflation expectations are something the Fed had often noted as being important and if they are becoming unmoored, that is a real concern.

MARKETS AND FED POLICY IMPLICATIONS: There have been so many strong economic numbers that one weak one shouldn’t indicate the start of a slowdown. Very simply, the economy is in very good shape. Looking forward, though, we need to be concerned about inflation. Pressure is building at every level for both producer and consumer goods. Households are noticing that, especially since it is eating into purchasing power, which has flatlined again. It is not enough to simply say growth is strong and conclude everything is fine. Too much of a good thing can be a bad thing as well. And investors are not very happy with the imposition of tariffs. While it is hard to argue that Canada is an unfair trader, especially given the U.S. runs a trade surplus with our Northern neighbors when both goods and services are considered, it is not unfair to say that China is an unfair trading partner. The issue is how you reduce the barriers. It is doubtful that the U.S. can cut greatly into the trade deficit with China without massive, wide-ranging tariffs and restrictions. Those would raise costs for consumers and businesses, reducing spending power, consumption and making U.S. firms less competitive internationally. About the best thing that has come from the talk of tariffs and trade wars is that people are finally recognizing that there is a thing called fair trade. Decades ago when that issue was raised, the free-traders of the world considered that approach nothing short of protectionism. Those same free-traders seem to have become tongue-tied when it comes to the ultimate protectionism, tariffs. Maybe now a rational, well thought out approach toward trade will be discussed, where trade barriers are reduced through trade agreements with our trading partners.    

Linking the Economic Environment to Your Business Strategy