KEY DATA: Productivity: 3.0%; Labor Costs: +0.5%/ Layoffs: 29,831/ Claims: down 5,000

IN A NUTSHELL: “Despite an extremely tight labor market where companies are not cutting workers, labor costs remain under control.”

WHAT IT MEANS: If the economy is to accelerate, productivity will have to increase faster than the pathetic pace we have seen over the past few years. And it may be doing that. Worker output rose sharply in the third quarter even as hours worked increased modestly. This led to a jump in productivity, which kept labor costs under control. The quarterly rise in productivity was the largest in three years while the 1.5% increase over the year was the best in two years. That said, productivity is still growing too slowly, given the modest rise in the labor force, to sustain growth much above 2.25%. And, it needs to be pointed out that the decline in payrolls in September, which was likely an aberration, hyped the productivity increase. The number of hours worked expanded at the slowest rate in two years. So, let’s enjoy this report while we can but at the same time, we need to be careful assuming it will be sustained.

Tomorrow is employment Friday and it is likely that payrolls rebounded sharply from the first decline in seven years. Reinforcing that belief was the Challenger, Gray and Christmas report on layoffs. The number of job cuts announced was modest in October and the ten-month total was the lowest in twenty years, when the dot.com boom was nearing its peak. Companies are having a tough time filling job openings so they are keeping as many workers as possible. Since job gains are the difference between hiring activity and job reductions for any reason, when cutbacks slow, the net number of new people hired rises.

And if you don’t think the layoff announcement numbers mean anything since they are just announcements not actual cuts, the jobless claims data should erase those beliefs. New claims for unemployment insurance declined last week and are at historic lows.

MARKETS AND FED POLICY IMPLICATIONS: It is good to see that productivity is improving, though as I pointed out, I am not so sure that is sustainable. Nevertheless, labor costs are under control and that has allowed the earnings season to look pretty good. But it also indicates that worker incomes are not growing fast enough to allow spending to surge. Indeed, on a year-over-year basis, real hourly compensation has declined for four consecutive quarters. It is hard to spend more when your spending power is declining. The way you do that is by reducing savings and the savings rate is already too low. So, while the data point to a solid economy, they also reinforce the view that growth is not likely to remain strong for an extended period without improved wage gains. Will investors see it that way? Actually, with the new Fed Chair to be named and the October employment report only a day away, I don’t think today’s reports will change a whole lot of thinking.

KEY DATA: ISM (Manufacturing): -2.1 points; Orders: -1.2 points/ ADP Jobs: 235,000/ HWOL: +81,500/ Construction: +0.3%

IN A NUTSHELL: “The economy did well in September but it looks like it didn’t build on those gains in October.”

WHAT IT MEANS: The September numbers came in pretty strong and that translated into in solid third quarter GDP growth. But as is always the case, all eyes are turning toward the next quarter and so far it looks like growth is solid but not accelerating. The Institute for Supply Management reported that manufacturing activity was really good in October, though it did moderate a touch. Indeed, the index level is consistent with strong manufacturing growth. Orders remained high, even if they increased a little less rapidly, while hiring and production also remained near recent highs. Backlogs continue to build and that implies continued solid activity going forward.

On Friday we get the October employment report and that means on Wednesday, ADP releases its estimate of private sector job gains. The September payroll decline broke a seven-year streak of job gains and it is expected that the drop was an aberration that will be corrected with a strong increase in October. ADP indicated that is likely. Their estimates are that private sector job gains in September and October totaled nearly 350,000. (ADP had payrolls expanding in September.) That seems to make sense to me, though maybe a little high. I expect an upward an upward revision to the September number and an October gain in the 300,000 range.

Reinforcing the belief that the October jobs report will be strong was the sharp increase in the Conference Board’s Help Wanted OnLine Measure. Gains in October were seen in every region and in most occupations. Still, businesses have been cutting back on their advertising for two years now and the level of ads is well below its peak. I suspect that may be more a function of the inability to fill jobs than a lack of openings. Firms may simply be assuming they can fill only so many open positions and are concentrating on the most important ones.

Construction activity rose in September, but all the gain was from government activity. Private nonresidential construction declined while residential building was essentially flat.  

MARKETS AND FED POLICY IMPLICATIONS: Today’s data indicated that the economy didn’t falter much, if at all, in October, but it didn’t speed up either. It looks like vehicle sales were solid in October and that should help, but it still isn’t clear to what extent hurricane replacement is driving the numbers, so be a bit cautious here. Friday’s jobs number should be really good, but don’t be fooled by the headline. To get a better picture of what is happening, average September and October together. I suspect that will look like something closer to about 150,000 per month. But before then, the new Fed Chair will be named and if it is Jerome Powell, as expected, investors will be able to assume that not much will change as far as Fed policy is concerned. They can go back to watching earnings and wondering – or dreaming – about tax cuts. As long as the Republicans embrace massive increases in the national debt, something they have decried for years, the tax bill will pass. But as the details keep dribbling out and the size of the shortfall keeps rising, questions grow about the Freedom Caucus’s willingness to go along with what is shaping up to be a very traditional tax cut bill. As for tax reform, it hardly looks like that is going to happen.

KEY DATA: ECI (Over-Year): +2.5%/ Confidence: +5.3 points/ Jobs Index (Over-Year): -0.51%/ Home Prices (Over-Year): +6.1%

IN A NUTSHELL: “Everything seems to be going up, including wages, home prices and confidence.”

WHAT IT MEANS: Boy have the data looked good lately and today’s numbers are no different. Let’s start with the third quarter Employment Cost Index. This is a more global measure than the average hourly wage number that most people talk about. It considers wages and salaries as well as benefits. Business labor expenses accelerated in the summer, but the rise was nothing major. The pick up was largely due to improving wage and salary gains, especially in the private sector. Public sector costs actually moderated. The wage pressures built in almost all industries and most professions. There has been a slow but steady acceleration in private sector wage costs but they are just now getting to levels we saw in the 2000s. That is, they are rising, but not yet high.

Consumers are becoming ebullient, at least if you believe the Conference Board. The Consumer Confidence Index rose sharply in October as both current conditions and expectations jumped. The index now stands at its highest level since December 2000. People are very upbeat about the labor market, as a rising percentage said it was easier to get a job right now. If there was a cautionary note in the report, it was that respondents were a little less confident about future employment conditions.

Home prices continue to surge. The S&P CoreLogic Case-Shiller national home price index jumped again in August and the rise over the year broke 6%. Since slowing sharply in 2014, the increase in the index has rebounded, accelerating from a low of 4.1% in February 2015 to its August pace. Seattle is leading the way as home prices rose by a huge 13.2% since August 2016. The recovery in Las Vegas is accelerating and prices were up nearly 9% over the year. Over the month there were solid increases in most of the major metropolitan areas except Atlanta, which posted a modest decline.

The only negative number was the Paychex HIS Markit Small Business Index, which declined in October. This index has receded most of this year and is pointing to a job slowdown in the small business segment of the economy. That point was reinforced by the recent deceleration in wage growth.

MARKETS AND FED POLICY IMPLICATIONS: The economy looks like it has accelerated from the sluggish 2% pace it was stuck in for quite a while. But the lack of labor may be keeping firms from hiring and that will likely limit the growth rate, at least until wage gains accelerate. Employment costs may be increasing but they are hardly surging, which is good for business but not for consumers. Given the rate of inflation, income is not rising fast enough to allow consumers to increase their spending pace. Also, the savings rate has fallen to a level that raises questions about the ability of consumers to maintain their current spending growth rate. Something has to change. Either wages need to rise faster or tax cuts have to be provided to lower and middle class families. Those cuts would accelerate spending, but only in the short-term. Longer-term, either wage gains will have to accelerate or the economy will slow. Tax cuts are so enticing because they cover up the fundamental issues and kick the problems down the road. For politicians, that is nirvana.

KEY DATA: Consumption: +1.0%; Disposable Income: +0.4%; Prices: +0.4%; Savings Rate: 3.1%

IN A NUTSHELL: “Consumers spent like crazy in September, but the declining savings rate is a warning sign that they may not be able to keep it up.”

WHAT IT MEANS: Last week, the third quarter GDP report was released and it indicated that September consumer spending was really strong. And it was. Indeed, the rise was the largest in eight years. But before we get too excited, keep in mind that much of the gain was due to a surge in vehicle sales. That was likely the result of many people replacing their hurricane-destroyed vehicles. Thus, we cannot take too much solace in the robust durable goods number. There was also a jump in nondurable goods demand, but much of that may have come from the sharp rise in energy costs that resulted from the temporary supply dislocations. Indeed, when the nondurable goods increase was adjusted for price changes, the increase was solid but nothing great. Finally, spending on services, the largest component, was also decent but nothing that would indicate the consumer has become irrationally exuberant. On the inflation front, prices were up sharply but when food and energy were removed, there was only a modest increase in consumer costs.

As for income, there was a solid increase as wage and salary gains rebounded from a minimal rise in August. Not surprisingly, given the surging stock market, dividend income was up sharply. Still, the gain in incomes did not come close to matching the jump in spending and the savings rate fell again. It is down to 3.1%.  

MARKETS AND FED POLICY IMPLICATIONS: On the surface, this looks like a really strong report and the consumption rise did keep third quarter consumption from faltering significantly. But it is doubtful we will see a repeat of the huge vehicle sales going forward and that means household spending may slow in the coming months. But what really worries me is the steady decline in the savings rate. Since 2010, the savings rate has averaged 5.8%, but while it has bounced around, the trend is down. Lately, that decline has accelerated. In 2015, it averaged 6.1%, fell to 4.9% in 2016 and it looks like it will average about 3.7% this year. That would be the lowest rate since 2007, which was the last year before the Great Recession. On a monthly basis, the rate hit its lowest level since December 2007, when the last expansion ended. Looking at the past few recessions, the savings rate tends to decline until just before a downturn starts and that pattern has started. I am not saying a recession is coming. But consumer incomes are not rising fast enough to sustain solid growth and that is a warning sign of future trouble. However, this red flag is not likely to be viewed as particularly important by investors. They are focusing on the tax plan, which is still undergoing changes and will have to go through a lot more in committee. But the faltering savings rate could give some Fed members pause. At the least, it will provide further ammo for those who want to raise rates very slowly.

KEY DATA: Durables: +2.2%; Excluding Aircraft: +0.9%; Capital Spending: +0.7%/ New Home Sales: +18.9%/ Home Prices: +0.7%; Over-Year: 6.6%

IN A NUTSHELL: “The expected September hurricane driven slowdown doesn’t appear to have occurred.”

WHAT IT MEANS: Normally, after a major catastrophe such as hurricanes, the economy slows. But soon afterward, as rebuilding begins, activity accelerates. Well, we may not have gotten that much of a softening in growth from the disasters. First of all, durable goods orders were up sharply in September. That was not a major surprise as demand had been solid and the impacts from the hurricanes were localized. While we did get a huge bump from aircraft orders, even excluding that sector, orders were still robust. There were increases in demand for communications equipment, fabricated metals and a modest rise in motor vehicles. But most importantly, the best measure of business capital spending, nondefense, nonaircraft orders, rose sharply. Over the year, business investment orders are up a very solid 3.8%. Backlogs increased again, another sign that economic conditions are improving.

If the strong durable goods numbers were not enough, we also saw today that the housing market is coming back with a vengeance. New home sales skyrocketed in September and it wasn’t just a huge rebound in the hurricane-battered South. Sales were up in every region and the percentage rise in the Northeast (33%) was even greater than in the South (26%). Before we get too bulled up about the housing market, we need to recognize that outsized gains are usually signs of special factors. So don’t be surprised if there is a pull back in October.

Housing prices continued their inexorable trek upwards in August. The Federal Housing Finance Agency’s index surged over the month and is up quite strongly over the year. Regionally, the increases range from a low of 5% in the MidAtlantic area to 9.5% in the Pacific region. The rise in home prices has been slowly but steadily accelerating for three years now. While we aren’t near the double-digit pace posted in 2005, we are betting closer to nosebleed levels that raise concerns about affordability.

MARKETS AND FED POLICY IMPLICATIONS: Today’s data point to a solid third quarter GDP growth pace. It may not match the 3.1% posted in the second quarter, but it should be pretty good. But the real eye-opener was the private sector capital spending. It has been picking up rapidly and the increase over the year is accelerating. It looks like business investment on durable goods will be up this year by between 4% and as much as 5%, if the gains continue.

Commentary: The rising pace of private capital spending raises a major question: Do we really need tax cuts targeted to increase investment? If companies are already investing more without any certainty they will get a tax cut, why would one be needed? Economic activity, not tax policy, is driving capital spending and that is the way it should, especially since tax incentives for capital spending are incredibly inefficient and massively expensive. They reward businesses for doing what they would have done anyway given all firms that invest get the break, not just those incented to spend more.

Consider this example. Nonresidential investment will likely total about $2.5 trillion this year, in nominal dollars. Let’s assume there was going to be no increase next year but the tax changes cause investment to rise by a huge 10%, to $2.75 trillion. That’s great, so what’s the problem? The first $2.5 trillion in investment would have occurred anyway, yet those firms still receive a tax cut. That is, 91% of the tax break goes to firms that have done nothing different than they would have without the tax change! And I used a pretty large impact from the tax cuts. If it is smaller, which is likely to be the case, the percentage is even higher. A five percent increase would put the percentage at 95%. Depending on the size of the tax break, the government might actually be paying for most if not the entire rise in capital spending. To me, that makes absolutely no economic or fiscal sense. It is just a tax giveaway. With businesses already indicating by their actions that they are willing to spend more on capital goods, do we really need an investment tax cut? Comments welcomed.

KEY DATA: Sales: +0.7%; Over-Year: -1.5%; Prices: +4.2%

IN A NUTSHELL: “A lack of supply is keeping housing sales down but prices up.”

WHAT IT MEANS: It is hard to buy homes that are not for sale and that is a problem facing the housing market. On Tuesday, we learned that new home sales fell in August, in no small part because Houston was underwater. That it is hard to sell properties you cannot get to should have surprised no one. Today we found out that once the waters recede, sales proceed. The National Association of Realtors reported that existing home purchases rose in September. Now that was a bit of a shock since Florida took a licking. Apparently, demand in Houston start ticking again and sales in the South were off only modestly. The Midwest and West reported increases but purchases were flat in the Northeast. Over the year, however, sales did drop. While the inventory of homes for sale edged up in September, it was down over 6% from September 2016. That is limiting buyers’ options and forcing them to pay up for what is available. There is little reason to think that will change anytime soon.

MARKETS AND FED POLICY IMPLICATIONS: Housing is critical to not just growth but inflation as well. We tend to think of all the sectors that are affected when home construction and sales rise sharply. But you also have to consider the impact of home prices on consumer inflation. This enters the Consumer Price Index through the category called “owners equivalent rent”. Basically, it is what homeowners think they can rent their homes. Prices and costs of operations are included in this, so it is not strictly a housing price measure. But in September, this component was up 3.2% over the year, well above the 2.2% rise in the overall index. Since it constitutes almost one-quarter of the index, continued housing price pressures will add to inflation. Of course, that may be good as far as many Fed members are concerned. If they are to defend a rate hike, it would be better if inflation is accelerating and the lack of supply in the housing market is just the factor that could help that happen. As for the markets, earnings do matter, at least sometimes, and this is earnings season. However, paraphrasing Animal Farm, “all earnings are equal but some earnings are more equal than others”. Thus, when there are big misses, even when they come from huge companies, investors continue to buy, buy, buy. Of course, there also may be some exuberance setting in.

KEY DATA: LEI: -0.2%/ Phila. Fed (Manufacturing): +4.1 points; Orders: -9.9 points/ Claims: -22,000

IN A NUTSHELL: “There are no indications the economy will break out to the upside after hitting a bump due to the hurricanes.”

WHAT IT MEANS: In August and September, Mother Nature ruled. The weather made a mess of large parts of Texas, Florida and Puerto Rico. But we are expecting an economic rebound as households replace lost vehicles and damaged homes while businesses fix up their operations that were set back by the storms. Will that upturn occur? It is way too early to know, but one measure, the Conference Board’s Leading Economic Index, usually provides some insight and it didn’t say conditions were going to improve quickly. Indeed, the index fell in September, the first decline in a year. Should we worry? Not really. The biggest issues were the labor market and residential construction components and those were likely temporarily depressed. Unemployment claims have already fallen to if not below where they were BH (before hurricanes) and don’t be surprised if the October employment report is a biggie. Since it is hard to build during a hurricane and in flooded areas, I suspect that we will soon see a pick up in building permits. So, don’t conclude that the economic data are flashing a slowdown ahead.

One indication that economic conditions have remained solid is the Philadelphia Fed’s Manufacturing Survey. The Index rose moderately in early October, though the details really don’t support any real improvement in activity. New orders and backlogs continued to grow, but less rapidly. Hiring improved yet optimism faded. Businesses are still positive about the future, but not quite as exuberant. And of more concern, their costs are rising and respondents believe they will rise even faster going forward.

Jobless claims pretty much bottomed last week. The sharp decline took us to a level not seen in nearly forty-five years. Then, the labor force then was only about 55% of what it is now. Adjusting for the size of the labor force, the level of claims is at an historic low.

MARKETS AND FED POLICY IMPLICATIONS: Today’s data don’t really change a whole lot as far as the outlook for growth is concerned. But we need to pay attention to the labor market numbers. Undoubtedly, the ups and downs in jobless claims created by the hurricanes caused some strange doings in the data, so the historically low claims number has to be seen in that light. But there were other reports released yesterday that indicate the labor shortages are beginning to bite. The ADP Job Vitality Report indicated that “job holders” are seeing better wage gains. In many sectors, the increases between third quarter 2016 and 2017 exceeded 4%. The information, leisure and hospitality and construction industries are all under intense pressure as shortages persist and workers are moving to the highest bidders. Also, the Labor Department reported that median weekly earnings rose 4% in the third quarter. The trend in wages is up and it is hard to see that it will do anything but accelerate going forward. There are lots of different measures of wage gains and most have issues. The ADP numbers try to “individualize” and there are clear signs that in a lot of sectors and in many parts of the nation, wage pressures are building.

KEY DATA: CPI: +0.5%; Excluding Energy: +0.1%/ Real Earnings: -0.1%/ Retail Sales: +1.6%

IN A NUTSHELL: “The sharp rise in consumer prices may have been hurricane driven, but for those on Social Security, it was great news.”

WHAT IT MEANS: Inflation accelerated in September – not! If all you do is read the headline number, that is your takeaway. But the reality, as usual, is in the details and that is a different story. There was, as we all know, a surge in gasoline prices as the Harvey hit the supply chain hard. Excluding energy, inflation remained quite tame. Food costs rose minimally even though the all-important snack category posted a large decline, vehicle prices fell, medical goods expenses dropped sharply and apparel prices were also down. Shelter costs, though, continue to rise at a moderate pace. Next month, the index could be flat to down as much of the gasoline price gain has already dissipated. In other words, there really is little to worry about when it comes to inflation.

But the increase in prices, even if temporary, is having impacts. First of all, while hourly earnings rose solidly in September, when adjusted for inflation, household earnings were down. As I always say, it is hard for consumers to buy more when their purchasing power is going nowhere. On the other hand, Social Security recipients are going to be quite happy. The cost of living adjustment is based on the third quarter over third quarter rise in the Consumer Price Index for wage earners and that was up 2%, in no small part because of the surge in gasoline costs. The adjustment will be the largest since 2012, when gasoline prices surged as well.

The hurricanes had a large impact on retail sales, as well. Total retail demand soared in September and the major reasons for the gain could be traced to the weather. Gasoline sales jumped as prices surged. Vehicle sales exploded as households who had their vehicles damaged started replacing them. And sales at home supply stores were up sharply as people bought everything they could to first batten down the hatches and then start to rebuild. Since so many had abandoned their homes, they wound up eating out and restaurant sales were up solidly. Just as consumer prices will likely reverse in the next month, it is likely that retain sales will be quite weak when the October report is released.

MARKETS AND FED POLICY IMPLICATIONS: The sudden increase in retail demand is likely to cause third quarter growth to come in somewhat better than expected before the hurricanes hit. But what Mother Nature may have given in the third quarter, she will likely take away in the fourth. That is true when it comes to consumers spending as well as inflation. I warned the data would be choppy and it looks like the waves will be fairly high. The Fed will not be swayed by the inflation report as there will be two more reports before the December FOMC statement is released. By then, the members should have a better idea about the pace of consumer prices. Therefore, investors will likely continue to focus mostly on earnings.