KEY DATA: Orders: +2.4%; Ex-Transportation: -0.1%; Core Capital Goods: -0.9%/ Confidence: +3.4 points/ Case-Shiller National: +0.5%; Over-Year: +3.5%
IN A NUTSHELL: “Businesses remain cautious about investing and as long as that continues, the economy will only muddle along. ”
WHAT IT MEANS: I keep saying that the consumer needs some help and I keep reporting that businesses are not willing to provide that support. That was true again in December. Yes, durable goods orders did surge during the month, but two-thirds of the gain came from defense aircraft orders. Now if you consider it absolutely fine that government spending drives the economy, well that should not be an issue. But for those of us who think businesses should invest, especially given the massive tax breaks they received, the durable goods report was another disappointment. For all of 2019 compared to 2018, core capital spending (nondefense, nonaircraft) increased by less than one percent. That is not good. The weakness in the latest report was essentially across the board as there were order declines in the primary metals, machinery, electrical equipment, computers, motor vehicles and nondefense aircraft sectors. Backlogs are shrinking and with inventories rising, it doesn’t look good for industrial production.
Meanwhile, consumers remain really happy. The Conference Board’s Consumer Confidence Index rose solidly in December led by a jump in the Present Situation component. Views on current business conditions and the labor market improved. Optimism about the future also picked up, especially when it came to expectations of future employment opportunities.
As for the housing market, there are growing signs that conditions are getting a little better, at least when it comes to prices. The S&P CoreLogic Case-Shiller U.S. National Home Price Index increased strongly in November and the year-over-year gain accelerated. On a seasonally adjusted basis, every one of the major metro areas posted a rise in values, something that has not been seen often lately. MARKETS AND FED POLICY IMPLICATIONS:Jobs are plentiful and consumer confidence is high, so why isn’t the economy growing strongly? The problem remains the cautiousness of the business community and the ebbing gains in household income. Capital spending is moribund and the major impacts of the 727 Max debacle are still to be felt. Boeing’s assembly line shut down is just starting to filter through the system. But it isn’t just aircraft. There are few sectors where investment spending is strong. Indeed, for all of 2019, total durable goods orders were down 1.5% compared to 2018. Yes, taxes matter, but so do expected returns. Uncertainty lowers the projections and as we saw last year, reduces capital spending. In addition, while restraining wage gains may be a goal of businesses, it also limits consumer spending capacity. So, it may be fun to say the economy will soar this year, but you also have to say where that added demand will come from and right now, that doesn’t look like it is coming from anywhere. Which brings us to the Fed, the coronavirus, equity prices and interest rates. Mr. Powell showed at the end of 2018 that equity markets are critical to Fed policy. The only major risk to growth right now is the possibility of an epidemic that harms trade and the Chinese economy. If that happens, we could see a consistent decline in the markets. Given the 2018 experience, calls would be coming for the Fed to cut rates, even if Mr. Powell knows that the economic impacts of the epidemic would disappear with the problem being brought under control. But Mr. Powell used much of his ammunition last year fighting a phantom problem. The economy didn’t fall apart and the interest sensitive sectors didn’t respond to the rate cuts. Will he fight another war against a phantom enemy? Who knows? But if he does, he will likely have to use up the rest of his interest rate bullets. How many pyrrhic victories can the Fed afford?