January Retail Sales, Industrial Production and Import and Export Prices

KEY DATA:  Sales: +0.3%; Ex-Vehicles and Gasoline: +0.4%/ IP: -0.3%; Manufacturing: -0.1%/ Import Prices: 0%; NonFuel: +0.2%; Exports: +0.7%; Farm: +2%

IN A NUTSHELL:  “The start to the year was pretty mediocre for consumers and manufacturing.”

WHAT IT MEANS:  With the coronavirus and Boeing leading the way, the first quarter of this year is expected to be pretty slow and the first set of data seem to point to that being the case.  Take consumer spending, please.  Retail sales were mediocre in January and they reached that disappointing level only because people were able to get out and do some work around the home and visit their favorite restaurant.  Building materials and food services were up strongly.  There was a pick up in furniture demand but electronics and appliance stores did not do well.  Gasoline sales fell, but so did prices a little, so don’t look into that too much.  Clothing purchases, which had soared in December, came crashing back to earth in January.  There was really nothing pretty in this report.  The one thing that is keeping consumer demand strong is consumer confidence and the University of Michigan’s mid-month February estimate posted a gain. 

Industrial output fell sharply in January as both weather and Boeing did a number on production.  The warm weather (you notice I didn’t say global warming because we know that doesn’t exist) led to a sharp drop in utility production.  Boeing’s 737 Max assembly line halt created an equally massive decline in aerospace output.  The saving graces for this report were strong increases in vehicle, petroleum, plastics and computer production.  That kept the manufacturing decline from being really ugly. 

On the inflation front, there isn’t much.  Import prices were flat in January, though there was a moderate uptick in nonfuel costs.  Food import prices were up as were imported vehicle costs.  On the export side, agricultural prices jumped.  Chinese demand for pork is surging due to the swine flu and that is helping farmers.  It is unclear what the coronavirus will do to agricultural sales to China over the course of the year, but it is not helpful right now and that may wind up depressing U.S. food costs this spring.       MARKETS AND FED POLICY IMPLICATIONS:Estimates for the first quarter are running well below 2% and today’s data do nothing to change expectations.  The coronavirus impacts are just starting to show up and the longer this problem goes, the greater the impact.  Don’t forget that China is critical to large segments of the world economy including many non-industrialized and industrializing nations as well as the EU.  There are many countries that will be hurt significantly if this doesn’t end soon and there is little reason to expect it to do so.  The same can be said of the Boeing shut down.  The company wants to start back up before getting final approval but no one knows when that will be.  The first quarter for Boeing and their suppliers is lost and it is likely the same will happen in the second quarter.  Right now, most economists have not included a significant impact of the coronavirus in the second quarter (I am one of them), so there are hopes conditions will be a little better in the spring.  The best I can say about that is maybe.  With that in mind, it is hard to rationalize the exuberance in the equity markets, at least if you believe the economy actually matters.  The latest Blue Chip consensus has growth at or below 2% for every quarter in both 2020 and 2021.  That is not a forecast that says happy days are here again and that investors should go all in.  But they seem to be doing that so it should be interesting to see what happens if growth does disappoint.  Or, maybe investors actually like 2% growth.  Economists do, but that level of growth is hardly a prescription for strong earnings growth.

January Private Sector Jobs, NonManufacturing Activity and December Trade Deficit

KEY DATA:  ADP: +291,000; ISM (NonMan.): +0.6 point; Activity: +3.9 points; Employment: -1.7 points/ Deficit: $48.9 billion (11.9% wider)

IN A NUTSHELL:  “When winter doesn’t strike, the data can become weird.”

WHAT IT MEANS:  It’s Employment Friday week and that makes it ADP Wednesday, the day when we get a rough estimate of private sector job gains.  ADP, an employment services company, thinks businesses went crazy hiring people in January.  The estimate was for robust job gains, well above consensus.  But the details should be viewed carefully as there was a very mild month for winter weather.  For example, two sectors that are sensitive to climate quirks, construction and leisure and hospitality, added a total of 113,000 new workers.  That is way above anything that would be considered reasonable.  Indeed, Mark Zandi, chief economist of Moody’s Analytics, noted that: “Mild winter weather provided a significant boost to the January employment gain. … Abstracting from the vagaries of the data underlying job growth is close to 125,000 per month…That doesn’t mean that Friday’s job number will not be good: Just don’t assume it would be a good idea to bet the farm on a blockbuster number.

The nonmanufacturing sector accelerated in January, which really should not have been a surprise.  This segment of the economy is very sensitive to weather conditions and they were pretty good last month.  The Institute for Supply Management’s index rose a touch as activity improved solidly.  Still, the details were mixed.  Hiring moderated, orders increased a bit faster and backlogs thinned more rapidly.  The big change was in imports, which surged.  Got me why that happened. 

Remember how the trade deficit shrank dramatically in November and hopes were that things were turning around?  Well, never mind.  The shortfall rebounded sharply in December, led by a sharp increase in imports.  We bought a lot more energy products, consumer goods and technology.  Export growth was decent, but hardly as strong as the demand for foreign products.  But the only really solid segment was energy, so we are really not seeing any great demand for our products.  As for the China situation, the monthly deficit continues to narrow and the total for 2019 was $74 billion, or 17.6% less than in 2018.  That’s a big change.  Overall, the deficit narrowed modestly, less than 2% as a solid decline in the goods shortfall was partially offset by a drop in the services surplus.  Still, that was the first decline in six years.  Since that entire drop came from the huge change in the China deficit, don’t expect further declines in the years to come.  

MARKETS AND FED POLICY IMPLICATIONS:  The economy is fine and the labor market is strong, but we need to get past this warm winter.  If the better than expected economic numbers have been weather driven, we will pay for it when normal weather returns.  That’s what seasonal factors are designed to do: If you get unseasonal conditions for some months, the more typical months get killed.  So wait a few months to determine the strength of the economy.  As for Friday, the consensus is for roughly 165,000, though I am a little lower.  The ADP report argues for a number above 200,000.  Watch the details.  If this is a strong report but the major gains were in the weather-sensitive sectors, dismiss it.  As for the markets, happy days are here again, the world is great and earnings are going to skyrocket.  And if you believe that, let’s discuss my investment opportunity in a Broadway musical.  First quarter growth is still likely to be below 2%, which hardly supports the rally we are seeing in the markets.  

January Manufacturing Activity and December Construction

KEY DATA:  ISM (Man.): +3.1 points; Orders: +4.4 points; Production: +9.5 points/ Construction: -0.2; Private: -0.1%

IN A NUTSHELL:  “The manufacturing sector started expanding again in January, but it isn’t clear why that happened.”

WHAT IT MEANS:  Manufacturing had been faltering for much of 2019 and then the GM strike hit.  We got over that impediment but Boeing then shut part of its production.  Despite the chaos, the Institute for Supply Management’s manufacturing activity index jumped in January.  This was the first time since July 2019 that the measure was above fifty, which means the sector is growing.  The consensus was for the number to show activity still slowing, though at a lesser pace.  The details backed up the rise.  New orders, including exports and imports, were strong and production soared.  But hiring was still contracting and order books thinning.  We have not seen any surge in durable goods orders and while some of the trade concerns have dissipated, the solid improvement in manufacturing implied by this report is not backed by other data.  I will take the rise as a positive sign, but it would be nice to have supporting figures and a better understanding why this happened.  I will wait a couple of months before I can believe the weakness in manufacturing is behind us.

As for construction, it is largely going nowhere.  Private sector spending faded in December as a large drop in nonresidential activity overcame a solid rise in home building.  Public sector construction spending was also down, though public housing activity improved.   For all of 2019, private construction spending declined, which is a real disappointment.     MARKETS AND FED POLICY IMPLICATIONS:Let’s hope the supply managers’ measure does indeed point to better times for the manufacturing sector.  This has become a real weak link, but part of that was due to the GM strike and the problems with the 737 Max.  We don’t know how much Boeing’s assembly line shutdown will take out of growth this quarter, but it is likely to be fairly large.  And who knows how the coronavirus will affect not only the Chinese economy, but also the U.S., EU and especially the developing nations that depend upon China to buy materials.  That is why I am reticent to declare that happy days are here again.  Still, you take the good news while you can.  But it isn’t the economic data that are driving equity prices.  The ebb and flow of coronavirus news is the focus of attention.  China seems to be acting much more forcibly, but an awful lot of cats have been let out of the bag and they are hard to herd – something we cat “owners” know so well.  With no real understanding of the extent of the problem, the huge movements in the markets are both understandable and disturbing.  But until we know more, look for the wild ride to continue.

December Income and Spending, Fourth Quarter Employment Costs and January Consumer Confidence

KEY DATA:  Consumption: +0.3%; Real: +0.1%; Income: +0.2%; Real: -0.1%/ ECI (Over-Year): +2.7%; Wages: 2.9%; Benefits: +2.2%/ Confidence: +0.5 point

IN A NUTSHELL:  “Rising consumer confidence can take the economy only so far given the relatively modest gains in income.”

WHAT IT MEANS:  Yesterday’s GDP report gave us a full view of where household spending stood at the end of last year, so the December numbers only provide some additional detail.  That said, it looks like household spending is decent but there are questions about the sustainability of the pace reached last year.  On the surface, it looks like household did spend money moderately in December.  But when inflation is factored in, real consumption gains were unexceptional.  Vehicle sales, which peaked in 2016, continued to slowly tail off, while demand for nondurable products and services, when inflation-adjusted rose somewhat modestly.  The reason is simple: Income is just not growing fast enough to support even the modest to moderate spending increases.  Real disposable income, which adjusts for both inflation and taxes, declined in December, the second month in the past three that happened.  As a consequence, households had to save less and the savings rate declined.  The level is still fairly high, so households should be able to draw from their savings more to sustain the spending pace.  However, it could become more difficult for consumption to accelerate if the income gains remain tepid.

And there are few indications that businesses are willing to pay more to their workers.  The fourth quarter Employment Cost Index, which includes both wages and benefits, rose at a moderate pace.  Wage gains were solid, but benefits were up modestly over the year.  The year-over-year increase in wages and salaries peaked in 2014 and since the third quarter of 2017, it has steadily decelerated.  Firms may have switched to providing non-pecuniary benefits, which many employees prefer, but that does nothing to spending power.  The opposite is true for government, which has minimal power to provide certain types of perks.  Benefit costs are rising faster in that part of the economy but wage gains are slower. 

With jobs plentiful and the unemployment rate at historic lows, it should not be a surprise that consumer confidence remains high.  The University of Michigan’s Consumer Sentiment Index rose modestly in January, but the level is only slightly below the peak in this cycle that was reached in March 2018.  The current conditions measure edged down while expectations improved.  Both are at quite high levels as well.  MARKETS AND FED POLICY IMPLICATIONS:The administration continues to insist that the economy will grow at a 3% pace or even more.  We could get a quarter here and a quarter there of stronger growth, but over an extended period, there are no factors out there that suggest that will will happen.And there is nothing wrong with 2% growth.  Yes, it is back to the future in that the “dreaded Obama growth rate” (similar to the Dread Pirate Roberts) has returned.  But as I and many other economists have argued, that is trend growth.Given the tight labor markets, growth well in excess of trend could put a major strain on labor markets and the ability to restrain wages could dissipate rapidly.  Which means we don’t even want 3% growth, unless rising inflation and interest rates is your preferred goal.  It appears that trend growth can be sustained for a while longer without creating major bubbles, so let’s embrace it not attack it.

December Durable Goods Orders, January Consumer Confidence and November Home Prices

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?

December New Home Sales

KEY DATA:  Sales (Month): -0.4%; 2019 vs. 2018: +10.3%

IN A NUTSHELL:  “Builders had a good 2019, but sales look like they plateaued at the end of the year.”

WHAT IT MEANS:  If the economy is going to pick up any steam, the housing sector needs to play a key role.  While the existing market did fine at the end of the year, sales of new homes were down modestly in December.  That was the third consecutive monthly drop.  Comparing 2019 to 2018, sales soared.  But even there, we have to read the data carefully.  The East and Midwest posted sharp declines in annual sales. However, double-digit gains in the South and West overwhelmed those cut backs.  But there was some question about those increases, especially in the West.  In December 2018, sales in the West were the lowest in over three years.  However, they doubled – yes doubled – from that pace in December 2019.   That makes no sense.  So, you have to conclude that the large increase in annual sales was somewhat overstated.  Stepping back from the data anomalies, it is likely that demand is improving somewhat, but it is hard to believe there will be any major increases going forward, especially given the limited supply of homes on the market. 

The Dallas Fed’s Texas Manufacturing Outlook Index rose a touch in January, though the details were better than the headline number.  New orders and production levels jumped, while wage gains continued to accelerate somewhat.  What kept the overall index down was weakness in hiring, hours worked and capital expenditures.  In addition, order books continued to thin, though not quite as quickly as they had been.  Expectations did improve.  At least for one part of the country, manufacturing is improving.  MARKETS AND FED POLICY IMPLICATIONS:Clearly, investors are concerned about the potential impacts of the coronavirus.  Given China’s lockdown of millions of people, there is reason to worry about how much further it will spread and what the short-term impacts will be on Chinese and world economic growth. It is easy to say that in past health crises similar to this, the actual effects were a lot less than what were feared and we can hope that is the case once again. Unfortunately, we just don’t know and uncertainty is never good for the economy or the markets.  Given the U.S. is expanding at a modest to moderate pace and there are few if any indicators pointing to a major acceleration in growth, any negative impact could push the pace of activity toward quite low levels.  But, we just don’t know.  Thus, the monthly data should take on added importance, as it would be nice to know we have a buffer just in case the health issues do have a negative impact on the economy.  But for now, the only thing that can be concluded is that the economy is in decent shape.  That should keep Fed Chair Powell from panicking again if the markets decline, but who knows what he is trying to accomplish.

December Housing Starts and Permits, Industrial Production and November Job Openings

KEY DATA:  Starts: +16.9%; 1-Family: +11.2%; Permits: -3.9%; 1-Family: -0.5%/ IP: -0.3%; Manufacturing: +0.2%/ Openings: -561,000; Hires: +39,000

IN A NUTSHELL:  “The surge in home construction was an eye-opener, but outsized gains are usually aberrations so don’t get too excited.”

WHAT IT MEANS:  Wow, what a housing number.  At least that was the initial reaction to the huge rise in housing starts.  Indeed, the level of activity reached a thirteen-year high.  Gains were not just in the volatile multi-family segment, which posted a nearly thirty percent rise, but they were in single-family as well.  The increases were spread across the entire nation and the only negative was a decline in single-family construction in the West.  On other hand, permit requests dropped.  They were down in the Northeast and the South but improved somewhat modestly in the Midwest and West.  When you see this type of outsized rise, the initial reaction is to think that conditions may be changing.  But the reality is that huge, unexpected increases are typically created by temporary factors.  December’s weather was warmer than usual with close to average precipitation.  Last December, the opposite was the case as temperatures were well below average and precipitation was above average.  There was likely a solid increase in construction, but much of the rise may have been due to seasonal factors.  We will know better when the January numbers come out, which I expect to be awful, so don’t rush to judgment about the housing recovery just yet.

While industrial production declined in December, largely due to the warm weather cutting utility output, manufacturing activity increased.  Despite the end of the GM strike, which aided the November numbers, the vehicle segment was still quite soft.  Assemblies were down sharply in December.  The good news was that computer, electronic and electrical equipment production is picking up steam.  Still, the outlook is uncertain.  Vehicle sales are slowly declining and Boeing is shutting it 737Max line and together, those negative as likely to lead to some pretty bleak manufacturing numbers in the first part of this year.

Job openings continue to fade, even as hiring remains solid.  Compared to November 2018, available positions were off by over eight hundred thousand.  The level was the lowest in nearly two years.  That said, there are still an awful lot of unfilled jobs waiting to be filled.  As for hiring, it has become more volatile and the trend is flattening out.  MARKETS AND FED POLICY IMPLICATIONS:The data for the final month of the year are flowing in and they are about as mixed as you can get. Yesterday’s December retail sales numbers were okay, but nothing special.  They indicated that fourth quarter consumption is not likely to be significantly below what we saw in the third quarter, which is good given that vehicle demand faded at the end of last year.  Today’s data muddy the waters a bit.  The shockingly large rise in home construction is likely to provide an unexpected boost to growth.As for the manufacturing sector, production was off compared to the third quarter.  But offsetting that could be a narrowing in the trade deficit.So, when you put things together, it looks like fourth quarter growth is coming in around 2%.  However, the first quarter of 2020 it might be a lot softer.  Decelerating wage gains and Boeing’s cut backs could restrain growth sharply.  While the phase one trade agreement might provide some temporary help to the agricultural sector, it is not clear when the additional sales will occur.  Which means that growth is likely to be at a pace that the Fed will be holding rates low for quite a while.  As for investors, sub-2% growth should be a red flag, but I have yet to see much that sways the markets from its seemingly never-ending upward drive.Economic fundamentals should matter, but I will believe that when I see it.

December Consumer Prices, Real Earnings and Small Business Confidence

KEY DATA:  CPI: +0.2%; Over-Year: +2.3%; Ex-Food and Energy: +0.1%; Over-Year: +2.3%/ Real Hourly Earnings: -0.1%; Over-Year: +0.6%/ NFIB: -2 points

IN A NUTSHELL:  “Despite reasonably tame inflation, household spending power continues to fade.”

WHAT IT MEANS:  With the Fed happy with its position on interest rates, we have to ask what could knock it off its stand.  They could hike rates if inflation or growth accelerates sharply or even reduce rates further if the opposite occurs.  Today’s data contain some insights into both growth and inflation.  On the household cost side, the Consumer Price Index rose moderately in December.  Energy prices jumped, as expected and food costs were up moderately.  Taking out those two volatile components, the so-called core index rose minimally.  There are always outliers and in this report there were two.  First, medical costs, including both commodity and services, are rising faster and faster.  Medical costs had been surprising tame for much of the past decade but that is changing.  It may be too early to conclude this but it is beginning to look like the current laissez-faire approach to health care is allowing providers to ramp up prices.  On the other hand, used vehicle prices cratered in December.  The record sales we saw are now creating huge inventories of vehicles coming off lease and that is an issue for dealers.  Overall, though, it looks like inflation is now running at a pace near the Fed’s target.   

On the growth side, my concern has been and will likely continue to be the diminishing gains in consumer purchasing power.  This is defined as the increase in earnings adjusted for inflation.  Real hourly earnings fell in December and the gain was well under 1% over the year.  When hours worked were factored in, inflation-adjusted weekly earnings were absolutely flat since December 2018.  It is hard for the average household to keep up the spending we have seen if their spending power is going nowhere. 

Meanwhile, small businesses remain pretty upbeat.  Yes, the National Federation of Independent Business’ Optimism Index eased in December.  But the level remains high and the components are still fairly strong.  But there is a warning sign in the report.  Earnings growth continues to fade, led by a growing softness in sales.  If the small business sector is the canary in the coal mine, the bird is still chirping but not quite as loudly as it had been.     MARKETS AND FED POLICY IMPLICATIONS:We get the first reading on fourth quarter growth in two weeks.  It should be in the 2% range, meaning the gain for the year should be about 2.3%. Basically, growth started off strong but faded as we went through the year.  Will that softening in growth continue?  One major factor restraining activity, especially capital spending, was the trade war.  As long as that doesn’t get out of control again, business spending may improve.  However, the deceleration in household earnings is likely to force consumption growth to slow.That likely means this year should be slower than 2019.  The January Blue Chip consensus is for 1.9% growth this year. I am a member of that survey panel and that is my forecast as well.  That may be enough to keep the unemployment rate relatively stable (I expect it to start rising slowly in the second half of the year), but it raises serious questions about corporate earnings.  Profits were soft last year and fading growth doesn’t point to better gains this year.  It could take additional financial manipulation, such as further stock buybacks, to keep equity prices up.  So, the Fed may be satisfied with inflation and growth right now, but that doesn’t mean everything is as beautiful as the members seem to believe it to be.

December Employment Report

KEY DATA:  Payrolls: +145,000; Private: +139,000; Revisions: -14,000; Retail: +41,000; Manufacturing: -12,000; Unemployment Rate: 3.5% (Unchanged); Wages: +0.1%

IN A NUTSHELL:  “Despite the ebbs and flows of the job data, the message remains that the labor market is strong.”

WHAT IT MEANS:  After the robust increase in new jobs in November, it was expected that the December report would be disappointing and that it was.  Hiring faded sharply, though the average for the last three months of 188,000 is still quite solid.  Actually, given the lack of workers, that was about as good as could be expected.  Still, there were questions raised by the data.  The over-the-year percentage increase in jobs continues to fade and was the second lowest in over eight year.  Just to get to the total payroll increase it took a huge rise in retail hiring. Three-quarters of that increase was in clothing stores.  Really?  Gains in professional and business services were a lot softer than they had been.  And as expected, manufacturers cut workers.  With Boeing shutting the 737 Max assembly lines, that weakness is likely to continue as suppliers react.  Wage gains continue to decelerate and that is not good news for workers.  Over the year, the average hourly wage was up only 2.9%, the lowest increase since July 2018.

The good news was that the unemployment rate remained at fifty-year lows.  But that was largely the only good news.  The labor force rose moderately and the gain over the year was decent but nothing spectacular.  The participation rate was flat over the month and up only modestly from December 2018.

MARKETS AND FED POLICY IMPLICATIONS:Just as the November report was misleading on the upside, the December report was misleading on the downside.  Put the two together, though, and you have a better picture of the state of the labor market: It is solid but the lack of supply is constraining hiring.  And that raises an interesting point.  Normally, strong growth drives strong hiring.  But with the labor shortage, it the softer growth we have seen may be the consequence of lowered payroll gains.  For businesses to continue expanding they will need more workers and they are just not being pulled into the economy at a pace to offset the loss of baby-boomers from the market.  About the only good thing for businesses in this report was the further slowing in wage increases.  That seems counterintuitive in that the labor shortages should be forcing firms to pay up for employees.  Instead, businesses are attracting workers with non-pecuniary compensation.  How long that can continue is unclear in that once you provide those benefits, it becomes harder to add to them.  The risk the economy faces is that firms are faced with the inability to meet growing demand because of the lack of workers.  They have only so many options, then.  They can reject contracts and grow more slowly or start a bidding war for workers so they can fulfill those contracts.  Neither would be very good for the economy.  So let’s hope for slow growth and be glad the wackos who told us we would get 3% growth for as far as the eye could see were dead wrong.

December NonManufacturing Activity and November Trade Deficit

KEY DATA:  ISM (NonMan.): +1.1 points; Orders: -2.2 points; Backlogs: -1 point/ Trade Deficit: -$3.9 billion; Exports: +0.7%; Imports: -1%

IN A NUTSHELL:  “Growth might have been modestly better than expected at the end of last year, but only because the tariffs created dislocations in trade flows.”

WHAT IT MEANS:  It’s a new year but we are still trying to get a handle on how the economy ended last year.  It looks like growth in the 2% is the new normal.  Actually, it is more like the old normal given that is what we averaged during most of the 2010s.  Looking at the service segment of the economy, that is the level of growth we are still seeing.  The Institute for Supply Management’s NonManufacturing rose in December.  The fourth quarter average points to a GDP growth rate of somewhere around (drum roll please) 2%.  That said, the details were not that great.  In particular, orders grew more slowly and backlogs shrank for the third consecutive month.  Those results don’t point to any improvement in the service portion of the economy in the early part of 2020. 

On the other hand, it looks like the fourth quarter may have been helped along by distorted trade flows. Indeed, despite what appears to have been decent consumer spending, imports fell in November.  That shouldn’t happen in this type of economy.  While we should not expect demand for foreign products to be booming, they should be growing.  Purchases of consumer and capital goods were down solidly.  Contrasting that was a moderate increase in exports.  The rest of the world is growing slowly and is still buying our products, an indication that our import situation is not due to fundamental economic factors.  With exports rising and imports falling, the trade deficit narrowed to the smallest level in three years.  Much of that came from the roughly fifteen percent drop in imports from China.  The trade deficit with China has also narrowed by the same percentage.   MARKETS AND FED POLICY IMPLICATIONS:We will not get the first reading of fourth quarter growth for three more weeks, but it is likely to be about 2% to 2.25%.  At least that is what I have had for months now and there is no reason to believe that will not be the case.  The wild cards are the usual ones.  We don’t know what happened to trade in December since the decision to put off the additional tariffs on Chinese products was made too late to cause any major change in the import pattern.  Also, Boeing’s decision to suspend production, which had led to planes being inventoried, also may have come too late to change the inventory number, though that is unclear.  But consumer and business spending looks to have been moderate and if we focus on those fundamental components, it is clear that growth is okay but not great. So, where do we go from here?  More than likely, more of the same.  And given the way investors loved that level of growth last year, they will likely continue to eat up stocks this year.  The one big difference is that there isn’t an extra trillion dollars to buy back stock, so the artificial hyping of stock prices may slow.  At least it should.  As for the Fed, it is likely on hold for quite some time.  There may still be some who think rates should be lowered, but not a lot of them are voting members of the FOMC.

Linking the Economic Environment to Your Business Strategy