October Housing Starts and Permits

KEY DATA: Starts: -2.8%; 1-Family: +4.2%; Multi-Family: -15.4%; Permits: +4.8%

IN A NUTSHELL:   “Home building is holding in and with permits rising, it looks like additional construction could be on the way.”

WHAT IT MEANS:  Builders have become quite optimistic, but the real question is: Are they translating that good feeling in action?  In October, at least, that just didn’t happen in all segments of the market.  Housing starts fell, but that was due to a huge drop in the very volatile multi-family segment.  That is not that unusual.  Single-family construction rose to its second-highest level since spring, 2008.  Of course, the housing bubble had already burst by then, but at least we are moving forward.  We still have a long way to go, though, before we get back to solid levels.  Still, so far this year, starts are up by nearly 10% compared to the first ten months of 2013.  In any event, permit requests are running a little ahead of starts causing the number of units permitted but not started to jump.  That permit excess implies that building activity should start ramping up in those areas not covered with snow or ice.

MARKETS AND FED POLICY IMPLICATIONS: The jump in the National Association of Home Builders index signaled growing confidence in the housing sector and low rates are leading to growing mortgage applications, so it is just a matter of time before builders start putting more shovels in the ground.  That permit request are outpacing starts just reinforces that view because builders stopped speculating a long time ago.  That doesn’t necessarily mean we will a large increase in November.  The massive snowstorms and deep freeze will probably temporarily slow things down.  But housing is moving forward and that is what is important.  For the Fed members, this type of report allows everyone to sit around and do nothing.  The starts numbers are neither weak, nor strong, nor not even just right.  They are just another sign of an economy that has yet to truly break out to the upside.  As for investors, I guess if you don’t set a new record on any given day, it is a disappointment so maybe record setting is the key driving force.  It cannot be that the U.S. economy is so strong and the world economy is looking so good that happy days are here again.

October Producer Price Index and November Home Builders’ Index

KEY DATA: PPI: +0.2%; Goods: -0.4%; Services: +0.5%: Food: +1.0%; Energy: -3.0%/NAHB: up 4 points

IN A NUTSHELL:  “While wholesale inflation remains modest, what energy is giving, food is taking away.”  

WHAT IT MEANS:  The economy is solid, jobs are being created and the unemployment rate is nearly at full employment, so the Fed has to shift its attention to something else if it is to come up with the next rationalization of why it is keeping rates low.  Right now, the FOMC seems to be locked into low compensation gains, but there is also the issue of inflation, or its lack thereof, to fall back on.  Some members have already expressed that concern.  When it comes to current and future consumer costs, wholesale prices seem to be telling a confusing story.  The Producer Price Index rose a little more than expected in October.  The large drop in energy costs was supposed to cause the index to decline but there were offsetting increases.  In particular, food prices continue to rise sharply and over the year, they are up a whopping 6%.  In addition, the index presents a variety of services prices, a key differentiation.  Since services comprise 63.5% of the index, this break down better mirrors the economy. The category called “final demand trade services”, which looks at retailing and wholesaling, surged.  As a result, the services component rose strongly.   Excluding energy, wholesale costs have increased by a moderate 2% over the year.  That said, the inflation pipeline is not showing any major problems ahead, even when energy is excluded.

On the housing front, home builders are smiling again.  The National Association of Home Builders’ Housing Market Index jumped in November.  The sales conditions, future sales and traffic components were all up.  The only weakness was in the Midwest.  It will be interesting to see if the current bad weather changes things.

MARKETS AND FED POLICY IMPLICATIONS: The Fed is suffering from wandering-eye syndrome.  First the members were worried about growth and jobs.  When those issues dissipated, they started focusing on the unemployment rate.  When that blew through their target they started talking about wage inflation.  Worker compensation remains muted but even if it starts to move up, there are rumblings that low inflation could become an issue.  In other words, if the Fed wants to keep rates low, they will find something out there that would defend their stance.  However, inflation is inching upward, even as it remains below its desired level.  The rise in producer prices points to a further modest uptick in household costs, but as I have said many times, the pathway from wholesale to consumer prices is hardly straight.   Meanwhile, the economy looks really good and the increase in the Homebuilders’ Housing Market Index reinforces the view that conditions are getting even better.  Thus, I am sticking to my belief that the Fed will start raising rates this spring.  Meanwhile, in the land of make believe, investors may look at the data and say there isn’t enough inflation for the Fed to do anything in the near term and with the economy improving, it is pedal to the metal, or whatever they say.

October Industrial Production

KEY DATA: IP: -0.1%; Manufacturing: +0.2%; Mining: -0.9%

IN A NUTSHELL:   “The manufacturing sector remains the rock on which the improving economy is being built, but it needs some help.”

WHAT IT MEANS:  The U.S. is the one shining economy in the universe of soft industrial nations.  The manufacturing sector has been critical to the continued growth and that remains the case as output rose in October.  There was a small decline in overall industrial production as mining and natural gas utility production fell sharply.  I guess no deed goes unpunished.  Cratering energy prices may be helping consumers but they are hurting producers.  Still, we cannot complain since the additional money left in wallets rather than pumped into gas tanks is coming at the best time possible – the holiday shopping season.  On the manufacturing front, output gains were pretty much across the board.  The biggest weakness was in transportation.  Vehicle assembly rates have come down with the stabilizing sales pace.  Demand may be quite solid, but it was in the 16.3 million units range for three of the past four months and that stability may be causing vehicle makers to build more cautiously.  There was also a cut back in aerospace, but I doubt with Boeing’s backlog, that will be sustained.  Improvements in technology may be helping consumers but the tech companies are having issues selling computers and output in that sector remains weak.

A second positive manufacturing report released today was the New York Fed’s Empire State survey, which showed that activity rebounded in early November after having declined in October.  The October drop was strange, having come after nine consecutive months of solid gains, so the return to growth was hardly a surprise.  It reinforces the view that the manufacturing sector is still growing solidly.    

MARKETS AND FED POLICY IMPLICATIONS: Kermit complained that it was hard to be green, but the greenback is having no problems these days.  That is occurring, at least in part, because the rest of the industrial world is not in great shape.  Indeed, Japan slipped back into recession.  Neither the Fed nor investors will likely take that news very well, especially since the rise in manufacturing activity was nothing great.  We are not talking about robust industrial output growth here.  Given the headwinds from the rest of the world, we need energy prices to stay low – despite its negative impact on output in the energy sector.   Lower energy costs feed into consumer spendable income and a really good holiday shopping season would keep the economic acceleration going.  The Fed looks at energy costs more as an economic issue than an inflation factor.  So the easing in top line inflation will not matter very much but any jump in consumer spending will.  Still, there are Fed members who are uncertain about the sustainability of a strong U.S. expansion and softening world growth and moderating manufacturing production is likely to add to those concerns.

October Employment Report

KEY DATA: Payrolls: 214,000: Revisions: +31,000; Private Sector: 209,000; Unemployment Rate: 5.8% (down from 5.9%); Hourly Wages: +0.1%; Year-over-Year: 1.9%

IN A NUTSHELL:   “Though people are coming into the workforce and finding jobs, we still need hiring to be stronger before we will see wage gains accelerate and worker confidence improve.”

WHAT IT MEANS:  The results are in and the labor market is close to being healthy but it is not there yet.  While there was little bad news in the October employment report, we really cannot say that workers should feel great about conditions. While job gains were less than hoped for, the August and September increases were revised upward solidly, bringing net gains to 245,000.  That is pretty solid.  The revisions are critical because they are showing better growth than first reported.  The initial job gain for August was 142,000, a disappointing performance.  But that now stands at 203,000, a pretty decent number.  It is likely that the upward revisions will continue, which means we have to focus on the previous months, not just the current month’s numbers.  Over the past three months, job gains have averaged just under 225,000, a strong but not yet robust pace.  Gains were across the board, including manufacturing, construction, retailing and even local government. So much for fiscal austerity.   The problem remains wages.  They rose modestly once again and the only thing that is keeping people afloat is the even slower rise in prices.

The unemployment rate declined to its lowest level since July 2008.  All components were strong as the labor force grew, unemployment dropped and the labor force participation rate rose.  One detail popped out: The teenage unemployment rate was 18.6%.  Teens comprise only 3.7% of the labor force but 12.1% of those unemployed.  The unemployment rate for those 20-years and older was 5.3%.  To make a big dent in the unemployment rate, we have to cut the teenage rate a lot more.  However, when it comes to labor shortages, teenagers are not the target hiring group, so we should keep a closer eye on the over-20 unemployment rate.

MARKETS AND FED POLICY IMPLICATIONS: Almost all the economic numbers point to an improving labor market and economy.  So, why did the electorate throw the Democrats out on Tuesday?  They blamed them for a “weak” economy and they were not really wrong.  The economic number that matters most to the average worker is income, not GDP or labor force participation rate.  Politicians and economists can debate those other data all they want, as long as wage gains are minimal, people will feel sour about the economy.  So let’s stop talking about jobs and start talking about income.  If anyone has any idea how to grow workers incomes other than reaching a point of labor shortages, let me know.  Thankfully, we are getting there and the unemployment rate is nearing full employment.  Wage gains will have to follow, but getting businesses to accept that reality may take a lot longer now than in the past.  That time frame is something the Fed members will be puzzling over, as it holds the key to Fed policy. 

Third Quarter Productivity and Weekly Jobless Claims

KEY DATA: Productivity: +2%; Year-over-Year: +0.9%; Unit Labor Costs: +0.3%; Year-over-Year: +2.4%/Jobless Claims: 278,000 (down 10,000)

IN A NUTSHELL:   “As the labor market continues to firm, there are growing hints, but still just hints, that wage pressures are starting to build.”

WHAT IT MEANS:  Okay, the election is over and we will have to wait until January for the new Congress to start creating whatever chaos they want to create, so let’s get back to economic reality.  Businesses are doing what they can to keep labor costs down and in the summer, they pretty much succeeded.  Third quarter productivity gains almost completely offset labor compensation increases.  That led to a modest rise in labor costs, which is good news for prices.  These data are wildly volatile, so it is worthwhile looking at the changes over the year.  Since the third quarter of 2013, productivity rose modestly while labor costs were up fairly solidly.  And, for the first three quarters of the year, productivity increased by less than 1% while, labor compensation rose by 3.1%.  Even adjusting for inflation, compensation is up by 1.3% so far this year.  It is possible that inflation-adjusted earnings could rise at the fastest pace since 2007.  That is a clear sign that the tightening labor market is forcing firms to pony up a little more money. 

There were other data on the labor market, but they were more mixed.  Weekly jobless claims dropped solidly and the four-week average remains at historically low levels.  However, The Challenger, Gray and Christmas layoff announcement report jumped in October to its second highest level this year.  It was noted that October and November tend to be big months for layoffs as firms set business plans, so we should probably wait and see how the rest of the year plays out.  Also, we really don’t know where those cuts will come or if they will even take place.  That said, layoff notices are down by over 4% so far this year.

MARKETS AND FED POLICY IMPLICATIONS: Firms keep pushing their workers harder and harder as they hold back both their hiring and compensation.  But the dam seems to be breaking.  Productivity gains this year will probably be in the one percent range, making it four consecutive years of modest increases.  With compensation rising, there is pressure on margins and firms are worried about paying workers even more.  But it’s the tightening labor market that will likely be the driving force in 2015 and that means either firms will have to start raising prices or shrinking margins.  Most likely we will see a little of both.  But that doesn’t mean earnings have to weaken.  If economic growth is above 3%, as I believe it will be, companies will have to make it the old fashion way, through volume.  Are investors thinking about the implications or modest productivity gains and rising labor costs?  Probably not, as the headlines don’t shout rising wage pressures.  But the Fed members know the devil is in the details and they say a lot.  Regardless, tomorrow is Employment Friday and we will see what happened with October payrolls and the unemployment rate.  I expect job gains to be well north of 250,000 while the unemployment rate remains at 5.9%.

October Supply Managers’ Non-Manufacturing Survey, ADP Payrolls and Online Labor Demand

KEY DATA: ISM (Non-Manufacturing): -1.5 points; Employment: +1.1 points/ADP +230,000/Help Wanted: +11,700

IN A NUTSHELL:   “The electorate may be disappointed with the economy but the numbers are pointing to accelerating growth and a tightening labor market.”

WHAT IT MEANS:  The Democrats got shellacked yesterday and massive discontent with the economy was a key reason for the rout.  But politics is politics and it often has little to do with reality.  In this case, there are reasons voters are correct and reasons they are wrong.  First, the wrong.  Basically, economic activity continues to rise.  The Institute for Supply Management’s Non-Manufacturing Index fell in October, but it remains at a level that is consistent with solid to strong growth.  Importantly, especially with the October employment report coming out on Friday, the employment index continues to break out on the upside.  Few firms are cutting back and more are hiring, a good sign for workers.  New orders continue to grow, but a little less briskly, while production has come down from outer space to the stratosphere.  In other words, everything is moving ahead quite strongly, though maybe not at break neck speed.

Where the electorate was right, was their feeling that their own economic conditions are just not great.  As I have said, ad nauseam, it is hard to spend, or feel good about things, if your income is going nowhere.  But that could change soon.  The labor market is tightening at a rapid pace, and it looks like we get confirmation of that on Friday.  ADP’s estimate of private sector payroll gains came in higher than their number for September and that could mean we will see a very strong October job increase.  The strong rise occurred despite an almost nonexistent rise in large-business hiring.  This sector had been strong for quite some time, so I don’t know what went on.  A firming labor market was also supported by a solid rise in the Conference Board’s Help Wanted OnLine Index.  Firms are looking for lots of people and I suspect they are also hiring a lot more workers. 

MARKETS AND FED POLICY IMPLICATIONS: The sour view about the economy expressed by voters makes sense when you consider that few have seen their wages rise and many have seen their benefits cut and their copays surge.  The only thing that will change that situation is a labor market that forces firms to bid for workers.  Each month, we see more and more signs that labor shortages are starting to appear.  We are approaching full employment nationally, but in some areas, industries and occupations, that condition already exists.  It’s just that shortages need to be more widespread before wage gains will accelerate and benefit cuts will be reversed.  I suspect by the spring, the intransigence toward paying more will fade as job openings become so great that firms have no choice but to start raising offers.  We are not there yet, but the Fed members need to recognize that a rising wage environment is not that far away.  As for investors, any euphoria over the election results may have to be tempered by the simple fact that being in power means you have to actually try to govern, something that neither party has bothered with lately.

October Supply Managers’ Manufacturing Index

KEY DATA: ISM (Manufacturing): +2.4points; New Orders: +5.8 points; Employment: +0.9 point; backlogs: +6 points

IN A NUTSHELL:  “The manufacturing sector is ramping up and it looks like strong October vehicle sales will keep things going.”

WHAT IT MEANS:  After two consecutive quarters of strong economic activity, questions remain about the sustainability of growth.  If the October consumer-oriented data that we have received so far are any indication, we could be in for another solid quarter.  Last week we saw a jump in confidence, a necessary but not sufficient condition for strong growth.  The jump in the Institute for Supply Management’s manufacturing index in October adds to the belief that the economy is in really good shape.  Activity surged back up to its August level, which was the highest in 3½ years.  New orders skyrocketed and with backlogs growing solidly, it looks like increases in production will continue.  Hiring accelerated as well as firms are adding workers to meet the growing demand.  Looking forward, early, but incomplete, sales numbers point to continued solid vehicle sales in October and that should help keep the momentum in the manufacturing sector going. 

In a separate report, construction activity eased in September, which was somewhat of a surprise.  With state and local governments spending again, one of the places that they are using their newfound revenues is in infrastructure rebuilding.  That did not show up in this report and public activity fell.  Private sector construction was down slightly even as residential spending rose.

MARKETS AND FED POLICY IMPLICATIONS: We seem to be in one of those Missouri moments, where despite six months of strong growth, everyone seems to still be saying, “show me” more.  Clearly, the Fed members are still somewhat agnostic about the current state of economic affairs.  But with Europe and Japan hurting and who knows what is going on in China, you don’t have a strong manufacturing sector unless the U.S. economy is humming along.  Investors should love the manufacturing and vehicle numbers, but on a day before an election, caution remains the better part of valor.  The markets are on hold and if some of the elections go as they could, we may be waiting weeks before we know who controls the Senate.  That would require people to turn their focus to the economic fundamentals, which right now look pretty good.

September Consumer Spending, Income and Third Quarter Employment Cost Index

KEY DATA: Consumption: -0.2%; Income: +0.1%/Employment Costs (Year-over-Year): +2.2%; Wages and Salaries: +2.1%; Private Sector: +2.3%

IN A NUTSHELL:   “Household incomes are finally starting to rise but there is no rush to spend it.”

WHAT IT MEANS:  Yesterday’s strong GDP report pretty much told us what happened with consumer spending during the summer and today’s report fills in the details about the monthly pattern.  Very simply, there is no pattern.  Consumption was flat in July, soared in August and fell in September.  Part of that was a robust return to vehicle demand in August, which skewed the trend.  But there were also ups and downs in the services and the nondurables components, so it is really hard to know what people have been thinking.  The real issue, though, is can they afford to spend more.  Two bits of information point to increases in incomes, but nothing great just yet.  Personal income was up in September, but when adjusted for inflation, it was largely flat.  That is, purchasing power went nowhere.  Disturbingly, wages and salaries, the key to both spending and Fed policy, rose minimally during the month.  That is important because the wage and salary component of the Employment Cost Index, an aggregate measure of compensation, has been accelerating.  In the third quarter, private sector wages and salaries rose at the fastest pace in six years.  Hopefully, the September moderation was just an aberration.  We need greater increases in household incomes if the strong economic growth we have seen for the past two quarters can be sustained.  Inflation remains totally under control.

MARKETS AND FED POLICY IMPLICATIONS: Fed Chair Yellen is looking for any sign that the tightening labor markets are finally causing wages to rise.  That is not happening just yet, but the trend is in that direction.  Worker compensation, especially in the private sector, is accelerating.  It is not so high just yet that warning bells are being set off at the Fed, but another six months and we should be there.  But the sluggish rise in wages in September is a warning that the pattern will not be clear-cut until employers start bidding for workers.  Right now, that is happening only in a few industries, occupations and regions.  It needs to be more widespread.  The limited income gains imply that spending will continue to grow moderately at best.  We need that to change if we are to get this economy into high gear.  The key may be the holiday shopping season and if the consumer confidence numbers are any indicator, it could be really good.  Today we saw the Thompson Reuters/University of Michigan’s Consumer Sentiment Index hit its highest level in over seven years.  That came after the Conference Board’s Confidence Index also hit a seven-year high.  Consumers are feeling good and it will only take a little more money to get spending to surge.  As for the markets, it looks like investors actually think that economic fundamentals, not the Fed, will drive prices and if that is the case, people should be feeling pretty good right now.

Third Quarter GDP and Weekly Jobless Claims

KEY DATA: GDP: +3.5%; Consumption: +1.8%/Jobless Claims: 287,000 (up 3,000)

IN A NUTSHELL:   “The economy just may have shifted gears before anyone expected and the firming in the labor market provides hope the strong growth can continue.”

WHAT IT MEANS:  I have been arguing for a while now that the underlying economic fundamentals are improving rapidly and the economy should be shifting into higher gear soon.  That shift may be taking place already.  Economic activity expanded by a better than expected pace in the third quarter and the report was not filled with too many head-scratchers.  Consumer spending remains disappointing and the weak link is still services.  Of course, this is the biggest individual component of GDP, accounting for two-thirds of consumption and 45% of all economic activity.  It is hard to grow rapidly if people don’t purchase things like housing, utilities, medical care or recreation services at a decent pace.  So, where did growth come from?  Business investment was solid, growing at sustainable paces for equipment, structures and technology.  The housing market improved, though residential investment was nothing spectacular.  We shipped a ton of goods overseas while cutting back on our demand for foreign products.  Major reductions in oil imports are really a great boon to growth as we are keeping an awful lot of money in the U.S.  The government is back in the spending business with national defense leading the way.  That was probably make-up for all the cuts made earlier in the fiscal year.  But nondefense purchases rose as well and state and local governments continue to translate growing revenues into increasing spending.  Inflation remains muted and actually decelerated fairly sharply.  I suspect the Fed members were not pleased to see that.

One reason I am so optimistic about the economy is my view that the labor market has already tightened and stronger wage gains are in sight.  While jobless claims edged up last week, the level remains extremely low and it really does look like the October jobs report could be better than the September one, which we all agree was quite good.

MARKETS AND FED POLICY IMPLICATIONS: The Fed ended quantitative easing yesterday, pointing to improving economic and labor market conditions.  What could encourage the FOMC to start raising rates in the spring, as I expect, is continued strong economic growth, which leads to really tight labor markets.  With consumer confidence rising, falling gasoline prices creating fatter wallets, job gains accelerating, unemployment declining and incomes rising, the holiday shopping season is setting up nicely.  The National Retail Federation expects demand to rise by 4.1% this season, up from 3.1% last year.  I think that may be conservative.  I am in the 5% range.  That could lead to a rise in fourth quarter consumption, powering growth back to the 4% range.  A string of 3% or more growth rates, which the Fed will likely be staring at when it meets in January, coupled with an unemployment rate closing in on the 5.5% full employment rate, should be enough for most Fed members to throw in the towel.  Investors will have to start balancing the reality of rate hikes in the first half of next year with better growth.  We will find out then if it was the Fed or the economy that generated the outsized equity market gains over the past few years.

October 28-29 ‘14 FOMC Meeting

In a Nutshell: “…the Committee decided to conclude its asset purchase program this month.”

Rate Decision: Fed funds rate maintained at a range between 0% and 0.25%

Quantitative Easing Decision: Ended.

The FOMC met and issued its statement about economy and the direction of monetary policy.  Not surprisingly, the Committee decided to end, finally, quantitative easing.  The members also reiterated “that it likely will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time following the end of its asset purchase program.”

While the ending of QE3 and the continued use of “considerable time” were expected, there were enough changes in the statement to make it clear that the Fed is transitioning to rate hikes.  First, and maybe most importantly, the members now believe “a range of labor market indicators suggests that underutilization of labor resources is gradually diminishing” rather than “there remains significant underutilization of labor resources.”  Since it is all about the labor market, it is now clear that the Fed believes the labor market is tightening.

But it wasn’t just the comments about the labor market that make this an important statement.  The Fed also signaled it is less concerned about deflation.  The Committee noted that “the likelihood of inflation running persistently below 2 percent has diminished somewhat since early this year”.  This is in contrast to just saying it was running below its desired pace.

So, what is the take away from the Fed’s comments?  If we keep seeing the kind of economic progress that we have had for the past few months over the next few months, the Fed will have to start talking specifically about tightening.  Between now and the December 16-17 FOMC meeting, we get third quarter GDP and two more employment, consumer spending and inflation reports.  Don’t be surprised if at that meeting, there has been enough strong data that the Committee removes the “considerable time” verbiage as a signal that the time for rate hikes is coming sooner rather than later.  I am sticking with my expectation that the first increase will come in the spring, possibly as early as the March 17,18 meeting.

How should the markets take this statement?  First, there really should not have been any surprise in it.  If people didn’t know QE was over, they probably made the mistake of flying into New Jersey and wound up being quarantined.  On the labor market front, I have been arguing for months that things are better than the common wisdom and the Fed’s edging toward that view also should not have been shocking.  But uncertainty on the timing of rate hikes remains, though those who pushed things off until well into the second half of next year are probably backpedaling, again.  Thus, we are still in for lots of volatility when the economic data surprise either on the upside or downside.  Rates are going up next year, so let me remind everyone that eight meeting times 25 basis points per meeting comes to 200 basis points in a year.

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