October Consumer Confidence, September Durable Goods Orders and August Home Prices

KEY DATA: Confidence: up 5.5 points/Orders: -1.3%; Excluding Transportation: -0.2%/Home Prices (Monthly): -0.1%; Year-over-Year: +5.6%

IN A NUTSHELL:  “The highest confidence level in seven years shows that it’s the economy that really matters and for many, it looks like it is getting better.”

WHAT IT MEANS: Ebola may be all people are talking about but it doesn’t seem to be getting a lot of us down.  The Conference Board’s Consumer Confidence Index jumped in October to its highest level since October 2007.  While the current conditions index moved up at a modest pace, expectations surged.  Fears of a job slowdown are fading rapidly and that is triggering a belief that incomes and business activity will be on the rise. 

The manufacturing sector has become a bit of a question mark.  For the second consecutive month, demand for durable goods fell.  Excluding transportation, it was the second decline in three months.  Still, the fall off has not been that sharp, so I am not yet worried about it.  As for the details, the biggest drop was in civilian aircraft.  Orders are still up by about 40% compared to last year.  There was also a huge reduction in communications equipment orders but more moderate declines in computers and machinery.  Vehicle demand was essentially flat.  Despite the sluggishness in orders, backlogs are growing and that creates expectations that production will have to be ramped up.

The steady deceleration in home price increases continued in August.  The S&P/Case-Shiller 20-city index declined as twelve of the twenty metropolitan areas were down.  Over the year, the increase slowed to 5.6% from 6.7% in July.  Prices are back to where they were in spring, 2005.

MARKETS AND FED POLICY IMPLICATIONS: The surge in confidence was the real eye opener in today’s reports.  It’s not as if the world is spinning along merrily.  It actually seems to be spinning out of control.  But that is not affecting the outlook for the future, especially when it comes to jobs and incomes.  And that is critical, since people tend to make spending decisions based on their financial situation, not because world events or vague threats of a disease outbreak.  The sharp decline in gasoline prices, undoubtedly, is helping, but since most of the gain came from expectations, not current conditions, it is likely that gasoline is just one factor in consumer thinking.   With outlooks brightening and more money being left in the wallet after filling up the tank, there are real hopes that this holiday shopping season could be very good.  I suspect that investors will grab onto that possibility.  As for the Fed, the FOMC is meeting and will issue a statement tomorrow.  Let’s wait and see what they say but I don’t think there is a consensus yet for changing much in the statement. 

September New Home Sales

KEY DATA: Sales: +0.2%; Year-over-Year: +17.0%; Prices (Year-over-Year): -4.0%

IN A NUTSHELL:  While the existing home segment is starting to run, the new home portion continues to take only baby steps.”

WHAT IT MEANS:  The housing market is moving forward, but the gains are hardly great and there are some weak segments.  The existing home part is in pretty decent shape as sales continue to rise and are nearing what we could call decent levels.  But the new home recovery is still in its infancy.  Yes, sales did rise to their highest level in over six years, but the rate is still way less than what would be considered healthy.   Also, the August number was revised downward sharply, which was the real reason September posted a gain.  Looking across the nation, demand jumped in the Midwest, rose moderately in the South, was flat in the Northeast and cratered in the West.  As for prices, they look to be on the way down.  There was a decline as builders may be downsizing to better match the market.  The number of homes on the market went up but given the sales pace, there is no major inventory overhang.

MARKETS AND FED POLICY IMPLICATIONS: Housing is the most enigmatic sector in the economy.  It is up, then down and then up, but only in parts and only in fits and starts (pardon the pun).  While it is nice that the existing home segment is basically back, we really need more the new home portion to be hale and hearty if overall economic growth is to be strong.  That is hardly the case right now.  Sales are under one-half million units annualized and that needs to at least double.  That could take a while, which is probably a major understatement.  Thus, housing starts, at least for single-family dwellings, is likely to remain less than we would like to see for, to coin a phrase, “a considerable time”.   This is not a report that should move almost anyone.  I have no idea what motivates investors right now but Fed members will not see this report as saying the housing market is so strong that rates should be hiked.  The FOMC meets Tuesday and Wednesday and we get third quarter GDP the day after, so things should heat up.  But for now, there is no reason to believe that QE will not be ended or the Fed will remove “considerable time” from its statement.  The December meeting could be different.

September Leading Indicators and Weekly Jobless Claims

KEY DATA: LEI: +0.8%; Coincident Index: +0.4%/Jobless Claims: 283,000 (up 17,000)

IN A NUTSHELL:  “Despite some issues with housing, signs are pointing to even better growth in the months ahead for the economy and the labor markets.”

WHAT IT MEANS:  With turmoil all around, you would assume the economy is in danger of stalling.  Wrong again.  Investors have decided that maybe the world is not falling apart, even as more chaos occurs, and the equity markets have rebounded.  Consumer confidence, at least through the first half of the month, has actually improved.  And now we see that an indicator of future growth, The Conference Board’s Leading Economic Index, rose sharply for the second time in three months.  The measure had stalled in August, but it bounced back with a vengeance and the three-month average increase is pointing to even better growth ahead.  The Coincident Index, which measures current activity, has not been rising as quickly as the LEI might imply.

Jobless claims, one of the factors driving the indicators, rose last week.  But the increase was from an historically low level when labor force size is considered.  These numbers are volatile.  Smoothing them, the four-week average was down to a new record low.  Also, a new index about the labor market, ADP’s Workforce Vitality Index, posted a solid third quarter rise from the second quarter level.  Conditions in the South and West have firmed sharply over the past year.  This report, when coupled with the jobless numbers, point to an accelerating economy.  

About the only concern in the Conference Board’s report was the housing market and the data are really all over the place.  But we are seeing things improve, such as existing home sales.  Also, the Federal Housing Finance Agency released its August Housing Price Index and prices rose solidly.  The index is back to where it was in August, 2005 but is still nearly 6% below its April, 2007 peak.  The year-over-year increase, however, is decelerating, though it was better in August than July.

MARKETS AND FED POLICY IMPLICATIONS: Today was a good day for the economic numbers.  They should brighten an already rebounding investor mood as they point to stronger growth in the future.  Issues such as Ebola and ISIS terrorism may cause concern, but they shouldn’t have a great impact on fundamental economic activity.  And if the labor markets are tightening, as most data seem to imply, then the Fed has to take notice.  We will see if the lights are on in the Eccles Building next week as the FOMC is meeting.  Quantitative Easing should be ended but concerns about less than desired inflation and labor market slack may still be at the center of the discussion.  Since some at the Fed want to see the whites of inflation’s eyes before shooting, there is no reason for them to indicate they are going to pull the trigger soon.  But if the October and November employment reports are as good as I suspect, conditions may be a lot different when the Fed members meet again in the middle of December.  That is when I expect them to start signaling that rates will be going higher and not after a considerable time.

September Consumer Prices and Real Earnings

KEY DATA: CPI: +0.1%; Excluding Food and Energy: +0.1%; Real Hourly Earnings: -0.2%; Year-over-Year: +0.3%

IN A NUTSHELL:   “Despite minimal inflation, worker compensation continues to go nowhere.”

WHAT IT MEANS:  The missing link remains a missing link.  The lack of any gain in household spending power has restrained growth during the recovery and there are still no signs of this changing, even as inflation remains in check.  Consumer prices inched up in September, which was a bit of a surprise given the sharp decline in gasoline costs.  Since energy costs are viewed more as an issue of consumer spending than underlying inflation, I think the index that excludes energy is a better measure to watch.  Here, prices moved up at a more moderate pace but still nothing threatening.  Food costs continue to rise more rapidly than general inflation, a trend that is likely to continue for a long time as growing incomes around the world pressure prices.  Medical costs are beginning to rise sharply once again and that includes commodities and hospital services.  There were also solid increases in rent and vehicle maintenance and insurance costs, as well as utility piped gas, which was odd.  Otherwise, prices remained well restrained.  Over the year, just about any measure you can use rose by less than the Fed’s 2% target.

Despite the minimal increase in prices, earnings, adjusted for inflation, fell.  An increase in hours worked offset the decline in wages and led to a gain in weekly earnings.  But the reality is that over the past year, both hourly and weekly earnings, adjusted for inflation, rose by only about 0.5%.  It is hard to have strong growth when spending power is largely flat.

MARKETS AND FED POLICY IMPLICATIONS: Inflation is not a major issue for the Fed as long as wage gains remain muted.  That has been Chair Yellen’s talking point since she has taken over and there is little reason to think that will not be the message in next week’s FOMC statement.  But there was a sign that labor shortages are on the horizon.  The September state unemployment numbers were released yesterday and fifteen states now have a rate below 5%.  With full employment around 5.5%, there are a growing number of markets where labor shortages have to be appearing and wage pressures building.  In addition, another eight states have rates between 5% and 5.9% and they are nearing the point of no return.  Since wages are not falling in above-average unemployment areas, the inevitable increases in the labor shortage locations will drive the numbers up.  Compensation gains are a lagging indicator and they are trailing even more now as firms cling to the belief that they don’t have to raise wages any more than minimally.  Good luck with that over the next year.  As for investors, it is off to the races again as either irrational exuberance has returned or there is a growing belief that strong growth is on the horizon.  I think GDP will rise well in excess of 3% next year and could exceed the 3.3% posted in 2005, making it the strongest gain in a decade, but that is not the consensus in the investing community.

September Existing Home Sales

KEY DATA: Sales: +2.4%; 1-Family: +2%; Condos: +5.2%; Median Prices (Year-over-Year): +5.6%

IN A NUTSHELL:  The housing market continues to improve though without much exuberance.”

WHAT IT MEANS:  Housing is one of the more enigmatic parts of the economy.  It led the way as construction, sales and prices soared, but then the sector seemed to stall.  The brutal winter didn’t help and the abandonment by investors just added insult to injury.  Well, the upturn continues, but not robustly.  New home sales increased nicely in September despite a sharp drop in demand in the Midwest.  It is not clear why that one region didn’t follow form, but these numbers do bounce around a lot.  Condos were the hot item but interest in single-family dwellings was also up. Investor demand seems to have stabilized, which is a good sign for the market.  The level of sales was the strongest since last September.  While it did not match the pace reached during the June through September 2013 period, it is up nearly 13% from the winter bottom.  As for prices, they were up solidly, but the days of large price increases are behind us. The supply of homes, as measured by the number of months it would take to clear the market at the going sales pace, eased in September but is still up from the year before.  Regardless, supply and demand seem to be reasonably well balanced.

MARKETS AND FED POLICY IMPLICATIONS: It looks like housing added solidly to growth in the third quarter, but we will not know until we get the GDP report on October 30th.  It has been a long process but the market is closing in on a sustainable sales pace.  Prices continue to rise, but the heat is largely gone.  That should not be a shock as costs are within ten percent of the highs posted in 2005 and 2006.  Basically, the existing portion of the residential housing market is largely healed.  Now if we can only get the new home segment to get going, everything would be back to normal.  It will be quite a while, though, before builders are selling their product at a more reasonable pace.  With fears easing, investors may start looking at economic fundamentals once again and since this report was better than expected, it should help keep the rebound going.  But it is not so strong that the Fed will actually start thinking the economy is in good shape.  Of course, there are some members who will not say it is strong until it has been strong for “an extended period”, but that is the way some central bankers think.  Regardless, I will take this report and move on as it supports the view that the economy continues on its upward path despite the craziness going on in the U.S. and around the world.

September Housing Starts and Permits

KEY DATA: Starts: +6.5%; 1-Family: +1.1%; Permits: +1.5%; 1-Family: -0.5%

IN A NUTSHELL:   “Builders keep putting those shovels in the ground and that is another sign that what happens on Wall Street probably just happens only on Wall Street.”

WHAT IT MEANS:  The roller coaster that has been the equity markets may continue, but since Wall Street and Main Street are so delinked, we need to remember, “it’s the economy, stupid”.  Where would we be if we didn’t have James Carville?  Anyway, the latest indicator of economic activity, housing starts and permits, showed that the housing sector continues to improve.  Starts rose solidly in September, driven by a large jump in multi-family activity.  As boomers and millenials look to higher density housing, this segment is likely to be the key driving force for the sector for a while.  The larger single-family component was up as well.  Permit requests rose modestly as well and are in line with starts, so builders are no longer getting ahead themselves.  Will the increase in construction continue?  Housing permit requests during the third quarter were only about two percent greater than housing starts, the number of homes permitted but not started has been filtering downward and the number of homes under construction is up almost 20% from September 2013.  All of those indicators point to only modest increases in construction in the next few months.

MARKETS AND FED POLICY IMPLICATIONS: As I noted yesterday, it should not have surprised anyone that a correction in the markets would eventually occur, given how outsized the equity price gains were compared to the increase in economic activity.  When reality was going to set in and the extent of the movement was, of course, unknown.  Otherwise I would be on the beach, not in my office.   But it is hardly bad and how long it will last is beyond my abilities.  I am just an economist, often confused why equity prices move in ways that don’t seem to be supported by the economics.  Regardless, the economy is still growing at a decent pace.  Third quarter housing starts were up about 4% from the second quarter, so housing should add nicely to growth when third quarter GDP comes out on October 30th.   The biggest uncertainty is not housing or the labor market or business investment: It is consumer confidence. ISIL, Ebola and the stock markets are real concerns.  Will confidence decline?  Surprisingly, the Thompson Reuters/University of Michigan’s mid-month reading of confidence went up, as expectations rose.  Wall Street may be Wall Street but the falling cost of filling up the clunker may be dominating perceptions.  That is a positive sign for future growth.

September Industrial Production and Weekly Jobless Claims

KEY DATA: IP: +1.0%; Manufacturing: +0.5%/Claims: 264,000 (down 23,000)

IN A NUTSHELL:   “Manufacturing is strong and with jobless claims at the lowest level in over fourteen years, it is clear that the economy and Wall Street are in different worlds.” 

WHAT IT MEANS:  With chaos reigning in the craps table called Wall Street, we need to step back a little and start looking at the underlying economy.  The data look pretty good.  Industrial production rebounded sharply in September as utility output surged.  Manufacturing was up solidly and the increase was actually better than the headline would have you believe, and that number was pretty good.  Vehicle sector production dropped for the second consecutive month but it looks like sales and inventories are reasonably balanced, so don’t expect the declines to continue.  Manufacturing production rose at a 3.5% annualized pace during the third quarter.  In September, more consumer goods, business equipment and supplies and construction supplies was produced.  The only industry, other than vehicles, that posted a significant decline was wood products while the gains were spread across both durable and nondurable goods industries.

Supporting the view that manufacturing is improving was the Philadelphia Fed’s October Manufacturing Business Outlook Survey.  While activity eased a little, it remained at a level consistent with those posted during the solid growth periods in both the 1990s and 2000s.  Also, the percentage of firms indicating activity had declined over the month actually fell.

Maybe the best number today was the jobless claims, which came in at the lowest level since April 2000.  Adjusting for the size of the labor force, we are at record low levels for a weekly number and the four-week moving average.  Firms are just not cutting their workforces and that points to the possibility that the October employment report could be really strong.

MARKETS AND FED POLICY IMPLICATIONS: The economic reports were really good but investors decided that panic was the better part of valor.  Really people, did you think that we could keep piling up huge gains in equities when the U.S. and world economies were growing moderately at best?  The Dow and S&P peaked in mid-September.  Over the previous two years, those indices rose by 27.3% and 38.7%, respectively.  Meanwhile, GDP grew by only 4.5% between 3rd quarter 2012 and 3rd quarter 2014 (assuming a 3% growth rate this past quarter). I don’t know how many times I said it but I will repeat it again: Wall Street and Main Street have become totally disconnected.  If you use the equity markets as an indicator of the economy, you are looking at the wrong thing and the Fed should care little about Wall Street when it comes to determining a monetary policy that is best for the economy.  I am sure there will those who argue the Fed has to put off tightening so it doesn’t spook the markets even more, but that would be arguing the Fed should use a misleading indicator.  Ultimately, equity prices, earnings and the economy will be better in synch but right now, I don’t worry too much about a market correction when the data keep showing the underlying economy continues to grow decently and the pace may actually be picking up.

September Retail Sales and Producer Price Index

KEY DATA: Sales: -0.3%; Vehicles: -0.8%/PPI: -0.1%; Goods: -0.2%; Services: -0.1%

IN A NUTSHELL:   “It looks like consumers have pulled back and while declining energy costs should help, there are questions about how strong growth will be going forward.”

WHAT IT MEANS:  Consumers are showing no signs of irrational exuberance.  Actually, there were few signs of any exuberance in the latest retail sales report.  Demand fell in September, but that was expected.  August vehicle sales were off the charts so the easing back to a more sustainable level was known and factored in.  Also, a sharp decline in prices was expected to cause gasoline purchases to drop, which they did.  But even adjusting for those two, sales were still off as demand for building materials, clothing, furniture and sporting goods declined.  We didn’t even shop online, which is a real surprise.  So, where did we buy? Electronics and appliances, and while we were out, we ate out.

The one thing that could cause the Fed to dawdle is concern that inflation could become too low.  The September wholesale prices report didn’t help ease the concerns of those on the FOMC who want to keep rates low for a considerable time.  The Producer Price Index fell as costs of both goods and services were down.  Energy led the way and that trend continues unabated.  That is good for the economy as energy costs are more an indicator of consumer spending power than inflation.  The drop is adding significantly to purchasing power.   The only component where prices jumped was unprocessed consumer food products.  However, that rise came after two months of huge declines.  Meanwhile, processed food costs eased, though they had been rising sharply.  Looking down the road, the rise intermediate and crude food prices indicates that consumer food costs will increase.  Otherwise, the pipeline is largely empty so inflation should continue at a modest to moderate pace.

The New York Fed’s Empire State Survey dropped sharply in October. It remained positive.  The headline overstates what happened.  This is a diffusion index and most of the change came from respondents saying that activity remained the same rather than increased.  There was little change in the percentage that said conditions or orders actually declined.

MARKETS AND FED POLICY IMPLICATIONS: It was expected that households would continue shopping for lots of things at a decent pace, but that didn’t happen and as a result, third quarter growth estimates could be revised downward.  To the extent that issues such as Ebola and ISIL are causing confidence to ebb, the moderating sales may be temporary.  But that is to be seen and since those two concerns have only deepened this month, I am not sure what to expect from the October retail numbers.  This has to worry the Fed, which meets at the end of the month.  With inflation below target and bond yields dropping, the doves will be flying high at the next meeting and we should expect that the “considerable timers” will rule the day.  But for the markets, the turmoil in foreign economies, uncertainty about the Middle East and Ebola and the growing reality that 25% increases in equity prices is neither sustainable nor even rational, may be causing reality to set in.

September Import and Export Prices

KEY DATA: Imports: -0.5%; Excluding Fuel: -0.1%; Exports: -0.2%; Farm: -0.9%

IN A NUTSHELL:   “With energy prices cratering and the dollar strengthening, it is not a surprise that import costs are on the way down.”

WHAT IT MEANS:  While the Fed watches the labor market for signs of potential inflation, the rest of us are also looking at what we pay at the stores and those costs are going nowhere.  Import prices fell in September for the third consecutive month, led by declines in all sources of fuels.  But it was not just energy that was down.  The cost of foreign agricultural food products, industrial supplies and vehicles were also off.  Indeed, except for some large increases in meat and fish, import prices were generally flat or down.  Since September 2013, overall import prices are down nearly one percent while nonfuel costs are up only 0.5%.  As for our exports, the agricultural sector to reel from declines in the prices.  Farmers are seeing their incomes slide but just about every other exporter is feeling their pain.

On the labor market front, yesterday we found out that new claims for unemployment insurance eased again. Adjusting for the size of the labor force, we are now at record lows.  Firms continue to hold on to workers and they are starting to pay up for new workers.  In a new report, a Workforce Vitality Index, ADP reported that wages gains for those who change jobs is beginning to soar even as “stayers’” incomes remain stagnant.  That is not a stable condition, as it will encourage more people to start looking around.

MARKETS AND FED POLICY IMPLICATIONS:  The Fed is worried about inflation, but unlike some of the hawks, many think the real threat is disinflation.  There is absolutely no inflationary pressure coming from imports.  With Europe slowing and the U.S. energy sector surging, fuel costs are dropping.  Add to that the firming dollar, which allows foreign firms to either lower prices of keep them stable, and you have a prescription for tame inflation.  That confounds the labor market situation.  If firms have to not only pay up for new workers but also start raising wages of current employees to retain them, they face a dilemma:  Do they keep prices down to compete with foreign firms or do they raise prices to pay for the labor cost increases?  The Fed has a target of 2% for inflation and that means inflation needs to rise.  After all these years of low interest rates, it is very hard for the Fed to expand the economy and limit deflationary pressures.  The members would probably welcome increased wage and ultimately price inflation. 

August JOLTS report and September Employment Trends Index

KEY DATA: Openings: +235,000; Hires: -294,000; Quits: -74,000/ETI: +0.3%; Year-over-Year: +6.1%

IN A NUTSHELL:  “There are lots of openings but firms still seem to be reluctant to hire.”

WHAT IT MEANS:  There is cognitive dissonance in business workforce actions.  According to the Bureau of Labor Statistics Job Openings and Labor Turnover Survey, JOLTS, firms have large numbers of job openings.  The level jumped in August and over the year, openings rose by more than 23%.  That is a clear sign of great need.  Unfortunately, companies did not go out and fill those positions.  Hires actually declined and since August 2013, the pace increased a mere 1%.  There is a real backlog in the HR departments that will have to be whittled down and for the economy, the sooner that happens the better.   That implies that job growth should accelerate.  As for job mobility, the quit rate moderated.  I am not sure if that is due to continued fear of becoming a free agent or that firms are starting to do things to retain workers.   A second indicator of the state of the labor market, released yesterday, also pointed to improving conditions.  The September Conference Board’s Employment Trends Index rose to its highest level since fall 2007, a few months before before the economy went into recession.

On the housing front, CoreLogic reported that home prices rose modestly in August.  Not surprisingly, the year-over-year rise decelerating once gain.  The question is, how much more will it ease?  We need prices to rise solidly so more homeowners will have enough equity to be able to sell their homes.

MARKETS AND FED POLICY IMPLICATIONS: Hiring and job openings are not in synch and ultimately, something has to give.  Firms can try to keep up with demand by pushing productivity, but we know that has not been very successful lately.  The next step is to throw in the towel and start adding to workforces.   The August hiring short fall is reflective of the less than stellar gain in nonfarm payrolls that month.  I suspect that the September JOLTS report will show that hiring expanded, in line with the jump in payrolls.  But the problem facing firms is that the number of people unemployed per job opening, a proxy for availability, has fallen to a level not seen since May 2008.  The vast supply of workers is just not there anymore.  Companies will have to start bidding workers away from other firms.  That is the change in the market that I have been waiting for because it will signal that wage increases will begin accelerating.  When that happens, incomes will rise and while housing price gains may be limited, the ability to purchase a home will improve and that would offset a rise in interest rates.  The Fed will continue to watch the labor markets closely and these reports reinforce the view that conditions are getting better but have yet to reach the point where the Fed absolutely has to act.  Of course, the Fed should move before they have no choice, but that is a different story. Investors, meanwhile, are worried about world economic conditions.  But falling gasoline prices should boost consumption allowing for better U.S. economic growth going forward.  Of course, you have to be linked to the U.S. economy for that to really help earnings.

Linking the Economic Environment to Your Business Strategy