August Industrial Production

KEY DATA: IP: -0.1%; Manufacturing: -0.4%; Vehicles: -7.6%

IN A NUTSHELL:   “If you believe that vehicle production is crashing, I have a bridge for sale and you can buy as much of it as you like.”

WHAT IT MEANS:  One of my more common warnings is that the headline number hides what is truly going on and the devil is in the details.  Well, welcome to the August industrial production report.  Output fell in August for the first time since January, and we know what the weather did to everything that month.  Worse, manufacturing production was down sharply.  So, has the industrial sector finally come to a grinding halt?  Yeah, right.  The biggest decline was in vehicles, where assembly rates dropped by nearly 12%.  Of course, the pace of new vehicle construction had surged by almost 13% in July, highlighting the problem with seasonal adjustments when trends change.  The important point is that vehicle sales in August hit their highest level in 8½ years, so output is likely to expand further.  It is clearly not shrinking.  Indeed, the 3-month assembly rate average was the highest since early 2006, when the housing bubble was funding everything that moved and didn’t move.  Meanwhile, the rest of the economy was doing just fine.  Production of high tech products, consumer products, business equipment and business and construction supplies were all up. 

Adding to the belief that the manufacturing sector is in great shape was the September Empire State Manufacturing Survey, a product of the New York Federal Reserve Bank.   The index hit its highest level in almost five years as new orders surged, hiring jumped and backlogs built.  Enough said.

MARKETS AND FED POLICY IMPLICATIONS:  It is sometimes good to get a headline that is so obviously misleading as today’s industrial production number.  It is not that the data are wrong; it is just that sometimes the marquee number is not reflective of what is actually going on.  The data are often volatile and the seasonal adjustments sometimes don’t work right if conditions change.  That was true with today’s industrial production decline and was likely the case with the weak August employment report.  Basically, the manufacturing sector is strong and should continue to lead the way.  The FOMC starts its 2-day meeting tomorrow and on Wednesday Janet Yellen will hold a press conference.  I expect the statement and the discussion to focus on changing the thinking from rates staying low an extended period to the strategy that the data will drive decisions.  If the numbers are stronger than projected, the Fed will be prepared to move sooner than expected.  This report changes nothing and investors will have to start getting used to the reality that the Fed is going to raise rates, most likely during the first half of next year.

August Retail Sales and Import Prices

WHAT IT MEANS:  The missing link in this economy is strong household consumption.  It’s hard to buy more when your pay is barely keeping up with inflation.  But wage gains are slowly improving and with so many more people working, income is growing.  The added funds are being spent on just about everything.  Retail sales jumped in August, led by a surge in vehicle sales.  With the vehicle sales pace of 17.4 million units being the highest in over eight years, that was hardly a surprise.  But even when you exclude vehicles, consumers were pretty frisky.  Demand for furniture, appliances and electronics, sporting goods, home building supplies, medical products and clothing were all up.  We even went out to eat again.  The only weak links were department stores and gasoline stations.  The decline in gasoline purchases was probably due to the sharp drop in prices, not a fall off in purchases, as these data is not inflation-adjusted.  All this came on top of an upward revision to July sales.

Household spending power is not likely to be eroded very much by inflation.  Import prices dropped sharply in August as fuel costs cratered.  Excluded energy, prices rose just a little, with only vehicles showing a gain, though that was minimal.  The only real trouble spot is manufactured food import costs, which continue to surge.  As for exports, U.S. firms are also getting less for their products with the farm sector once again suffering sharp drops in its goods.

MARKETS AND FED POLICY IMPLICATIONS: The second quarter is setting up to be pretty good.  Consumers are spending again and not just on vehicles.  Right now they are being helped by the drop in gasoline costs, which is leaving a lot more money in their wallets.  Indeed, low inflation is has kept consumption from largely disappearing and with import prices essentially going nowhere, minimal inflation pressures are likely to continue.  Once we get better wage gains, spending could really surge.  The Fed generally treats energy costs as an indicator of consumer spending, not inflation and it looks like the downward trend in prices and the upward trend in household spending should continue.  Since it is all about a tightening labor market and the potential for rising wages, this report should buoy the spirits of the inflation hawks who worry that the Fed is waiting too long to start raising rates.  The FOMC meets next week and the pressure is building for the statement to drop the words “extended period” when describing how long rates will be kept low.  That would provide the flexibility to start tightening sooner than expected.  I suspect that will happen, since the public discussion about doing that has largely taken away any shock that would occur if the statement actually drops that language.  As for investors, it is the usual: Does good economic news trump rising rates?  Who know what side of that coin comes up on any given day?

August Conference Board Online Help Wanted

KEY DATA: Ads: up 164,600

IN A NUTSHELL:  “With job openings rising as unemployment is falling, is there really any doubt that the labor market is tightening?”

WHAT IT MEANS: Businesses are out there looking for workers all over the place.  The Conference Board’s Help Wanted Online Index jumped sharply in August.  The rise in labor demand was spread across the nation as only five states had lower levels of ads.  Seventeen of the top twenty metropolitan areas reported gains.  Philadelphia was not one of them, though.  Which jobs are seeing an increase in demand?  All of them!  Every occupation category posted a rise in want ads.  All of this is created some real labor shortages, not just a tightening in the labor market.  The ratio of the number unemployed to the number of job openings is a measure of labor availability.  Over the past three months, that ratio has averaged 1.93 workers per opening.  To put that in perspective, from May 2005, when the data were first released, to December 2007, when the expansion ended, the ratio averaged 1.95.  In other words, the current measure of availability is lower than what it generally was during a significant portion of the previous expansion.  Looking at occupations, computer and mathematical science, healthcare practitioners, management and business and financial operations all have ratios less than one.  In other words, they have already hit labor shortage status.

MARKETS AND FED POLICY IMPLICATIONS:  We still have to wait for Friday’s report to see how much, if any, the labor market tightened in August.  Regardless, most of the labor market tightness indicators are flashing red.  So, why are we not yet seeing any pressure on wages?  My argument, which I have made a number of times in the past, is simple:  Business leaders have not had to worry about compensation or attraction and retention issues for so long that they don’t believe they have to do anything but pick the perfect job candidate and pay the person what they want to pay them.  Well, Bob Dylan said it best: “The times, they are a-changin’”.  Maybe the best way to end this piece is to quote the lyrics, which when it comes to the labor market may be the clearest warning:

Come gather ’round people
Wherever you roam
And admit that the waters
Around you have grown
And accept it that soon
You’ll be drenched to the bone
If your time to you
Is worth savin’
Then you better start swimmin’
Or you’ll sink like a stone
For the times they are a-changin’.

(Copyright © 1963, 1964 by Warner Bros. Inc.; renewed 1991, 1992 by Special Rider Music)

August Supply Managers’ Manufacturing Report and July Construction Spending

KEY DATA: ISM (Manufacturing): +1.9 points; Orders: +3.3 points; Employment: -0.1 point/ Construction: +1.8%; Private: +1.4%; Public: +3.0%

IN A NUTSHELL:  “Manufacturing activity is soaring and construction is starting to boom, so why are people doubting that the economy is finally switching gears?”

WHAT IT MEANS: I hope everyone had a wonderful weekend but summer is unofficially over and it is time to get really serious about the economy.  While some may think I am suffering from heat stroke, I really do think we are closing in on escape velocity.  Manufacturing activity continued to accelerate in August, according to the Institute for Supply Management.  The most eye-opening part of the report was another surge in new orders.  We are talking about really strong order growth here.  As a result, companies ramped up production, also to a high level.  Despite the growing output, order books filled and that means production levels could continue expanding.  About the only negative component of the report was the employment index.  It eased a smidgeon.  However, there is still a lot of hiring going on.  Despite the problems in Europe, export orders grew, a sign of that U.S. firms finally get it when it comes to world trade.

We got another indication that construction will be adding to growth this quarter.  Construction spending soared in July.  The increases were spread across much of the economy.  In the private sector, nonresidential activity jumped even more than residential.  But for me, it was the pick up in public construction activity that was most noteworthy.  Government has been the biggest roadblock to growth, restraining spending and hiring.  That is clearly changing.  We saw an increase in state and local government activity in the second quarter and hiring is starting to grow again.  Now we see that governments are back in the building business and they are even investing in schools again.  Amazing.

MARKETS AND FED POLICY IMPLICATIONS:  It is the week that contains Employment Friday so anything that comes earlier tends to be downgraded.  But the robust manufacturing report, one that was well above expectations, makes it clear that the economy is hitting on almost all cylinders.  It also provides some substance to my expectation that we will get really strong numbers on Friday.  My payroll increase is just north of 275,000 and we could see a gapping down of the unemployment rate to 6%.  Neither are consensus numbers but that is my story and I am sticking to it.  If my forecast does indeed happen, there could be some real screaming at the Fed.  There are a number of very anxious inflation hawks out there waiting for the right time to show their talons.  But right now, that is just conjecture.  We still have three days before E-Day.  As for investors, the improving economic environment should be good for sales.  But it also may mean a sooner than expected rise in rates and growing pressure on wages.  Which trend will rule is a good question and I am not sure anyone can answer that right now.  We will have to wait and see.

July Income and Spending

KEY DATA: Inflation Adjusted Disposable Income: +0.1%; Inflation Adjusted Consumption: -0.2%

IN A NUTSHELL:  “The lack of wage gains is keeping consumers from spending more money.”

WHAT IT MEANS: The constraining cycle of minimal wage gains leading to minimal consumption increases continues.  Households saw their incomes rise modestly in July as the increase in wages and salaries was the slowest this year.  Adjusting for inflation, the rise was barely perceptible.  Real disposable personal income has increased by 2.6% over the year, enough to drive decent but not great consumer spending.  In July, households decided to go on a shopping vacation.  They spent little but some of that may be due to the relatively mild winter that reduced air conditioning needs.  Utilities are part of services spending and that component, which is two-thirds of all consumption, was flat.  Also, while vehicle sales were strong, they did not come close to the robust pace posted in June so spending on durables was off sharply.

Will consumption rebound?  The likelihood is yes as the University of Michigan’s Consumer Sentiment Index increased in August as households are more optimistic about their economic conditions.  However, they remain somewhat uncertain about the future.  A sharp rise in the Chicago Business Barometer adds to the indicators showing that the manufacturing sector is improving.  That is likely being led by better consumer spending, even if the government is not yet finding that is happening.

MARKETS AND FED POLICY IMPLICATIONS: We need better consumer spending but we cannot get it until wages actually rise.  This is the trap we are in and it is not resolving itself quickly.  Indeed, businesses remain convinced they can get the perfect candidate at the price they think they should pay despite the growing number of job openings.  The disconnect in this economy is between what an employer wants to pay and what an employer needs to pay to get the worker they want.  In the business community, which is a firm believer in the market economy, there is a belief that the labor market doesn’t follow the laws of supply and demand.  In economist’s parlance, employers think that the labor supply curve is flat so they can pay a constant price for any number of workers they want.  The high unemployment rate of the past six years allowed that concept to take hold since it was basically accurate.  But with excess labor supply diminishing, a normal shaped labor supply curve is reappearing and that means to get more workers, you have to pay more.  If you don’t, the opening will go unfilled.  Markets work, even the labor market, and while wages may be sticky downward in a recession, as we approach full employment, they will go up.  The longer businesses take to recognize that wages need to be increased, the faster they will likely rise when that recognition sets in.  On that positive note for workers let me say:

Have a safe and enjoyable Labor Day Weekend!

July Pending Home Sales, Revised Second Quarter GDP and Weekly Jobless Claims

KEY DATA: Pending Sales: +3.3%; Year-over-Year: -2.1%/ GDP: 4.2% (from 4.0%); Corporate Profits: +8.0%/ Claims: 298,000 (down 1,000)

IN A NUTSHELL: “If the housing market really is getting better, then there are every reasons to believe the strong growth seen in the second quarter can be repeated.”

WHAT IT MEANS: Housing took a big hit in the winter and the spring was better but not great.  However, it appears that conditions are beginning to really improve.  We saw that existing home sales hit their highest sales pace this year in July, housing starts surged and builder Confidence continued to pick up. Today’s report showing pending home sales increasing just added to the impression that housing has thrown off its winter-induced lethargy.  While these are contracts not closings, they do point to more home sales ahead.  Granted, the level is still slightly below what we saw in July 2013, but they are coming back nicely.  The only recent negative housing report was new home sales and that looks like an aberration. Developers don’t develop and builders’ confidence doesn’t rise if demand is weak.

In other reports, the economy grew even more strongly than initially estimated and the robust increase in activity led to a jump in corporate profits.  The good news is that firms are using some of the money to invest in equipment, software and even new plants.  What they are still not doing is paying their workers more and they will continue to do that as long as they can get away with it.  But the time to pony up may be getting near.  Unemployment claims eased last week and seem to be settling into a range that puts it at the lowest in history if you adjust for the size of the workforce.  The level points to a potentially very strong August employment report, which we get at the end of next week.  I would not be surprised if job gains around 275,000 and we could even see the unemployment rate at 6%.

MARKETS AND FED POLICY IMPLICATIONS: Today was a good day for economic numbers, which should mean a good day for investors.  Of course the economy often takes second place to geopolitical concerns and the situation in Ukraine continues to be worrisome.  Vlad the Invader seems to be at it again and that is not good news.  But domestically, the economy is in good shape and getting better.  If the August employment report is as good as I believe it could be, the screeches coming from the hawks will get awfully loud.  Janet Yellen

conceded that conditions may improve faster than expected.  While a robust gain in payrolls and a drop in the unemployment rate will not likely cause the Fed Chair to come out and make that admission just yet, it will likely give her pause.  The interesting question is how will investors react to the Fed moving closer to hiking rates?  Since tightening will only come when Chair Yellen and her band of merry low-raters think the economy is really strong and the labor market is becoming an issue, a rate hike should be viewed positively.  But that is just an economist talking.

August Consumer Confidence, July Durable Goods Orders and June Home Prices

KEY DATA: Confidence: +2.1 points: Current Conditions: +6.7 points; Expectations: -1 point/ Orders: +22.6%; Excluding Aircraft: +1.6%/ Home Prices (Monthly): 1%; Year-over-Year: 8.1%

IN A NUTSHELL:  “Consumers are getting some real smiles on their faces and that should help propel spending, but only if wage increases improve.”

WHAT IT MEANS: There were a number of key reports released today and maybe the most interesting one was the Conference Board’s Consumer Confidence numbers.  Overall confidence rose solidly again in August, the fourth consecutive increase.  The level hasn’t been this high since October 2007.  The eye-opening component was the Present Situation index, which surged.  There was a sharp rise in the percentage of respondents who thought that jobs were plentiful and a modest decline in those who felt it was difficult to find a position.  Strangely, fewer believe job openings will rise in the near future.  Rationality may not be at work here.  The other key finding is that people are not overly optimistic about their incomes increasing going forward.  That, even more than their general view of the world, could keep households from spending briskly.

Orders for big-ticket items skyrocketed in July, but when civilian aircraft orders rise 318%, you know that the headline is largely meaningless.  Excluding private and defense aircraft, orders did jump and that was due to strength in the vehicle sector, which was up over 10%.  Otherwise, the numbers were largely off, with only communications posting a nice gain.  Business capital spending eased, but quite modestly compared to the jump posted in June.  Backlogs are building nicely and that should mean expanding production going forward.

Home prices continue to rise, but the rate of increase is decelerating.  The S&P/Case Shiller 20-city index was up decently in June and has moved back to fall, but the gain over the year was down in all twenty cities.  The price index is back to where it was in fall 2004.

MARKETS AND FED POLICY IMPLICATIONS: Consumers are feeling a lot better about economic conditions, but they are not exuberant about their income possibilities.  That is holding back spending and until the labor market tightens further, wage increases will remain limited.  That is why the debate over the slack in the workforce is so important.  In addition, home price gains are slowing.  While that may help affordability, it hurts the churn in the market as fewer homeowners will see their equity levels rise to where they can once again sell their homes.  That said, the jump in orders does point to continued decent overall economic growth but until we get the consumer going, strong growth will remain a wish not a reality.  Investors should understand that, even as they bid up prices.  But these reports only add to the divisions that exist at the Fed.  It’s still the labor market and we don’t get the August employment report until the Friday after Labor Day.

Fed Chair Yellen Talk at Jackson Hole Conference

In a Nutshell: “… if progress in the labor market continues to be more rapid than anticipated by the Committee, then increases in the federal funds rate target could come sooner than the Committee currently expects … Of course, if economic performance turns out to be disappointing … then the future path of interest rates likely would be more accommodative than we currently anticipate.”

If you don’t like two armed economists, you will truly dislike the talk that Fed Chair Janet Yellen gave today at the Federal Reserve Bank of Kansas City’s Economic Symposium in Jackson Hole, Wyoming.

The greatly anticipated speech delved into the details of the labor markets, the impact of wages on inflation and the way that monetary policy should react.  Of course, being a good economist and academic, Chair Yellen discussed all sides of the issues.  For example, is the decline in the participation a result of changing structural factors such as the aging workforce or is a cyclical decline due to frustration that will unwind once the labor market firms more?  The answer is, of course, yes.  That is, it could be one, or the other or even both, which it likely is.

Similarly, there were discussions about wage pressures, how long it could take for wages to rise faster and when rising labor costs would actually translate into rising inflation.  As any economist will tell, the answer is hardly clear since there are multiple competing factors.  Thus, wage pressures could ignite quickly or be delayed.  Rising wages could signal future increases in inflation, or maybe not.  The Fed should react quickly to rising wages or maybe wait if the wage increases are temporary.  In other words, the answer is any or all of the above.

So, given the talk, is there anything to take away from the speech?  Yes.  First, the Fed members recognize that we are a lot closer to their desired goals than they had projected.  Second, the lack of wage inflation is not necessarily a good sign for future inflation.  The apparent current slack in the labor market could disappear more quickly than expected.  In the past, the Fed Chair had generally been on the side that current labor market conditions argue for keeping rates low for an extended period.  Now, those same conditions need to be watched more carefully.

If Janet Yellen was viewed believing the labor market had plenty of slack and wage pressures would not build anytime soon, that perception has to change.  She recognizes that the risks are more balanced.  That means she will be more willing to move rapidly if the economy continues to improve surprisingly quickly.  Thus, investors should not assume any time frame for Fed rate hikes.  It is easy for economists and market analysts outside the Fed to pick a date.  But today’s talk makes it clear that if the Fed has to move sooner or deems it necessary to wait longer, the Fed Chair is totally prepared to go in that direction, whatever it may be.

July Existing Home Sales and Leading Indicators, Weekly Jobless Claims

KEY DATA: Home Sales: +2.4%/ Leading Indicators: up 0.9%; Claims: 298,000 (down 14,000)

IN A NUTSHELL:  “It looks like the economy is approaching escape velocity.”

WHAT IT MEANS: There were a lot of numbers released today and they all were really good.  First, there was existing home sales, which rose solidly in July.  The pace of demand is back to October after having posted four consecutive increases.  While the level is not spectacular, it is probably within ten percent of a solid market.  The huge levels posted during the mid-2000s should be viewed as aberrations not targets.  Increases were in all regions except the Northeast, which was flat.  As for prices, they continue to moderate.  After peaking last August at a 13.4% rise over the year, the gain is now under 5%.

 

Looking forward, the Conference Board’s Index of Leading Indicators popped in July.  This measure is accelerating as there were 0.6% increases in both May and June.  Gains in both the coincident (current conditions) and lagging indicators support the view that the economy is in really good shape.  And then there were the weekly jobless claims number, which got back to “normal”, that is, below 300,000.  Last week’s pop was a surprise and assumed to be due to a non-seasonally adjustable pattern of vehicle production shutdowns.  That we moved back to such a low rate is an indication that the labor market is really in good shape.

There were two other reports released that also point to a strengthening economy.  The Philadelphia Fed’s Business index surged in August, as did expectations.  Supporting the view that manufacturing is really cooking was the Markit flash August number which jumped to its highest level in 4.5 years.  The report noted that “robust manufacturing growth momentum has been sustained through the third quarter”.

MARKETS AND FED POLICY IMPLICATIONS:  Janet Yellen speaks tomorrow morning and that is the focus of attention.  Her talk takes on even more importance given the growing indications that the economy is beginning to break out of its sluggish growth mode.  While waiting for wage gains is not exactly the equivalent of sitting on a bench waiting for Godot, it is not really the best way to run monetary policy.  Wages is a lagging, lagging indicator and monetary policy needs to look forward.  The economic data are pointing to stronger growth than the Fed has been forecasting, which is hardly a surprise.  I always use the Fed’s numbers as a lower bound for growth.  Of course, I have been aggressively optimistic this year and seeing the possibility that my forecast could actually turn out to be correct makes me a bit giddy, so I will limit my criticism of the Fed.  That said, I have argued that wage gains are coming sooner than later and that the Fed will be compelled to raise rates earlier than many have expected.  Today’s data reinforces that view.  These data should make investors happy, but only when they realize that it’s the economy not the Fed that should be driving prices.

August National Association of Home Builders Index

KEY DATA: Housing Market Index: 55 (up 2 points)

IN A NUTSHELL:  “Builders may not be irrationally exuberant but the rise in confidence is an indication that the housing market is getting better.”

WHAT IT MEANS: The housing market has been adding to growth but the recent data have not created any great feeling that the sector will lead the way toward much stronger economic activity.  That still seems to be the case but at least it now appears that residential construction should continue adding to growth.  The National Association of Home Builders/Wells Fargo Home Builders Index rose in August, making it three consecutive months that builders’ optimism increased solidly.  The level is not yet back to where it was last August, when it hit a nearly eight year high, but it is getting close.  The three components, current sales, future sales and traffic, were all up.  Only the traffic measure remains at a low level, which is clearly a concern.  Apparently, the limited traffic is turning into sales, though.  Regionally, optimism was mixed.  Gains were posted in the Northeast and especially the Midwest, but were down somewhat in the South and West.  The weakest link remains the Northeast, where builder confidence may be rising but it still is in the “not very good” range.

MARKETS AND FED POLICY IMPLICATIONS:  The housing sector has been sending mixed messages since the winter weather cratered activity.  Sales have been improving in fits and starts while construction has wandered aimlessly.  The trend may be up, but not with any vigor.  The Home Builders seem to be saying that activity could start picking up again.  Of course, that is only one voice.   Fannie Mae’s economists toned-down their view of the housing market for the second half of the year, indicating that “With respect to housing’s contribution to growth this year, we have downgraded our outlook following the disappointing housing activity seen during the first half of the year“.   I guess the simplest thing to say is that housing will add to growth but not be the driving force behind any major upturn in economic activity.  Anything that implies less than stellar growth helps those at the Fed who want to watch and wait, and that includes the Fed Chair.  As for the markets, the Home Builders and Fannie Mae reports will probably just add to the view that rates are not going up anytime soon.  Of course, there are geopolitical concerns that seem to ebb and flow, as well as Chair Yellen’s talk on Friday in Jackson Hole.  Past Fed Chairs have used this forum to send messages about the future direction of policy.  It is fervently hoped that we will get some idea about Yellen’s thinking on how a tightening in the labor market translates into inflation issues and the need to raise rates.  Wage pressures only matter to the extent they create inflation concerns and we have no idea about the speed of that transmission process and what that may mean for Fed policy.  In other words, the era of “better communication” continues with very little good communication.

Linking the Economic Environment to Your Business Strategy