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.

September Supply Managers’ Non-Manufacturing Survey and August Trade Deficit

INDICATOR: September Supply Managers’ Non-Manufacturing Survey and August Trade Deficit

KEY DATA: ISM (Non-Manufacturing): -1 point; New Orders: -2.8 points; Employment: +1.4 points/Trade Deficit: $40.1 billion ($0.2 billion narrower)

IN A NUTSHELL:  “With all components of the economy expanding and with exports growing, it should be no surprise that firms are hiring.”

WHAT IT MEANS:  The September jobs report was better than expected but it should not have been.  The economy continues to grow across the board.  The Institute for Supply Management’s index of business activity in the construction and services sectors may have moderated a touch in September, but the level is still quite solid.  New orders grew at a slightly slower pace but there was a sharp acceleration in export demand.  The level of demand is strong enough that firms are ramping up their hiring, something we saw in the payroll data.  That is helping keep backlogs under control and order books grew at a more moderate pace.

Despite issues facing so many countries, our trade situation continues to improve.  The trade deficit narrowed slightly in August, but the big story was exports: They rose to a new record level.  Okay, the gain was modest, but new highs are new highs.  The increase was driven by rising sales of capital and consumer goods.  There was a surprisingly large decline in both vehicle and farm exports.  The surge in energy production is allowing us to dig deeply in our petroleum deficit.  We sold a lot more services as well.  Our purchases of foreign goods also were up, but not greatly.  Jumps in aircraft and consumer goods demand outweighed declines in food, oil and vehicles.  The revitalized domestic vehicle sector is helping out here.  Adjusting for inflation, the deficit has narrowed sharply in the third quarter, implying that trade should add solidly to growth, which could be as high as 3.5%.

MARKETS AND FED POLICY IMPLICATIONS: Everything seems to be coming together, except wages.  The increase in payrolls is generating a solid rise in total hours worked and that, conjunction with some rise in wages over the year, is helping generate moderate income gains.  But if we are to really get consumers spending, we need demand to come not just from the new workers, but also from those already employed.  And that requires businesses paying the current workers more.  Understandably, firms don’t want to do that, especially since they have not had to for so long.  But with the unemployment rate coming down, scattered labor shortages are appearing in some industries, occupations and geographic areas.  There is little reason to think the decline in the unemployment rate we have seen over the past two years will not continue over the next year and that means by next summer, we should be at full employment.  If the Fed waits until it sees the whites of wage-inflation’s eyes to pull the trigger, it will be overrun.  But for now, firms will continue to hold the line and the Fed will continue to continue to keep rates low because of less than stellar growth, a strong dollar and low inflation.  As for investors, today’s numbers should ease some of the wounds they have suffered recently.

September Employment Report

KEY DATA: Payrolls: +248,000; Private: +236,000; Unemployment Rate: 5.9% (down 0.2 percentage point); Hourly Wages: down $0.01

IN A NUTSHELL:  “Firms are hiring but that has yet to translate into any increase in wages.”

WHAT IT MEANS:  The greatly anticipated September employment numbers did not disappoint, unless you were hoping for some wage pressures.  Payroll gains were well above expectations, but the headline number actually understates the increase because there were large upward revisions to both the July and August totals.  There were a total of about 69,000 more jobs created in those two months than had been initially estimated.  If you add the 38,000 additional jobs in the August report to the 248,000 added in September, the net gain was 286,000.  (I had 289,000, so I feel pretty good, especially after last month’s debacle.)  Given the NFIB’s report that small business hired heavily in September and those increases only trickle in, I would not be surprised if the September job increase was also revised upward.  Over the past twelve months, businesses have added over 2.6 million new positions, the largest increase since May 2006.  The rise in payrolls was distributed across the economy.  Construction was up solidly, but the rise in manufacturing was less than expected.  Retailers, restaurants, personnel service firms, trucking companies and health care providers all added positions solidly.   States are also back into hiring mode.

The best news was that the unemployment rate dropped below 6% for the first time since July 2008.  (I expected a 6% number.)  Yes, the labor force participation rate dropped, as did the labor force, but the number of people employed soared and the number unemployed dropped sharply.  In any event, I have explained, ad nauseam, why this whole discussion is absurd so let it go.  What was disappointing was the lack of any increase in wages.  The labor market may be tightening, labor shortages may be appearing, but firms are still holding the line on wages.   

MARKETS AND FED POLICY IMPLICATIONS: This was a very good report.  The economy averaged nearly 225,000 new positions over the past three months, which is pretty solid.  So, why is the growing job demand not showing up in worker compensation?  Part of the issue may be measurement and part structural.  Salary increases are not granted uniformly across the year.  They tend to be bunched at review times, which could be quarterly, semi-annually or annually.  There may be labor shortages, but in-between reviews, wages are not going to rise unless a worker can get another job and leverage the offer.  For those on contracts, wages are fixed until the contract ends.  Since the government reports average wages, any increases by the additional workers may not move the needle a whole lot.  That doesn’t mean wage pressures aren’t building.  It just means that when they show up, they will not rise smoothly.  They could gap up.  If the Fed waits for wage gains to appear in the data, they will be well behind the curve.  Wages have always been a lagging indicator and with businesses still convinced that they can hire people at the wage they want to pay rather than the wage they have to pay to actually get the person, it will take extreme shortages before businesses thrown in the towel.  But when they do, watch out.

September Challenger Layoff Announcements and Weekly Jobless Claims

INDICATOR: September Challenger Layoff Announcements and Weekly Jobless Claims

KEY DATA: Layoffs: down 23.8%; Jobless Claims: 287,000 (down 8,000)

IN A NUTSHELL:   “With layoffs nearing a 17 year low and jobless claims at historically low levels, the logical next step is for hiring to surge.”

WHAT IT MEANS:  One more day to the jobs report and a couple of indicators are really pointing to a solid increase in payrolls.  Let’s begin with the Challenger, Gray and Christmas monthly report on layoff announcements: In September, job cut warnings fell dramatically, hitting the lowest level in 14 years.  The third quarter total was down 8.6% from the same quarter in 2013 and it is possible that for all of 2014, layoff announcements will be the lowest since 1997.  I guess the simplest thing to say is that companies are holding on to their workers as tightly as possible.  The lack of pink slips is showing up at the unemployment office.  Jobless claims fell again and when you adjust the level for the size of the workforce, we are at record lows.   The number of people receiving unemployment payments is also declined sharply, reaching its lowest level since 2006.  While continuing claims are not near record lows, given the extended period that people can receive unemployment insurance, they are really low.

Several other reports were released today.  On the labor front, the National Federation of Independent Business found that small business hiring was strong in September, which supports a stronger than expected level of hiring.  However, small business hiring generally doesn’t make it into the initial BLS numbers, so don’t be surprised if the September gain, whatever it is, gets revised upward.  There was some concern about future hiring as plans to add workers eased.  The New York City Supply Managers’ survey indicated that manufacturing activity picked up steam in September after moderating in August.  Expectations also rose solidly.   And August factory orders were off sharply, basically because of the wild swings we have seen in aircraft orders.  Fattening order books means output should expanding.

MARKETS AND FED POLICY IMPLICATIONS:  The underlying data on labor market conditions point to a firming in the market.  Companies are not cutting workers and as long as growth continues at a decent pace, hiring will have to accelerate.  Whether it shows up in the September or October report is hard to say but one of them should be really big.  Still, feedback I get from personnel firms are that companies continue to be hesitant about pulling the trigger on hiring.  The number of searches is up but placements remain difficult.  It seems that executive management is still resistant to expanding payrolls and adding to costs even though line management is begging for more workers.  Something will have to give with the question not being what but when.  Regardless, today everyone simply watches and waits.  Those who like to gamble may do so but keep in mind, the employment numbers can be very volatile.  There was no reason to have such a low gain in August and if it was just a seasonal adjustment issue, then we could get some make-up in September.  That would imply the likelihood is that the number will surprise on the upside than the downside.

Linking the Economic Environment to Your Business Strategy