Economic Notes – November 5, 2012


Written by: Jon McGraw

Last week, superstorm Sandy closed markets for Monday and Tuesday and put a damper on most routine governmental and financial services, especially on the East Coast. We wish our partners affected in the part of the country the best during the recovery process. Anecdotal stories that have come our way paint a picture of damage being quite a bit worse than news reports portray, particularly when it comes to transportation and power.

From an economic level, estimates of damage from Hurricane Sandy have been raised from an initial $10-20 billion to more like $30-50 billion. Almost half of these appear to be insured. While this may not end up being of the magnitude of Katrina in 2005 or Andrew in 1992 in physical destruction or cost terms, due to the dense urban locations of the storm, it may end up being one of the most expensive to clean up. Problem areas include public utilities and transportation infrastructure damage. In fact, early estimates are that a quarter- or even a half-percent of GDP for the fourth quarter might be shaved off due to the demand destruction, lost work hours and repair time for infrastructure, although some of these effects may offset (think rebuilding efforts following Japan earthquake) in the first quarter of 2013.

Otherwise, it was a relatively busy week in terms of economic reports.

Personal income for September gained +0.4%, which was on target with forecast. Consumer spending rose +0.8%, which was a bit better than the median forecast number of +0.6%. However, as the headline PCE price index that these correspond to rose +0.4%, the real after-inflation effect was minimal. The savings rate fell -0.4% to 3.3% in September.

The ISM manufacturing index gained in October, from 51.5 to 51.7, which was a few ticks above the forecasted 51.0 result and a bit of a surprise considering other news recent weeks—more in line with a more lackluster reading. Composition was also a little better as new orders and production gained while inventories pared back. Nonfarm productivity gained an annualized +1.9% quarter-over-quarter, which was generally in line with forecast.

Construction spending was a light compared to expected for September, +0.6% versus +0.7%, as a positive residential number of +2.7% was offset by nonresidential construction being down -0.4%.

Factory orders were up, largely in line with expected levels, at +4.8% for September versus a forecast +4.6%. The ‘core’ durable goods piece (ex-defense, ex-aircraft) was revised upward a bit as well as core shipments were revised up. Motor vehicle sales ended October with 1.09 million, an increase of 7% but a bit short of analyst estimates of an 11% gain—thought to have been curtailed a bit by the storm on the East Coast. Regardless, it’s the best October since 2007.

The Chicago PMI, by contrast, came in weaker than expected, at 49.9 versus a forecast 51.0 figure—even though it’s an improvement on last month. The underlying composition was mixed, as well, as an improvement in new orders was offset a bit by weakness in production, inventories and employment. Net-net, not a hugely impactful result.

The Conference Board’s consumer confidence index showed improvement from 68.4 to 72.2 from September to October, although it fell short of the expected 73.0 result. The underlying composition of the index was decent, as both the ‘expectations’ and ‘present situation’ components improved, as did the ‘labor differential,’ which asks the question ‘Are jobs hard to get?’ In fact that latter component was at the highest level since fall 2008. While we can take fickle surveys with a grain of salt, consumers need to feel better before recoveries really improve. Then, spending improves. Then, company performance improves. A simple cycle, actually, and self-fulfilling but much more difficult in practice. It really starts with confidence.

Initial jobless claims for the Oct. 27 ending week came in at 363k, which was a shade below an expected 370k figure. The four-week moving average ended at 367k. Continuing claims for the earlier Oct. 20 week were 3,263k, which were a little higher than the consensus 3,250k level.

The ADP private-sector payrolls report has been ‘retooled’ a bit, now based on a larger sample universe and more detailed industry and individual company information, and showed a +158k jobs gain for October—which exceeded expectations for a +131k gain—and Sept. data was revised upward. The gain was split between various company sizes (a positive) and was led by construction.

The government jobs report on Friday was better than expected for October, released in a critical pre-election week. Nonfarm payrolls gained +171k, which was sharply higher than the +125k expected number (although we warned you before about the +/- 100k room for error in this measure). Nevertheless, it was seen as a positive development, and should help with near-term sentiment (and possibly prospects for incumbents). Cyclical manufacturing positions showed the strongest gains, in areas like manufacturing, construction and temporary employment (the latter of which is being used to a larger degree for marginal worker additions). Figures for August and September were also revised higher, which doesn’t hurt. For the record, the 12-month trend rate is +162,000 jobs… if this rate continues, a 7.0% unemployment rate will be reached in mid-2014.

The unemployment rate moved upward from 7.8% to 7.9% (as expected), which appeared to be the result of an increase in labor force size. This isn’t unusual, of course, as a common tendency in improving labor markets is a small deterioration in the unemployment rate a more discouraged unemployed feel better about things and re-enter the fray, which pushes up the size of the pool. (Why these unemployed, but wanting to be employed folks fall out of the official labor pool after a certain amount of time anyway is problematic and puzzling to us from a common-sense perspective, but that is a topic for another day.) The U-6, which captures all underemployed and discouraged workers as well, fell by a bit—0.1% to 14.6%. Average hourly earnings were flat, however, despite an expected pop of +0.2% or so, and the average workweek length dropped slightly.

Within 48 hours of the time we post this, we’ll very likely know who our next President will be. Regardless of the outcome, history has shown that markets prefer certainty to uncertainty, but there are other differences that investors will be paying attention to. An incumbent’s policies are generally well known, but questions surround any challenger. From a basic economic philosophy level, Pres. Obama prefers some cutting of spending paired with tax increases on the wealthy (a loose term, but call it households over $250,000 income for a starting point), whereas Gov. Romney is interested in spending cuts alone without the higher taxes. Unsurprisingly, there is a perception that Romney is certainly more ‘pro-business’ and ‘pro-investor’ than is Obama.

From a tax standpoint, there’s a decent possibility we’ll see dividend and capital gain rate increase regardless for at least some segment of the higher-income population, unless the previous cuts are temporarily lengthened again. This again is speculation, and also depends on other factors such as congressional election results, which affects the House and Senate power balance. Of course, assuming ‘compromise’ solutions (even if at the 11th hour) is often a safer bet than party line-based outcomes at either extreme.

There are other differences, notably in the long-term treatment of entitlements, but these are more multi-year horizon issues than they are shorter-term. Both parties have stated that the nation’s level of debt and fiscal condition remain priorities; differences in the candidates/parties lie in which government programs to cut.

Additionally, Romney has shown little interest in extending Ben Bernanke’s Fed chairmanship when his term expires in early 2014 (assuming Bernanke is even interested in staying on for another term, which is debatable). The philosophy of any replacement chairman at that time could push forward the potential for rising interest rates earlier than the current ‘mid-2015’ timeline. This remains, of course, speculation.

Another facet in the backdrop is the upcoming ‘fiscal cliff’ debate, which is reliant upon congressional agreement to either postpone cuts this year or retroactively do so in early 2013. A decision made this would be dependent on incumbent congressional members, while any push-out to next year would obviously be affected by the newly elected group. The consensus view is that the full force of the budget sequestration would be disastrous for the economy (along the lines of a 4.5% or so cut in GDP, almost certainly pushing us into recession), while the base case for likely outcomes is a much narrower range of fiscal tightening—perhaps in the range of 1-2% of GDP. Of course, when GDP growth is fairly sparse anyway, these small percentage points add up. From a dollar standpoint, some of this may be offset by the QE package announced by the fed in September.

This takes us full-circle to how this could impact our investments. In short, the uncertainty of multiple probabilities appears to already be priced in. If interest rates rise earlier than the promised 2015, it could result in a more difficult environment for conventional fixed income—making our tilts towards assets like floating rate loans more valuable as both a return provider and protection against higher rates. On the equity side, it is all about growth (and valuation). Growth is slow, but positive, and in our opinion, valuations are still compelling. One positive side of higher rates is as a signal that growth is better than expected and extremely low levels of accommodation are no longer needed—which could boost market sentiment. The international environment will also play an important role, as the continuation of the sovereign debt situation in Europe as well as management of ‘soft landings’ in China and other emerging market nations.


Stocks were generally slightly higher in a weather-shortened three-day week, mostly due to a pop on Thursday. Consumer discretionary and industrial stocks led the way domestically, while energy and utilities fared the worst—energy stocks presumably on demand fears surrounding the storm’s aftermath. Foreign equities fared much better, led by strength in emerging markets—China and Latin America fared especially well on the week, with China’s PMI survey moving above 50 for the first time in several months.

Bonds were generally flat on average this week with a minor change in interest rates. Longer duration debt and credit, including high yield, ended up positively, while foreign developed and emerging market government bonds were negative on the week.

Real estate was generally positive across the board, with U.S. residential, retail and European REITs were up well over 2%. Asian REITs lagged other markets, but still performed positively. In Hong Kong this week, a new 15% ‘buyer’s stamp duty’ (aka property tax) was put into effect for all non-permanent residents in an effort to slow the very robust property market there.

All broad commodity groups were down on the week, with precious metals and energy faring worst—down over 2%. Industrial metals and agriculture held up a bit better, down 1%. Again, concerns about possible timeframes for rebuilding after Sandy affected petroleum demand prospects which added uncertainty to that market.