Economic Notes: August 18, 2014

August
18

Written by: Jon McGraw

  • Data was mixed on the week, with retail sales disappointing, but surveys and sentiment still decent on the manufacturing/small business end.
  • Equity markets deflected geopolitical concerns and gained, as did bond prices with interest rates falling a fraction of a percent to very low levels (even lower in Europe, which reported flat economic growth for the quarter.

(-) Retail sales for July came in a bit weaker than expected, rising +0.1% on a headline level, versus +0.2% expected.  Core sales were relatively worse, also rising +0.1%, but relative to a forecast of +0.4%.  The softness in sales was broad-based but especially poor in general merchandise/department stores (down a half-percent), auto sales were also down two-tenths of a percent, while building materials gained by two-tenths.  This report was disappointing but not entirely surprising, as retail sales have been quite mixed among sectors this year, reflecting the slow growth economic environment.

(+) Industrial production for July rose +0.4%, which outperformed forecast by a tenth of a percent; the ‘core’ manufacturing production (everything but utilities and mining, as those two segments are not truly ‘manufacturing’ anything) as a component of this rose +1.0%, more than double the forecasted increase.  Autos and auto parts production led the way, with a +10% gain, as productions schedules were favorable (with lessened impact from summer shutdowns).  Capacity utilization for the month was reported in line with expectations at 79.2%, rising a tenth from last report and +1.7% over the past year, and represents the highest level since the summer of 2008.  Business inventories for June rose in line with expectations of +0.4%.  Retail inventories as a sub-component rose a tick higher than that.

(0/-) The NY Empire manufacturing survey for August showed decent expansion, but at a slower rate than last month, falling -11 points to +14.7 (consensus hoped for +20.0).  Note that this survey is also a diffusion index, so any positive number over 0 notes growth over the prior month (similar in concept, but differs from the ISM style index, where 50 is the baseline ‘zero’ for positive or negative growth).  Shipments rose to an even stronger +25 level and six-month-ahead capex expectations improved by almost +10 points on the positive side; new orders and employment declined by a few points (but remained solidly positive), and inventories fell into negative territory.

(0) The import price index for July fell -0.2%, which was just a touch off the expected -0.3% decline.  The largest driver, petroleum, fell -1.2%, as other prices were generally unchanged net-net.  Over the past year, import prices including petroleum gained +0.8%, and +0.7% ex-energy.  From the standpoint of potential foreign inflationary influences (a negative), this remains tempered.

(0) The Producer Price Index for July showed an increase of +0.1%, right in line with forecast.  Core PPI, sans food and energy, was aligned with an expected +0.2%.  The similarity between the two was largely due to a +0.4% gain in food prices negated by a -0.6% drop in energy prices.  Otherwise, trade services prices (which measure changes in margins received by wholesalers and retailers) showed a gain of +0.2%.  The trailing 12-month increases in PPI on a headline and core level were +1.7% and +1.6%, respectively, so those metrics continue to show subdued pressures.

(-) The preliminary Univ. of Michigan consumer sentiment survey for August was weaker than the expected 82.5, falling just over a point to 79.2.  Future expectations ticked down a few points; consumer assessments of current conditions improved a bit.  Inflation expectations for the coming year moved up a tenth to 3.4% (!), while the five-year-ahead figure moved up a tenth as well to 2.8%.  No doubt affected by current conditions, food prices appear to have consumers a bit jittery.  While skittish month-to-month, officials and economists keep tabs on consumer inflation expectations to the extent that it can adjust buying/saving behavior if persistent enough and it becomes a self-fulfilling prophecy.

(+) The NFIB small business optimism survey moved higher, from June’s 95.0 to 95.7 for July (expectations called for 96.0).  Responses calling for the economy to improve gained the largest amount of traction, while the net percent responding that it is a good time to expand also rose—this included stronger hiring, but also difficulties in finding qualified workers.  While a point or so short of the post-recession high, we naturally welcome improvement, as small businesses have been hit especially hard during the last several years and remain skeptical of government taxation and fiscal policies, and have been somewhat slow in bringing on new employees.

(+) The government JOLTs report for June showed strength, with job openings growing to 4,671k, exceeding last month by 100k and expectations by 70k.  The ratio of unemployed-to-openings fell to 2.0 (best since 2008, but still high), the hiring rate ticked up a tenth to 3.5%, while the quit and discharge rates remained unchanged (1.8% and 1.2%, respectively).  While some aspects of the report showed improvement, the hiring rate has remained low relative to prior cycles and the Fed in particular would like to see movement in the quit rate, which implies stronger job-seeker confidence and mobility.

(-) Initial jobless claims for the Aug. 9 week rose a bit to 311k, 21k higher than the prior week and the expected 295k.  No special factors were reported.  Continuing claims for the Aug. 2 week also rose to 2,544k, compared to estimates of 2,507k.

Where do we stand in the current economic cycle?  Usually, a few years of economic growth after a recessionary trough would put us solidly in the area of mid- to even late-cycle, based on the longevity of the average cycle.  This time, it’s obviously been a bit different, and economists consider this case to be quite unusual.  Due to the structurally financial nature of the Great Recession (financial system crises have historically tended to worsen the accompanying recession), the recovery process has been slower and stretched to a longer length than normal.  Based on a variety of metrics, we appear to still be in the early part of the cycle, with some movement toward ‘mid.’  As we’ve reported on in recent months, there have been patches of improvement, but also areas that remain below-cycle, including housing.  We also could be a ways away yet from the later-cycle tendencies that tend to be coupled with excessive risk-taking, leverage, extremely loose credit and disregard for asset pricing.  This coming week, the Fed’s Jackson Hole conference begins and, unsurprisingly, several of the scheduled topics of discussion involve labor markets, labor resource utilization and wage levels—per Yellen’s sphere of focus.

Market Notes

Stocks experienced a positive week, as geopolitical concerns again faded into the background until later in the week.  From a sector standpoint, health care and technology shares gained several percentage points while energy and financials lagged—the former coupled with falling petroleum price trends.

Foreign markets experienced higher-profile news than in the U.S.  Other than a few outliers, the bulk of nations experienced positive returns, led by the European periphery, Brazil and India.  Prospects in those areas appeared a bit more promising than in core Europe and Japan, although returns among regions didn’t differ a great deal.

European/German stocks have corrected sharply in recent weeks (falling -11%) as German GDP contracted -0.2% in the 2nd quarter (-0.6% annualized) and France’s GDP stagnated, while nations like the Netherlands and Spain actually fared positively, but not enough to turn the ship around—bringing overall Eurozone growth to a flat result for the quarter.  Deterioration in outlook for German growth specifically (accounting for a large proportion of Europe’s economy), broader continental struggles staying ahead of deflation and Ukraine concerns certainly weighed on sentiment.  Hopes are high for the third quarter, though, as central bank stimulus policies, improving employment and continued low interest rates for borrowing continue to provide a needed tailwind.

Japanese real GDP for the 2nd quarter was terrible (-1.7%, -6.8% annualized), as the imposition of a VAT tax hike reduced demand and/or contributed to pre-hike purchases in Q1.  But the result has largely been expected and equities have rebounded over the past several months.

U.S. bonds experienced a particularly strong week, with a reverse of the steepening that’s been happening recently, as rates fell up to 10 basis points in the mid to longer parts of the curve.  Municipals, an area we haven’t discussed in a while, has benefitted by a reduction in debt supply, with issuance 15% lower than last year.  While the budgets of certain state/local jurisdictions have improved along with economic recovery tax revenues and property tax payments, higher-profile headlines in Detroit and Puerto Rico have kept sentiment tempered.

High yield performed well again, in a recovery from losses in July—ETFs appear to be an increasing driver of performance, accounting for perhaps a fifth of asset class flows.  According to a few managers in the asset class we’re in contact with, this has contributed to volatility in an area where liquidity isn’t always as freely available as in investment-grade debt.

Outside the U.S. fixed income markets, the yield on the 10-year German Bund dropped below 1% for the first time, in line with announcements of negative GDP growth on the quarter.  Perhaps there is a bit of anchoring effect on global treasury yields from this slide downward, but effects are debated.

In real estate, European REITs led the way, followed by domestic industrial/office and retail, although all areas were in the positive.

Commodities lost ground a bit on the week, as gains in the grain sub-sector were offset by weakness in energy and metals.  Losses in energy and agriculture have been especially damaging to commodity returns since the end of the 2nd quarter, in a reversal of prior trend, as waxing/waning tensions in Eastern Europe and the Middle East failed to keep oil supply fears elevated.  Crude oil prices have fallen -10% since mid-June—one of the possible reasons is an increasing supply glut.  As we’re producing more and more oil/gas locally (and efficiencies causing us to use less), it’s been argued that minor shocks may not have the same impact they once did.  But we may need a more severe crisis for this theory to be more robustly tested.

Moving to another segment, something interesting is also happening in the silver market, which will also have eventual implications for how other precious metals will be priced (such as gold, later this year).  For the last 120 years, prices were set by a unique negotiation between dealers (the price set this way has been known as ‘the fix’).  Last week, this format was replaced by an electronic one for silver, in light of accusations of manipulation, lack of regulation and demands for better transparency in several key world markets (think LIBOR a while back, where a basis point or two were allegedly purchased for a plate of day-old sushi), but litigation risk due to these old-world methods had been rising in many such ‘human’ markets for some time.