Economic Notes – August 5, 2013


Written by: Jon McGraw

It was an eventful week in regard to economic releases, so we’ve tried to keep todays summary relatively succinct (sometimes a tall order).

(+) Perhaps the biggest news was the release of real 2nd quarter GDP. Estimates had been continually downgraded over the past few weeks, to a consensus level of +1.0% or so, but even a sub-1% number didn’t appear to be out of the question. So, the actual figure of +1.7% was quite a positive surprise for markets. Personal consumption gained +1.8%, which surpassed expectations by two-tenths of a percentage point, while nonresidential fixed investment gained +4.6% and residential investment rose over +13%. Per the numbers, housing and peripheral effects from housing-related industries are significant pieces of the growth puzzle. Federal spending declined -1.5% (not as bad as feared, though), as defense cuts stabilized somewhat—poor defense spending has been a largely negative drag on economic growth as of late. Imports rose about twice as much as exports (roughly 10% vs. 5%), so the trade deficit widened a bit. Exports have been hit a bit with a much stronger U.S. dollar as of late. Inventory accumulation helped by adding almost a half-percent onto the final GDP number.

Additionally, historical revisions (coupled with a methodology change) lowered annualized GDP growth by about a third of a percent from the past year—bringing year-over-year economic growth to +1.4%. It also lessened the severity of the 2008-2009 recession slightly, as well as raised 2011-2012 recovery data somewhat. At the same time, growth over the past year was lowered a bit, so, all-in-all, this had the overall effect of ‘smoothing’ the extremes of the past few years. These are the types of data changes that economists could talk at length about, but since they’ve already occurred, mean much less for investment market participants looking forward—who are more focused on the second half of this year and 2014.

As we noted a few months back, several other calculation changes were incorporated into GDP this quarter (historical results were also backdated, for consistently). These changes were relatively minor in scope (raised overall GDP levels by about 3.4%) and include additions like capitalization of research/development (i.e. background creative work done to create products like the Apple iPad), intellectual/creative property products (i.e. ‘entertainment originals’ like creative work behind films and music) and real estate ownership transfer costs (i.e. title insurance and the like). Not earth-shattering, but a nod to an ongoing multi-decade shift the U.S. economy has been experiencing—from basic heavy industry to an increasing focus on service and intellectual businesses.

The GDP price index rose +0.7% and core PCE price index gained +0.8% for the quarter, both of which were just a shade below the +1.0% anticipated for each. This is in keeping with other inflation measures, which are also falling just below or near +1.0% on an annualized basis—implying inflationary pressures have been kept in check.

(+) The ISM manufacturing index came in at a much stronger level than expected for July, at 55.4, which surpassed June’s 50.9 result and the forecasted 52.0 number. The details of the report were also quite strong, with new orders, production and employment all gaining 6-12 points each. Inventories, however, fell a bit below 50, but the ratio of orders to inventories turned a more bullish direction. Overall, 50 is the breakpoint with these types of indexes—readings over 50 indicate expansion, while below 50 signifies contraction. This reading is a solid positive and surprised markets somewhat.

(-/0) Construction spending fell -0.6% for June, which stood in contrast to a forecasted gain of +0.4%; however, this was tempered by 1% revisions upward for both April and May in both the residential and non-residential construction categories. This brought the year-over-year trend for private residential building to over +18%, which strongly surpassed private non-residential, up just over a percentage point, while public construction fell almost -10% (not a surprise with government cutbacks.

(-) Factory orders for June were up +1.5%, which lagged the forecast of +2.3% growth; however, at the same time, May’s growth was revised upward by about a percentage point.

(-) The Chicago PMI came in a little weaker than expected, rising from June’s 51.6 to 52.3 for July, but lagged the expected 54.0 reading (anything over 50 in this diffusion index indicates expansionary conditions). However, by segment, the new orders, production and employment components all fell a bit on the month.

(0) The headline PCE price index rose +0.4% for June, which was in line with expectations (and resulted in a +1.3% year-over-year figure). The core PCE index level rose a bit more than the expected +0.1% gain and trend of the past several months, at a reading of +0.2% for the month and +1.2% year-over-year. Energy price gains contributed to a good part of the headline increase, while GDP revisions also made an impact. Overall, inflation results remain tempered relative to history and Fed target levels.

(-) Motor vehicle sales for July came in lower than expected, at a seasonally-adjusted 15.6 million annualized units versus 15.8 mil. anticipated, and June’s 15.9 mil. figure. For the domestic portion of these totals, the 12.1 million for July fell short of the 12.4 mil. expected—so it’s obvious that U.S. production was the biggest contributor to the decline (by contrast, sales for Honda and Toyota rose 15-20% compared to a year earlier). Two-thirds of the overall decline was accounted for by lower light truck volume and inventory issues with more popular models. From a longer-term view, levels remain near post-recession highs.

(0) Pending home sales for June fell a bit less than expected (-0.4% versus -1.0%), although May’s results were also pared back by almost a percent. Year-over-year gains remained strong, at +9.1%. From a regional standpoint, the West fared best with gains over +3%, while the South dropped by about -2%. The Northeast and Midwest were generally flat.

(-) The Case-Shiller home price index rose +1.1% for May, which fell short of the +1.4% increase expected. This brought the year-over-year gain to over +12%, which is the fastest-growing twelve-month period since 2006. For the month, the biggest gains were seen on the West Coast (San Diego, Las Vegas and San Francisco all up over 2%), as well as Detroit and Miami, with the recovering housing bust states outperforming.

(-) The Conference Board’s consumer confidence index slowed slightly in July, coming in at a reading of 80.3 versus a forecasted 81.3—but remains near a post-recession high point. Assessments of the present situation improved, while future expectations declined a bit (each by roughly 5%, respectively). The labor measure, which indicates the ease of finding employment, improved, which is certainly a positive.

(+) Initial jobless claims for the June 27 week fell from the previous week’s 345k down to 326k—a new post-recession low. The Labor Department has continued to note volatility in this series as a result of normal summer auto plant shutdown activity, which should taper off in coming weeks. This brought the four-week moving average of claims down by 5k to 341k. Continuing claims for the June 20 week came in at 2,951k, which was lower than the forecasted 3,000k level.

(+) The ADP employment report came in positive, adding +200k jobs versus the +180k expected. Job growth was focused in the area of trade/transports/utilities, which added 45k jobs, while professional/business services added nearly 50k and construction added over 20k. The ADP measure, while somewhat informative and watched by markets, hasn’t been shown to be an always-highly correlated indicator to the government payroll report that comes a few days later (as we found out again).

(-) The closely-watched government employment situation report was mixed, with nonfarm payrolls disappointing somewhat at +162k (relative to the +185k expected) and a downward revision of -26k for the prior two months. Professional/business services gained +36k jobs, but slowed relative to the average of the past several months; leisure/hospitality rose +23k, about half of the recent average; and health care only added +2k jobs, a fraction of the nearly +20k a month on average. Construction jobs actually declined and several thousand manufacturing jobs were added. Government sequester activity continued to appear tempered as an input to job losses in this survey, but private activity in non-auto transport equipment, such as shipbuilding and aerospace, was adversely affected by several thousand.

(0) The unemployment rate dropped from 7.6% to 7.4%, which was a tenth lower than the expected 7.5%. On the positive side, it did feature more jobs and is the lowest rate since December 2008; but, more negatively, a lot of recent job growth is the part-time variety and labor force participation also fell. Both appear to be ongoing problems, not only in the U.S., but in the developed world overall. Average hourly earnings fell -0.1% for July (+1.9% year-over-year), which was several tenths lower than the expected +0.2%. The average workweek length fell from 34.5 to 34.4 last month. The latter two measures also point to continued slow employment growth, but also tempered inflation pressures.

Personal income rose +0.3% for June, which trailed estimates by a tenth of a percent. Personal consumption expenditures rose +0.5%, which was in line with expected.

(0) The FOMC meeting ended with a whimper. The committee downgraded their assessment of economic activity somewhat from ‘moderate’ to ‘modest,’ in a reflection of conditions flattening out a bit in recent weeks. This was seen in manufacturing activity results as well as in housing activity. Language regarding QE continued to be firm, in light of recent interest rate volatility around ‘taper talk’—so while fears of removal of accommodation appear premature, rising rates wouldn’t be a surprise if economic data surprises on the upside (economists are now looking to September or December, for a pullback on the current bond-buying program). Inflation continues to be contained, but the committee acknowledged the doubled-edged effects of inflation being too low (and indicative of too little economic growth) as well as too high.

Market Notes

U.S. equities gained on the week, with solid reports from the ISM and GDP figures, despite lackluster monthly government job numbers at the end of the week.  The S&P touched 1700 for the first time, which could provide a newsworthy sentiment boost (whenever round numbers are reported as a key item on the national news).  Earnings have been a little better than expected, but continue to look lackluster overall.  Industrials and technology led, while telecom and healthcare lagged on the week.

Developed foreign markets ended up as the strongest performing markets in the equity area, with peripheral Europe as well as Japan (+3%, on weaker Yen and strong carmaker results) gaining the most ground, although the majority of developed nations ended in the positive.  Emerging markets fell off, with India and Brazil posting losses (India by more than -5% with growth rates falling to their lowest points in a decade and a pessimistic forecast by Goldman Sachs being published about that region).

With risk assets reacting to strong news, and rates being pushed a bit higher overall, short duration debt led in fixed income, along with convertibles, TIPs and floating rate loans. Not surprising, long treasuries suffered most, as did most foreign bonds.

In real estate, European issues gained a percent, with Asian names up roughly half that level.  U.S. REITs were largely negative, with mortgage and retail leading, and industrial/office and residential lagging behind.

Commodity markets were led by strong weeks in industrial metals tin and lead, while copper also performed positively on the stronger economic news.  Wheat and crude oil also gained several percentage points, while soybeans and natural gas posted dramatic declines.

Talk has surfaced regarding the potential exit of heavyweights Goldman Sachs and JPMorgan from the world of physical commodities trading, in favor of more traditional financial activities.  Part of this is increased regulatory scrutiny over the past month regarding the role of Wall Street in the ownership of assets like pipelines, warehouses and other commercial assets and allegations that such participation resulted in higher prices in certain commodities markets (like aluminum, which angered can manufacturers).  Most likely, it is also the realization that earning a small percentage of overall firm profits from these peripheral businesses just isn’t worth the hassle and added scrutiny.

Summer Fun – Is Greed Good?

We often cover our share of weighty topics in these weekly pieces.  Here’s a bit of ‘summer fun.’  We were recently reminded of an interesting interview of Nobel Prize-winning economist Milton Friedman on the Phil Donahue show in 1979.  There are a series of connected videos that cover the entire 45 minute interview, but we found this particular clip especially poignant.  The consistency in human behavior and timelessness of these types things are always interesting. 

Have a great week.