Economic Notes – December 10, 2012


Written by: Jon McGraw

Some of the more important manufacturing indexes were released this week, and offered mixed results—on par with recent consensus expectations as we get close to closing out the year.

The ISM Manufacturing Index for November was weaker than anticipated in November, declining to 49.5 versus an expected 51.4 figure. Details and rationale for these types of surveys are sometimes difficult to quantify, but it appears the hurricane played a negative role in results, as did uncertainty about the upcoming fiscal cliff. Upcoming new orders declined, as did employment; however, the production and inventory components improved. This is not a major disappointment, but is a little soft for a variety of well-discussed reasons.

The ISM Non-Manufacturing Index for November, on the other hand, rose by a bit more than expected for November, to 54.0, versus an anticipated 53.5 reading. Being service-focused helped the index sidestep some hurricane impact; however, it was still seen in a few underlying figures like wholesale trade. New orders and general business activity here were higher (in contrast to the manufacturing index), while employment declined. Overall, this report wasn’t bad, and helped offset the slightly more negative manufacturing index numbers.

Factory orders, expected to be flat for October, actually rose +0.8%—a positive surprise. A bulk of this was due to core capital goods/shipments (non-defense ex-aircraft) being revised higher. Construction spending gained +1.4% for the month of October, which surpassed the expected +0.5% increase. Both residential and non-residential sides of the construction business were up, more so on the former than the latter.

Nonfarm unit labor costs (defined as hourly compensation as compared to hourly output) for the quarter fell an annualized -1.9%, which was roughly double expectations of a -1.0% drop. This is a figure not always closely watched, but it bears looking at, due to signs of inflation that can creep into labor costs. Nonfarm productivity rose +2.9% for the third quarter, largely in line with forecast.

The ADP employment report, sometimes thought of as a precursor of and supplement to Friday’s big government report, showed a result of +118k jobs, which was just a bit weaker than the expected +125k gain. The firm noted that implications from Hurricane Sandy largely affected results (perhaps by up to 90k jobs), but as we know, these numbers can feature shorter-term inconsistencies and errors that largely self-correct back to trend. Manufacturing declined on the month overall, while construction employment improved. Additionally, large companies continued to add more jobs than small- to medium-sized firms did—again, perhaps not surprising, considering additional regulatory and ‘Obamacare’ uncertainty that has plagued smaller employers for some time.

Initial jobless claims for the Dec. 1 ending week fell quite a bit more than expected, to 370k, versus an expected 380k reading. Continuing claims for the Nov. 24 week were also lower, at 3,205k, relative to the median forecast of 3,275k. In both cases, it appears the effects of Hurricane Sandy have dissipated somewhat and these reports should show more ‘normal’ figures in coming months.

The employment situation for November was a positive story. Nonfarm payrolls were up +146,000 for the month, which was much more than the expected +85,000. Contrary to expectations, the DOL stated that the hurricane didn’t have a material impact on the final number. Job gains were focused in service industries, like business service and retail, as well as the hospitality industry. At the same time, October’s initial figure of +171,000 was revised down to +138,000—another example of the statistical trickiness of these job reports in the first place as a precise measure of any kind.

The unemployment rate fell to 7.7%, which was also 0.2% below October’s figure and below this month’s consensus estimate of no change. But, as usual, the details are more complicated, as the drop was largely the result of reduced labor force participation, which just changed the denominator in the ratio. In fact, according to the household survey component of the employment situation report, jobs fell by -122,000, which ran counter to the trend of recent months. Similarly, the U-6 measure of both unemployment and ‘underemployment’ fell by -0.2% to 14.4%. Retail jobs in apparel were significantly higher, which is consistent with seasonal patterns around Christmas.

Employment continues to be an issue: improving, but at a snail’s pace. What has been debated for some time is how much of our labor problem is ‘cyclical’ (more temporary conditions based on the economic cycle) versus how much of it is ‘structural’ (a byproduct of mismatches between job requirements and qualifications/training of job seekers). We may be at a crossroads of sorts, which of course gets intertwined in the political arena. Consider the following. The U.S. Department of Labor’s mission statement consists of the goal: ‘To foster, promote and develop the welfare of the wage earners, job seekers, and retirees of the United States; improve working conditions; advance opportunities for profitable employment; and assure work-related benefits and rights.’ A balanced objective no doubt, and not unsurprising based on the development of the agency and its historical context (formed in 1913, at the height of political monopoly-busting, workers’ rights and decline of the ‘robber baron’ era). On the other hand, consider the more progressive vision statement of Singapore’s Department of Manpower, which focuses on ‘the aspirations of lifelong learning and the need for Singaporeans to adapt, learn and re-learn skills, attitudes and competencies for lifelong competitiveness.’ Some of the difference could be rooted in cultural differences for sure, and modernized language, but our own labor efforts may need to take on more of this individualized tone if our competiveness in the world is to remain high.

The University of Michigan Consumer Sentiment survey fell from 82.7 in November to 74.5 in December, which was quite a bit weaker than expectations (which called for an 82.0 reading). Much of this was due to more downcast consumer expectations about the future, which is assumed to be related to the ‘fiscal cliff,’ based on survey responses (25% of respondents mentioned higher taxes being a negative from a sentiment standpoint). Inflation expectations, which are also worth watching, edged up to 3.3% for the one-year period, while moved to 2.9% for the 5-10 year assumption—these aren’t too far out of range of normal, and these tend to be spotty and inconsistent as well, but do give us a sampling of what’s on the public’s mind.

Market Notes

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Stocks were a just a touch higher on the week, but only by a few basis points on a net level. Large-caps generally outperformed smaller-caps by a trivial amount. In the S&P, financials and industrials outperformed, while materials and technology underperformed on the week. A large positive story in the financials sector (at least from a share price perspective) was Citigroup, who announced a round of further downsizing, layoffs and possible asset sales—stock markets tend to look fairly positively these types of ‘streamlining’ events.

In foreign equities, emerging market stocks fared relatively well, up nearly two percent, with the biggest gains coming from BRICs China, Brazil and Russia. Many major nations outperformed the U.S. on average.

Treasury yields were very little changed across the curve last week, but the small tick up resulted in high yield and credit outperforming areas like long governments.

In real estate, U.S. retail and Asian REITs performed the strongest on the week, much better than equities overall. In fact, only European and U.S. mortgage REITs rounded out the week in the red.

Commodities all lost ground last week, with precious and industrial metals holding up the best, and energy the worst—as West Texas intermediate crude oil fell from $90 to $86 a barrel, nearly 5%, mostly on news that U.S. oil production has reached its highest level in 15 years.

This has been a slowly evolving story that we find quite interesting. Just a few years ago, many were lamenting the what appeared to be the increasingly energy-dependent state of the U.S., which translated into predictions of $100+ and even $150+ oil in years to come as resources overseas became increasingly scarce, and competition for oil from China and other emerging markets intensified. The picture has shifted a bit recently, however. Horizontal drilling and hydraulic ‘fracking’ are driving a new era in oil production—in fact, American oil is expected to emerge as the largest world oil producer for a period of time by 2020—surpassing Saudi Arabia (amazingly enough). This has certainly been a boon for certain states in the upper Midwest and rust belt, which have been in need of high-quality jobs—these have been the best-performing states in the U.S. during the recovery (North and South Dakota are two significant examples).

Will this activity and technology sea change have a downward effect on price? This is hard to say, since, firstly, oil reserve estimates are constantly being revised—it’s a moving target. Also, prices in other parts of the globe affect overall world pricing, so geopolitical price risk from the Middle East persists. But, assuming these estimates prove correct, we have increasing access to larger pools of previously-inaccessible petroleum. If simple economics holds up, and if this supply keeps up with prevailing demand, prices could remain stable or even fall in the best case. The bad news for the environmental movement during all this is that the biggest hurdle to ‘green’ energy success is a low price for conventional oil.