Economic Notes – December 23, 2013


Written by: Jon McGraw

(+) We discussed this already in depth via the mid-week ‘Fed Note,’ but the FOMC elected to taper—on the order of $10 bil. in total (taking the monthly $85 bil. purchases down to $75 bil.). Per the official statement and Ben Bernanke’s Q&A afterwards (his last as Fed Chair), the focus was on ‘forward guidance,’ which referred to the current intentions of the Fed to keep rates as low as possible for even longer than previously anticipated, despite the tapering, and likely beyond the point where the 6.5% unemployment target is reached—inflation permitting. This was a change from the previous meeting, and the item which spurred a positive market reaction as expectations for simple tapering either now or in a few months already seemed to be a foregone conclusion, as was the expectation for QE bond-buying to be completed by 2014. Based on current economic and employment forecasts, the first round of rate hikes appear to be slated for late 2015 to early 2016.

(+) Industrial production was stronger than anticipated for November, showing a gain of +1.1% versus an expected +0.6%. On the headline side, utilities production rose +4% due to especially cold weather, so can be discounted somewhat. Manufacturing as a component of overall industrial production (essentially the series without the mining and utilities segments) rose +0.6%, which outperformed forecast by two-tenths of a percent and was led by +3% gains in motor vehicle output, although the non-autos elements themselves gained a half-percent—considered strong across the board. The October report for manufacturing was also revised upward by +0.5%, which is a positive. Capacity utilization for November reached 79.0% relative to a median forecast of 78.4%, which is actually the highest level since 2004.

(-) The Empire manufacturing survey for December came in slightly weaker than expected, at a level of +1.0 relative to consensus +5.0, but was an improvement upon November’s -2.2 report. The underlying elements in the survey were a bit mixed, with the positives being improvements in shipments and new orders (albeit still negative), while employment remained flat and capex expectations for the 6-mo. look-ahead period falling a bit despite staying positive. Anecdotally, on the qualitative side, survey respondents mentioned employee benefit costs and (interestingly) finding enough qualified workers. The benefit cost comment is in line with other broader business surveys, especially those for smaller companies; the qualified worker note has been seen a few times (not consistently) in several surveys, and points to an underlying worry of some economists and the Fed in that some unemployment is become structural rather than only cyclical. This is a topic we’ve touched on in previous reviews.

(-/o) The Philadelphia Fed index rose a half-point to +7.0 for December, but fell below the expected consensus of +10.0. New orders, shipments and employment all improved by at least a few points, while only capex plans for the coming half-year fell by 10 points, making this a generally positive report.

(-) The preliminary Markit PMI release for December was slightly disappointing, falling to 54.4 from a revised 54.7 number in November (compared to an expected 55.0). In the details, new orders and output declined; however, employment rose by just over a point—in essence, the opposite of the pattern we’ve been used to.

(0) The consumer price index for November was unchanged, compared to the forecast of a slight +0.1% increase. The core CPI component, sans food and energy, rose +0.15%, versus consensus calls for +0.1%. The largest individual increase over the month was hotel lodging, which gained +3% and reversed an earlier decline, and owners’ equivalent rent gained +0.3%. Over the trailing 12-month period, the headline and core CPI increased +1.2% and +1.7%, respectively, which are largely unchanged from trend and, of course, still significantly below the Fed’s target level.

(+) The U.S. current account deficit in the 3rd quarter narrowed a bit, to $94.8 billion (versus expectations of a $100.2 bil. final figure). The difference was almost entirely accounted for by an improvement in income, as the trade balance for goods/services moved closer into deficit. To put it into perspective, those figures tend to change by about $2-5 bil. each, so up to 5% of the total.

(+) The nonfarm productivity figure for the 3rd quarter was revised up from +2.8% to +3.0%, which outperformed forecast (which called for the original number). Business output rose a percent to just under +5% while the number of hours was unchanged—the total productivity number for the trailing year was a quite low +0.3% and line with the multi-year trend. Unit labor costs (comp. per hr./output per hr.) were revised down almost a full percent to -1.4% for the quarter, which was on target with what was expected. Strangely, over the start of the Great Recession and since, we’ve seen a negative correlation between productivity and employment. The timing of this no doubt is related to the depth of business slowdown during the crisis, but are jobs being eliminated by technology?

(-) Existing home sales fell -4.3% for November, to 4.9 mil., versus an expected lesser decline of -2.0%. Both main categories were down: single-family by -4% and condos/co-ops by -8%, and the months supply of homes rose a few tenths to 5.1. All four major regions of the U.S. experienced weaker sales for November.

(+) The NAHB housing market index gained more than anticipated, from November’s 54 to 58 in December, which beat the forecast of 55. This changed the momentum from a bit of autumn weakness and re-established another post-recession high. The details of the report showed gains in current sales, future sales expectations and buyer traffic—so broad-based in that regard.

(+) Housing starts for the past three months were all released together, due to delays from the government shutdown (the impacts sadly continue). Now old news, the Sept. and Oct. starts were largely flat, but November gained more than expected, +22.7% to 1,091k versus consensus expectations of 955k. It was the largest single monthly gain since 1990, which was surprising considering the colder weather that month, and showed strength in both single-family (+21%) and multi-family (+27%). Building permits fell but didn’t do as badly as expected for November, at 1,007k permits compared to the expected 990k result. Here single-family units gained a slight +2% while multi-family dropped -11%. These particular data pieces should help 4th quarter GDP somewhat.

(-) Initial jobless claims for the Dec. 14 ending week rose from 369k to 379k, above the consensus estimate of 336k. Again, this time of year can be a bit volatile and dependent on the timing of when the holidays occur. Continuing claims for the Dec. 7 week came in at 2,884k, also a bit higher than the 2,770k expected.

Lastly, the third and ‘final’ estimate of third quarter GDP was tweaked up to +4.1%, compared to the consensus estimate of +3.6% (unchanged from the second estimate released last month). Encouragingly, personal consumption expenditures were responsible for 80% of the upward revision—services in particular, which was the primary lagging component so far in the recovery (much more so than durable and non-durable goods). At the same time, the second revision’s large impact of inventory accumulation remained intact, which is less impressive. The most recent release and over-4% result provides some hope that the economic recovery could be gaining some traction and made the Fed’s taper decision even more appropriate and timely.

What about the 4th quarter? Expectations continue to remain on the lower side (2.0-2.5%) although some of the more bullish folks think 3% is possible. The recent housing starts figures and decent results from various manufacturing surveys this quarter lend some support to this, as does the strong revision for the third quarter.

For 2014, a good number of economists expect stronger results (of course, the more that agree, the more skeptical we should be perhaps). On average, the estimates for full-year GDP range from 2.5% on the low end to 3.0-3.5% on the more optimistic side (consensus is in the high 2’s). Even bearish PIMCO upped their forecast to 2.5% or so, which reverses some of their prior bearishness. The reason is a reduction in public sector drag as well as continual improvements in housing and consumer spending (particularly in services, that had been lagging up until now in the cycle).

Market Notes

Stock markets were mixed early in the week but rallied on Wednesday with the Fed’s taper yet-continued easing decision—the additional forward guidance of lower rates for longer was no doubt behind a lot of this. We saw the day referred to as ‘historic,’ but that’s probably a stretch. The last two trading days of the week were more muted, but showed positive carry-through nonetheless.

All sectors in the S&P gained ground, but were led by telecom, up 4%, and industrials, while more defensive consumer staples and utilities ended up with sub-1% weeks. Small caps outperformed large caps, in line with the strong sentiment. Specifically, as a status check on the holiday season, it was interesting to note that Amazon reported ‘date-shifted’ same store sales gains of almost 40% between Nov. 28 and Dec. 15, while eBay sales rose 21% over the same period on a year-over-year basis.

Developed foreign stock markets were also generally higher, with Europe/U.K. names up 3%, with strong manufacturing and sentiment data, and Japan up 1%. Emerging markets, however, lost ground on average. Results here were driven by weak results in Chinese stocks, which lost ground with a weaker PMI and a People’s Bank of China intervention to alleviate a money market cash crunch.

Bonds provided an interesting mix, with higher rates for the 2- and 5-year Treasury, while the 10-year barely moved on the week and the 30-year rate actually fell a bit. The Fed’s mixed message of tapering bond buys while also keeping the strong accommodation message intact falls right in line with this. The best performing issues were long treasuries, corporates and emerging market bonds due to duration effect and tighter spreads, while intermediate-term treasuries and developed market foreign bonds lagged with negative returns.

With news of ongoing Fed accommodation, real estate investment trusts gained several percentage points, the best of which were industrial/office and mortgage. Asian and European REITs were also positive, but to a lesser degree, while U.S. residential only rose marginally.

Commodities were generally higher on the week with positive economic numbers and general positive sentiment towards risk assets. Unleaded gas and industrial metals such as copper and lead gained several percent and led the way, followed by crude oil also up nearly 3%. On the negative side, precious metals fell several percent with the same improved economic data and lessened global worries. In looking back at 2013 as a whole, we saw the usual volatility and disparity in the commodities universe with a general trend towards the negative in terms of returns (the DJ-UBS index is down almost -10% year-to-date). The strongest returns were in the agricultural contracts of soybeans and cocoa, both of which were up +20%, followed by natural gas and crude oil, which were up around 10% so far this year. On the most dramatic losing side, wheat, coffee, gold and silver are all down over -25%—silver being the worst of the bunch.

In the municipal bond arena there continue to be headline-worthy goings-on here. As you might expect from the political and economic micro-climates that affect the multitudes of issuers (of which there are tens of thousands—most of which pay their interest on time and without incident and you’ll never hear about). In particular, the U.S. territory of Puerto Rico has come under fire for continued strains in fiscal conditions, and review by several rating agencies and insurers. If it sounds like the high-profile difficulties faced in several other locales like Detroit, the situation is similar, although perhaps less dire. One big problem in muni land is a systematic one—muni bond income from U.S. territorial obligations (which also include Guam and the U.S. Virgin Islands) are treated as ‘triple-tax free,’ so can offer the same tax exemption from federal and state/local taxes as can bonds from one’s own state. For that reason, they’re of particular investment interest to single-state muni funds who dabble in these for diversification from the bonds in their primary locale, but more so for their higher yields. By far, Puerto Rico is the largest of these sub-markets, and the territorial government has used that demand to its advantage by dialing up fiscal leverage, which itself has created budget sustainability issues. (In munis, like in any other bond market, higher yields tend to coincide with higher underlying risks—recent Puerto Rico general obligation debt in the 8-year range is yielding upwards of 10% on a yield-to-maturity basis.) The more prudent muni funds only hold a nominal amount of riskier debt like Puerto Rico, commensurate with these risks, but there are some notable exceptions in the open-end and closed-end fund worlds that own significant percentages. Like any with these types of characteristics, these are bonds that should be handled with care, should you use or come across funds with such exposure.

Here’s to a safe, fun and relaxing Holiday and New Year for all!