Economic Notes – January 20, 2014


Written by: Jon McGraw

It was a very busy week in regard to economic releases, so we had to be a bit brief for a few of the less critical pieces.

(+) Retail sales for December came in stronger than anticipated on a relative basis, gaining +0.2% compared to consensus expectations of +0.1%. Removing the choppier items of autos, building materials and gasoline, the ‘core’ retail sales number rose +0.7%, which more than doubled the forecast +0.3%. A near -2% decline in autos was the primary culprit in the difference between headline and core, but the overall number was marked by near +2% gains in grocery stores, apparel and ‘non-store’ (aka online) retailers. Sounds like Christmas to us, despite the seasonal adjustment already made for the holiday. Unfortunately, November core sales were revised down a few tenths to offset some of the positivity of December.

(+) The NY Fed Empire manufacturing index came in stronger than expected, rising from December’s +2.2 to +12.5 for January, its highest level in a year (the expected figure was +4.0). The base details were also stronger for the month, which included shipments, new orders, inventories and employment all up in the double-digits, which is quite significant. Expectations for the future (six-months out, anyway) were also better.

(0/+) The Philadelphia Fed index rose from +6.4 in December to +9.4 for January, which bested expectations calling for an +8.7 reading. The details here came in more mixed than the NY survey, as forward-looking new orders fell, shipments were flat, while employment rose by +5 points. Inventories fell dramatically (by -35 points), but these can be sporadic. While not as strong as the NY Fed survey, these two strong releases bode well for early 2014 economic activity.

(0) Industrial production rose +0.3% for December, which was largely in line with consensus expectations. Manufacturing production did a bit better than the broad figure, up +0.4%, led by autos and auto parts rising +1.6%. Auto assemblies reached a new post-recession high at an annualized rate of 11.8 mil. vehicles. On the downside, utilities output acted as a drag with a decline of -1.4%. Capacity utilization for the month came in a tenth of a percent higher than forecast at 79.2%, the highest level since June 2008. This has historically been viewed as an indicator of pricing pressures in the industrial production pipeline, and while the measure is currently at a ‘strong’ level, it hasn’t reached the low 80’s where it may begin to raise some eyebrows.

(0) The Consumer Price Index rose +0.3% for December, while the core CPI gained +0.11%—both were in line with forecast and remained quite low. The difference between the two can be blamed, as usual, on a +2% increase in seasonally-adjusted energy prices. The less volatile core number was affected by mixed results in several components, such higher clothing and tobacco prices tempered by drops in the prices of airline tickets and prescription drugs, while shelter prices rose at a tempered rate of +0.24%. These numbers have become so small that hundredths of a percent are commonly quoted, despite these small differentials being less meaningful in the whole scheme of things. For 2013 as a whole, headline and core CPI rose +1.5% and +1.7%, respectively, so below long-term historical norms and certainly below the Fed’s target.

(0) Like its cousin, the CPI, the December headline Producer Price Index rose at a tempered +0.4%, while the core PPI gained +0.3% (headline was in line with forecast, while the core figure was a bit of a surprise at two-tenths higher than expected). Similarly, energy price gains accounted for the small differential while components in the core behaved much like those in the CPI, including a tobacco producer price at year-end. Finished goods have only risen in price by +1.4% over 2013, which, when coupled with the tempered CPI reading, only reinforces the lack of overall inflationary pressures in the current environment.

(0) Import prices for December were flat, lower than the forecast +0.4% gain expected. Energy imports gained a similar +0.4%, while capital and consumer goods prices both fell a few tenths for the month. For 2013 as a whole, prices fell -1.3% (-1.2% with fuel impact removed), which alludes to continued lack of ‘imported’ inflation.

(0/+) Business inventories for November rose +0.4%, beating the median forecast by a tenth of a percent. Additionally, October inventory growth was revised upward by a tenth. Within the underlying data, retail inventories rose by +0.8%, autos/parts gained +1.3%, while non-autos rose +0.6%, so consistent across the board. The drag from inventories we saw in Q4 is likely to be smaller this quarter.

(-) The NAHB housing market index of homebuilder sentiment fell one notch from a revised 57 in December to 56 for January. Present single-family sales, future single-family sales, and potential buyer traffic all ticked down -1, -2 and -3 points respectively in the release. That said, sentiment measures here being in the mid-50’s are generally considered to be quite good, and continuing to show improvement.

(-) Housing starts for December fell -9.8%, which slightly surpassed forecast of a -9.7% drop. The single-family group fell -7% while the more volatile multi-family series fell by -15%; all of which unfortunately reversed some of the strong November gains. Building permits fell -3.0%, which was a larger disappointment relative to an expected -0.3% decline. Removing the month-to-month volatility, the housing market continues to trend higher and doesn’t seem to be as affected by higher lending rates as it could be with continued recovery from a few years of underbuilding.

(+) The NFIB small business optimism survey rose from November’s 92.5 to 93.9 for December, beating expectations of a 93.1 reading. The content was generally positive throughout, with survey respondents noting improvement in the economy, higher sales, expectations for more capex spending (this metric being the best since 2008—which is encouraging) as well as more positive sentiment for expansion (in order from strongest to weakest improvements). This is the strongest the survey has been in several months, but remains weak relative to equivalent periods in prior business cycles.

(-) The University of Michigan consumer sentiment survey took a turn for the worse in January, falling from December’s 82.5 to 80.4 (83.5 was expected). The current conditions and future expectations components within the survey generally weakened along with the broad measure. Regardless, the index continues to hover near recovery highs. Insofar as inflation is concerned, year-ahead expectations remained steady at 3%, while 5-10 year expectations moved slightly up to 2.9%. While not noted as such, higher stock prices are usually a tailwind and higher gasoline prices a tailwind for this and similar types of measures—anything that makes us feel ‘richer’ is generally good for sentiment, as we might expect.

(+) The Fed’s Beige Book, the periodic light brown-bound anecdotal survey of regional economic activity, was generally positive as we expected considering the quantitative data over the past several months. Notably, the number of districts reporting moderate growth rose from 7 to 9 (out of 12) in the most recent report—the exceptions were Boston and Philadelphia, which cited modest growth, and Kansas City, that reported the economy held steady in December. Most districts reported stronger retail activity; bad weather weighed on things a bit. With the exception of one district, all reported improving sales and improvement in the manufacturing environment—namely in planes, cars and construction materials. Real estate also rose consistently throughout the country, while pressures on wages appeared ‘contained’ as it was put.

(-) Initial jobless claims for the Jan. 11 ending week fell to 326k, a small positive surprise versus the 328k estimate. Continuing claims for the Jan. 4 week jumped higher, however, to 3,030k, more than the 2,850k expected, which ended up being the highest reading since July (it does not include those covered by the emergency extended unemployment insurance that expired at year-end).

(+) Lastly, the JOLTS job openings survey for November surprised on the upside, with 4,001k openings relative to expectations of 3,930k. Hiring and layoff/discharge rates were unchanged for the month, but the quit rate (an anecdote looked at by economists and the Fed in particular) rose a tenth to 1.8%, which is a small bump but does imply greater confidence in workers relocating to new positions. Overall, however, the rate of hiring continues to be weak relative to where it should be at this point, but the increase in openings outright and as a percentage of the total working labor force is a demonstration of continued improvement.

That leaves us the final question of where we stand in the economic cycle…

Despite the improvement, we are reminded that expansions do not generally die of old age, but of excesses, overheating and eventually, monetary tightening – not to mention the wildcards of external shocks like a 1970’s style oil crisis, war or any other number of unforeseen events. At present, slack continues, meaning output and job creation could be better (and is getting better). In addition, inflation remains low—in fact, as mentioned above, it is running lower than the Fed would prefer. Since World War II, business cycles have generally lasted 4-8 years, and we’re still in the shorter end of that right now.

Some of this improvement is already reflected in market pricing, no doubt (2013 stock market returns are a reflection of that). But, there is also the possibility that growth could continue as economic conditions continue to undergo a huge repair from the 2008 period and rebuild towards ‘normal.’ What ‘normal’ is has been debated at length—either a 2.5-3.0% GDP growth environment or, more worrisome, a 2%-like muddle-through condition pulled lower by demographic factors and a corresponding lull in innovation and consumerism. Time will tell which of these two camps is correct. So far, the bullish case appears to be in favor.

Market Notes

Despite some volatility over the course of the week, U.S. stocks ended roughly flat. Technology and telecom stocks led the way, while consumer discretionary and energy lagged with over -1% losses on the week. Earnings results so far have been mixed, with only a tenth of firms in the S&P reporting, but results ranging from generally in-line with expectations to small positive surprises. About 70 firms, representing about a fifth of the index, report this week in a variety of industries, which will provide a clear view of conditions.

Foreign stocks were led by solid performances by the U.K. and Eurozone, while Japan lost ground on a limited trading week with a poor balance-of-payments report. Specifically, we have seen improved numbers coming out of Europe, examples being better consumer sentiment and retail sales in the U.K. and industrial production in Italy.

Emerging market returns were mixed and nation-specific for a change. Indonesian stocks rallied in response to the government’s that all nickel and bauxite exports have been banned (nickel being about a third of that nation’s output), while taxes on copper exports are being raised 60%, both in an effort to diversify the economy away from raw materials export into more meaningful manufacturing activities. Australian stocks lost ground on a terrible unemployment report, which weighed on the Aussie dollar and could cause continued interest rate easing. Turkey, Greece and Mexico also lost several percentage points on the week.

U.S. bonds rallied strongly with a 5 b.p. fall in yields that coincided with mixed economic data. Again, it doesn’t seem like much, but when coupled with duration, price moves can become dramatic. Accordingly, long treasuries led the way, as did investment-grade credit and high yield. Short-term bonds and TIPs lagged with flat or slightly negative returns.

The dollar rose by a bit more than half-a-percent on the week, which carved off roughly the equivalent amount for developed market foreign bonds. Emerging markets didn’t have the same dollar headwind, so were able to earn a positive return on the week.

Real estate returns were led by European real estate, U.S. industrial/office and retail. Asian REITs brought up the rear.

Commodity indexes were higher by about a percent on the week. Natural gas prices, volatile as always, spiked on the week with reported lower inventories following huge cold weather usage. Precious metals, nickel and crude oil also led in the gainers category—gold due to stronger Chinese physical demand and lower long-term real yields, nickel due to the Indonesian news mentioned earlier and crude oil on a surprise drawdown in stockpiles. Sugar fell sharply on a reported surge in crop harvests, notably from Brazil and Thailand, while coffee prices also dropped due to record output globally.

Happy MLK Day and have a great week!