Economic Notes – July 8, 2013
Despite it being a fairly quiet Independence Day week, a few significant releases made the news and affected markets later in the week.
(+) The ISM manufacturing index came in a bit better than expected, rising from 49.0 in May to 50.9 for June (vs. a forecasted 50.5 number). Forward-looking new orders and production both improved, but employment fell and inventories rose a bit on the negative side, as did raw materials prices. Manufacturing employment fell for the first time since Fall 2009 (more on that later). The best industries from a growth standpoint were furniture/related products, apparel, electrical equipment and appliances (several not a surprise, considering the housing recovery); while the worst were computer/electronics, chemicals and transports. From anecdotal survey comments in a variety of industries, business seems to be growing…albeit slowly.
(-) Conversely, the ISM non-manufacturing index fell, somewhat unexpectedly, from 53.7 in May to 52.2 in June—versus a forecasted 54.0 result. The forward-looking new orders dropped, as did overall business activity and new export orders. However, the employment component posted a solid gain. Interestingly, the non-manufacturing index was the mirror image of the manufacturing version. Anecdotal comments from respondents in these industries reflected a more challenging and nuanced environment, with cost savings measures playing a role in profitability, greater volatility in customer behavior, and uncertainty surrounding the healthcare reform issue.
(0) Construction spending was slightly lower than expected, growing at +0.5% versus an expected +0.6% rate. There were some revisions higher for prior months of 2013 (particularly a large one in January) that affected the underlying base levels a bit, however.
(0) Factory orders for May rose +2.1% for the month, which was a slight surprise on the upside compared to the expected +2.0%. The transportation sector, which tends to be volatile, boosted the final numbers for the month, although core capital goods orders were also revised higher. Manufacturing inventories were generally flat on a net basis. The inventory-to-shipments ratio ticked down a bit from a high point in that series (to 1.3), meaning less inventory buildup is taking place.
(+) Motor vehicle sales surpassed expectations again for June, growing to 15.9 mil. seasonally-adjusted annualized units, versus a consensus estimate of 15.5 mil. The domestic portion of June sales came in at 12.4 mil., which was above the estimate of 12.1 mil. Total sales reached their highest levels since 2007, and have been on a steady path of recovery since the economic trough in 2009.
(-) The U.S. trade deficit widened substantially in May, to -$45.0bn versus an expected -$40.1bn, as exports weakened -0.3% and imports rose +2%. The biggest impacts were in areas outside of petroleum (the largest deficit component), such as a drop in consumer goods exports that partially reversed a sizable gain in April.
(+) Initial jobless claims for the June 29 week fell to 343k, which were a slight improvement on expectations of 345k and a drop from the prior week’s revised 348k figure. Continuing claims for the June 22 week came in at 2,933k—lower than the 2,958k expected.
(+) The ADP employment report, which serves as a precursor to the big government release on Friday but doesn’t always show a lot of correlation to it, surprised a bit to the upside with +188k jobs added (versus the median forecast of +160k). The details included +21k in construction jobs, +1k in manufacturing (a reversal of losses from prior months), +40k in professional/business services, and +43k in trade/transportation.
(+) On an otherwise quiet Friday, the employment situation report came in better than expected. The unemployment rate was unchanged at 7.6% (despite forecasts for this to drop 0.1% to 7.5%), but the labor force participation rate improved—which was taken as a positive development, even if it was by only a tenth of a percentage point. Nonfarm payrolls grew by +195k in June compared to the median forecast of +165k, and a total of +70k jobs were added to the prior month reports. For June, the largest job gains were in leisure/hospitality of +75k, professional/business services of +53k and retail trade of +37k, while manufacturing lost -6k. Aside from planned ongoing attrition from the U.S. Postal Service, Federal government job losses were minor (which surprised some fearing the worst from sequester effects). Peripheral data, such as average hourly earnings rose +0.4% (+2.2% year-over-year), compared to the expected +0.2%, while average hours worked were unchanged at 34.5. The aggregate weekly payrolls (which combine employment, hours worked per worker and per hour earnings) ticked up +0.6%—the important part about this being the correlation to wage growth as an inflation input. This appear contained and in line with other data.
The bottom line is that the strong report raised the probability of the Fed ‘tapering’ bond purchases perhaps sooner than it might have otherwise (perhaps this fall rather than winter). This boosted interest rate expectations, making this a bad day for bond prices; on the other hand, equities were stronger on the report. These responses are much more typical of the response we would expect. But don’t count out the Fed and their mission to keep rates as low as possible while the recovery is solidifying—some analysts are now saying the 6.5% threshold could even be reduced somewhat to lengthen their timeframe. The Fed seems quite adamant about some inflation forces taking hold and appear quite willing to err on the side of stimulus until they do—rather than run the risk of any deflationary or stagnation outcomes.
This gets beyond investment markets somewhat, but the employment picture is also a more complicated story than it first appears. The jobs being added are of an increasingly lower-end service, retail and temp variety, as opposed to manufacturing and other higher-wage skilled labor. There has been quite a bit of research by the Fed and other economists about this trend, and whether this is a continued cyclical aftermath from the Great Recession, or is a deeper structural issue. The answer is not yet conclusive either way and may take time to determine.
Stocks were flat for most of the shortened week until Friday, where the positive employment report boosted sentiment. From a sector standpoint, cyclical consumer discretionary, energy and technology stocks led, while utilities and consumer staples lagged. Small-cap stocks gained strongly, as one would expect from a domestic-driven rally.
Developed foreign stocks also gained, led by Japan, Spain and the U.K., while some of the largest emerging market nations, such as Brazil and Turkey, continued to suffer. In Brazil’s case, continued rioting and lackluster GDP prospects continued to weigh on investment markets.
Bonds were well-behaved until Friday, when prices plummeted on higher rates accompanying the jobs report. As expected, floating rate performed the best, while long treasuries lost several percentage points on the week. Emerging debt suffered again with tighter liquidity conditions in those markets.
The fixed income positions in our portfolios generally held up well last week (much better than the broader BarCap Aggregate), with positive contributions from floating rate, developed market foreign debt and high yield. This is in keeping with shorter durations and positioning for higher interest rate conditions.
European REITs were the strongest performing real estate securities on the week, followed by Asia and U.S. office/industrial, while mortgage REITs fell significantly on prospects for higher interest rates.
In the commodities asset class, crude oil gained sharply (over 5%) on a combination of reduced stockpiles in the U.S. and continued unrest in Egypt to a 14-month high. Other members of the energy complex, including heating oil and unleaded gas, also rose as a byproduct. On the other part of the spectrum, several agricultural commodities such as soybean, sugar and corn, fell over 3% on continued poor sentiment and strong supply prospects this summer. Weather conditions have generally resulted in stronger harvest forecasts and consequently lower prices for this summer—this may reduce pressure on food price inflation if it continues, although it takes time to filter in.
Have a great week!