Economic Notes – November 18, 2013


Written by: Jon McGraw

A week shortened by Veteran’s Day left us with fewer data points than usual, but enough to weave a story around.

(0/+) Industrial production fell -0.1% in October, which was a bit of a surprise considering expectations called for a +0.2% increase. Much of this was due to a 3% drop in natural gas utilities output, caused by a stretch of warmer weather, so this element should be discounted. Otherwise, the larger and more economically-relevant manufacturing production component rose +0.3%, which beat consensus expectations by a tenth of a percent. It would have been even a tenth better if it weren’t for the single area of autos/auto parts production, which held things back. Wholesale inventories rose +0.4% for September, matching consensus, led by a larger gain in non-durables than durables, and the August number was revised upward by 0.3%. Interestingly, since much of the third quarter GDP results came from inventory build, these better numbers might even boost final GDP a bit in the next release.

(-) Capacity utilization for October was disappointing, at 78.1%, compared to an expected 78.3%. Interestingly, capacity utilization often falls in a fairly tight band—the current level is in line with modest business investment growth. (To put it into perspective, levels over 76% usually correspond to positive growth, the average for the U.S. since the late 1960’s is 80-82% and levels above 82% or so often correlate with overheating and heightened inflation risks.) At the same time, business investment also tends to follow sustained improvement in corporate profits—which has been slowly occurring over the past quarter or two. This is intuitive in that firms spend money on growth when they feel the ‘tide has turned,’ so-to-speak and re-investment going forward looks to make better sense.

(-) The Empire state manufacturing survey came in weaker than expected for November, ending up at a level of -2.2 versus an expected +5.0. In the underlying components, shipments, forward-looking new orders and employment all declined, as did look-ahead capital expenditure expectations—so generally a tough month across the board.

(+) Import prices fell -0.7%, more than the expected -0.5%—largely led by a -3.6% decline in energy prices, while consumer and capital goods prices were largely unchanged. The last year saw import prices fall -2%, which adds further support for tempered inflation—especially imported from abroad; in fact, quite the opposite.

(-) The NFIB small business optimism index fell from 93.9 in September to 91.6 in October, falling below the expected 93.5. Almost all segments of the survey deteriorated, including expectations for higher sales and economic improvement (the latter fell from bad to worse). Much of this pessimism seemed to be tied in with the government fiscal debate, as has been the case for several months—highlighted by the fact that a record number of small business owners blame the Washington political climate for this being a bad time to expand business efforts. While not specifically noted by name, no doubt Obamacare has had something to do with this as well, as the uncertainty underlying costs, premiums and coverage intricacies has not improved in recent months.

(-) The September trade deficit widened to -$41.8 bil. vs. the median forecast of -$39.0 bil. Both the petroleum and non-petroleum balances widened into deeper deficit, as imports rose by +1.2%.

(0) Nonfarm productivity for the 3rd quarter grew at +1.9%, which trailed the estimate of +2.2%—productivity hasn’t increased for the past year. Of this total figure, business output rose +3.7%, while total hours gained +1.7%. Unit labor costs actually fell -0.6% for the quarter, which underwhelmed the estimate of a minor -0.1% decline; total compensation per hour rose at a 1.3% annualized rate, which is quite tempered and in keeping with other price indexes. These latter factors are interesting to keep tabs on due to the embedded inflationary pressures therein and could serve as a useful signal.

(-) Initial jobless claims for the Nov. 9 week fell a bit from a revised 341k to 339k—higher, though, than consensus calls for 330k. While the large data discrepancies seem to be behind us, the Veteran’s Day holiday did cause claims for five states to be estimated. Continuing claims for the Nov. 2 week came in at 2,874k, which was unchanged from the prior week and near expectations of 2,870k.

Lastly, the Senate Banking Committee confirmation process for potential incoming Fed chair Janet Yellen has proceeded largely as planned; albeit for even more dovish talk than we first expected, given the political sensitivity to excessive/ongoing stimulus spending. The initial prepared statement and Q&A session cast more light on Yellen’s views concerning the use and breadth of economic stimulus. Like Bernanke, she has been and looks to continue a predilection towards accommodation, but her comments include the added twist of a deeper focus on labor markets than Bernanke.

Overall, it looks like she believes the benefits of accommodation continue to exceed the costs and doesn’t see signs of any bubbles at this point (side note: who does, until after the fact?). Considering those factors and her focus on the economic fragility due to ongoing troubles with job growth, and the unemployment overlay which translates into her own ‘optimal control model’ assessments, we could be in for a longer QE period than was originally anticipated.

Are Bernanke and Yellen seeing something other economists aren’t? No, but their objectives are different.

Many brokerage and bank economists take more of an all-encompassing, global viewpoint, especially as global financial markets have become more integrated. Of course, that’s related to the fact that their attached firms offer products in a variety of asset classes and essentially offer several choices about where to invest—so it’s easy to prop up their favorites and throw stones at the others. Government economists, on the other hand, do retain a worldview as it affects domestic affairs and our place in the global economy; however, the sole focus is the internal welfare of the United States.

In recent years, this has incorporated employment conditions, and requires a difficult balancing act between decisions that don’t often work well together (we’ll avoid going into another discussion about the problems inherent with the Fed’s dual mandate of price stability and full employment). So, even if we see economic data get a lot better, we may also see less action than we normally would until the jobs picture improves. It may also include lowering the Fed unemployment threshold from 6.5% to 6.0% (or even 5.5%) in order to buy more time.

Market Notes

Stocks hit an all-time high this week yet again.  The Yellen hearings seemed to reinforce the positive market sentiment, to the extent that the tone leaned toward perpetuating the status quo—easing as far as the eye can see (as noted above).

From a sector standpoint, consumer discretionary and health care gained over 2%, while telecom was the primary laggard, losing a few basis points on the week.

Developed foreign stocks returned in line with U.S. equities—much of which related to the impact of the dollar, Yellen testimony and potential of continued QE (incredible how much of the world’s sentiment is focused on this).  Japan gained 4%, on a stronger U.S. dollar vs. the Yen, which surpassed greater Europe’s sub-1% and a flat result in the U.K.

In emerging markets, China gained over 4%, as did Brazil.  In China’s case, the optimism stemmed from potential government efforts to elevate the role of markets, as the Communist party ‘plenum’ concluded with 15 bullet points and 60 ‘concrete tasks’ laid out by the council.  Per usual, there is a lack of transparency about what is really happening behind the scenes, but there does continue to be a realization of the importance of free market activity and global integration as the size of their economy expands.  While policymakers are still hoping for double-digit GDP gains, such growth could be more challenging unless traditional export activity from lower-value-added goods is balanced with consumer demand from within.  Additionally, there appears to be signs of both bank and non-bank financing tightening from a supply standpoint, which has been watched for some time due to the impact on local housing markets.

Bond prices ticked up with rates moving lower a bit, perhaps aided by positive Yellen sentiment.  Long treasuries gained, as did international bonds with the dollar falling about half a percent on the week.  Most other issues gained in line with the index, but all were in positive territory.

REITs experienced a strong recovery week, with most categories up 1-2%, with Asia leading, Europe lagging and most U.S. sectors right in the middle, including retail and office/industrial.  This stood in contrast to the ~4% losses for the week prior.  REITs had been hit hard off-and-on due to speculation of tapering, which caused a push upward in interest rates; however, the dovish Yellen testimony seemed to help here as well last week.  Over the short-term, REITs often respond with some sensitivity to upward moves in rates, in common with other higher-dividend securities, like preferred and utility stocks.  However, longer-term real estate fundamentals are usually more closely tied to tenant demand, supply of properties and underlying economic trends (so, if the economy is improving, this is typically a good thing for commercial real estate).  One negative is that borrowing costs rise along with these higher rates, so the cost of carry is tightened, but this is true for other businesses as well—not only real estate.  In our opinion, REITs continue to look a bit inexpensive to fairly valued, based on conventional views, with opportunities for better valuation exist outside of the U.S.—particularly in Europe, where the global recovery is taking a bit longer to materialize.

Commodities were generally flat on the week overall, with strong results from cocoa and natural gas (the latter being somewhat weather-dependent in the week-to-week analysis; last week was due to lower-than-expected inventories).  While gold prices were relatively stable, silver fell off by several percent, which added to its (-33%) loss year-to-date (the worst commodity performer in 2013).  Odd, but not unheard of.  While silver certainly possesses some of the same precious metals following as gold, it trades at a fraction of the price, so is often swayed by retail demand—as well as a tie-in to some industrial activity as well.

Crude oil sold off dramatically this week, by a few percent, as the IEA announced its prediction that increased shale oil/fracking activity would propel the U.S. to the lofty status of top global oil producer by 2015.  In terms of moving parts, commodities can be a complicated asset class at times but we believe the long-term benefits of the non-correlation to other asset classes remain compelling over time for more aggressive investors.

Have a great week!

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