Economic Notes: September 8, 2014


Written by: Jon McGraw

  • Economic data for the week came in fairly strong, highlighted by the ISM manufacturing report, which is closely watched by markets. However, the August employment situation report for August was a bit disappointing.
  • S. stocks gained on decent economic data and eased geopolitical tensions; bonds lagged on higher rates.

(+) The ISM manufacturing index for August came in stronger than the expected 57.0, rising to 59.0 and now lies just under the recovery high of 59.3 set in early 2011.   New orders and production were stronger by several points (new orders showing the best result in over 10 years), while employment dropped off a bit. All but one of the 18 industries measured reported growth last month and anecdotal commentary included in the compilation of the data was quite positive (other than some concerns about foreign geopolitical events).

(+) The ISM non-manufacturing index for August also came in stronger than expected, rising to 59.6, almost 2 points above expectations. Business activity and employment were both several points higher, while new orders here ticked down a bit (although remaining at a high level).

(0) Factory orders for July rose +10.5%, which was strong but still below consensus expectations of a +11.0% increase. The reading was highlighted by a record level of civilian/non-military aircraft orders, which tends to be a sporadic contributor on a month-to-month basis due to the magnitude and nature of the aircraft business, so not as helpful in isolation. Manufacturing inventories increased just a tenth, due to durable goods, while non-durable inventories fell almost a half-percent.

(+) Construction spending for July gained +1.8%, which was stronger than the forecasted increase of +1.0%. Residential gained +0.7%, while non-residential rose +2.5%—generally split between private (oil and gas power mostly) and public construction.   Highway/street activity rose +7% in the month, despite Federal highway trust fund fears earlier in the busy summer season.

(0) Nonfarm productivity for the 2nd quarter rose +2.3%, just a tenth of a percent below forecast. Unit labor costs declined -0.1% for the quarter, which fell below the expected increase of +0.5%; over the past year, these are +2.8% higher, slightly higher than or on par with other inflation measures (now that policymakers appear to be watching wage pressures more closely in recent quarters).

(+) Initial jobless claims for the Aug. 30 ending week came in at a roughly unchanged 302k, about 2k above expectations. Continuing claims for the Aug. 23 week came in a bit lower than expected, at 2,464k, compared to consensus estimates calling for 2,510k.

(-) The ADP employment report showed a job gain of +204k for August, but underperformed the median forecast calling for +220k. Compared to the prior month revised figures, jobs in trade/transports/utilities fell, but were stronger in manufacturing. These haven’t been strongly correlated with nonfarm payrolls on initial release, but do slightly better upon revision.

(-) Despite a strong trend as of late, the August monthly employment situation report was a bit of a disappointment. Nonfarm payrolls rose +142k in August, which paled compared to the +230k expected, and was coupled with a net revision downward of -28k for several prior months.   From an industry perspective, manufacturing fell by the largest amount (with no gain) and a -8k drop in retail, although the manufacturing component may have been related to less extreme summer auto plant shutdowns compared to normal, which depressed re-hiring.

The unemployment rate fell a tenth to 6.1%, inline with consensus. This was largely due to a one-tenth decline in the labor force participation rate, to 62.8%. The household employment component showed a gain of +16k, while the ‘payroll consistent’ version of this to account for definitional differences, equated to a decline of -41k jobs. The U-6 underemployment measure improved two-tenths to 12.0%, the lowest point since Fall 2008 when the graph was moving in the opposite direction higher. Average hourly earnings rose +0.2% on the month, which was on target with expected, bringing the year-over-year gain to +2.1% (even more tempered than the unit labor cost report noted earlier). The average workweek came in at an unchanged 34.5 hours.

(0) Lastly, the Fed beige book from the September FOMC meeting again showed growth around the country in the range of ‘modest to moderate,’ with very little change from the previous release. This has been the story of the last several years, and was reiterated in the anecdotal data from the individual Fed districts. Consumer spending has improved in recent months, as noted in the book, especially in autos and back-to-school sales, as well as in summer tourism. Housing effects were mixed, with about half of the reporting districts showing stable/growing activity (multi-family building in urban areas a high point), but residential mortgage demand was less dynamic overall (and certainly less than the Fed had hoped). Otherwise, loan demand improved across the country—mostly in auto loans—but business credit also expanded, which is another critical area being closely monitored.   Reports on inflation/wages looked relatively stable from the last report.

Not mentioned in the beige book, but a worthy side note is the larger proportion of auto loans deemed ‘sub-prime,’ rising to levels last seen before the financial crisis (at about a quarter of all car loans). We might delve into this phenomenon further at a later date if necessary, as there are some similarities but also some important differences between these types of loans and the low-quality mortgages that helped jumpstart the financial crisis. The similarities are common to all types of loans for which credit conditions have been eased: low interest rates (per the Fed, passed through to automakers and finance companies) and longer terms. The normal term for an auto loan used to be 36-48 months—these have expanded to 60-72 months in recent years to allow for lower payments and greater availability for a wider array of increasingly expensive models for a larger segment of society. Ironically, Henry Ford was a strong critic of debt in general and didn’t agree to participate in vehicle financing until the 1930’s when the industry was already well-established. Obviously, as with any loan, ability to pay and sufficient underwriting standards are the lynchpin to avoiding credit losses.

There are some large differences between auto loans and home mortgages, however. The auto loan market is about one-half the size of the sub-prime market at its pre-crisis peak. Another is the size of the individual loans themselves (obviously, the fraction of the cost of a home in most cases, and lower per household payment in nominal dollars). Another is the implied assumption behind what is ‘supposed’ to happen to a home or car over time. Per their long-term price behavior, single-family homes have historically been modeled to hold their value or rise in price with inflation (unfortunately, these assumptions became stretched a decade ago when the possibility of losing value wasn’t even considered, and exponentially high growth in some regions was deemed perpetual—both errors of rating agencies in hindsight). By contrast, most autos lose value immediately after being sold, and are subject to continual depreciation during their short lives, so higher loan ‘spreads’ have helped compensate lenders for this eroding collateral protection over time. If these assumptions don’t hold true, cars tend to be more easily repossessed than homes, due to the unique legal status of real estate as well as vastly differing jurisdictional nuances. Regardless, this remains a double-edged sword for policymakers and lenders:   kick-starting economic growth through the promotion of easy credit for goods purchases on one end, but retaining financial prudence/common-sense on the other.

Market Notes

U.S. equities moved slowly higher on the week. From a sector standpoint, consumer staples led with a 1% gain, followed by utilities, while energy fell back, losing almost -2% on the week. Large-caps continued to outperform small-caps domestically.

Developed market foreign stocks were mixed, with half-percent gains in Europe and Japan, while the U.K. fell backward by almost a percent.   Emerging markets were the leaders again on the week, this time led by Russia, China and Poland—the former due to a reported cease-fire with Ukraine (strange being that they were never an official participant, but involved nonetheless).

The seesaw in fixed income continued, with mid- to long-rates moving higher by 10-15 bps on some stronger economic growth numbers—consequently, long bonds suffered the brunt of the damage, but the higher volatility didn’t help any segments to a positive degree, at least in the U.S. Some areas like high yield corporate were lower on a seasonal change from summer slumber to an autumn-like higher-issuance mode, creating some spread widening.

The ECB cut its benchmark rate from 0.10% to 0.05% as well as rolled out plans to purchase private asset- and mortgage-backed securities, but stopped short of a full ‘QE.’ As expected, most European bonds gained on lower yields following the announcement, with the periphery leading the way (Italian bonds, for one, have experienced a great run over the past 12 months).

Real estate groups were generally in the positive on the week, in line with broader equities. U.S. core REITs gained just below a percent on the week, followed by Asia at half that pace, and Europe faring worst with a loss. Obviously, weak European tenant demand fears go along with a weak economic growth, rendering this fairly easy to explain.

Broad commodities indexes were down about a percent on the week, about the same magnitude as the increase in the U.S. dollar on the week.   Industrial metals, particularly nickel, led the way. On the downside, grains, cocoa and natural gas fared weakest—in the case of natural gas, a dramatic -7% decline—on forecasts of cooler summer weather.   Strong crop harvest forecasts have resulted in potentially higher supplies and price declines in the agricultural group as of late. Good for food prices/inflation fears, bad for commodity investors.