Bouncing Up or Bouncing Back?
After some truly horrendous data in December, January, and February, the economy needed its recent show of strength just to get back to the trend line.
With a flood of economic data, earnings, and merger news, equity markets managed just a small gain this week. The S&P 500 gained 1% while European markets grew a faster 1.5%, and emerging markets an even faster 2%. Interest rates continued to fall despite a very strong employment report and the Fed's decision to continue the taper. The 10-year U.S. Treasury bond yield fell from 2.67% to 2.59%.
On the surface, the economic data was contradictory, but less so if one were paying attention to the dates. First-quarter GDP growth was sharply below expectations, barely growing at 0.1%. Just about every category was flat or down, with only the consumption of services saving the United States from an outright decline in GDP.
Lately, GDP data has proven volatile and nearly useless unless carefully teased apart, and this quarter was no exception. This data was for the first quarter, the period ended March 31. Other forward-looking data, much of it from April, pointed sharply higher. April auto sales looked great, stacking together two 16 million-plus unit sales months in a row. Pending home sales looked much better too, indicating that the decline in existing-home sales is nearing its end. April employment data looked great, but not perfect. Manufacturing continued to make modest progress with another month of increasing ratings from purchasing managers in the sector. Even chain store sales managed year-over-year growth of 3.1% in the latest period, their best performance since December.
With all that good news, I offer some caution. Some of the December, January, and February data points were truly horrendous. The economy needed these really strong numbers just to get back to trend line--and this week we got them. I am as excited as the next guy to see the great numbers, but they are not the start of a new normal of rapid and always-accelerating growth. Yes, we may see 3% or more GDP growth in the second quarter, but that would likely still hold economic growth in the first half to less than 2% when the two quarters are combined. Not meaning to sound like a broken record, but growth for the full year is likely to remain stuck in a 2.0%-2.5% growth rate for all of 2014.
Monthly Jobs Report Spikes, Slow Longer-Term Growth Persists
April's nonfarm job growth of 288,000 plus revisions to the previous two months was a pleasant surprise to me and other economists who were expecting something closer to job growth of 220,000 and the 12-month average of 190,000 jobs. There is a lot to like in this month's report, as I will detail below. However, the longer-term trend, using an average of three months of data compared year over year, has not broken out of its slow upward trend, even with April's great performance.
The report did contain one ominous dark cloud. Hourly wage growth was nonexistent for the second month in a row. Adjusted for inflation, the United States has seen two months of hourly wage declines. I am thinking that there may be a short-term anomaly in the monthly data as manufacturing hourly wages declined month to month, which is unusual, to say the least. On a year-over-year basis, the noninflation-adjusted wage growth remains relatively steady. So the yellow flag is up on the short-term wage data. For now, the longer-term picture is still benign, but the two back-to-back poor months mean we will need to watch future data very closely.
The inflation-adjusted wage data (combining employment, hourly wages, and hours growth) shows that the economy is still running a little below average and certainly well below some healthy data last fall when inflation was unusually low. Unfortunately, drought-related issues and potentially higher health-care costs will likely keep inflation rising in the months ahead, putting a little more pressure on consumers.
Still, there were some real bright spots in the report. The economy did even better than advertised in April, adding over 1.1 million jobs before a seasonal adjustment factor of over 800,000 brought the job additions to 288,000. For one reason or another, April is a great month for hiring, and this month was no exception.
The sector data was reason to cheer. Job gains were very broad-based with good news in professional services (includes executives and temp workers), construction, manufacturing, and retail. Over a full year, professional services have added 666,000 jobs of the 2.3 million total over the same period. These are the great-paying job categories that include computer programmers, management, and administrative folks. For some further perspective, retail added about 492,000 jobs, and restaurants and hotels 381,000. A lot of us have whined about huge job growth in these low-paying sectors, but this month the higher-paying jobs seem to be taking the baton. For April, 75,000 professional services jobs were added with just 35,000 retail jobs, and 28,000 restaurant and hotel jobs.
Longer-Term, We Will Be Talking About Job Shortages, Not Unemployment Rate
Markets tend to get upset about things at all the wrong times. Just last year, I couldn't print enough stuff on inflation because of fears of a sharp pickup. Inflation hedges were all in vogue. Instead, inflation for all of 2013 made a new recovery low and commodities were just about the worst-preforming asset class in 2013. This time everyone is fixating on the headline unemployment rate and various unemployment statistics and the crummy state of the employment market. Within the next 24 months, I believe that current employment assumptions will be turned on their heads. The U.S.-born working-age population numbers (22- to 62-year-olds) are slated to decline for the first time in decades sometime in 2015. Spot shortages are already beginning to creep up in skilled machinists, airline pilots, truck drivers (average age 55), and machinists. Even homebuilders are complaining about a lack of skilled workers.
Unemployment Rate Could Drop to Under 6% by Year-End
Some of this is already becoming visible with the unemployment rate dropping to 6.3% in April (from 6.7% the previous month). That rate could drop to under 6% by the end of 2014. I do caution that this month's unemployment rate was a little quirky, driven sharply lower as there were 800,000 fewer people looking for work in April--very odd for a month when the job market was red hot. Just as inexplicably, participation had increased 1.3 million people over the previous three months even as extended unemployment benefits ended, the Affordable Care Act began guaranteeing reasonable coverage for young but not necessarily healthy retirees, and retirement portfolios ballooned. I could spend all day arguing about the usually unreliable and volatile household survey (which is used to construct the unemployment report), but it's not worth the ink. I just depend on the more reliable establishment survey, which showed the sharp improvement in job growth, but offers no comment on participation rates and unemployment rates.
Auto Manufacturers Stack Two Back-to-Back Months With Sales Above 16 Million
April auto sales came in at 16.1 million units on a seasonally adjusted annualized basis, well above last year's 15.2 million and just below March's exceptionally strong 16.4 million units. It is the first time during this recovery that there have been back-to-back sales months above 16 million units sold. Previous trips above the 16 million-mark were always one-month wonders, aided by either weather or calendar effects. That said, I should mention that sales for the first two months of the year were abysmal at 15.2 million and 15.4 million units for January and February, respectively. The annual sales rate for the first four months is about 15.8 million units, which puts the industry on target to hit full-year industry estimates of 15.8 million-16.5 million units, up from 15.6 million units for all of 2013.
I have always viewed auto sales as a key metric in determining the health of the consumer, and the March and April data were quite reassuring. Certainly incentives and new models helped the April sales report, but the news on those fronts wasn't much different from March's report. SUVs and new truck models were the keys to strong April results. More sedan-dependent companies such as Honda (HMC) and Volkswagen (VOW) were on the bottom of the pile for April (along with Ford (F), whose new truck entry isn't due until later this year). Meanwhile, Nissan (NSANY) led the growth pack with new SUV models along with Chrysler, which introduced new truck models. In general, retail sales to users were particularly strong in April, while fleet sales were a little softer. A higher retail component is generally better for manufacturers and indicative of stronger underlying market strength.
Auto sales have been a key component of this recovery, and sales are now approaching the highest full-year number of units sold (17.0 million for 2005, compared with the annual low of 10.4 million units). The industry probably won't make it back to that full level until 2015. As good as things appear to be now, the annual growth rates are slowing as the law of large numbers begins to set in. Even at the highest industry estimates, autos are likely to be a smaller contributor to GDP growth in 2014 than they were in 2013.
Free-flowing credit has been instrumental in the improvement in auto sales. Because autos are so critical to individuals and so easily repossessed, consumers usually defaulted on home loans and credit cards before they ceased making auto loan payments. That is slightly different from past recessions when people tended to put their home loan payments first. The upshot is that auto loans (because of the recent track record) were relatively easy to get shortly after the recovery began, unlike the housing industry that still faces incredibly tight lending conditions. The road map to better housing results probably will need to include loosening of lending/appraisal standards that still remain burdensome. I do worry a little that auto lending may have swung just a bit too far to the lenient side. A recent Car Connection article noted that a third of all auto loans were now for 72 months (six years) or longer. Among younger buyers, that percentage jumps to 44%.
Pending Home Sales Data Plus Last Week's Permits Data Indicate Housing Market Bottoming
The housing market has been in a funk for some time, partially related to higher prices and higher mortgage rates and partially due to weather. The numbers for March transactions, new and existing, were horrific. Still, there was another ray of hope this week with a decisive turn in pending home sales.
Pending home sales are counted when an initial contract is signed for purchase and existing-home sales register only when the deal is completed and the deed is transferred to the new owner. There is usually a one- to three-month gap between the initial contract and closing to allow time for inspections, obtaining a mortgage, etc. Pendings are generally a reliable indicator of existing-home sales. Existing-home sales affect GDP through brokerage commissions, which badly hurt the past two quarters of GDP calculations. Existing-home sales will also push up moving expenses, furniture sales, and remodeling expenses two to three months after closings. The front of this long chain of events is finally beginning to move.
Pending home sales for March, the latest reported data, was up 3.4% from February, and its first improvement in eight months. The year-over-year data still shows a decline, though the rate of decline is slowing some. Too, the gap between existing-home sales growth and pending home sales is beginning to narrow sharply, so I would expect that existing-home sales should be bottoming out soon, too. That's great news for the housing market. When that's combined with last week's permits report for new homes, which showed the number of permits meaningfully above the current level of starts, it points to improved housing starts in the months ahead. Hopefully, this will put an end to the painful subtractions from housing in the quarterly GDP calculations.
Personal Income, Consumption Improve During First Quarter
One of the key bases for my forecast of slow and steady growth for the economy has been relatively anemic consumption growth. Consumption has been stuck at the 2% level for some time, but that number has begun to break out over the past two quarters, as shown below.
The month-to-month data looks good too, but things are slowing a bit. Furthermore, spending growth is outpacing incomes again at a relatively healthy pace. While the two metrics can become untethered for a few months, longer-term they do tend to move in tandem. So in the months ahead, consumption will need to come down or incomes will need to come up.
For the full first quarter, consumption was up a surprising 3% despite all the complaining about the bad weather. Nevertheless, more 80% of the growth in consumption occurred in health care (mainly related to the Affordable Care Act) and utilities (because of abnormally cold weather, natural gas usage was up 50%). Other categories didn't fare as well, but didn't fall off of a cliff, either.
Unfortunately, the outsize performance was in health care (which benefited from the one-time startup effect and will likely grow at the pace of the economy in the months ahead) and utilities (no more massive gas bills, and air conditioning bills may not be so high). In fact, the March month (versus full-quarter) numbers in these two categories weren't much help while rents and owner equivalent rents took over the growth baton. One downside to the categories that are currently growing the fastest is that they aren't big helps to the employment situation or overall economic activity. Overall, I expect consumption growth to be lower in the months ahead compared with the breakneck pace witnessed in the first quarter, especially February and March.
First-Quarter GDP Grew Measly 0.1%--Don't Be Frightened
Over time the GDP calculation is being oddly skewed by highly volatile activity in noncore sectors of the economy that often have little relevance to overall employment and activity levels. Seasonal factors and the annualization of small changes in quarterly data have really distorted this broad measure of business activity. The year-over-year data is at least a little less subject to faulty seasonal adjustment factors and the amplification of small changes. The data below proves out that thesis.
Notice that the quarter versus the year-ago quarter data is in a relatively tighter packed range of 1.3%-3.3% while the sequential quarterly growth rate annualized has been all over the place, ranging from 0.1% to 4.1%. Given the relatively steady employment and consumption growth of the past three years, I don't think the volatile annualized numbers are good for much of anything other than helping websites, magazines, and newspapers write ominous-sounding headlines that help sell more issues. Overall, I still believe the U.S. economy's growth tendency is in the 2.0%-2.5% range despite what the headline writers would have you believe. And that rate has been surprisingly consistent.
I am going to dispense with my category-by-category GDP analysis and tables until the next revision because the changes between readings is now quite significant. However, I will say that every category showed little or no growth except consumption, which is the most important of all the metrics. Consumption growth did look healthy at 3%, although the Affordable Care Act and spending on home heating drove much of that, as noted above.
Home Prices Holding Up a Little Better Than Expected
For the full year I thought the Case-Shiller 20-City Price Index would increase only 4%-6% compared with a 13% growth rate for 2013. The law of large numbers, declining affordability, and big spikes in mid-2013 due to a race to purchase homes prior to future rate increases all pointed to a substantially lower growth rate. Indeed, those rates have slowed a bit, as shown below, but not by as much as I would have thought.
The CoreLogic (CLGX) data has even managed to show a small increase in the annual growth rate since December. Though not my favorite way of looking at the data, the seasonally adjusted month-to-month price increases are still quite healthy. The Case-Shiller seasonally adjusted number for February (released this week) was still up a very large 0.8% (about 9% annualized). Given some continued tough comparisons in the spring data, I am nevertheless sticking with a single-point forecast of 5% for 2014.
I'd Rather Have Growth in Housing Starts Than Home Prices
In the past I had said that we would either have strong growth in housing starts or large price increases, but probably not both. I used to believe that I really didn't care which I got, higher prices or more starts. Either helped the economy by slightly different mechanisms. Now, though, I wish that starts were the better performer. Starts drive high-paying construction jobs and the need for more manufactured goods. Previously, I thought that higher prices would drive consumer confidence and perhaps even some equity loans much higher as well as help re-liquidate bank balance sheets and drive lending sharply higher. Home equity loans still aren't growing much, and bank balance sheet have improved sharply, but lending standards are still tight, holding back loan (and economic) growth.
Just Export Data Next Week; Relax and Enjoy
The economic calendar landed in a weird way this month, which threw almost all the data into this week's report with almost no data to speak of the following week. Only the official trade report is due next week and that's on Tuesday. The export data has been all over the map for the past several quarters, and it has been the largest swing factor in the massive GDP swings that we have witnessed recently. I don't think these swings are real, but instead represent ongoing measurement and seasonality issues. Nothing changed so drastically that net exports could have added 1% to fourth-quarter GDP and then subtracted 0.9% the next quarter, even as world growth has been picking up a little steam. Analysts aren't using much creativity in their March forecast, expecting the trade deficit to shrink only modestly to $40.5 billion from $42.3 million the prior month and not far off the $39 billion that the government assumed in the most recent GDP report. Any larger deficit would force a reduction in the next GDP reading for the first quarter.
Robert Johnson, CFA does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.