Making Slow Progress
Written by Stephen Swanson
The economic data released during the past week tended to be solid and confirming with no sharp breaks from past trends and nothing to change the course of our thinking. If anything, we better understand the inner workings of the new normal and our limited prospects for growth.
Regional Fed Reports
Against slight improvements in the Philly Fed and Empire State surveys last week, the Richmond Fed opened the week with mixed signals and a survey release pointing to new troubles for the region’s sector. The index fell to minus 7 in this month’s reading from positive 4 in September, a reversal that points to outright contraction in monthly active. This index first slipped into negative ground in June. New orders are once again contracting, to minus 6 from plus 7. Backlog orders remain in contraction while shipments, like new orders, are moving back into contraction. Manufacturers in the region continue to cut back their workforces.
Later in the week the Kansas City Fed District followed in the steps of the Richmond Fed and announced its composite index declined to minus 4 in October from plus 2 in September, revealing a contraction in manufacturing. Manufacturing slowed at most durable and nondurable goods-producing plants, particularly among producers of machinery and electronic equipment. Most other month-over-month indexes also fell in October. The production index eased further from minus 4 to minus 6, and the new orders and order backlog indexes also declined. The employment index moved into negative territory for the first time this year, while the shipments index inched higher but still remained negative.
With two regional Fed surveys showing slight improvement and two others showing deterioration, Markit confirmed this muddled picture with the release of its Flash Survey of US Manufacturing showing marginal improvement in October over September with the current month inching up to 51.3, 0.2 higher than the preceding month. Among the eleven components comprising the survey, there were a number of marginal differences between October and the prior month but one line item which stood out was in input prices. Input prices jumped from 52.8 to 57.6 while output prices remained flat, suggesting potential for margin compression on stagnating sales.
Substantiating Markit’s assessment, The Chicago Fed also released its index of national economic activity based upon eighty five measures of economic activity. Quoting the Chicago Fed:
Led by improvements in production-related indicators, the Chicago Fed National Activity Index (CFNAI) increased to 0.00 in September from –1.17 in August. All four broad categories of indicators that make up the index increased from August, and each one except the consumption and housing category made a positive contribution to the index in September.
The index’s three-month moving average, CFNAI-MA3, increased from –0.53 in August to –0.37 in September—its seventh consecutive reading below zero. September’s CFNAI-MA3 suggests growth in national economic activity is below its historical trend as it has been for the last half year.
Durable Goods and Unemployment
As if to underscore inherent volatility in durables goods orders, new factory orders for durable goods rebounded 9.9 percent in September SAAR after a sharp 13.1 percent plunge in August (originally down 13.2 percent monthly). The comeback was largely due to aircraft orders within the transportation component-where weakness was in August. Excluding transportation, orders rose 2.0 percent after decreasing 2.1 percent in August (originally down 1.6 percent).
Excluding transportation the two months tend to cancel each other out but orders for core capital goods, often viewed as a proxy for business investment, remained flat in September following a 0.2 percent rise in August and a 5.6 percent drop in July.
Initial claims for unemployment have been equally volatile with claims plunging two weeks ago, surging one week ago and moderating this week. Last week’s claims were revised up to 392K from 388K and this week’s claims were reported as 369K, down 23K from the prior week. Notwithstanding the insights of pundits to the contrary, initial claims averaged across four week are not falling and appear to be moving sideways in a channel established in early April.
U.S. Housing Market
Meanwhile, the new home market is increasingly a source of strength for the economy with new home sales up a very sharp 5.7 percent in September to 389,000 which is the best annual rate since the stimulus efforts of mid-2010. September’s gain is convincing and is led, with a 16.8 percent jump, by the South which is far larger than all other regions combined. Supply, at 4.5 months for the lowest reading since 2005, is very tight and is limiting sales. Prices for new homes, which have been going straight up, eased a bit last month, down 3.2 percent for the median to $242,400. Still, the year-on-year rate, at plus 11.7 percent, is in rare double-digit ground for a second straight month
Sales growth for existing homes, though, has been lagging sales growth for new homes and looks to continue to lag based on September’s modest 0.3 percent rise for pending sales of existing homes. The National Association of Realtors says the result points to no more than “minor movement” for near-term sales of existing homes, though the group believes that underlying fundamentals, which include low mortgage rates, are positive with sales likely to re-assert their uptrend through next year. This view is open to debate because mortgage rates for the average 30 year mortgage have edged up to 3.5%, the highest since September 20 and just bps before announcement of QE infinity. Further, purchase applications have collapsed.
The U.S. Consumer
Much has been said lately about the disconnect between the confidence of CEO’s and that of consumers with that of the former falling and that of the latter improving, creating yawning gap. Well the gap widened further this week as the Bloomberg Consumer Comfort Index inched to its highest since mid-April, advancing to minus 34.6 from minus 34.8 the prior week on its scale of minus 100 to plus 100 since a summer stumble to minus 47.4 in late August.
Similarly, the Reuters/University of Michigan Consumer Sentiment Index posted a final reading of 82.6 for the month of October, holding onto most of the gains seen in the first two weeks of the month. The 88.1 reading for current conditions is up a noticeable 2.4 points from September to hint at general growth for October’s slate of economic data. The expectations index is up a sizable 5.5 points from September which hints at confidence in income prospects and is a positive for the holiday shopping outlook. Some believe core pocketbook issues such as falling gasoline price and rising homes are driving confidence higher.
And consumer confidence is exactly what we saw in the widely expected BEA release of its first estimate of economic growth for the third quarter which came in a little stronger than expected at 2.0%. Personal consumption expenditures accounted for 1.42 points of the 2.0 points of growth with an 8.5% increase on spending on durable goods (autos) adding 0.63 points of growth. Spending on residential investment increased at a rate of 14.4% (note similarity to housing) and added .33 points of growth, close to what your humble analyst suggested last week. Excluding a small contraction in inventories, business investment was flat and the difference between imports and exports subtracted 0.18 points of growth. The big surprise was the surge in government spending (defense) which added 0.7 points of growth. Without this, growth would have been 1.3%, exactly what it was in the second quarter. Rick Davis of Consumer metrics Institute asked: “Is this improving growth or continued weakness?”
Before drawing inferences from data discussed thus far and speculating on what direction we might move towards, it would be useful to briefly review international developments so that both our backdrop and context is complete.
Last week a raft of data on the Chinese economy was released with the most important being GDP growth for the third quarter which came in at 7.4% YOY, not that far off what was expected. And then on Monday Markit released the HSBC prepared flash estimate for Chinese manufacturing which showed the index increased to 49.1 from 47.9 in September. Among analysts, most viewed the combination of data constructively and believe the economy could stage a moderate recovery in the coming months on the back of accommodative monetary policy, recovering property prices, increasing infrastructure investment and improving external demand.
But the same day Markit released data for China it also released the Eurozone composite flash PMI which fell from 46.1 in September to a forty month low of 45.8 in October. Services held up while orders for manufacturing and output stumbled badly. As Markit notes:
By country, Germany saw only a mild fall in output. The rate of decline gathered pace on September, but remained less severe than in both July and August. In contrast, a steep contraction was again seen in France. Output there fell only slightly more slowly than
in September, suggesting that France remains in its steepest downturn since early-2009.
A worse performance was again seen outside of France and Germany, however, where output fell on average at the fastest rate since May. This extended the sequence of sharp decline that has been evident throughout the past year.
Were this not enough Spain’s unemployment rate is now 25% and Eurozone officials remained mired in endless discussions with Greek officials over the next tranche of aid (euro 31.5bn) and requests to extend Greece’s defcit targets two years until 2016. Dutch finance minister Jan Kees de Jager said that “Greece must bear the costs of any delay”, as think tank Open Europe warned that a two-year extension would cost at least euro 28.5bn to ensure the struggling eurozone nation can refinance its debts and pay its bills. Eurozone finance ministers are scheduled to discuss its release next week while Athens has warned it will run out of money next month unless it gets the funds. What a mess.
We also learned that Asia’s fourth-largest economy, often viewed as a bellwether for global trade, grew 1.6 per cent in the third quarter compared with a year ago, according to the Bank of Korea. That followed 2.3 per cent growth in the previous quarter. Exports slowed to 2.6 per cent from 3.2 per cent growth in the previous three months, amid cooling global demand for chips, ships and cars. And Capital investment dropped 6 per cent with companies investing less amid the uncertain global economic outlook while private consumption increased just 1.5 per cent with debt-laden Korean households reluctant to spend.
Sorting it Out
Now the fun part: trying to sort through all of the available data and try to make sense of it while fitting it to larger macro global trends. As to the US, it’s very clear that the consumer is in full control of the economy and whatever manufacturing is underway is taking place to satisfy demands for consumer goods. Purchases of auto’s and homes are literally supporting an otherwise fragile economy. Businesses are hesitant to invest and exports are falling and manufacturing to support these sectors is waning, which explains the odd behavior of manufacturing. And it’s unlikely to change course until a host of uncertainties have been resolved, including issues pertaining to global growth, the election and the fiscal cliff.
And while the most recent news out of China is welcome, Europe is roughly twice the size of China and China’s largest export market and the Eurozone is clearly crawling into recession which will act as a drag on Chinese exports and complicate a rebound. With global economies linked through trade and capital flows and the BRIC’s unable to de-couple, there more obstacles to growth than there are catalysts which is becoming more evident by the day in guidance being offered by companies on the fourth quarter. According to FactSet, of the 66 companies that have issued guidance on the fourth quarter, 48 or 73% have issued negative guidance or earnings projections below the mean of analysts.
The global economy has reverted to the new normal of anemic growth and it’s expected we will muddle through until China restructures its economy or we get serious about unleashing our energy potential and aggressively encourage “insourcing” to take advantage of abundant energy, lower tansportation costs and increasingly competitive labor costs.
And with unfavorable corporate guidance, growing layoff announcements, a contracting global economy and mounting uncertainty, it would be a challenge to make a case for economic improvement in the immediate future. In the near to intermediate term the consumer will keep the economy afloat through purchases of automobile purchases investments in housing but should there be a disruption in the labor market or an underminig of confidence and these purchases are curtailed, look out. We will continue to remain vulnerable to shocks, be they financial, geo-political or economic and very much hostage to the determinants of consumer spending including employment, confidence and incomes.
About the Author
Stephen Swanson has a degree in economics and an MBA. His corporate experience includes several executive positions including a divisional VP assignment. More recently he has left the corporate world and has been investing in financial instruments and real estate, with interests expanding into S&P futures and commodities. Stephen is known on the internet under the pseudo nom CautiousInvestor and is a frequent commentator at Seeking Alpha where he also posts blogs.