Friday, June 6, 2014

June Macro Update: Still Moderate Growth

Last month we reviewed all the main economic data (post). Our key message was that (a) growth is positive but modest, in the range of 3-4% (nominal), and; (b) current growth is lower than in prior periods of economic expansion and a return to 1980s or 1990s style growth does not appear likely.

This post updates the story with the latest data from the past month. The overall message remains unchanged.

We'll focus on four categories: labor market, inflation, end-demand and housing.

Employment and Wages
The May non-farm payroll (217,000 new employees) was in the middle of a 10 year range. This follows prints of 84,000 in December and 282,000 in April. Moving between extremes like these has been a pattern during every bull market. Since 2004, every NFP print near or over 300,000 has been followed by one near or under 100,000 (circles).

This is not a recent phenomenon. The 1980s and 1990s bull markets were the same, only the range was higher. If anything, the swings in extremes was greater.

It's better to look at the trend; in May, trend growth was 1.7% yoy. The trend in NFP employment has not much exceeded 2% growth yoy since 2000; the monthly prints shown above have been noise within a growth trend between 1.5% - 1.9% since the start of 2012. It wasn't much different in the 2003-07 bull market, so be careful assuming a trend with much higher growth than 2%. In order to reach the 3% growth of the 1990s, NFP will need to start printing 400,000 per month.

Released together with NFP is a report on average hourly earnings. In May, this showed growth of 2.1% yoy. Wages are not accelerating; 2% is the middle of its range since late 2009.

Similarly, the employment cost index shows modest growth in compensation. For 1Q14, it was 1.7% yoy. It is also not accelerating.

These employment and wage reports do not suggest much pressure from labor on inflation.

CPI and core CPI (excluding more volatile food and energy) are growing at 1.8-2.0% yoy. Neither has been much above 2% since 2Q 2012. Moreover, there has been no sustained acceleration in inflation, yet. This is in contrast to 2003-07, when inflation was consistently closer to 3%.

The Fed prefers to use personal consumption expenditures (PCE) to measure inflation; both core and total PCE are near 1.5% yoy. Neither has been above 2% since 2Q 2012. Like CPI, there has been no sustained acceleration in inflation, and the rate is well below levels in 2003-07.

Next, let's look at several measures of demand growth. Regardless of which data is used, real demand has been growing at about 2%, equal to about 3-4% nominal.

On an annual basis, real (inflation adjusted) GDP growth through 1Q14 was 2.0%. This is right in the middle of the post-recession range (1.3-3.3%). It's positive, but lower than what the US is used to; prior expansionary periods since 1980 experienced growth of 2.5-4.5% yoy.

Stripping out the changes in GDP due to inventory gives you real final sales. In 1Q14, this grew 1.95% yoy. This is on the low end of the range (1.7-2.7%) since 4Q 2010. This is a better measure of consumption growth than total GDP.

Similarly, the real personal consumption expenditures component of GDP grew at 2.5% yoy in 1Q14, in the middle of its range (2-3%) since 2Q 2010, but below the 2.5-4.5% that was common in prior expansionary periods after 1980.

Real retail sales grew 2.0% yoy measured on a monthly basis. The range has been closer to 1.5-4% yoy for most of the past 20 years.

Core durable goods orders (excluding military, so that it measures consumption, and transportation, which is highly volatile) grew at 1.6% yoy in April. This continues to be sluggish. During the heart of the prior bull market, growth was over 5%.

Industrial production is an important measure but it travels in a wide range. The typical range has been 1.5-4.5% yoy through the past 15 years; last month it was solidly in the middle at 3.5%.

Finally, let's look at two measures of housing. If there is a red flag in any of the macro data, it's in housing.

First, new houses sold declined 4.2% yoy in April. It has not recovered from winter weakness. While sales continue to be weak, note that it had similar declines in 1994 and 2004. The overall level of sales is also meager relative to prior bull markets. This deserves close monitoring.

Second, after a decline in winter, housing starts is now back to growth. The overall level of construction is well off those during the prior two bull markets.

In summary, the major macro data so far suggest a positive, but slow growth. This is consistent with corporate sales growth.  SPX sales growth the past 3 years has been positive but modest, averaging about 2% per annum. That's the trend, although there is considerable variation around trend each quarter. This variation is usually noise; the low growth of 1Q14 and the high growth of 4Q14 are recent examples.

The difference between SPX sales growth of 2% and domestic macro growth of 3-4% is the ex-US activity of US corporations; European economic (and earnings) growth has been close to zero.

Until valuations return from high levels, we think the current pace of sales growth is likely to be the limiting factor for equity appreciation. This is important, as the consensus expects earnings to grow at more than 10% in 2014 and 2015.

Modest growth should not be a surprise. This is the classic pattern in the years following a financial crisis like the one experienced in 2008-09. It is also what the spread in yields have been signaling for several months.

If there is a bright spot, it's that macro expectations usually improve in the second half of the year; it has already started to improve and this will likely carry into 2H14. That doesn't mean growth above 3-4%, but data that meets or exceeds lowered expectations.