Friday, October 7, 2016

October Macro Update: Solid Wage Growth But Housing Construction Flattening

SummaryThe macro data from the past month continues to mostly point to positive growth. On balance, the evidence suggests the imminent onset of a recession is unlikely.

Overall, the main positives from the recent data are in employment, consumption growth and housing:
  • Monthly employment gains have averaged more than 200,000 during the past year, with annual growth of 1.7% yoy.  Full-time employment is leading.
  • Recent compensation growth is the highest in 7 years: 2.7% yoy in July and 2.6% in September. 
  • Most measures of demand show 3-4% nominal growth. Real personal consumption growth in August was 2.6%.  Retail sales reached a new all-time high in July.
  • Housing sales are near a 9 year high. Starts and permits in August remain near their 8 year highs.
  • The core inflation rate has remained above 2% since November 2015.
The main negatives are concentrated in the manufacturing sector (which accounts for just 10% of GDP):
  • Core durable goods growth fell 3.7% yoy in August. It was weak during the winter of 2015 and it has not rebounded since. 
  • Industrial production has also been weak, falling -1.1% yoy due to weakness in mining (oil and coal). The manufacturing component fell -0.2% yoy.
Prior macro posts from the past year are here.

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Our key message over the past 2 years has been that (a) growth is positive but slow, 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.

Modest growth should not be a surprise. This is the typical pattern in the years following a financial crisis like the one experienced in 2008-09.

This is germane to equity markets in that macro growth drives corporate revenue, profit expansion and valuation levels. The saying that "the stock market is not the economy" is true on a day to day or even month to month basis, but over time these two move together. When they diverge, it is normally a function of emotion, whether measured in valuation premiums/discounts or sentiment extremes (enlarge any image by clicking on it).

A valuable post on using macro data to improve trend following investment strategies can be found here.

Let's review each of these points in turn. We'll focus on four macro categories: labor market, inflation, end-demand and housing.

Employment and Wages

The September non-farm payroll was 156,000 new employees less 7,000 in revisions.

In the past 12 months, the average monthly gain in employment was 204,000.

Monthly NFP prints are normally volatile. Since 2004, NFP prints near 300,000 have been followed by ones near or under 100,000. That has been a pattern during every bull market; NFP was negative in 1993, 1995, 1996 and 1997. The low prints of 84,000 in March 2015 and 24,000 in May 2016 fit the historical pattern. This is normal, not unusual or unexpected.

Why is there so much volatility? Leave aside the data collection, seasonal adjustment and weather issues; appreciate that a "beat" or a "miss" of 80,000 workers in a monthly NFP report is equal to just 0.05% of the US workforce.

For this reason, it's better to look at the trend; in September, trend employment growth was 1.7% yoy. Until this spring, annual growth had been the highest since the 1990s.  Ahead of a recession, employment growth will likely markedly fall (arrows). Continued deceleration in employment growth in the coming months is therefore an important watch out.

Employment has been been driven by full-time jobs, which are at a new all-time high (blue line), not part-time jobs (red line).

The labor force participation rate (the percentage of the population over 16 that is either working or looking for work) has been falling. This has little to do with the current recovery; the participation rate has been falling for more than 16 years. Participation is falling as baby boomers retire, exactly as participation started to rise in the mid-1960s as this group entered the workforce. Another driver is women, whose participation rate increased from about 30% in the 1950s to a peak of 60% in 1999.

Average hourly earnings growth in September was 2.6% yoy, nearly the highest growth rate in 7 years. This is a positive trend, showing demand for more workers. Sustained acceleration in wages would be a big positive for consumption and investment that would further fuel employment.

Similarly, 2Q16 employment cost index shows compensation growth was 2.6% yoy. This is the second highest growth rate since the recession.

For those who doubt the accuracy of the BLS employment data, federal tax receipts have also been rising (red line), a sign of better employment and wages (from Yardeni).


Despite steady employment growth, inflation remains stuck near the Fed's target of 2%.  But note: CPI and PCE are finally beginning to tick higher.

CPI (blue line) was 1.1% last month. The more important core CPI (excluding more volatile food and energy; red line) grew 2.3%, among the highest levels since 2008 but still just oscillating near 2%.

The Fed prefers to use personal consumption expenditures (PCE) to measure inflation; total and core PCE were 1.0% and 1.7% yoy, respectively, in August. Neither has been above 2% since 2Q 2012.

For some reason, many mistrust CPI and PCE. MIT publishes an independent price index (called the billion prices index). It has tracked both CPI and PCE closely.


Regardless of which data is used, real demand has been growing at about 2-3%, equal to about 3-4% nominal.

Real (inflation adjusted) GDP growth through 2Q16 was 1.3% yoy (it was 3.0% in 2Q15, so the yoy comparable is unfavorable). 2Q growth was near the bottom of the post-recession range (1.0-3.0%) and lower than the 2.5-5% common during prior expansionary periods since 1980.

Stripping out the changes in GDP due to inventory produces "real final sales". This is a better measure of consumption growth than total GDP.  In 2Q16, this grew 1.9% yoy (it was 2.7% in 2Q15, so the yoy comparable is unfavorable). A sustained break above 2.5% would be noteworthy.

Similarly, the "real personal consumption expenditures" component of GDP (defined), the component which accounts for about 70% of GDP, grew at 2.7% yoy in 2Q16 (it was 3.4% in 2Q15, so the yoy comparable is unfavorable). The last seven quarters have seen the highest persistent growth rate since 2006. This is approaching the 3-5% that was common in prior expansionary periods after 1980.

On a monthly basis, the growth in real personal consumption expenditures was 2.6% yoy in August.

GDP measures the total expenditures in the economy. An alternative measure is GDI (gross domestic income), which measures the total income in the economy. Since every expenditure produces income, these are equivalent measurements of the economy. A growing body of research suggests that GDI might be more accurate than GDP (here).

Real GDI growth in 1Q16 was 1.2% yoy (it was 3.8% in 1Q15, so the yoy comparable is unfavorable). This is at the low end of the range of prior expansionary periods since 1980 (2-5% yoy).

Real retail sales reached a new all-time high in July; annual growth in August was 0.8% yoy. The range has generally been centered around 2.5% yoy for most of the past 20 years. The latest month is near the bottom of the range.

Retail sales in the past year have been strongly affected by the large fall in the price of gasoline. Retail sales at gasoline stations fell by 10% yoy. Real retail sales excluding gas stations grew 1.8% in August. Growth has been stronger in the past year than during most of 2011-14.

The main negatives in the macro data are concentrated in the manufacturing sector, as the next several slides show. It's important to note that manufacturing accounts for less than 10% of US employment and GDP, so these measures are of lesser importance. Even within manufacturing, the weakness is concentrated; most sectors are not contracting (more on this here).

Core durable goods orders (excluding military, so that it measures consumption, and transportation, which is highly volatile) fell 3.7% yoy (nominal) in August. During the heart of the prior bull market, growth was typically 7-13%. Weakness in durable goods has not been a useful predictor of broader economic weakness in the past (arrows).

This is a nominal measure and thus negatively impacted by the fall in the inflation rate. On a real basis, growth continues to trend higher (blue line is real; gray line is nominal; chart from Doug Short).

Industrial production growth fell -1.1% in August. The more important manufacturing component (excluding mining and oil/gas extraction; red line) fell -0.2% yoy. It's a volatile series: manufacturing growth was lower at points in both 2013 and 2014 before rebounding strongly.

Weakness in total industrial production is concentrated in the mining sector, which fell 9% yoy in August, the worst annual fall in more than 40 years. It is not unusual for this part of industrial production to plummet outside of recessions. 


Housing sales in July reached a new 9 year high.  Housing starts and permits are near an 8 year high but growth is flattening. Overall levels of construction and sales are small relative to prior bull markets but the trend is higher.

First, new houses sold was 609,000 in August, slightly lower than in July's sales which were at the highest level in the past 9 years. Growth was 21% over the past year after growing 12% yoy in August 2015.

Second, overall starts in August remained near an 8 year high but growth is flattening.

Likewise, growth in building permits is flattening (red line).

Single family housing starts (blue line) were the highest since the recession in February, and only marginally lower in August. Multi-unit housing starts (red line) are flat over the past three years.


In summary, the major macro data so far suggest positive, but slow, growth. This is consistent with corporate sales growth.  SPX sales growth the past year has been positive but only about 2% (nominal).

With valuations above average, 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 1% in 2016.

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.

There has been a tendency for macro data to underperform expectations in the first half of the year and beat expectations in the second half. For the first time since 2009, macro expectations were below zero to start the year and are now positive in the second half of the year.

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