Friday, May 5, 2017

May Macro Update: Two Watch Outs Are Retail Sales And Employment Growth

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.

One concern in recent months had been housing, but revised data shows housing starts breaking above the flattening level that has existed over the past two years. A resumption in growth appears to be starting.

That leaves two watch outs. The first is employment growth, which has been decelerating from over 2% last year to 1.6% now. It's not alarming but it is noteworthy that expansions weaken before they end, and slowing employment growth is a sign of some weakening that bears monitoring.

The second watch out is demand growth. Real retail sales excluding gas is in a decelerating trend. In March, growth was just 2.0% after having grown at more than 4% in 2015. Personal consumption accounts for about 70% of GDP so weakening retail sales bears watching closely.

Overall, the main positives from the recent data are in employment, consumption growth and housing:
  • Monthly employment gains have averaged 187,000 during the past year, with annual growth of 1.6% yoy.  Full-time employment is leading.
  • Recent compensation growth is among the highest in the past 8 years: 2.6% yoy in 1Q17. 
  • Most measures of demand show 2-3% real growth. Real personal consumption growth in 1Q17 was 2.8%.  Real retail sales (including gas) grew 2.7% yoy in March.
  • Housing sales grew 16% yoy in March. Starts grew 9% over the past year.
  • The core inflation rate is ticking higher but remains near the Fed's 2% target.
The main negatives have been concentrated in the manufacturing sector (which accounts for less than 10% of employment). Note, however, that recent data shows an improvement in manufacturing:
  • Core durable goods growth rose 6.4% yoy in March. It was weak during the winter of 2015-16 but has slowly rebounded in recent months. 
  • Industrial production rose 1.5% in March, helped by the rebound in mining (oil/gas extraction). The manufacturing component grew 1.0% yoy in March.
Prior macro posts are here.

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Our key message over the past 5 years has been that (a) growth is positive but slow, in the range of ~2-3% (real), 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 April non-farm payroll was 211,000 new employees minus 6,000 in revisions.  In the past 12 months, the average monthly gain in employment was 187,000. Employment growth is decelerating.

Monthly NFP prints are normally volatile. Since the 1990s, 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 print of 79,000 last month, 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 April, trend employment growth was 1.6% yoy. Until spring 2016, annual growth had been over 2%, the highest since the 1990s.  Ahead of a recession, employment growth normally falls (arrows). Continued deceleration in employment growth in the coming months continues to be a critical 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) had been falling but has more recently stabilized. The overall trend down has little to do with the current recovery; the participation rate has been falling for more than 17 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 was 2.5% yoy in April. 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, 1Q17 employment cost index shows compensation growth was 2.6% yoy. This is near the highest growth rate since the recession.

For those who doubt the accuracy of the BLS employment data, federal tax receipts have also been rising to new highs (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 ticking higher.

CPI (blue line) was 2.4% last month, the fourth month in a row it has been over 2% (last time was April 2012). The more important core CPI (excluding volatile food and energy; red line) grew 2.0%, among the highest levels since 2008 although still just oscillating near 2%.

The Fed prefers to use personal consumption expenditures (PCE) to measure inflation; total and core PCE were 1.8% and 1.6% yoy, respectively, last month. February was the first month since 2Q 2012 that total PCE was above 2%.

Some mistrust CPI and PCE. MIT publishes an independent price index (called the billion prices index; yellow line). It has tracked both CPI (blue line) and PCE closely.


Regardless of which data is used, real demand has been growing at about 2-3%, equal to about 4-5% nominal. One concern is real retail sales growth: excluding gas, growth has decelerated to under 2%.

Real (inflation adjusted) GDP growth through 1Q17 was 1.9% yoy. 2.5-5% was common during prior expansionary periods prior to 2006.

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 1Q17, this grew 2.1% yoy. A sustained break above 2.5% would be noteworthy.

The "real personal consumption expenditures" component of GDP (defined), which accounts for about 70% of GDP, grew at 2.8% yoy in 1Q17. 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 2.8% yoy in March.

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 4Q16 was 1.9% yoy.

Real retail sales reached a new all-time high in January; in March, annual growth was 2.7% yoy. The range has generally been centered around 2.5% yoy for most of the past 20 years.

Retail sales in the past two years have been strongly affected by the large fall in the price of gasoline. In March, real retail sales at gasoline stations rose by 12% yoy after having fallen more than 20% yoy earlier in 2016. Real retail sales excluding gas stations grew 2.0% in March. This is a weakening trend.

The main negatives in the macro data have been 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, 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) rose 6.4% yoy (nominal) in March. This is the best annual growth rate since mid-2014. Weakness in durable goods has not been a useful predictor of broader economic weakness in the past (arrows).

Industrial production growth growth was 1.5% yoy in March. The more important manufacturing component (excluding mining and oil/gas extraction; red line) rose 1.0% yoy. This is a volatile series: manufacturing growth was lower at points in both 2013 and 2014 than it was in 2016 before rebounding strongly.

Weakness in total industrial production has been concentrated in the mining sector; the past two years had the worst annual fall in more than 40 years. It is not unusual for this part of industrial production to plummet outside of recessions. With the recovery in oil/gas extraction, mining rose 3% yoy in March. 


Housing sales grew 16% yoy in March.  Housing starts and permits in March grew 9% and 17% yoy, respectively.  Overall levels of construction and sales are small relative to prior bull markets but the trend is higher.

First, new houses sold was 621,000 in March, the highest level in the past 9 years. Growth was 16% over the past year after growing 10% yoy in March 2016.

Second, overall housing starts in February were at the second highest level since August 2007; starts in March were only marginally lower and 9% higher than a year ago. Importantly, data shows housing starts breaking above the flattening level that has existed over the past two years. A resumption in growth may be beginning.

Building permits have been on an improving trend since March 2016, growing 17% in the past year (red line). The trend is flat over the past two years, however.

Single family housing starts (blue line) reached a new post-recession high in February and were only marginally lower in March. Multi-unit housing starts (red line) are flat over the past four years; this has been a drag on overall starts.


In summary, the major macro data so far suggest positive, but slow, growth. This is consistent with corporate sales growth.  SPX sales growth in 2017 is expected to only about 5% (nominal).

With valuations now well above average, the current pace of growth is likely to be the limiting factor for equity appreciation. This is important, as the consensus expects earnings to grow about 10% in 2017 (chart from Yardeni).

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. Unlike typical cyclical expansions, consumers have reduced their relative debt, and this has constrained their consumption.

Macro data was ahead of expectations to start the current year. During the current expansion, that has led to underperformance of macro data relative to expectations into mid-year and then outperformance in the second half of the year (green shading). 2009 and 2016 were exceptions as these years began with macro data outperforming expectations into mid-and then underperforming in the second half (yellow shading). Should this pattern continue, macro data should be better than expected in 2H17.

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