Tips From Donna (October 2016 Wesban Monthly)
by Donna Gordon on February 15th, 2017

Slower Healthcare Job Growth Raises New Concerns

Markets didn't move too far this week, reflecting the economic data that generally hit expectations, but was nevertheless lackluster. Developed-world equities were generally weaker as increased chatter of a U.S. Federal Reserve rate increase in December kept a lid on market activity. Renewed talk of a quicker Brexit and Prime Minister Theresa May's setting a date to commence the proceedings also hurt European markets. Emerging markets managed to show small gains, related to better economic data in some emerging-markets regions. Hurricane worries also helped along the commodities sector, moving up for the week after a dreadful performance for the third quarter. 
U.S economic news this week obviously wasn't great, as the Atlanta Fed's GDPNow forecast dropped to just 2.1% for the third quarter, not all that much better than the 1.4% rate in the second quarter. In the United States the week kicked off with weak auto sales that showed little growth from a year ago. Construction also continued its slump in August. However, on Tuesday, purchasing manager data from both the ISM and Markit registered a reading of 51.5, indicating modest growth. Still, the Markit index was down modestly in the United States, even as the ISM reading improved. The current low reading shows that U.S. manufacturing isn't moving very fast in either direction. Year-over-year U.S. auto sales growth rates also continued to fall to nearly zero as this pillar of U.S. economic growth continues to crumble.
In more positive news, the Markit Manufacturing purchasing manager readings for Europe and China were both up. The European index improvement reflects the fact that Brexit impacts are likely to come later than sooner. However, that was before Prime Minister May announced that she would formally begin the Brexit process in March. China's improved data for September was a relief after an unexpected drop in August. However, a weak U.S. trade report on Thursday suggested that U.S. imports were every bit as anemic as export growth, despite the dollar's ups and downs. That certainly is great news for U.S. trading partners, though markets seemed to shrug it off.
Finally, the market topped off the week with a very dull employment report that showed low year-over-year growth levels, lower year-over-year hours worked, but strong hourly wage growth. Markets fear that higher wage growth may spur the Fed into action later this year. We were more worried about continued slow growth in retail employment, and now even the normally strong healthcare sector is showing signs of weakness. With most new potential Medicaid enrollees (under the Affordable Care Act beginning in 2014) signed up, healthcare spending and employment growth are likely to continue to diminish.
Although the market focus seems to be on the Fed and Brexit again, we remain much more worried about slowing growth in the United States. Sooner or later the market will realize that slow growth isn't such a great thing after all. Our full-year GDP growth expectation is now 1.6%, and our 3% forecast for the third quarter is looking a little rich at the moment. With autos, airlines, shale-related activity, and now healthcare, getting back to 2.0%-2.5% growth looks like a real challenge. However, workers and consumers may fare better than GDP and corporate profit growth as demographics continue to put workers in the catbird seat.
Employment Growth: More of the Same Slog
Overall, employment data looked a little better month to month, as the private sector added 167,000 jobs, compared with August's 144,000. Hours worked, which were at a recovery low in August, sneaked up to 34.4 and wages were up 0.23% month to month, which annualizes to about 2.5%. Whether that is good or bad news depends on if you are an employer or an employee. The year-over-year, averaged data didn't look as good with employment growth and hours worked growth still near the lows of the past 12 months, as shown below.
Year-Over-Year Employment Growth Showing Some Strain
​Overall employment growth has slumped from 2.1% in early 2015 to a more meager 1.7% currently. Rather than one big bang of a decline, this rate has slowly crept downward. We suspect that given strong employment levels last fall and soft GDP data, that rate is likely to fall under 1.5% by the end of the year.
Declining Hours Worked Still a Problem
Combining hours worked with employment levels, the deterioration looks quite a bit worse and is probably a truer reflection of reality. Given that it is so hard to find and train workers, employers continue to hold on to workers for dear life, even in weak sectors, and appear to be adjusting hours downward instead. This is particularly true in the retail sector.
However, hourly wages are a bright spot, at least for employees. Hourly wage growth continues to accelerate as employers are forced to pay up, either because of market demand or new minimum-wage levels. Higher wages may help the consumer do better than other sectors. However, higher wage rates come with a downside. If the rates go high enough, employers may engage in more labor-saving activities. Or they may choose to grow more slowly. Also, higher wage growth often results directly in more inflation, which could scare the Fed into action.
​Rolling all of the statistics together, higher hourly wages are not going to offset fewer hours and lower employment growth rates. When we piece together the parts (which exclude bonuses and benefits), over the past year, total wage growth has fallen from 4.8% to 4.0%, enough to have some impact on consumer spending.
Adjusting for Inflation Wage Growth Is Looking More Problematic
​As inflation rates have inched higher, real total wages have taken an even bigger hit, falling from 4.7% to just 3.2%. That situation is likely to worsen in the months ahead as energy inflation increases, potentially bringing headline inflation to over 2% as early as January or February.
Auto Sales Clearly Peaking Out
We have talked about peaking auto sales for a very long time. Recent data showed almost no growth in total auto sales in September. And to get to even those levels, incentives were higher than usual and fleet sales looked a bit high, too. It appears that auto sales are topping out very close to two other major tops in auto sales. The only good news is that higher-priced light trucks, with bigger sticker prices, greater U.S. content, and better profit margins, are still increasing as conventional sedans continue to take a pounding.
​Although the unit data has topped out, the averaged growth rates are even more worrisome. After peaking at over 12% in 2013, unit growth rates have fallen to under 2% and are likely to approach zero as we lap last year's exceptionally strong autumn. Auto sales have been a regular contributor to GDP, adding 0.2%-0.4% to GDP growth over many years, which is no small potatoes in a world of 2%-2.5% growth.
​World PMI Data a Rare Bright Spot
Manufacturing data around the world has been slumping for some time, as slowing commodity cycles halted growth in almost all regions of the world. The overall reading dropped to almost 50 this fall, the demarcation between growth and decline. With better news out of some markets recently, the overall world reading is finally improving again. More stimulus out of China and fewer worries about Brexit mean there is some hope for continued improvement, though no boom is in sight.
​The improvements in the major markets look particularly good. China, still registering low numbers, has shown some improvement for almost a year. The European numbers looked better as everyone worried less about Brexit and realized that the impact won't be felt for a while. However, we caution that this was before this week's announcement of a formal Brexit negotiation date for March, which will set off the countdown.
ISM Data for the U.S. Up for Single Month of September, Markit Down; Both Now at Same Level
We generally prefer ISM Data to Markit data, but they do tend to track each other. In August, the single-month gap was unusually wide, with Markit registering over 52 and ISM under 50. However, the data converged in September, as shown below.
​I think that with the numbers finally tracking together, the odds of very modest growth have improved, and the recession risk suggested by the ISM number last month is now behind us. Still, the current low reading suggests little growth.
Imports Look as Bad as Exports, Limiting Damage to GDP Growth
There were a lot worries that a stronger dollar, a potential Fed rate increase, and a relatively stronger U.S. economy would send the trade deficit wildly higher, with stronger imports and weaker exports. We got that half right. Year over year, nonpetroleum exports showed no growth, as we might have suspected. However, a recent surge in soybean sales might be providing a little bit of an artificial lift in exports. The big surprise has been limited import growth, which is up just 0.2%. The current trend of more interest in having experiences versus material goods is compounding import issues in capital goods, which was hit by issues in the oil and gas complex.
​Markets Mistake Statistical Noise for Accelerating GDP Growthetirement Planning in Your 20s and 30s

Seemingly stronger economic data in the middle of this week caused a brief panic in stock and bond prices as investors feared that the odds of a U.S. Federal Reserve rate increase sometime this year had increased dramatically. Markets focused on the first-quarter GDP increase, from 1.1% to 1.4%, some favorable trade data, and a renewed focus on a potential rebound in third-quarter GDP growth to 3% or more.
Although that potential was well-known among economists, the popular press doesn't focus on current-quarter GDP until the final data for the previous quarter is released. The final data for the second quarter was released on Thursday. Even the normally sedate Wall Street Journal chose to focus on third-quarter growth on the front page of Friday's edition, trumpeting the possible third-quarter 3% growth rate as the fastest growth in two years and substantially better than the sluggish first half. However, most of that rebound is related to the fact that inventories are unlikely to hurt GDP in the third quarter after subtracting 1.2% off of second-quarter growth. We view these quarterly ups and downs in inventories as statistical artifacts. We believe the real economy is likely growing 2% or so, with full-year GDP potentially being slightly lower at 1.5%-1.75% as first-half statistical anomalies prove difficult to fully overcome.

Contrary to the popular view, we believe the data this week showed a stable if not weakening economy. In fact, markets rallied sharply on Friday when some softer data was released (because that potentially means the Fed will be more reluctant to raise rates after all). Consumption data on Friday was particularly soft and worrisome when combined with weaker income data. Pending home sales fell both month to month and year over year, suggesting existing-home sales will detract from the GDP calculation in the third quarter. Durable goods orders, after subtracting out volatile transportation goods, showed that the manufacturing sector is still stuck in the mud, doing little to help or hurt the overall economy. In a rare bit of good news, home sales, while down month to month, showed a continuation of positive longer-term trends and healthy unit growth rates of 10%-12% annually.

Modest Upward GDP Revision Does Little to Change the Economic Story
The GDP growth estimate for the second quarter was revised up from 1.1% to 1.4%, primarily because of business structures and net exports. The broad contours of the report were little changed, with consumers continuing to lead the way with a strong but unsustainable growth rate of 4.3%. On the other hand, inventories shrank yet again, subtracting 1.2% from the GDP calculation, though that was less than previously estimated.
​Little else made much difference, but there were a lot more negative signs than we would like to see in the category detail. In a rare moment of weakness, housing subtracted 0.3% from GDP in the quarter, instead of its more typical 0.3%-0.5% contribution. A short-term weather-related February spurt in housing starts aided first-quarter results and killed the second quarter. We suspect that housing still won't be its strong self again in the third quarter, but it is unlikely to be a big subtractor, either. Improving new home sales are likely to be offset by lower commissions on existing-home sales.

Given Special Factors, We Suspect Second-Half Growth Will Be Substantially Stronger
Better inventory and housing data in the second half could boost second-half growth to as much as 3% on the widely reported, seasonally adjusted annual rate basis. However, that won't be enough to overcome the weakness in the first half or keep the year-over-year GDP growth from shrinking to the lowest level of this recovery.
​In addition to the slowing full-year over full-year growth, note that the likely quarter over the same quarter a year ago growth rates will also be relatively frail even with our relatively aggressive 3% sequential estimates for the third and fourth quarters. The ongoing slowing in GDP growth is one reason we are worried about employment growth and the consumer over the intermediate term.

Paradoxically, mechanically based forecasting systems started out the quarter forecasting very strong growth (Atlanta Fed GDPNow started at 3.6% in August), while the Blue Chip consensus forecast was much more muted at 2.5% at the same time. The GDPNow data has dropped considerably to 2.4% and the Blue Chip consensus is up to 2.8%. We are still hopeful that the third quarter will look better than those two forecasts and get very close to 3% growth. However, as noted above, the more important third-quarter over third-quarter growth rate is likely to remain well below 2%.

Consumption and Income Data Lost Some Momentum
Real consumption and real income data for August was disappointing and below expectations, as consumption shrank by 0.1% and incomes showed no growth at all month to month. The weaker consumption data was driven by poor auto sales, and income growth was limited by poor employment growth.
Consumption growth has been trending down for several months and income growth has been low, but trendless. Unfortunately, spending growth has been better than income growth in most months of 2016 following a period in 2015 when income growth generally exceeded spending growth. This leaves less dry powder of unspent funds to fuel more consumption growth in the months ahead.
​While the monthly data does raise some cautionary flags, the year-over-year, averaged data doesn't look quite as bleak, though the slowdown in income and consumption growth is still quite apparent. On the plus side, wage and consumption data is showing signs of bottoming, though total income (which also includes small-business profits, rents, and investment income) continues to move in the wrong direction.

The good news is, with even modest growth in consumption in September, third-quarter consumption is still likely to be up close to 2.6%-2.9%. That's not as good as the second quarter's anomalous 4.3% but in line with recent averages. Because of the way consumption growth built throughout the second quarter, a strong performance in the third quarter was almost preordained. Anemic monthly data recently will not be enough to ruin the third quarter. However, the fourth quarter could be a different story, especially if auto sales falter.
​With consumption driving 70% of GDP and incomes driving spending, this data set will be one of the key ones to watch in the months ahead. If employment growth remains sluggish, incomes and consumption will be blunted. However, consumption could still do slightly better if consumers feel confident enough to dip into savings or take out loans to leverage income gains. Sadly, consumers are showing little interest in motor vehicles, which are quite leverageable, and more interest in travel and health, which are harder items to borrow against.

New Home Sales Trends Intact at Healthy Levels
New home sales data this week seemed quite contradictory on the surface. Month-to-month sales dropped back to earth in August after a great July. However, year-over-year data was up a strong 22%. We believe the trend is best captured by the rolling 12-month sales data, which continue to show the same 10%-12% positive growth rate.

​One side note: The dip in 2014 was due to sustained cold winter weather and higher mortgage rates, and the strong bump in early 2015 was due to better weather conditions. If you could visually smoosh those artificial bumps, a 10% trend line becomes more apparent.

There were some other interesting trends worth reporting, too. First, sales of new homes not yet started was the largest category of sales (versus homes under construction or finished), which is highly unusual. Usually homes under construction dominate the statistics. Year over year, homes bought sight unseen were up 33% year over year, and actually increased month to month even as sales in the other two categories dropped. We like to see this category do well because it will generate new housing starts in the months ahead. It's one of the more forward-looking housing indicators that we have.

Second, builders appear to be reacting to demands for additional lower-priced homes. With land supplies tight and demand strong at the high end, builders initially focused their efforts on that segment. Now, demand in the middle categories appears to be gaining strength and drove August sales results. Homes in the $200,000-$299,000 category surged to 37% of sales versus just 29% last August and 32% for all of 2015.

Strong New Home Results Offset by Faltering Pending Home Sales
Regrettably, pending home sales, a great indicator of existing home sales, continues to stall out. After a great run since 2010, the Pending Home Sales Index (and existing-home sales, too) have stalled out and have showed little improvement in 2016. The index has vacillated around the 110 level for most of the year, suggesting little improvement ahead. That is consistent with the National Association of Realtors' forecast for little or no growth in existing-home sales in 2016. The good news is that existing-home sales are about half as important as new single-family home sales in the GDP calculation.
​Existing-home sales are suffering from a lack of inventory with boomers staying in their homes longer (including their retirement years), and lower job mobility, which tends to generate more home sales. Higher prices have also affected affordability and new home prices are now more competitive with existing homes. Remodeling a current home has also become a more popular option, further cutting into existing-home sales.

Durable Goods Orders Going Nowhere Fast
Manufacturing can't seem to find a catalyst to help accelerate growth. New orders, excluding the volatile transportation sector (airliners and autos) generally lead industrial production, as shown in the chart below.
​Because of price issues and the ability to cancel orders, the New Order Index is more volatile than IP and in downcycles tends to do worse than industrial production. We re-scaled the data so readers could better see the correlations and lag times between new orders and industrial production. Unfortunately, the chart shows more of the same with durable goods orders down just over 2% on a moving-average basis, about the same as the rest of 2016. That correlates to just about no growth in industrial production, which is what we have seen.

The details of the report weren't particularly bullish, either, with four of seven categories down for the month of August, and three of seven down on a year-over-year basis. Separately, the report also showed that shipments (not orders) of nondefense capital goods were down 0.4% in August and 0.7% in June. That information is used to calculate the equipment portion of GDP, providing a potential source of weakness in the third-quarter GDP calculation. It's also probably not great news for manufacturing employment or exports.

​Tiny Social Security COLA Another Hurdle for the Economy

Last week, we took a decidedly more cautious view of the U.S. economy, based on various labor market reports. Despite decent employment and wage gains, hours worked have slipped enough to put pressure on total wages.

This week our concern is Social Security recipients who are likely to receive a very minimal COLA increase in 2017 (likely less than 0.5% or $5 to $10 per month). This tiny increase comes despite healthcare inflation that has continued to re-accelerate with a vengeance according to the CPI release for August. The report showed year-over-year healthcare services inflation increased 5.1%, and medical commodities, mainly drugs, grew 4.5%.
The total wage worries and now Social Security issues are on top of our ongoing concern about airliner and automobile production as well shale oil and gas issues. Weaker-than-expected industrial production figures this week seem to suggest that those worries were well placed. Retail sales also missed the mark, showing a month-to-month decline. However, looking at that data on a year-over-year, average basis, the retail report was OK, though certainly not great.
In a piece of good news for the consumer, job openings continued to expand, suggesting that more wage increases may be in the works. But on the flip side, that isn't great news for labor-intensive businesses and their profits.
Headline Inflation Stays Low and Stable, but Note the Underlying Shifts
Headline or total inflation has been stuck at either 1.0% or 1.1% on a year-over-year, three-month moving average basis since February. However, that disguises the fact that there has been less energy deflation, more grocery deflation, and an ever-accelerating rate of inflation for services, as shown below.
Given these shifts, the move to higher headline inflation is taking a lot longer than I expected, which is good news for the Fed. However, we think headline inflation will be over 2% within the next six to 12 months. We had previously thought that inflation might reach that rate by October. Lower food prices and lower auto prices are the reason for the push-out of accelerating inflation.
​Workers Still Ahead of the Game
Hourly wages still are doing better than both core and headline inflation, which is one reason our relatively dire assessment of the economy could be wrong. However, for those wages to help, hours worked and total employment both need to improve, not just wage rates.
​Services Inflation Still a Problem, With Healthcare and Housing Leading the Way
Despite generally tame inflation overall, services inflation continues to worsen, now at 3.2% year over year averaged. Healthcare inflation and rent inflation continue to drive most of the services inflation. Rents are up 3.8% year over year, and healthcare services are up 5.1%, putting pressure on a lot of consumers, but certainly not everyone.
​Tight Labor Markets and High Job Openings Point to Higher Wages and More Services Inflation
Small business reported a new high in job openings with few or no qualified applicants. The correlation between that statistic and wage increases is very high, suggesting that wages will likely march higher, which is both good news and bad news for the economy and businesses.
​Inflation Data Suggests Minimal Social Security Cola Increase for 2017
As much as we are delighted for the current wage workers (over 140 million wage recipients), Social Security recipients, numbering 65 million, got no raise in 2016 and an insignificant one in 2017. Of course, that assumes the pre-election pressures don't force Congress to act to give retirees a raise.
​Retail Sales Data Confused by Weather, Shifting Tax Holidays and Deflation
Retail sales didn't look good month to month, but the year-over-year data was just fine, especially after adjusting the data for price changes.
​And the current growth is not far off of long-term trends.
​Manufacturing Going Nowhere Fast
We had been hoping that higher oil prices and commodity prices might help the manufacturing data, but August production data was soft yet again. While manufacturing isn't really hurting the economy, it is not helping, either. Manufacturing represents about 12% of the U.S. economy and is providing no help to growth rates currently.

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