(By Robert Johnson) This week, financial markets paid little
attention to positive economic news and treaded water while awaiting
announcements from the U.S Federal Reserve and the European Central
Bank. Given some very strong statements by the ECB the prior week,
markets were expecting concrete action from it on Thursday. When the ECB
merely rehashed old bromides, markets fell apart. But a far
better-than-expected jobs report on Friday, as well as a favorable
report from the ISM on the non-manufacturing sector, set markets on fire
Friday.
Robert Johnson, CFA, is director of economic analysis with Morningstar.
Participants could no longer ignore the fact that the economy was
clearly not falling apart. With central banks distracting investors,
many failed to notice that not only did the economic data not get worse,
but also July data showed improvement from June. Home prices were up,
auto sales came in as expected, construction spending was up, personal
income continued to inch up, and initial unemployment claims continued
their downward trend on a three-month, moving-average basis. Same-store
sales reports on Thursday truly took markets by surprise. The monthly
ICSC data showed same-store sales growth of 4.6% in July, the best
showing since March. Then on Friday, a stronger-than-expected employment
number forced all the nattering nabobs of negativism to reconsider
their "we're in a recession now" mantra, a least for a day.
Markets Loved the Employment Report; I Liked the Retail Sales Data
While investors went gaga over the employment numbers, I was a lot more
excited about the retail sales data for July and continued improvement
in the Case Shiller Home Price Index. The employment data had a little
short-term help from seasonal factors and shifting auto industry summer
shutdown practices. And taken on a year-over-year basis, July employment
numbers were little different from their 1.8% long-term trend. On the
other hand, the July retail sales report finally reversed several months
of weakening spending data. The recent weakness in spending seemed odd
because consumer incomes have seen some of their best improvement during
the last two quarters, compared with the recent past. With increased
spending in July, the income numbers make a little more sense again.
The Economy Is Neither a Roller Coaster, Nor a Sporting Event
The media loves to talk about an economy that races ahead and
then slumps, like some poor Olympic competitor. But the reality is that
the world is a little more stable and flexible than the media would have
you believe. When something goes amiss, consumers react and adjust. Gas
prices go up, we buy smaller cars. Jobs get scarce, we go back to
school. We adapt, but sometimes not fast enough for the short-term
economic indicators.
It is really easy to fall into the trap of looking at monthly and
quarterly numbers and annualizing them--and seasonal adjustment factors
that have run amok aren't helping any, either. The table below shows an
economy that is flowing at a steadier rate than many give it credit for.
The Economy Is More Stable Than You Think
Improved Employment Data Provides Investor Relief
Though investors were greatly relieved that there were no
negative surprises in this month's employment numbers, the report itself
was even more boring than usual. Year-over-year private employment
growth remained steady at 1.8%, although investors were excited that the
private sector jobs added grew from 73,000 jobs in June to 172,000 in
July, which looked more dramatic than it really was.
Hours worked were flat and hourly wages were up about 0.1%--good,
but not as good as the June progress. Most of the job growth by category
was anemic with only business services, restaurants, health care, and
manufacturing providing much of a boost. Government hiring shrank by
just 9,000 in July, one of its smaller declines for 2012. The biggest
disappointment in the data is that the construction industry continued
to contract. The residential segment did a little better but was offset
by poor construction hiring in the commercial sector.
Employment Growth: Stuck in a Rut
Seasonal Factors Make the Numbers Look a Little Better Than They Were
Seasonal factors have provided a headwind for the past several
months. Massive job gains were offset by even more massive seasonal
factors. This month there was almost no job growth, but a modest
positive seasonal adjustment factor. Again, my point isn't that we
should ignore seasonal factors, but that the size of the adjustment is
massive compared with the underlying job growth rate, meaning even a
tiny boo-boo in the seasonal factor would swamp the job growth rate in
several months of the year.
Inflated Auto Sector Gains Offset by a Utility Strike
Also, the shifting timing and magnitude of summer shutdowns
continue to mess with the auto employment data. This shift caused a
massive drop in initial unemployment claims several weeks ago. Now it
seems to have caused an increase of 20,000 auto-related jobs in the
monthly employment reports, making it one of largest monthly increases
this year, which seems just a little bit suspect to me. On the other
side of the coin, a strike at a major utility took about 8,500 jobs off
of the July count.
Retail Sales Surprise to the Upside--the Best News This Week
I was very pleased to see stronger same-store retail sales
growth for July when it was reported on Thursday. At the end of the week
we had a poor consumption figure for June, suggesting that consumption
fell by 0.1% in June when adjusted for inflation. This came despite
several months of solid income growth (which caused the monthly savings
rate to spike to 4.4%).
Apparently consumers got back to their shopping ways in July as
year-over-year, same-store sales growth increased 4.6%, according to the
International Council of Shopping Centers. This was far above more
modest expectations of 3% growth. With the exception of luxury goods
retailers, every category looked better than June's rather dismal
showing.
Auto Sales No Longer Fueling the Economy
Vehicle sales for July came in at 14.0 million units, in line
with expectations but slightly below revised numbers for June. Auto
sales were a big help for the economy in the both the December quarter
and the March quarter. Auto sales were basically flat from March to June
and consequently didn't provide much help for the economy in the second
quarter. With July's data, the auto industry is holding its own, but
things are not accelerating and therefore won't be a big help in the
second half of 2012. Most full-year estimates are now in a range of 14.0
million-14.5 million units. The good news in all the reports was that
it appears that more of the sales were to consumers and not to corporate
fleets or rental car companies. Consumer sales tend to occur at higher
prices and are considered more indicative of economic strength.
Manufacturing: No New Disasters to Report
Purchasing manager reports managed to show minuscule gains in
the U.S. and China at levels close to the 50% mark, while Europe showed
further erosion in July and levels that are getting painfully close to
recessionary levels and well below 50. Our Industrials team summed up
the reports as follows:
The ISM Purchasing Managers' Index ticked up in July, but remained below 50. The
Institute for Supply Management's PMI increased to 49.8 in July from
49.7 in June, with new orders increasing slightly to 48.0 from 47.8; any
reading below 50.0 suggests expectations for future contraction. We're
encouraged that the reading didn't fall off a precipice, although we
caution the trend certainly doesn't indicate a solid growth picture for
industrial production over the short run. Perhaps the biggest cause for
concern, managers indicated that new orders are contracting faster than
inventory levels (for the first time in 10 months), suggesting an ever
lesser need for additional manufacturing output in the near term.
China's final manufacturing PMI was a bit below last week's flash estimates, but still increased month to month in July. The
HSBC China Manufacturing PMI posted a 49.3 final reading in July, a bit
below the earlier flash estimate of 49.5, but still an increase from
June's 48.2 level. The report's authors noted that the level of
new-order contraction was the slowest in three months, but that
companies still laid off staff in large amounts; the employment index
was its lowest in 40 months. The authors continue to suggest that
further policy easing is likely to boost employment levels, but we
caution that many international industrial companies have commented that
the business climate has cooled materially during the last several
months, with minimal growth expectations on the horizon.
The eurozone final manufacturing PMI was in line with the earlier flash estimate, and indicates further weakness. The
Markit Eurozone Manufacturing PMI came in at 44.0 for July (only
slightly below last week's 44.1 flash estimate), a 37-month low. The
report's authors mentioned that many companies continued to cut both
employment and inventories in the face of further expected declines, and
that the weakness was broad-based; of the eight countries included in
the survey, only Ireland posted a reading above 50 (with a 53.9, a
15-month high). Importantly, both Germany and France posted their lowest
levels in more than three years, suggesting further weakness is likely.
Some Credit News and the Trade Deficit Are the Only News Items Next Week
Early next week we get the monthly report from senior bank
lending officers as well as consumer credit data. I suspect that the
senior lending survey is likely to show that banks loosened their
standards a bit in recent months. As the spread between long-term rates
and short-term rates continues to shrink, banks need to seek modestly
riskier loans just to keep earnings flat. Loosening credit (some, but
not too much) could prove to be a big help as more borrowers can then
take advantage of lower rates. Part of the reason the auto recovery has
been so strong has been easier credit terms. CarMax's (KMX)
chairman indicated that auto loan standards are now close to
pre-recession levels. On the other hand, some retailers are still
complaining ( Blue Nile(NILE))
that tight credit is holding back sales at the low end of the market.
Next week's report should give us some feel if additional easing of
lending standards is forthcoming.
So far, consumers have been willing to take out additional loans as
their confidence slowly grows. After a couple of years of contraction,
credit growth for consumers has surprised economists for most months of
2012. Last month, consumer credit grew by $17 billion, and I am
expecting a similar increase in the June data.
Trade Data Likely to Show Continued Improvement Due to Falling Oil Prices
After spiking to $53 billion earlier this year, the trade
deficit has been retreating as nominal oil imports have declined. For
June, I believe the deficit will fall to $47 billion from $49 billion in
May. Interestingly, exports have yet to see much of a decline despite
worldwide turmoil. For June, I suspect exports may decline some, but
imports will decline faster, in my opinion. Government statisticians
included a small increase in exports for June but declining imports in
the most recent GDP estimate.
Robert Johnson, CFA, is director of economic analysis with Morningstar.