Market Mood Gyrations Continue on an Hourly Basis

Even amid market mood swings courtesy of the Fed, steadily rising employment offset weak manufacturing data.

Robert Johnson, CFA 24.06.2013
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The fixation on potential Federal Reserve moves continued yet again this week. Markets gyrated with every new speech from a Fed governor. In fact, all one really needed to trade the market last week was the Fed governor speaking schedule and some knowledge of the speaker's predisposition to support quantitative easing. With tongue firmly in cheek, maybe I should close my columns with the Fed's impending appearances instead of upcoming economic events. (For the curious, you can find the speeches and other Fed activities here.)

One piece of economic data this week, Friday's employment report, did have a very big impact. It was the perfect Goldilocks report: not too hot, and not too cold. It was a nice end to a week that started with some surprisingly weak manufacturing data from throughout the world, this time including the United States. The trade report was no thriller, either, with a generalized slowing in international trade. And construction data was modestly slower than expected, too. From here the week got better for the economy--the ISM report on services showed a surprise increase,  CoreLogic(CLGX) reported a huge jump in home prices, initial unemployment claims dropped, and consumer assets took a big jump even as total consumer debt dropped. My favorite shopping center metric finally showed a very healthy weekly jump and even the averaged data are now back in the safety zone, increasing to 2.8% year-over-year growth (the safety zone is 2.5%-4.0%).

All in, it was a good week for the economy and I am a little less worried than I was a week ago. That said, the number of engines of growth has narrowed to just the U.S. consumer and housing (and even that seems to be in a short-term plateau). Exports, manufacturing, government, and even business investment aren't providing any kind of a tailwind. Although I seem to be alternating between warning readers not to be too optimistic and too pessimistic, my long-term view of 2%-2.25% long-term growth is intact and has been for more than a year. Paradoxically, some of the Fed governors who are less favorably inclined to quantitative easing believe that this could be the year of a rocket-ship recovery. That's just not going to happen, in my opinion.

A Very Boring Employment Report--but That's Great News
The U.S. economy added 175,000 jobs in May, just a little better than April's 149,000 and the consensus forecast of 169,000. That's not far off the average for the previous 12 months, which is 179,000 jobs. So even to the untrained eye, the headline job numbers are finally showing the same steady-state growth that my year-over-year averaged data has shown for almost two years.

 

The 1.9% year-over-year growth rate in private sector employment is consistent with GDP growth of 2.1%-2.3% (productivity growth means employment growth usually trails GDP growth).

Equity markets couldn't have been happier with the news, although commodity and bond markets were less than thrilled. The jobs report was high enough to convince investors that the next recession wasn't around the corner after some bleak manufacturing and trade data earlier in the week. And it was just weak enough that Fed bond-buying programs wouldn't be eliminated in the very near future, though the day of reckoning is coming at some point. Since the Fed's line in the sand is an unemployment rate of 6.5% and the May measure ticked up to 7.6%, the quantitative easing crowd took some solace from the May report.

Employment Report Important, but Overrated
The employment report probably gets a lot more attention than it deserves even though it is generally a lagging indicator. It is just about the first data point the U.S. gets for any month and because the Fed has named the unemployment rate as only one of two metrics mentioned explicitly for guiding Fed policy (the other being inflation). That's why the report has taken on a life of its own. Also, incomes have trailed spending for a couple of months, so it is good to see the employment data begin to close some of that gap. Nevertheless, the retail/consumption data are much more indicative of future growth than the employment report. If consumers demand goods, businesses will ultimately have to produce more and hire additional employees. For more on the employment report, check out our weekly economicvideo.

Real Estate Prices Continue to Boom
My favorite real estate metric, the CoreLogic Home Price Index, continues to show accelerating growth. The April data for a single month compared with the same month a year ago showed a jump of 12.1%, its 14th consecutive month of growth and the biggest jump from all the way back to 2006. Even the three-month average showed year-over-year growth of 11.0%.

 


I don't think things are quite in bubble territory, as prices remain about 22% below their previous peak of April 2006, according to CoreLogic. That's not to say that there might not be an occasional market here and there that could be getting a little overheated. State performances ranged from gains of 24% in Nevada and 19% in California on the top to 2% losses in Mississippi and Alabama on the bottom. Outperformers were concentrated in the West, while the upper Midwest and some of the Northeast and the Deep South were lagging. The data below for the seven most populous states clearly captures some of this dichotomy.



The Worst Rise From the Dead

These seven states show that the really big increases over the last year were associated with states that saw the largest declines. The opposite isn't always true, as Illinois data plainly indicates. Prices are down big in Illinois and prices have yet to show much of a bounce. These seven states capture the overall national picture; almost every state is better than a year ago, but the divergence is breathtaking. Examining state economic and job performance compared with the home price data is fertile ground for future analysis and columns.

Are Investors Behind These Big Moves?
This New York Times article created a huge stir in Morningstar's Chicago office and created a lengthy email chain.

The article correctly stated that a lot of the home price increases are being driven by investors in states with tons of foreclosures, in some cases displacing local, first-time buyers. Investors are a big deal in the market, accounting for 20%-25% of recent transactions and even more in foreclosure-prone states like California and Florida. The fear raised in the article is that these may prove to be fickle buyers who can cut and run on a moment's notice. Furthermore, these long-distance owners might not maintain all of the units that they are buying. Finally, they are crowding out first-time buyers who can't compete against private equity giants. 

While the article makes some good points, investors have really been the savior of the housing market, in my opinion. Banks now have a reasonable outlet and mechanism for selling foreclosures. That wasn't true in 2008 when the real estate market went into a free-fall. The banks just dumped them, making a bad situation even worse. While investors may withdraw from the real estate market over time, the affordability ratio for individuals still remains very near record highs. In some markets, investor participation is already beginning to wane, now that homes aren't quite the steal that they were just two years ago, without a new collapse in prices. 

Poor PMI Data Not the End of the World, or as Bad as Media Makes It Seem
The ISM version of the Purchasing Managers' Index in the U.S., which set off the usual alarm bells relative to the U.S. manufacturing sector. The May reading fell to 49% from April's 51% level and below consensus estimates. The most predictive part of the index, new orders, also dropped below 50. Of course the decline got the deluxe media treatment: "Worst reading since the recession." There is no doubt that manufacturing is having one of its typical soft spots, but the data are certainly no disaster.

Now is a good a time as any to remind readers that there is nothing magical about the 50 level. The ISM research suggests that the metric has to drop below 43 to trigger a recession. Even that proved a bit trigger-happy in the 1990s when the metric dropped all the way under 40 on four separate occasions, with only one of those dips resulting in a recession. Also, the media typically uses the words "50 represents a reading that separates growth from declines." That is categorically false. A reading below 50 indicates that a greater "number" of firms saw weaker conditions than stronger conditions than in the prior month. The index does not speak to dollar values. If a handful of firms had exceptionally strong growth and a large number of firms had minuscule declines, we could have a growing manufacturing economy and a PMI reading well below 50.

While Short-Term Trade Deficit Bounces, Long-Term Trend Improving
A lot of the analysis of the monthly trade data takes one of two flavors. Either analysts were micro-analyzing it and deciding the exact impact of China's weeklong Lunar New Year holiday, or, economists were trying to gauge the trade deficit impact on the first and second quarters (not much, by the way). However, this misses some really powerful trends. For example, the trade deficit has continued to shrink from a post-World War II high of 5.7% in 2005 to 2.9% in 2012 and 2.85% in the first quarter of 2013.

 



The deficit has remained steady the last several years, even as the U.S. economy has entered a recovery. The trade deficit generally increases in a recovery and decreases in recessions. While the deficit is under much better control, it is still substantially higher than its 60-year average. However, continuing good news on the U.S. oil and gas front could improve the deficit even further. Smaller deficits generally point to smaller imbalances that can really upset the U.S. and world economic system. Smaller trade deficits also point to a smaller need to borrow money from outside the U.S. to finance the trade deficit. A smaller deficit also generally means a stronger currency which in turn helps control inflation.

Monthly Trade Data Shows a Slowing Growth Rate in Imports and Exports
Looking at the inflation-adjusted data on a year-over-year basis, the three-month moving average (which helps eliminate all the jabbering about the Lunar New Year) for both import and export growth have dropped to next to nothing. In fact, imports are down slightly and exports are up just a tad for the period ended in April. The trend is not pretty, at least for world growth prospects.


While falling imports of oil-related products were a key to the decrease in imports, even the growth rated of non-oil related products has slipped sharply and is way below the long-term averages. That is not good news for U.S. trading partners.   

Oil export growth continues to be the name of the game in slightly better export data. However, even oil-related growth has slowed a bit. Slowing in exports came mainly from outright declines in three categories: corn, coal, and fuel oil.

Global Trade Slows, Europe Takes the Worst of the Hit
Since 2012 U.S. export growth has slowed from almost 5% in 2012 to a lame 0.4% for the first four months of 2013 as a soft world economy takes its toll. Exports to Europe shrank by 6.2% and even exports to the Pacific Rim, largely China, had shrunk.


Auto Sales Better Than Expected, But Growth Is Still Slowing

According the BEA, auto sales increased to 15.2 million units after dipping to 14.9 million seasonally adjusted annualized units in March. This came as a great relief to me and other analysts who feared that consumer weakness evidenced in retail sales data might spread to the auto sector. While an improvement month to month, sales have been stuck in a fairly narrow range since November. Furthermore, year-over-year growth rates are slowing dramatically as sales approach a typical range of 16 million to 18 million units. For all of 2013, Morningstar's auto team is continuing to predict sales of 15.2 million-15.5 million units. At that rate, year-over-year sales growth could be close to zero by the end of the year, so no big boost to the economy here.

 

Retail Sales, Treasury Report, and Industrial Production on the Boards for Next Week

The retail sales report, which is always a little tricky to interpret, is expected to improve from 0.1% growth in April to a healthier 0.4% in May. Data from the International Council of Shopping Centers would seem to support an improving trend in retail sales growth. The ICSC report showed monthly May sales growth (this is calculated differently from the weekly data I usually reference) of 3.2% year over year, the metric's best performance since January. Strong consumer asset growth trumped unusually cool weather, according to the council.

The budget deficit showed surprisingly strong improvement for April, which caused huge changes in the official budget statistics. May is not a big collections month for the U.S. Treasury, but the May report could reveal whether the amazingly good April report was just a statistical fluke. Because April is the month when most people file their taxes, it is a huge collections month and usually pushes the normal deficit into a one-month surplus. May data is likely to return to deficit territory, in my opinion. But will the data be better than last May? Stay tuned.

Manufacturing has been taking it on the chin lately. Industrial production is expected to show a 0.4% increase, an improvement over April's loss of 0.5%, which seems a little optimistic. Even the year-over-year manufacturing part of the industrial production equation dropped below its long-term average last month. The ISM data didn't paint a particularly flattering picture for May, either. This metric has become particularly tied to the vagaries of  Boeing (BA), the auto industry, and homebuilding production schedules. That's because these are the only sectors showing much intermediate-term growth. Even exports of manufacturing and mining equipment are going in reverse. Luckily, manufacturing isn't a key driver of the economy right now. And, despite some recent sloppiness, the trends in the U.S. manufacturing sector remain better than almost any other part of the world.

 

Robert Johnson, CFA, is director of economic analysis with Morningstar.

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Robert Johnson, CFA  Robert Johnson, CFA, is Director of Economic Analysis with Morningstar.

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