Reconciling Contradictory Data

Originally published in RGJ’s Business Section, Sunday, 4/5/15

The markets are still concerned about a weakening U.S. economy, as data from the industrial portion of the economy continues to show weakness, even in March.

• The ISM Manufacturing Index fell to 51.5 in March, its lowest level in more than 2 years;
• ADP indicated that private sector job creation fell to 189,000 in March from 214,000 in February with most of the job creation in the service sector (184,000; only 5,000 in the goods producing sectors);
• Construction Spending (Seasonally Adjusted – SA) fell .1% in February;
• Retail sales continue to be a disappointment, and consumers apparently aren’t spending their gas pump savings;
• The savings rate was 4.4% in November and it has risen every month to 5.8% in February; had it stayed at 4.4%, we would have a real boom on our hands.

Manufacturing

• The ISM Manufacturing Index represents only about 13% of GDP.  There are two reasons it is weakening:
  • The fall in the price of oil has had a huge impact on the energy economy, with the oil rig count falling every week.  The Dallas Fed’s Texas Manufacturing Index fell to -17.4 in March from -11.2 in February, so clearly, the lower price of oil is impacting the energy economy (energy employment is only a small portion of total employment);
  • The rising value of the dollar is having a significant negative impact on manufactured exports.  But note, it is still above 50, which is the dividing line between expansion and contraction;
• Nevertheless, the energy economy doesn’t seem to have significantly impacted other parts of the general economy.  The Purchasing Managers Indexes in both Chicago and Milwaukee, just recently released, rose;
• Meanwhile, the Non-Manufacturing ISM Index, which represents the bulk of the economic activity in the nation, is still showing strength (February = 56.9, latest data as of this writing).

Construction Spending – this indicator has been flat since last fall

• Seasonal Adjustment issues are part of the issue here, as the tight labor market and growing consumer confidence would appear to be contradictory to flat construction spending levels (Conference Board’s Consumer Confidence Index for March rose to a very strong 101.3, up from 98.8 and much stronger than the expected reading of 96.2!);
• Part of the reason is that tax policy in the U.S. has just not been conducive to organic growth in corporate capital spending (cap ex); corporate boards have concentrated on increasing dividends, stock buy backs, and mergers and acquisitions.  Capital expenditures for organic growth continue to disappoint;
• We are witnessing a hot labor market (the largest cumulative expansion of jobs since the dot.com boom of the ‘90s) with disposable income rising at an annual rate of more than 4% while corporate profits are struggling due to the rising value of the dollar and falling labor productivity (cost of labor rising per unit of output) due to the lack of reinvestment in organic growth (cap ex).  No wonder there is pressure on corporate profits;
• In the housing market, new home sales have picked up, but existing home sales are still struggling.  You certainly can’t blame this on interest rates;
  • The first issue is the lack of supply of homes, as land development has essentially been non-existent since ’08;
  • But an equally important, and often ignored, is the lack of traditional financing available to former home owners who were forced to short-sell their property.  Those potential buyers are locked out of the market, as all government programs and major portfolio lenders won’t even look at a file unless the short-sale was more than 4 years ago.

Retail Sales

• The poor retail sales data is misleading for the uninformed, as the retail sales does not include spending on services, only goods.  Services are a much larger portion of consumer spending.  With that in mind, while the spending on goods appears to have been stagnant in the first quarter, as of February, spending on services had risen more than 4.6% on a year on year basis (i.e., vs. February ’14).  When taken together, sales of goods and services, i.e., consumption, has risen 2.2%.  Furthermore, recent readings of consumer confidence are strong.  With strong job creation and rising consumer confidence, it is hard to imagine that consumption won’t follow, especially in the U.S.

The Fed and Interest Rates

Meanwhile, the Fed remains on the sidelines, with Fed Chair Yellen recently remarking that “the economy, in an ‘underlying’ sense, remains quite weak.”  While they are likely to increase short-term rates before 2015 is over in order to maintain their credibility, the strong dollar and miniscule interest rates worldwide will prevent medium and long-term rates from rising over the medium-term horizon.  It should also not be a foregone conclusion that the oncoming Fed rate hike is the first of many.  It may very well be “one and done.”

Conclusions

Like in 2014, first quarter GDP is likely to disappoint, perhaps growing less than 1% (some pundits even say negative).  But, like 2014, a strong rebound appears to be in the cards.

• The SA process simply doesn’t work when weather extremes;
• The west coast port strike had a big impact on the industrial economy in January and February with some spillover into March;
• Job growth is strong, and consumer confidence is rising.  Consumption will follow;
• The labor market remains hot with businesses unable to find qualified applicants.  Walmart, Target, Toyota, and now McDonalds have already announced rising wage scales, and some states and cities have raised legal minimum wage levels.  This phenomenon is about to become a tidal wave, as all major corporations will have to respond just to keep their existing employees; cost–push inflation is now likely.

Robert Barone (Ph.D., Economics, Georgetown University) is a Principal of Universal Value Advisors (UVA), Reno, NV, a Registered Investment Advisor.  Dr. Barone is a former Director of the Federal Home Loan Bank of San Francisco, and is currently a Director of AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Company where he chairs the Investment Committee.  Robert is available to discuss client investment needs. Call him at (775) 284-7778.

Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information. A more detailed description of the company, its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV  89521.  Ph: (775) 284-7778.