Friday, August 7, 2015

August Macro Update: A Recession Is Not Looming Ahead

Summary: This post reviews the main economic data from the past month.  Most, but not all, of the data was positive:
  • Employment growth is the best since the 1990s, with an average monthly gain of 243,000 during the past year.  
  • Compensation growth is positive but not accelerating: 2.1% in 2Q15.
  • Personal consumption growth the last two quarters has been the highest in 8 years: 3.1% in 2Q15.  2Q15 real GDP grew 2.3%, near the upper end of the post-recession range. 
  • Housing starts are near an 8 year high. New home sales in June rose 18% yoy. 
The main negatives are:
  • Core durable goods growth fell 3.5% yoy in June. It was weak during the winter and there has been little rebound since. Industrial production is also weak, growing at just 1.5% yoy, one of the low rates in the past 15 years.
  • The core inflation rate remains under 2%. It is near its lowest level in the past 3 years.  
Bottomline: the trend for the majority of the macro data remains positive. The pattern has been for the second half of the year to show increased strength.

Prior macro posts from the past year are here.

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Our key message over the past year has been that (a) growth is positive but modest, in the range of ~3-4% (nominal), 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. This is germane to equity markets in that macro growth drives corporate revenue, profit expansion and valuation levels.

Let's review each of these points in turn. We'll focus on four categories: labor market, inflation, end-demand and housing.

Employment and Wages

The July non-farm payroll was 215,000 new employees. In the past 12 months, the average gain in employment was 243,000, the highest since the 1990s.

Monthly NFP prints are normally volatile. Since 2004, NFP prints near 300,000 have been followed by ones near or under 200,000. That has been a pattern during every bull market. The low print of 119,000 in March fits the historical pattern.

Volatility in NFP is not a recent phenomenon. The 1980s and 1990s bull markets were the same, only the range was higher. If anything, the swings were more extreme: NFP was negative in 1995, 1996 and 1997.

For this reason, it's better to look at the trend; in July, trend growth was 2.1% yoy. Annual growth continues to be the highest since the 1990s.  Employment growth in 2015 has been better than at any time during the 2003-07 bull market.

Average hourly earnings growth in July increased to 2.1% yoy; in April and May, the rate of growth was the highest since the end of the recession. Sustained acceleration in wages would be a big positive for consumption. Not yet.

2Q15 employment cost index shows compensation growth was 2.1% yoy. This is down from 2.7% in 1Q15, which was the highest growth since the recession.

For those who doubt the accuracy of the BLS employment data, federal tax receipts are also accelerating, a sign of better employment and wages (data from Yardeni).


Despite improving employment, inflation remains below the Fed's target of 2%.

With oil prices collapsing, CPI was just 0.2% in June. The more important core CPI (excluding more volatile food and energy) grew 1.8%.

The Fed prefers to use personal consumption expenditures (PCE) to measure inflation; total and core PCE were 0.3% and 1.3% yoy, respectively, in June . Neither has been above 2% since 2Q 2012.

For some reason, many mistrust CPI and PCE. MIT publishes an independent price index (called the billion prices index). It tracks both CPI and PCE closely.


Regardless of which data is used, real demand has been growing at about 2-3%, equal to about ~3-4% nominal.

Real (inflation adjusted) GDP growth through 2Q15 was 2.3% yoy. 2Q growth was near the upper end of the post-recession range (1.5-3.0%). It's positive, but lower than the 2.5-5% common during prior expansionary periods since 1980.

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 2Q15, this grew 2.2% yoy. A sustained break above 2.5-3.0% would be noteworthy.

Similarly, the "real personal consumption expenditures" component of GDP (defined), the component which accounts for about 70% of GDP, grew at 3.1% yoy in 2Q15. The last two quarters have seen the highest growth rate in 8 years. 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 2.9% yoy in June. This is solid growth.

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 through 1Q15 was 3.2% yoy. This is within the range of prior expansionary periods since 1980 (2.5-5% yoy).

Real retail sales grew 1.2% yoy in the past month. The range has been 1.5-4% yoy for most of the past 20 years. The latest month is therefore at the low end of the range.

Retail sales has recently been affected by the large fall in the price of gasoline. Retail sales at gasoline stations fell by 17% yoy. Retail sales excluding gas stations grew 3.0% (nominal) in June.

Core durable goods orders (excluding military, so that it measures consumption, and transportation, which is highly volatile) fell 3.5% yoy (nominal) in June. During the heart of the prior bull market, growth was typically 7-13%. Weak growth in winter has been a pattern the past three years (arrows) but there has been no reprieve this year. This is weak.

This is a nominal measure and thus negatively impacted by the fall in the inflation rate. On a real basis, growth continues to trend higher over the past year (blue line is real; gray line is nominal; chart from Doug Short).

In June, industrial production growth was 1.5%. The manufacturing component (excluding mining and oil/gas extraction) grew 2.1%. The current growth is at the low end of the past 15 years' range (1.5-5%). It's a volatile series; manufacturing growth was lower at points in both 2013 and 2014 before rebounding strongly.


Housing starts in June remained near an 8 year high. Building permits are at an 8 year high. New home sales in June rose 18% yoy. Overall levels of construction and sales are small relative to prior bull markets but the trend is clearly higher.

First, new houses sold was 482,000 in June. This is 18% higher than a year ago. The overall level of sales is still meager relative to prior bull markets. 30 years ago, 600,000 would have been at the low end of the range for monthly sales.

Second, overall starts in April increased to a new 8 year high; they remained near those highs in June.  The overall level of construction is well off those during the prior two bull markets, but the trend is clearly positive.

While housing starts were disappointing during the winter, they were not alarming. Building permits remained robust (red line) with June at a new 8 year high.

The rebound in starts has been widespread. In April, single family housing starts (blue line) were the highest since the recession; June was only slightly lower. Multi-unit housing starts (red line) in June were the highest since the recession.


In summary, the major macro data so far suggest positive, but modest, growth. This is consistent with corporate sales growth.  SPX sales growth the past year has been positive but only about 2% (nominal) excluding energy.

With valuations at high levels, the current pace of sales growth is likely to be the limiting factor for equity appreciation. This is important, as the consensus expects earnings to grow 2% in 2015 and 12% in 2016.

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. I

There has been a tendency for macro data to underperform expectations in the first half of the year and beat expectation in the second half. That pattern appears to be at work in 2015 as well.

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