Here’s a snapshot of economic data, updated through March since the full slate is not available through April:
Let’s walk through the economic situation in the United States next.
Labor market continues to show strength
The labor market remains the bright spot in the U.S. economy, pushing back fears that a global slowdown, triggered by China, would tip the economy into a recession. The unemployment rate remains at a low 5%, even as labor force participation has started edge higher, rising from 62.4% in September 2015 to 63% in March 2016. Monthly job growth in the first quarter has been healthy, averaging 209,000. While the pace of monthly job growth in 2016 has slowed from the prior two years (251,000 in 2014 and 229,000 in 2015), the current pace is more than sufficient to keep up with population growth and indicative of a growing economy. As the following chart shows, year-over-year growth in payrolls is hovering around 2%, which is close to the highest growth rates seen prior to the Great Recession.
Weekly initial unemployment claims have also remained in a tight range between 250K and 290K over the first four months of the year, with the four-week average falling to its lowest levels since 1973 at the end of April. At the same time, average hourly earnings have seemingly slowed their rate of increase in 2016. While year-over-year growth rate is still in the 2.0-2.5% range, the upward trend in earnings growth that we saw in 2015 appears to have broken. As the next chart shows, earnings growth is still mired at levels well below what we saw prior to the Great Recession, a fact that has significant implications for the Federal Reserve’s interest rate policy and their decision to continue on a rate hike trajectory amid a lack of sustained wage growth.
Housing impeded by lack of inventory
The housing recovery continues, albeit sluggishly. Both housing starts and building permits declined in March but the prior two months were revised higher. Starts are up 14.2% and permits up 4.6% from their March 2015 levels. New home sales have also declined over the first quarter, though sales were up 5.4% year-over-year in March. The big picture however remains the same, in that new home sales are still at historically low levels, despite their rise from the bottom in 2011. The chart below shows the seasonally adjusted new home sales rate across several recessions (shaded areas) since 1970.
A lack of inventory has led to home prices continuing their rise nationally. The Case-Shiller national home price index increased 5.3% year-over-year in February. In nominal terms, prices are still 3% below the bubble peak, while in real terms, the index is still 17% below the peak.
Slower growth is expected going forward as low inventory puts pressure on sales, except in oil-producing areas like Houston, where inventory is actually rising but prices are declining. A big issue in the housing market currently is that too few houses are being built up for the number of people that want to move into them. This drives up prices and keeps lower-end or first-time buyers off the market. According to recent data from the nonprofit Conference Board, the number of Americans indicating that they plan to buy a home in the next six months is at historic levels, 5.4% in April versus an average of 3.6% since 1978.
Consumption remains the driving force
Consumer sentiment has remained strong through the first four months of 2016 amid reasonable wage gains. The University of Michigan consumer sentiment is hovering in a tight range around 90, close to the highest levels seen prior to and post-recession. This is belied in the continued strength in auto sales, which remain strong. After a slight slowdown from decade-highs in the first quarter, light vehicle rebounded to a seasonally adjusted annual rate of 17.42 million in April. This is up 6% from the March sales rate and 4.2% from April 2015.
Retail sales excluding autos also picked up their pace of increase in the first quarter of 2016. Consumption has remained the backbone of the economy, contributing 1.27 percentage points to GDP growth in the first quarter even as investments and trade dragged down quarterly GDP growth to 0.54% (advance estimate). Yet the pace of personal consumption expenditures slowed to 1.9% in Q1 2016, compared to 2.4% in Q4 2015 and 3.0% in Q3 2015. The personal savings rate also ticked up through the first quarter, hitting 5.4% in March compared to 5% in December.
It remains to be seen whether consumption will pick up again in the second quarter as it did during the past two years, which also helped GDP growth rebound in respective second quarters. The rebound in auto sales in April may be an early indicator of this.
Manufacturing may have bottomed, but remains weak
Manufacturing, buffeted by the slowing oil and gas industry, continues to remain weak. As the next chart shows, ISM manufacturing PMIs (left axis) appeared to bottom out in December 2015 (at 48), and rose above the 50 level in March (51.8) for the first time in six months. However, April PMI fell back to 50.8. While the latest number still indicates expansion, it is an open question whether the sector will continue to do so.
Durable goods orders (right axis) continue to show negative year-over-year growth, though the pace of decline has slowed since September 2015. Once again, we see a dip in March which suggests continued weakness in the sector despite a weakened dollar and a rebound in energy prices.
Even as oil rebounded by more than 75% from its February lows of around $25 a barrel, U.S. production is yet to respond. Drilling activity, as indicated by the Baker-Hughes tally of rigs operating in the U.S., fell to a new low of 332 at the end of April, compared to 1,609 rigs at the peak of drilling activity. As Bespoke notes, it is unlikely that production will increase without a marked rise in the number of operating rigs, and despite a massive rally in crude prices we have not seen more rigs come on line. The opposite has happened.
The impact of lower oil production is clear when you compare the unemployment rate in the Houston area to the national average, as in the following chart. Unemployment in the Houston area has been ticking up since the beginning of 2015 and now matches the national rate, reversing a decade long trend when the area’s unemployment rate was well below the national average.
A point we have consistently stressed in prior updates is that manufacturing makes up only about 12% of the U.S. economy. So it is important to keep some perspective on the impact of this sector on the overall economy.
A weak dollar may provide a respite
The rally in oil prices has been accompanied by a softening of U.S. dollar strength, with the U.S. dollar index falling more than 5% over the first four months of the year. In theory, this should provide some breathing room for the export sector. Yet the advanced Q1 GDP estimate indicated that export demand actually softened, dragging down quarterly GDP growth by 0.31 percentage points, compared to 0.25 percentage points of drag in Q4 2015.
The diverging fortunes of the consumption sector and the export sector is summed up in the following chart, which shows personal consumption expenditures remaining solid (despite recent softening) while exports continue to decline year-over-year.
On the earnings front, Factset reports that the blended year-over-year earnings (combines actual results for 62% of companies that have reported and estimated results for companies yet to report, as of April end) have declined -7.6% in Q1 2016. Seven sectors are reporting a year-over-year decline in earnings, led by the Energy (-107.7%) and Materials (-15.3%) sectors. Three sectors are reporting year-over-year growth in earnings, led by the Consumer Discretionary (+17.7%) and Telecom (15.3%) sectors. If the overall earnings decline remains as it is now, this will mark the first time the S&P 500 index has seen four consecutive quarters of year-over-year declines in earnings since Q4 2008 through Q3 2009.
Going forward, a weaker dollar should provide less of a headwind for several multi-nationals. So the earnings situation should turn around, especially in the latter half of the year thanks to lower base effects for year-over-year comparisons. Of course, the big question is whether or not the dollar weakness will indeed continue, and that brings us to the Federal Reserve.
The Federal Reserves pulls back from tightening, for now
Much of the dollar weakness came about in March and April, after the Federal Reserve (Fed) indicated movement to a more dovish policy stance. At the same time, European and Japanese central banks also indicated that they were done with more stimulus measures as of now, thus boosting their respective currencies versus the dollar.
On the U.S. side, the Fed chose to back off raising rates in March and April after an initial hike in December. As the economist Tim Duy notes, tumultuous financial markets and softer data in the winter gave Fed doves the upper hand, leading to a pause in the ‘normalization’ campaign and cutting in half the expected pace of rate hikes this year.
The Fed seems more aware of the asymmetric risks they face than in December, and hence chose to err on the side of looser policy amidst all the uncertainty and tumult. However, it is not yet clear that the Fed wants to back off a rate hike in June, and would probably prefer to stay on a pace of quarterly rate hikes if they believe financial conditions have eased sufficiently. It also remains an open question as to whether economic data will move upwards after a lackluster start to 2016, and most importantly, if the Fed will deem any improvement as sufficient for tightening monetary policy further. Note that core inflation numbers, as we saw on top of this post, softened slightly in March. Core personal consumption expenditures, the Fed’s preferred measure of inflation, is sitting at 1.6%, which is still below their target of 2%.
At the same time, financial markets have essentially written off a June rate hike. As of this writing, Fed Fund futures put the likelihood of a June rate hike at less than 15%. There is precedence for the Fed switching their stance within the space of six weeks, as they did between December and January. If they do so again, expect more volatility in financial markets as the Fed tries to prime the market for a June rate hike.
Given the uncertainty of the economic situation, and how the Federal Reserve will move next, we believe it may be prudent to be cautious over the next month or two. Our own proprietary economic index, which provides a monthly nowcast of the economy using underlying factors that drive the business cycle, suggests a Caution-Hold rating.
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