Revised Data Show Better, But Not Booming, Economy

This week, there wasn't much to report in terms of economic or earnings news, so markets had time to fret about Fed governor speeches for most of the week. Governors on this week's speaking circuit all seemed to indicate that tapering of bond purchases could happen as early as September or October. These worries led to a declining stock market this week, for the first time in a while.

What economic news we did get was respectable: initial unemployment claims were down, the services sector is picking up steam, home prices continue in boom territory, and trade data made a drastic turn for the better. Normally I would say the improved data may have raised tapering fears, scaring markets of all types, but interest rates barely budged this week while stocks and commodities trended down.

The news overseas was also better this week, with China reporting better export data and Europe showing better production data. (I commented on better manufacturing data out of Europe last week.) Given continuing debt issues, I don't think Europe is out of the woods just yet. I do have to admit that the data is looking better than I would have expected. Slightly improved exports, a little less government austerity, and a consumer who is a little more willing to spend seemed to put an end to the European slide, for now.

Revised Data Paint a Picture of an Improving Economy, but No Boom
Last week's GDP revisions gave everyone a chance to revisit where the economy is and where has it been. While forecasting the economy has proven to be a tough job, pinpointing where the economy is now has proven remarkably difficult for statisticians over the past several months. In fact, new data shows that GDP contracted in the first quarter of 2011 and nearly dropped into negative territory in the fourth quarter of 2012.

As I outline in this week's video, the data now paints a picture where the economy peaked in summer 2012, and almost drifted into recession territory in the fourth quarter as a result of Hurricane Sandy and reduced business confidence because of all the fiscal uncertainties in Europe and the United States. The lack of confidence manifested itself in greatly reduced inventories in the fourth quarter. Dramatically slowing defense spending hit hard both fourth-quarter and first-quarter data.

The first quarter of 2013 was better, though a drastic (and perhaps artificial drop) in spending on commercial buildings weighed on the first-quarter data. The second quarter showed even more improvement, though consumer spending was a touch weaker, perhaps because of the delayed effects of the increase in taxes. Also, the first quarter benefited from a consumer-related rebound from Hurricane Sandy that didn't recur in the second quarter. Second-quarter improvement was largely due to a swing in commercial buildings and defense spending. Through thick and thin, consumer spending was not much statistically different among the four most recent quarters with the exception of some Sandy-related effects.

Statistical Anomalies and Leading Indicators Point to a Temporary Bounce in the Second Half
As export data improves, housing picks up a touch, and if just maybe government spending doesn't collapse, a growth rate of close to 3% is a real possibility in the fourth quarter. In addition to the statistical bump in the second half, almost every leading indicator has now begun to turn the corner, including the Architectural Billing Index, the Purchasing Manager Indexes, initial unemployment claims, and durable goods orders, to name just a few.

Unfortunately, I think the growth rate will drop back to the 2.0%-2.5% range in 2014 as the helpful reversals in the second half of 2013 are no longer providing a tailwind. The wild cards to all of these forecasts includes the remaining impact of the sequester, improvements in overseas economies, and the potential for even higher interest rates. In any case, I am still thinking no boom and no bust for the U.S. economy. The first-half "reported slowness" didn't seem to hurt employment data, so I don't expect an accelerating GDP growth rate in the second half will do much to boost employment growth.

Initial Retail Sales Data for July Point to a Better Government Report Next Week
Over the last week there have been a number of reports released that seem to suggest some modest improvement in consumer spending and retail sales. Last week's employment report showed the second straight large increase in retail employment with both months showing growth of more than 40,000 new jobs. Either those hires picked up because business was better in July or there was a bigger emphasis on back-to-school sales in July and August. In addition, while weekly sales data from the International Council of Shopping Centers aren't lighting the world on fire, they are making a slow, gradual comeback, as shown below:

I am providing the weekly data in addition to the normal five-week average to show that the upward trend is now favoring growth in the average for at least a few more weeks. Generally, I would prefer to see growth in the 2.5%-4.0% range, which I hope will happen next week.

Monthly data from ICSC also looked relatively strong (although it measures a different store base). Sales in July were up 4.4%, its strongest gain since January and above the ICSC forecast of 3.0%-3.5%. Unfortunately, with some many chains now refusing to publish monthly data, the survey has dropped to just 13 or so chains, depending on the month, down from more than 30 a few years ago.

With both ICSC data series I worry, at least a little, about the declining role of shopping centers compared with online retailers such as  Amazon (AMZN). Next week's retail sales report from the U.S. Census Bureau should clarify some of the retail picture.

Import/Export Data Remains on a Yo-Yo Again as Trade Deficit Gaps Down
May's trade data by itself was inexplicably soft with the deficit widening to $45 billion from its $40 billion trend. For June, the deficit just as inexplicably declined to $34.2 billion, more than offsetting May's deviation from trend.

Again, gold, diamonds, and jewelry played a big role in the volatility, along with the oil industry. As excited as everyone was about the monthly data, even the year-over-year three-month average data seems to indicate that we have seen the worst of the slowing trade situation. However, the situation is still far from robust, although rising oil exports and falling oil imports, continued increases in airliner shipments, and sluggish economic growth point to a smaller U.S. trade deficit over the intermediate term.

Smaller Trade Deficit for June Likely Means an Upward Revision in Second-Quarter GDP Growth
Trade took a whopping 0.8% off of the 1.7% GDP growth estimate for the June quarter (GDP growth would have been 2.5% without the trade hit). Trade data was particularly negative in May, and government statisticians had estimated a nice improvement in the deficit for June, which they used for their GDP calculation. However, the improvement was an awful lot better than they were estimating. It now looks like trade was little changed between the first and second quarter, suggesting that the GDP number might be due for a substantial upside revision. However, I caution that changes in the inventory data often offset a fair amount of the anticipated gains from trade. Besides inventories, retail sales and construction industry revisions could change the magnitude of the revision.

This week's two labor market reports, the Jobs Openings Report for June and the weekly initial unemployment claims reports for the week ended Aug. 3, continue to point to a sluggish labor market characterized by lackluster hiring but reduced layoffs. Initial unemployment claims, on a four-week moving-average basis, hit their lowest level since November 2007. While the claims numbers are volatile over the summer due to shifting auto summer shutdowns, the downward trend is clearly in place. The four-week claims average was 335,000 compared with a 2013 high of 362,000 in April and 368,000 for the same week a year ago. The statistics look even more dramatic when looking at the number of people collecting unemployment. The number of people collecting unemployment has dropped 21% from 5.75 million people a year ago to just 4.52 million as of mid-July.

However, there was less to get excited about in the job openings report. Although some headlines trumpeted the highest number of openings since 2008, the monthly increase was a mere 29,000 and the openings figure has been stuck at 3.8 million-3.9 million openings for four months without much headway. Even worse was the fact that hiring data showed that 289,000 fewer people were hired in June than May, the biggest drop since 2010. The number of people voluntarily quitting in June also dropped, which is generally an early indicator of falling consumer confidence.

All of the June job opening report could easily be a statistical anomaly (although employment data for July, just one month later was soft). However, a major labor market breakout is not indicated by the data in front of us today.

Home Prices Continue to Accelerate, According to CoreLogic
Continuing tight inventories are keeping home prices accelerating. The  CoreLogic Home Price Index increased 11.9% year over year and 1.9% month to month in June. The gains even continued to shine through in our more conservative three-month moving average process, as shown below:

Data for July suggest similar improvements, with annual prices likely to be up 12.5%, based on pending home sales data in CoreLogic's database. The only potential fly in the ointment is that month-to-month price growth has slowed just a bit and is expected to slow even a little more in July. With gains the highest they have been since 1977, a pause in home price growth would not be unexpected, especially given higher interest rates.

The usual caveats also apply. While price appreciation is being realized in all sections of the country, previously troubled states are benefiting disproportionately at the moment. The biggest improvements were seen in Nevada (26.5%), California (21.4%), and Arizona (16.2%). Delaware and Mississippi were the only two states registering declines. The 10 westernmost states all had gains in excess of 10%. Meanwhile, east of the Mississippi River, only Florida and Georgia had gains larger than 10%.

As nice as all the price appreciation has been, CoreLogic points out that prices are still 19% below previous highs. That is a lot better than the nearly 35% drop recorded at the worst of the price recession, though. Many of the recent big-gaining states are still well below the average decline rate of 19%. As an example, Nevada is still a whopping 44.3% below previous high-price levels.

Purchasing Manager Report for Services Exceptionally Strong
Usually the more volatile and longer-history manufacturing report from the ISM gets all the attention, and the service report is largely ignored. However, it was hard to ignore the report this week. At 56.0 (roughly meaning that 56% of businesses saw improvement between June and July) the report is now at its best reading since February. By sector, 16 of the 18 industry groups demonstrated growth, with only Mining (China, natural gas and coal issues) and health care (Affordable Care Act issues, government disbursements) on the downside. Stronger industries included construction and retail. The more forward-looking New Orders Index rose to 57.7, which should bode well for the months ahead. That said, while it's nice to see a good reading on this report, it has shown a number of medium-sized ups and downs that really haven't shown up in any subsequent economic releases, which is why I seldom write about it. However, this month's jump from 52.2 to 52.6 was too big not to mention it.

News Due on Every Sector Next Week: Housing, Prices, Retail Sales, and Federal Budget
Housing has been an important and consistent driver of the recovery over the past year, but housing construction has plateaued. In fact, in the second quarter, new home construction wasn't much of a contributor to GDP. Instead brokerage commissions on home sales and remodeling efforts contributed to most of the residential fixed investment category. This week will show if we are finally breaking into new growth territory or are due for more of the same slow growth.

Markets Looking for Improved Housing Data
Market expectations are for a decent sized pop in both housing starts and permits after surprisingly poor data in May. However, higher interest rates will complicate interpretation of the July report. With just 836,000 starts in June, the worst performance since August 2012, the market is hoping the July data was just a fluke. Expectations are for starts of 895,000, which is still a little below the first-half average of 915,000. Even if the consensus is correct, my conservative forecast of 1 million units is looking like a stretch with just five months of the year to go. Permit data and construction industry employment growth suggests that the June swoon in starts was temporary, but that we should expect a return to the spring averages and not a move to new highs. Builders' sentiment data on Thursday (which has been trending better than starts) should provide some hints about the starts market on Friday.

Retail Sales Expected to Move Up Again
The consumer is the key driver of the economy and the retail sales report should give some hints as to how the consumer did in July. Auto sales, which had an unusually large jump in June, basically held its ground in July, which generally means that consumers are doing well. The headline non-inflation adjusted retail sales figure is forecast to grow 0.4% in July, about the same as June. The International Council of Shopping Center monthly data would support that type of growth, but flat auto sales month to month and lower inflation will weigh on the July report. Given the huge jump in restaurant employment over the past several months, the restaurant portion of that report will be of strong interest. In June restaurant sales were down. That trend should reverse in July.

Improved Purchasing Manager Data Pointing to Improved Manufacturing Data
Purchasing manager data has been on a real tear lately, which should translate into improved industrial production data, due on Thursday. Reduced auto summer shutdowns should also provide a tailwind to this month's report. Employment growth in manufacturing was minimal in July, potentially limiting the amount of improvement. Consensus estimates peg the Industrial Production growth rate at 0.4% (4.8% annualized) up from June's 0.3%. Because of an improved auto situation and the  Boeing (BA) ramp-ups, I think production can grow slightly faster, although slow utility growth could be an issue in the headline number. Cool weather in the Midwest could hurt the utility contribution.

Consumer Prices Growth for July Should Slow Down
Largely because of gasoline prices, consumer prices jumped 0.5% in June, hitting consumers in the pocketbook. Gasoline prices in July were basically flat but there is a seasonal adjustment that will modestly raise gasoline prices. A lot of food commodities have been moving down (think corn and soybeans), which should eventually help consumer food prices over the next several months, even if the relief probably did not come soon enough to help July. If the consensus estimate for the combined Consumer Price Index for July is correct, the year-over-year three-month average for the CPI will be 1.7%, up from May's low of 1.3%, but still below my full-year forecast of 2.0%. Inflation has now been trailing its 65-year average of 3.7% (3.1% median) for several years. Although recent inflation data has been relatively benign and like watching grass grow, it remains one of the best indicators of consumer spending and economic growth. At 1.7% annual growth, the CPI indicator is flashing all systems go.

Federal Budget Deficit Should Continue to Shrink
On Monday the Treasury Department releases budget data for July. These reports have been volatile lately, and don't completely jibe with data used to calculate the GDP report. Still, the report will be a decent indicator of the possibility of meeting drastically lower budget deficits for 2013 and 2014. We at Morningstar have been hearing more about the sequester impact lately, including our defense contractors and even utility usage in the Washington, D.C./Virginia area. Some of the short-term impact of furloughs on civilian Department of Defense employees (650,000 of them) are also beginning to hit home.