Current Recovery Has Had Staying Power

Since I am writing this midweek, I am going to dispense with my weekly comments on market activity. Through Wednesday, most markets were relatively tame. However, it was a huge week for U.S. economic data. The data seemed to show manufacturing slowing some, housing still stuck in a rut, and even the employment market showed some unusual clouds. Initial unemployment claims backed up over 300,000 people last week. I'm hoping that's just a Thanksgiving holiday snag and not the start of a longer-term trend.

On the bright side, the GDP growth rate in the third quarter was boosted to 3.9%, up from 3.5%, and well ahead of expectations of 3.3%. A lot of that improvement was due to high-quality items--more consumer and business spending. Unfortunately, that will make growth that much harder to achieve in the fourth quarter, which is now likely to grow less than 3%. That would still leave the full-year GDP growth rate at about 2.3%, not much changed from 2012 and 2013.

Perhaps the biggest news this week was the sizable downward revision of the wage data in the second quarter. This might seem like a small thing, but it now implies that consumer spending growth topped income growth over the past six months, an unusually drastic change in affairs. Before the revision, consumers had looked like prodigious savers. Also, April's 304,000 jump in employment looks likely to have been a statistical mirage based on the revised wage data contained in this week's personal income report.

Although most of the week’s data was disappointing, it affirms my belief that the U.S. will have a slow but longer-than-normal recovery.

Third-Quarter GDP Growth Better Than Previously Believed
The second look at GDP growth in the third quarter showed a healthy 3.9% growth between the second and third quarter at a seasonally adjusted annualized rate. That's a nice uptick from the last estimate of 3.5%. It was a step up in quality as consumer spending growth was higher than previously estimated, as was business spending on equipment.

The highly volatile net exports and inventory categories were both revised to much less dramatic numbers, with revisions in the inventory factor offsetting an unfavorable revision in net exports. The relatively large contribution from the government sector (0.8%) was left unrevised. Many had posited that the large increase among a sea of negative reports would not stand the revision test. On the other hand, the big upward surprise versus expectations was the revision to the consumption number.

The broad flavor of the GDP was little changed. The story was a bit more balanced than it has been in a very long time. Consumption, business investment, net exports, and even government made decent-size contributions. As expected, residential housing was relatively disappointing, contributing just 0.1% to GDP growth in the third quarter. During this recovery, it has not been unusual for one category to drive most of the growth, while almost everything else shows limited growth or even a negative contribution.

GDP Growth Remains Below Long-Term Trends but Has Been Relatively Stable
Everyone remains quite focused on the short-term growth rates, but a look at the longer-term picture is really a lot more interesting.

The graph above represents GDP growth rates, using four-quarter averaged data. I'm hopeful this removes seasonal factors and weather-related hiccups. Still, the range of annual growth rates is quite large, ranging from over 10% in the early 1950s to almost as low as negative 4% in the latest recession. The mean growth rate is 3.2%, including both periods of expansion and contraction. Even given that easy mark, the past few years of this recovery have underperformed, with current growth levels of just 2.5%. Still, the current recovery has sustained its growth rate for longer than almost every other recovery with the exception of the Internet boom of the 1990s.

Also of note is that each peak in activity has generally moved downward over the life of the chart. The early peaks were due to postwar spending returning to more normal levels. I believe that slowing population growth and less-favorable demographics have driven those GDP levels down. It's really hard to grow GDP without significant population growth. In its purest form, population growth and productivity growth are the primary ways to change the GDP growth rates over the longer term. (Labor force participation rates and net exports can exert additional pressures on the long-term growth rate.) Since the 1950s, population growth has slowed from as high as 1.8% to 0.7% currently.

Over history, the booms and busts have come less often (notice how close together the peaks are at the beginning of the chart). And until the latest recession, we had three recessions in a row where the dips were less intense. Unfortunately, investors and homebuyers bet the ranch on lower volatility and levered up their balance sheets as the world looked to be a little safer. Confidence that the U.S. Federal Reserve had learned how to tame the business cycle was running high and seemed to suggest that adding more debt was quite safe. However, all the additional leverage turned what could have been a low-grade recession into a financial apocalypse. The depths of that financial adjustment and deleveraging in general have contributed to the slowness of this recovery.

Despite the slowness of the recovery, it has been relatively long-lived, especially compared with recoveries of the '50s and early '60s. Furthermore, the United States has been stuck in a very narrow 2%-2.5% growth for at least the past three years, as shown below.

Given that the housing market has yet to recover even half of its previous high, I believe that the recovery has a lot more room to run. Argh--make that walk.

Some of Consumers' Dry Powder Goes Up in Smoke
I have been exceptionally bullish on the consumer recently because of a rapidly increasing savings rate, especially since early in 2014. Incomes were going up at a healthy rate but consumer spending was going up much slower. This caused savings to apparently pile up. This is a somewhat unusual state of affairs, because U.S. consumers are pretty well known for spending every dime that they make.

However, the government restated recent consumption and income numbers so some of that short- term powder has disappeared. In the original government data, incomes went up a whopping 1.4% between March and September while consumption grew a measly 0.6%. The revisions to the six-month data now show that spending increased by 1% while incomes increased just 0.8%. In other words, savings decreased, not increased, over the past six months. In addition, the restated income data would seem to imply that eventually some of the job growth in the period April through June will be revised sharply down. The 304,000 jobs added in April now looks like it will be cut (or hours worked or hourly wages, which already weren't that hot). It's unclear exactly which monthly revision will show the new second-quarter data.

Even the averaged year-over-year data took quite a hit with this series of revisions. Real disposable income in September, on a three-month moving-average basis, is now up 2.3% and not the 2.6% reported last month. Income and consumption growth are now roughly in line, as they should be.

The adjustment in wage growth is even more stunning. In the revised three-month, year-over-year data set for September, wage growth was running at just 2.8% and not the sharp acceleration to 3.7% that the original data stated (shown below). That data suggested that holiday sales could be a real moon shoot. The new data is still good and positive, but not nearly as good as it was.

The wage growth rate at 2.9% for October is comfortably ahead of consumption growth of 2.4%. Wage growth is often a better predictor of short-term consumption than the more comprehensive real income number, especially in the short run. That is because real income includes a lot of investment income typically not spent right away. The real income data is a slightly better indicator longer-term.

Although the most dramatic changes were in wage data for the second quarter, some recent consumption data was boosted, too, as implied by the GDP report earlier in the week. The double whammy of lower wages and higher spending had a very significant effect on the savings rates. The before-and-after data appears below.

Pending Home Sales Data Implies Full-Year Existing-Home Sales of 5 Million Units
2014 was a rough year for existing-home sales, which now appear likely to fall from 5.1 million units in 2013 to 5 million units in 2014. However, the 2013 data was aided by a rush to close homes before interest rates moved ever higher.

Slower investor sales, poor weather, higher mortgage rates, and a dramatic price spike all conspired to hit existing-home sales hard in 2014, especially in the early parts of the year. Now interest rates are lower again and the weather has improved some. Sales have moved up from an annual rate of 4.6 million units during the winter to 5.3 million units in October, which just about equaled the best month of 2013.

The pending home sales index, which often portends changes in existing-home sales, was off modestly, just 1.2%, from 105.3 5 in October to 104.1 in November. Despite the fall, it is still the third-best reading of 2014. It is also nicely ahead of last year's reading of 101.9. Even the three-month averaged pendings data has broken into the green for the first time this year, and should gap up over the next month or two.

With pendings growth still ahead of existing-home sales, we can also expect more improvement in year-over-year existing-home sales. Though, a combination of low sales in November and December 2013 and the relatively small change in the pendings index growth rates suggest that the 5.26 million annualized unit sales registered in October could end up being the highest reading of the year. Over the next two months existing sales should drop into the 5.1 million-5.2 million unit range. Looking to 2015, I expect existing-home sales to grow at a 6%-8% rate, which would mean about 300,000-400,000 more units than in 2014. That would bring sales to 5.3 million-5.4 million units for the full year. Nothing stellar, but better than the 2% or so decline I am expecting for 2014.

Durable Goods Orders Don't Shed Much Light on the Manufacturing Sector
The durable goods orders report is always tricky to interpret because of volatile sales of aircraft, both to the airlines and to governments. The auto sector is a big part of this report, but we get much better-quality and timely data on the health of this industry elsewhere. So analysts generally toss out the transportation numbers (autos and airplanes) when analyzing this data set. Still, the numbers are highly volatile. Worse, the report seems to show giant upward steps, followed by plateaus and then an occasional slip in the month-to-month numbers. This month, the ex-transportation orders fell 1.3% for October, after falling a similar amount in September. However, looking at year-over-year data, averaged over three months, the news is much better with continued trend-line growth of about 6%-8%.

Most of seven categories are in a relatively tight 6%-8% growth rate with the exception of the fabricated metals group, which has had a dismal year. The month-to-month sector data is all over the place. In October, four sectors were down, two up, and one unchanged. In September three sectors were up, and four down. Yet the declines in total were about the same in both months. This volatility by sector speaks to the dangers of using single month to single month data points.

My analysis of the report is that manufacturing continues to move along and is likely to remain a significant contributor to the recovery. However, the year-over-year growth rates appear to be in the peaking process with the year-over-year growth rates no longer moving ever higher. Back-to-back monthly declines also suggest that the best periods of improvement may be behind us. I am not looking for any big decline, just less growth. It would take a significantly better housing market or robust improvement overseas to arrest the recent slowing in durable goods orders and the manufacturing sector in general. With world economies slowing and the consumer data still less than robust, the manufacturing data seems to be a little too good to be true, even with the October issues noted above.

Capital Goods Orders Also Pausing
Capital goods ex-aircraft orders is often a good way to measure business confidence. These products generally entail capital expansion over the long term. These are not decisions made easily. Just like the overall report ex-transportation goods, the year-over-year trend in capital goods remains basically intact. Still monthly numbers are soft, which could eventually pull down the strong monthly trends.

Home Price Increases Returning to a More Sustainable Rate (written by Roland Czerniawski)
With the release of Federal Housing Finance Agency (FHFA) and S&P/Case-Shiller Home Price Indexes Tuesday (CoreLogic HPI was already released three weeks ago), we now have all three home-price pieces that we track.

CoreLogic showed a 0.1% monthly decrease in September, while the year-over-year three-month moving average growth slowed down to a 24-month low of 6.0%. The Case-Shiller index, on the contrary, saw a 0.3% increase in September. Both indexes track home price changes in a wide range of large metropolitan areas nationwide.

Although it might look odd to see two seemingly similar indexes move in opposite directions in the same month, one should note that monthly numbers are quite volatile, and year-over-year three-month moving averages are more reflective of the underlying trend in the housing-market prices. On that basis, the Case-Shiller data saw a decrease to a 4.9% growth rate in September, which was, in fact, very much consistent with CoreLogic's fall to the aforementioned 6.0% growth rate.

FHFA, a measure that tracks prices of homes backed by high-quality Freddie Mac and Fannie Mae mortgages, showed that prices remained flat in September. By region, three of the nine geographic territories showed a decline, month to month. Year-over-year, on a three-month moving-average basis, the growth number dipped further to 4.5%, all the way from the 7%-8% pace recorded late last year.

While all three indexes are showing a slowdown in home price growth, it is important to mention that now, for the first time in a while, all three metrics are showing growth rates that are very close to each other. One possible explanation of this phenomenon could be that the housing market is returning to its more natural rhythm as various price distortions, such as distressed sales, investor-oriented cash transactions, and massive swings in the West Coast market, are beginning to slowly return to a more normal level.

After a series of fast-paced increases that peaked in late 2013, the rate of home price increases is moderating. As of now, home prices recovered about 82% of the previous high, and about 14 states are currently either above or close to the previous 2006 peak, according to CoreLogic. Nonetheless, Nevada, Florida, Arizona, and a few other states still remain 20% or more below the peak, and it is likely to take many years for those prices to return to their prerecession levels. On the positive side, slower-growing prices are good news for prospective buyers and for the health of the housing market in general. Those slower increases, coupled with lower interest rates, should improve affordability, providing an essential boost to this so-far anemic housing recovery.

Trade, Employment, Autos and Manufacturing on Deck for Next Week
There's a lot of data next week, but I am not so sure that any of it means much. What is needed to drive the economy forward now is more consumer spending, and there isn't much data on that front next week except maybe Black Friday results. Even those aren't necessarily indicative of the whole holiday season.

Manufacturing data has been all over the map during the past month: multiyear highs in ISM purchasing manager data at the beginning of the month; good but slowing manufacturing data, according to Markit, for November; and at least one regional survey that showed the best results in decades. Industrial production was OK, and durable goods orders were trending down. That's why investors are likely to be focused on the PMI data for December. That figure is expected to fall from 59 to 58, but I think the results could be a little worse than that. Auto sales are also due, with the consensus expecting monthly annualized unit sales to increase from 16.5 million units in October to 16.6 million in November. However, the industry forecasters are a little bolder at 16.5 million-17 million units, aided by a stronger Black Friday offering. I think the bulls may prove to be correct.

The trade deficit has held up exceptionally well, even in a relatively weak world economy. Yes, exports have been a little slower, but so have imports. The iPhone-inflated deficit is expected to drop from $43 billion in September to $41 billion in October. I think that is a tad optimistic. Lower soybean shipments and continued slow capital goods shipments might keep the deficit up at $43 billion. The wild cards on trade are port slowdowns and bottlenecks, which may serve to artificially reduce imports, with less impact on exports. The trade report has recently been having an undue and volatile effect on the GDP report.

The employment report is always a lagging indicator, but it still gathers more attention than almost any other report. Last month, the report was modestly disappointing, with 214,000 jobs added. The November jobs report is expected to be better, with 230,000 jobs to be added. I think that could be too pessimistic. Restaurants have been doing much better lately, and that has yet to really show up in the numbers. The retail higher number wasn't very good last month despite promises of a lot more hiring by some big-name retailers. I am guessing that they show up in this month's report. Job growth of 250,000 or more would not surprise me.