U.S. Consumers Have Gas in the Tank
Wage and income growth should drive consumption higher in the months ahead.
Because we are writing this report midday Wednesday, and markets around the world are open on Thursday and Friday, we didn't think it made a lot of sense to report our normal full market summary by category. However, most equity markets were flat to slightly down at that halfway point, and U.S. Treasuries and commodities were both stronger, most likely because of the downing of a Russian plane by Turkey.
It was an unusually big week for U.S. economic releases despite the holiday. As expected, none of the data was particularly market-moving and a lot of it was dead-on expectations. Housing data was largely consistent with expectations and existing-home sales, new home sales, and single-family housing permits all showed convergence to something that looks like an 8% year-over-year growth rate. That rate may prove difficult to improve on in 2016 as home inventories are low, prices are high (our 5%-6% home-price increase forecast for 2015 is looking a tad low after this week’s data), and interest rates are likely to be higher.
U.S consumption data looked soft at 0.1% growth between September and October, but adding back a 0.2% hit from low utility usage (warm weather) gets us very close to recent growth trends and market expectations. However, income growth at 0.4% is an entirely different story. As income growth has exceeded spending growth for the fifth month in a row, we believe that inflation-adjusted consumption growth looks poised to grow at 3% or more for at least several months into the future. Since consumption is 70% or so of GDP, that puts the base starting rate for GDP growth at 2.1% (3.0% x 0.7), even if there is no net growth in any of the other categories.
Speaking of the GDP report, the third quarter was revised up to a 2.1% growth rate from the previous 1.5% rate, largely on the basis of smaller inventory shrinkage and little change in the underlying categories, provoking nothing more than a mild yawn from investors.
The durable goods report showed some surprising strength in October and some large upward revisions to the September data. Manufacturing isn't exactly booming, but at least that sector shouldn't be the growth detractor that it was early in 2015, based on this report and the recent report on industrial production. Separately, the import-export report was also better than expected, at least in nominal dollars, as the trade balance in goods contracted in October. Unfortunately, the declining deficit was a result of both falling exports and imports and no net new growth in either. That's news the U.S. economy can handle, but it isn't such great news for U.S. trading partners.
In a story that we have been a bit slow to catch on to, Europe seems to be finding its economic footing. This week's manufacturing purchasing manager reading showed its best level in more than a year, and the number for services was the best in four years. The improvement was broad-based and included Germany and the peripheral economies, with only France not showing much improvement. Some of the individual data sets for the peripheral countries were the best since the recession began, showing perhaps that some of the reforms are finally working.
Instead of our normal outlook section that appears at the end of this report, we have tacked that outlook on to the end of our weekly video. There is a lot of data due next week, but auto sales, employment, and the Chinese PMI reading should dominate the headlines. In the video, we did forget to mention that pending home sales will also be out next Monday, and that may give us some idea if the small drop we saw in existing-home sales in October was a normal dip after some very strong months, or the start of something worse. We will see next week. Happy Thanksgiving to all!
Poor Utility Sales Dog Otherwise Healthy Consumption Report
Consumption grew a relatively pathetic 0.1% in October (versus an expectation of a 0.3% growth rate) as falling utility usage took a full two tenths off of the consumption growth rate. In other words, consumption would have grown a very healthy 0.3% (3.6% annualized) if it weren't for the unusually warm October.
Because utility bills are paid in arrears, consumers won't have that extra money to spend until November or December. Furthermore, a return to more normal weather likely means that the November consumption report will get a 0.2% tailwind from higher utility usage.
Incomes grew an impressive 0.4%, as expected, outpacing spending growth for the fifth month in row. Such spending droughts have often been followed by a spending surge once consumers fully adapt to and believe in their higher earnings. Also interesting to note, there has been no month-to-month inflation for four months in a row (according to the PCE deflator). Nominal growth and inflation-adjusted growth in both spending and incomes are now, and have been the same for several months, a highly unusual state of affairs, which makes economic analysis a little easier than usual.
Year-over-year data shows a similar pattern of relatively sluggish but stable consumption growth (around 3%), better income growth (3.8%), and downright impressive inflation-adjusted wage growth (4.7%).
Total income growth is at its high for the year while wage and consumption growth are marginally lower than their 2015 highs. We think the wage and income growth should drive consumption higher in the months ahead, underpinning our 2.0%-2.5% GDP forecast (consumption is 70% of U.S. GDP and was 2.0% of the 2.1% total GDP growth rate in the third quarter), even in the face of sluggish business investment and government spending as well as slumping exports.
Third-Quarter GDP Growth Rate Moved Higher, Underlying Fundamentals Remain Similar
The GDP revision was small and pretty much as expected, revised from 1.5% sequential annualized growth to 2.1%. Because the lion's share of the revision related to new inventory data, the economy's underlying fundamentals were little changed from the last estimate, as seen in the individual category data below:
Outside of the inventory adjustment, the other category data changes were small and for the most part, offsetting. We are less than excited about adjustments due to inventory changes; it's more likely that they represent counting errors rather than changes in economic fundamentals. We tend to like looking at GDP data without those pesky inventory adjustments that are so large on a quarterly basis and tend to cancel themselves out over the course of a full year.
The broad contours of the third-quarter GDP report remain the same. The consumer remains king. Consumption accounted for 2.0% to the 2.1% growth rate, and everything else canceled itself out, on a contribution basis.
About 0.5% of overall growth was due to auto production. There was nice growth, approaching 10%, in equipment, but because equipment is just under 3% of GDP, it wasn't as helpful as the high growth rate suggests. And the 0.6% contribution in equipment was offset by a decline in net exports and structures. The structures category is taking a real hit from the slowdown in drilling-related investments, which fell over 60% on an annualized rate basis. It's a good thing that this category is so small, but it nevertheless took 0.3% off of the overall third-quarter growth rate of 2.1%.
Government was also a help in the quarter, and we expect to see continued improvement in this category as state and local government finances improve and the federal government begins to pick up. Although export growth rates have slowed to a trickle, imports have slowed just as fast, limiting the impact on GDP growth. Consumers' preferences for autos largely produced in the U.S. and for services, combined with a falling need for oil imports, have really kept a lid on imports. That is good news for U.S. producers, but not such great news for U.S. trading partners that have yet to see a surge in U.S. demand because of lower prices resulting from the stronger dollar.
Comparing GDP growth calculated on the same quarter a year-ago basis and on a four-quarter-average-basis both show more consistent growth rates versus the normally reported, sequential growth rates. Faulty seasonal factors and erratic inventory and export data have diminished the usefulness of sequential GDP data.
We have also included our fourth-quarter and full-year GDP estimates above. We believe the sequential fourth-quarter data will show acceleration in growth because of a smaller inventory hit as well as smaller negative impact from net exports and a small acceleration in government spending. The consumer sector, already one of the healthiest, may see an even better fourth quarter compared with the third quarter, too. Although not shown in the table above, we suspect that the economy will again grow at a 2.0%-2.5% growth rate in 2016 and potentially 2017, for that matter. An aging population (which will tend to spend less and save more) and limited population growth will continue to weigh on overall economic growth rates.
Early Trade Reports Suggest Trade Won't Be a Big Drag in the Fourth Quarter
The government has begun to report trade data a couple of weeks earlier, significantly reducing subsequent GDP revisions. However, the government just reports the imports and exports of goods and not services. The initial data also is not adjusted for inflation. The full set of trade data will be available next week.
With those caveats, the trade deficit in goods for the month of October was lower than every month of 2015 except February, when West Coast labor actions artificially depressed imports. Unfortunately, the trade balance shrank because exports and imports both dropped at an over 2% rate, but because imports are much larger than exports, the trade balance narrowed. Even though almost every category registered monthly declines (only the "other" export category saw a small gain), we suspect that oil and other commodities accounted for a good part of the outright decline. It was exceptionally odd to see imports of consumer goods show an outright decline just before the holiday season. That usually happens only during a recession. We suspect that the data may not look quite as dire when adjusted for inflation next week. The data may also be revised, too.
Nevertheless, this has to be terrible news for the world economy that was counting on the U.S. for growth. Finicky U.S. consumers who are concentrating their purchases on big-ticket goods made in the U.S., or services, are hurting retailers and exporters to the U.S. alike.
Durable Goods Orders Showing Signs of Life
U.S. core durable goods (excluding transportation) finally managed a month-to-month increase of 0.5% after two months of back-to-back declines. Just as good, the September decline was revised smaller so orders now declined only 0.1% instead of 0.3%. On a single-month, year-over-year basis, orders for October were down 2.4%, sharply better than the 5% year-over-year decline for September.
Even on a moving-average basis, the year-over-year declines in orders have finally stabilized, with averaged growth of very close to 4% three months in a row. Barring some kind of weather event or an economic disaster, those year-over-year growth rates should break into positive territory sometime over the next several months.
October 2014 marked the first month of five straight months of sequential declines as a combination of bad weather and a slowing China (and related commodities) made a serious dent in the manufacturing sector. While these items won't necessarily all return to normal, it's doubtful that the rates of decline last winter will be matched in the 2015-16 winter season.
Non-Defense Capital Goods Ex-Aircraft Orders Up, Indicating Higher Business Confidence
Because capital goods last so long, are expensive, and take considerable time to put in place, they are a very good indicator of business confidence. So we were pleased to see new orders in this category increase 0.4% in September (revised sharply from a negative 0.1% decline in the initial estimate) and 1.3% in October. (A 1.4% decrease in August is weighing on the month-to-month averaged data, and when that drops out next month, the month-to-month averaged growth rate should show a nice pop.) The year-over-year averaged data still shows a steep 4.2% decline, though that is still a lot better than the 5.5% average just a month ago.
The sector data was quite improved too, with only two of the eight major categories showing a decline in order activity (electrical equipment and fabricated metals), and seven of eight categories managed an improvement (either higher increases or lower declines), compared with the September data.
European Manufacturing Data (and Services, Too) Are Picking Up Steam
Eurozone November Flash PMI data for manufacturing was a pleasant surprise, increasing from 52.3 to 52.8 in November, its highest reading since April 2014. Current output, new orders, and employment all did well, with all three falling in the 52-55 range. The strong new orders figure bodes well for the months ahead as those orders are filled. Apparently, a weaker currency and monetary stimulus are really beginning to kick in.
Although we typically focus on the manufacturing-only component, we could not help but notice that the services PMI reading hit 54.6, a 54-month high. The composite index flash reading would be consistent with just under 0.5% sequential GDP growth rate in the fourth quarter or almost 2% annualized. Of course, all of this is before the recent terrorist attacks in Paris and the full effects of the Volkswagen (VLKAF) scandal were identified. Unfortunately, France was already one of the weakest areas in the eurozone. Growth in output and employment remained strongest outside of France and Germany. Employment growth outside of France and Germany was at its best pace since 2007.
Although we are seldom fans of sentiment, we noticed a EuroNews article yesterday suggesting that German business morale for November has surged recently to an 18-month high, despite Volkswagen's problems and the French terrorist situation. The article surmises that strong consumption data combined with higher state spending on refugees is boosting the German economy. The report credits record employment levels, improving wages, and low inflation with improved consumption. Stronger demand from the U.S. and Britain seem to be offsetting weakness from China and Russia on the all-important German export front.
For completeness, we are providing the PMI data for China, though only through October. (There is no longer a flash report for China.) We are also showing the U.S. data, which showed a marked decline in November. However, this metric has done a terrible job of predicting the U.S. manufacturing sector. As we mentioned last week, U.S. manufacturing production improved in both the second and third quarters as well as in October, yet this index has been in a relatively straight-line decline since March. As it turns out, March is when the improvement in actual production began. Furthermore, the U.S. durable goods report discussed above seems to suggest that manufacturing is at least stabilizing.
Housing Data Looks a Touch Softer Than Expected With No Clear Trend
Existing-home sales declined about 3.4% month to month to 5.36 million annualized units, which is still above the year-to-date average of 5.26 million units. We do caution that really warm weather in October should have helped the data a little more than it did. Realtors are quick to point out bad weather, but somehow we didn't see a mention of the highly positive weather data in the official release. Volatile data makes spotting trends, even with year-over-year averaged data, a little tricky. However recent data suggest that existing-home sales growth in units has slipped from a relatively steady 8% into a range of 6%-8% growth.
The way the comparisons work out for the last couple of months of the year, it seems that growth will stabilize in that range, even if sales are a little rocky for the last couple of months of the year. It is also interesting to note that the average price increase noted above is lower than in the FHFA and Case-Shiller price increases noted below, and even the Realtors' own median (not mean) price index increases are all closer to 6% than the average price increase of 3.4% noted above. The slower growth in the average price suggests a mix shift to lower-priced homes. That lower average price is also consistent with an increase in first-time buyers from 29% a year ago to 31% this year. First-time buyers tend to be on the tightest budgets.
Given that the last two months of the year get a relatively low weight, we suspect that existing-home sales will come in close to the year-to-date average of 5.26 million units, or about a 7% increase. After a rocky 2014, that looks pretty good, and we would suspect a slightly smaller gain next year as inventories remain incredibly tight and as interest rates move higher.
Home Prices Begin to Heat Up Again (by Roland Czerniawski)
FHFA and Case-Shiller Home Price indexes were released this week, showing that the pace of home price increases has accelerated. These were additions to an already-published CoreLogic (CLGX) report that showed a similar picture. The monthly sequential data ranged from 0.6%-0.8% in September, bringing single-month year-over-year growth (not shown below) to a 5.5%-6.4% range. On a three-month moving average basis, the prices have not yet reached a 6% rate, but the trend appears to be moving upward. We have been predicting that the home price growth in 2015 will range 5%-6%, and we have pointed out on many occasions that the upper side of that range was more likely.
New Home Data Improved Between September and October, but 2015 Strength Remains a Puzzle
New home sales have always been kind of an odd duck, including sales of homes not started, homes under construction, and homes sitting completed on a developer's lot. When we started following the housing data, this report was always a bit puzzling, and we tended to ignore it because of its monthly volatility, plus it is more prone to restatement than any other housing report. However, the report included homes not even started, which gave us a very early read on the potential for housing starts and future permits growth rates.
The report tends to move with single-family housing permits, but the divergence this year seems a bit extreme. In 2014, housing permits and new home sales both grew at 2% or so. In 2015, single-family housing permits are up 8.6% year to date and new home sales are up a more impressive 15.7%. The gap was even wider before some extensive downward revisions in the new home sales report for October, released this week. Some of that gap is a result of the inclusion of homes not started or even permitted, exhibiting some sizable growth.
While October total new home sales were up just 7% from a year ago, homes sold but still on the drawing board grew by 27%. This is just a single month, but it does provide a potential explanation. It also means that, just maybe, permits and even starts may look a little better in the months ahead. However, despite a better inventory situation, I suspect new home sales will moderate from the hefty 16% YTD pace that we are seeing now. Also note, that the recent availability of lower price home programs (where fewer homes have been started or sitting in inventory) may also explain some of the strong year-to-date performance. However, the strong outperformance of the new home sales report does seem to be waning, as year-over-year, moving-average data has already slowed from a stunning 24% to just 6% recently.
Our guess is that in months ahead the new home report may underperform the permit data, and both could stabilize in the 8%-10% range, mirroring existing-home sales. Everything in our housing world seems to be converging at an 8% growth rate. That's enough to contribute a couple of tenths to the GDP growth rate. That is nice, but not a game changer and perhaps would make housing an even smaller contributor to GDP in 2016 than it was in 2015.
Robert Johnson, CFA does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.