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Employment Provides Some Cheer to a Gloomy Week

Strong jobs number helped take the edge off disappointing consumption, autos, and other data this week.

A respectable employment report at the end of the week provided great relief to many economists who were still a bit stunned from the negative data earlier in the week.

Motor vehicle sales continued to be the biggest disappointment, showing year-over-year declines yet again, despite some healthy incentives. The slow motor vehicle sales data was particularly disappointing in light of production rates that have not fallen nearly as fast. While some of the inventory buildup was intentional to enable shutdowns for plants to convert to more SUV production, we were still quite shocked to see one of the Big Three with inventory levels of over 100 days, levels not seen since the last recession.

Despite our relatively neutral stand on the economy, shifts in auto production often create a lot of problems across several industries as well as in employment data. June consumption data was also unusually disappointing, with almost no growth at all between May and June. Wage and income data from the same report also continued to slump year over year, though the month-to-month data and parts of the July employment report suggest that wage and income data could be poised for some improvement in the second half if the auto industry doesn't muck things up.

Pending home sale, construction spending, and ISM Purchasing Manager surveys also managed to disappoint investors. Pending home sales barely grew in June and construction spending overall was down for the month of June.

Employment Growth Beats Expectations and Averages Month-to-month nonfarm payroll managed to show another month of growth (209,000 jobs) in excess of the 12-month average (180,000), the consensus forecast (180,000), and my forecast of 160,000. While we believe some faulty seasonal factors and unusual sector data have helped results over the past two months, we are pleased with the relatively strong data.

In a sea of negative economic reports over the past two weeks, the employment data seems to suggest that things are not so bad. And a combination of better employment levels, hours worked, and hourly wage rates should keep wage data and likely consumer data moving ahead in the second half.

The month-to-month data, though always volatile and subject to revision, showed employment growth in excess of 200,000 jobs per month for three of the past four months. Although I can pick apart some of the strong monthly data, three very strong months suggest that, at a minimum, job growth deterioration has come to an end.

Nevertheless, I will offer up the fact that job growth in June 2016 and July 2016 both approached 300,000 and also surprised everyone to the upside. This year's job growth was better than most of the economic metrics released this week, as we noted in our opening, but not nearly as good as last year, suggesting that we shouldn't pop the Champagne just yet. That is especially true given that August almost always provides a negative shock to the employment data.

Even the Year-Over-Year, Averaged Data Is Forming a Bottoming Pattern If we want to get rid of funky seasonal factors and quirky industry-specific one-month flukes that will just get reversed the next month anyway, we use year-over-year changes (the same faulty seasonal factors apply in both months).

The year-over-year growth has stabilized at about 1.7% for almost all of 2017 for the private sector. That's good news compared with the rather dramatic fall from the 2.5% level reached in early 2015. I am being a little melodramatic here because the 2.5% rate was unnaturally high compared with year-ago levels that were depressed by the foul winter of 2013-14. That low level likely boosted the year-over-year comparison in 2015 by 0.2%, likely making the true growth peak about 2.3%. Even with all of my averaging and data tricks, I couldn't really remove the 2014 dip and the 2015 bounce.

Longer-Term View: Employment Growth Slower Than Usual; Peaking Suggests Slower Economy Ahead

Above is a 37-year history of both nonfarm (labeled) and private payroll growth (the higher blue line, not labeled). The postrecession peak job growth rate is currently 2.2%, compared with 3.25% following the 1981 recession and 2.8% in the 1990 recovery, but still slightly better than the 2.08% rate of the recovery of 2001.

Given the length of this recovery and demographic factors (slower growth in the working-age population), I am not as surprised or troubled as some. What did strike me about this chart was that once job growth formed a clear peak, the jobs recovery never really accelerated again. Although this is a narrow data set and may be a mere coincidence, the peak in job growth in each of the past three recoveries was followed by a recession about two years later. That would make the current recovery somewhat vulnerable over the next six months or so. This is not a forecast, just an observation.

Hours and Hourly Wage Growth Support Total Wage Growth As we almost always mention, hourly wage growth and the number of hours worked is nearly as important as the overall employment level in determining the total wage dollars paid out in the economy. That in turn drives consumption and GDP growth. Below is a graph of each component. Add all three components, and it should approximate total wage growth for the entire economy.

Making a small adjustment for the winter weather anomaly (affecting both job growth and hours), total wage growth has slipped from about 4.8% to a low of 3.9% earlier this year before rebounding to 4.5% with this month's report. It's worth mentioning that the July 2017 data was the best data of the past 12 months for total wage growth.

A Swing in Hours Worked Has Provided Most of the Recent Improvements Hours worked fell off meaningfully in 2015 and 2016 because of decreases at retailers that were initially afraid to lay off workers. This tended to buoy employment levels.

However, as retailers realized that their issues were not about the weather and that the

While we think this represents most of the real story, it is interesting to note that hours worked usually improve before employment levels, suggesting that better employment growth may lie just ahead. However, issues in the auto industry may quash some of our enthusiasm, as discussed later in this report.

Hourly Wage Growth Healthy, but Not Accelerating The bad news is that the nominal growth in hourly wages has slowed some from about 2.8% to 2.5%. The good news is that CPI based inflation dropped from 2.6% to 1.8%, providing consumers with a little breathing room.

Are We Hoping for Too Much in Terms of Hourly Wage Growth? Many economists, including us, have complained about the lack of accelerating wage growth. Maybe our expectations have been too high given history and the demographic impact of more young workers, who are generally paid less than those they replace.

The 12-month average wage graph chart below shows that spikes in real wages can occasionally be large (especially during bouts of deflation during a recession). Long, sustained runs in real hourly wage growth are extremely rare. Only three times over the past 50 years have real wages grown more than 3%. And all of those times were related to a temporary run of recession-related deflation. The possible exception was the period from 1995 to 2000 or so, the last time the U.S. economy faced a labor shortage.

Averaging the data over a five-year period does a better job of showing the long-term trend. Still we didn’t want to hide from some of the shorter time frames, with better results that everyone seems to remember. Everyone seems to forget the long expanses of time when wage growth was effectively zero or less between 1980 and the late 1990s.

Sector Data Continues to Surprise In June we had a huge surge in healthcare and government employment and a rather dramatic slowing in the professional and business services category. All of those categories returned to more normal levels in July. This month there was a surge in restaurant workers, which isn't necessarily a category we like to do well because of its low wages and low hours worked.

We don't worry a lot about these monthly variations in some sectors. Though we do note that the leisure sector growth rate has come under pressure over the last year as higher restaurant prices and lower grocery prices eat into the overall growth rate for restaurants and restaurant employees. Please see our weekly video for a more detailed employment sector analysis.

Consumption Growth Remains Modest and Below Trend Following the high hopes of March, month-to-month consumption data has been disappointing, capped by almost no growth at all in June.

Year-Over-Year Trend Falters Less Month-to-month consumption numbers can prove to be quite volatile, as shown above. However, the trends in year-over-year data have proved relatively stable until recently.

Three Big Consumption Growth Leaders Remain the Same Overall, year-over-year consumption growth showed only a modest decline at 2.6% in June 2017 versus 2.8% in 2016. Communications, furniture and appliances, and recreational goods and services remain the three high-growth categories. Recreational goods and services, led by a lot of electronics, has taken the growth leadership mantle with 6% inflation-adjusted growth, while furniture and appliances slipped back to second place with 5% growth. New products, attractive pricing, and millennial purchasing have all helped boost the electronic portion of recreational goods.

Furniture has done well with an increase in new home sales. However, we suspect that some of that growth has been tempered recently with existing home sales slipping. A combination of new home sales and existing homes are key variables for a lot of household-related spending.

The strong communications sector is being driven by strong growth in cellular services as well as Internet access, partially offset by significant losses in land-line services. However, we suspect some of the growth in the communications sector is a bit artificial. It reflects shifts in a lot of provider plans that have more data (more consumption) for the same price, a factor that has had a massive impact on the Consumer Price Index.

Outside the Big Three, there are some interesting side stories. Grocery sales have spiraled ahead to heady (at least for this stodgy sector) 3% growth. Historically this sector has been hard-pressed to grow by much more than 1%. Falling prices and the desire for more healthful eating have helped this unprecedented move. However, it comes at the expense of the hotel and restaurant sector. Prices at restaurants have accelerated because of labor shortages and new minimum wage laws. That has opened a wide pricing gap between restaurants and the grocery stores, and consumers are voting with their wallets. Unfortunately, restaurant growth tends to be a much bigger driver of employment growth than grocery store sales.

The other interesting consumption story is healthcare. Healthcare is one of the very largest consumption categories. The Affordable Care Act in general and the new Medicaid provisions (that added more than 15 million enrollees in a very short period of time) caused a sharp short-term spike. At one point in 2014, healthcare growth was a whopping 6.6%. In the most recent quarter, that dropped all the way back to 2.9%.

Wage Data Sends Mixed Messages on Future Consumption The total wage paid and accrued data have shown more volatility than we like to see, suggesting potential data issues. Relatively low wage growth, combined with hefty swings in the inflation rate, doesn't help matters.

The good news is that the bars shown in the graph below seem to be stabilizing at about 0.25% a month or approximately 3% a year, which is just about the rate we need to support the current 2.9% consumption growth rate.

However, year-over-year wage growth is now running considerably below consumption growth, suggesting that consumption may need to fall a bit, or at least that consumption growth will be hard-pressed to show acceleration. Despite the greater volatility in wage data than consumption, they do tend to move together.

Also, wage growth tends to be a little higher than consumption growth because of people living on fixed income (like Social Security) and because of savings.

Using the very same graph, but using different scales, the relationship between wages and consumption is more apparent. Unfortunately, the data seems to be suggesting that unless wage growth accelerates soon, consumption growth could get pulled down below its recent 3% trend. Until very recently, consumption has managed not to get sucked down by wage growth. Again, we caution that when we refer to wage growth, we are talking about total dollars paid to all workers. As we noted in our employment section, total wage growth is a function of hourly wage rates, hours worked, and employment levels.

Real Disposable Income Also Supports Our Slowing Theory Over time, we have found wages to be the best indicator of consumption, because most wages are spent. However, wages are only about 63% of total income. The rest is proprietors' income (small-business profits), rents, investment income and transfer payments (such as Social Security).

Many of those additional categories are saved rather than spent. Nevertheless some improvement in these other categories can offset some of the wage issues. We also include a deduction for taxes in the calculation of real disposable income, which, unfortunately, adds a large chunk of volatility to the income data. That explains the volatility in 2013 and 2014 when there were major tax law/expiring tax holiday issues.

Despite Monthly Uptick, Motor Vehicle Data Still Soft and Disappointing As the chart below shows, monthly unit sales at annualized rates have been below 17 million units since February, after spending a bunch of months above that key level. About the only good news is that July was slightly better than June at 16.8 million units compared with 16.7 million units. The data is adjusted for the fact that there was one more selling day. However, both months were five Sunday months, which typically produce above-trend selling rates. July a year ago was the second-best performer over all of 2017.

For this and other reasons we aren’t fans of the month-to-month data, but this is how the media and the industry typically report it. At least averaging three consecutive units' sales reports manages to do a decent job of showing trends, and it is not pretty.

The year-over-year data even looks a bit worse and doesn't show many signs of stopping. Year-over-year growth rates remain in negative territory.

And Even the Popular Light Truck Sector Is Having Issues

While the drop in unit sales growth of SUVs, minivans, and pickups has been much less dramatic than the sedan market, sales growth has still dropped from a high of close to 20% to less than 5% over the past couple of years.

So Far the GDP Impact Has Been Less Than One Might Expect While the drop in growth rates has been dramatic, GDP hasn't seen a dramatic impact just yet. For one, the mix shift from sedans, which are priced in the $23,000 range, to light trucks, which are typically priced in the $37,000 range, has softened some of the financial impact.

More recently, GDP growth has been aided by the fact that production has remained relatively strong even in the face of poor demand. Part of the strong production was based on higher sales expectations and a belief that demand would pick up in the seasonally strong summer months. Demand did not budge.

Secondly, there was some intentional build-up in inventories by the manufacturer as a number of sedan plants were going to be converted to SUV plants, entailing some plant shutdowns this summer and fall. That won't be great news for production- and employment-related data in the second half of 2017. As plant capacity is temporarily shuttered, GDP growth is likely to face some large headwinds in the third quarter. (Remember, the P in GDP stands for production, not sales.) That's even before the potential collateral damage to suppliers.

We Are Choosing to Ignore the Purchasing Manager Data for Now We have a very had time ignoring national purchasing manager data either from the ISM or the Markit data sets. These data sets have a very long history and a very good track record at market bottoms. The ISM data along with initial unemployment claims were the only two major indicators flashing a buy signal at the bottom of the 2009 recovery.

However, the readings have always tended to be very hyperactive at industry tops, with many false readings. Worse, the data increasingly seems to be more of a sentiment indicator, with strong correlations breaking down. Plus, many of us put weight on relatively small swings. However, past data shows that it takes a really big swing in the indexes to make a difference.

Lately, we have found durable goods new orders to be slightly more reliable and also able to provide a slightly earlier signal than either of the two major PMI series. As we indicated last week, those readings suggest modest improvement for the manufacturing sector overall in the back half of 2017. The July manufacturing data from ISM declined modestly and is below several key peaks established during this recovery.

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