Any Conversation these days needs to begin with the phenomenal run the KC Royals made to winning the World Series and becoming the 2015 Champions. They kept at it. Overcame sizable obstacles, long odds and yet persevered. Similar to the US economy and markets. The odds of a total financial collapse were high. The resolve, flexibility and commoditization of the US work force were questioned. Yet here we are six years later. We too just refused to tap out.
The US economy continues to run at below historical trend levels of 2 ¼%-2 ½%. Perhaps this is just the new normal until the next technological breakthrough. Perhaps we are now all benefiting from our last breakthrough and rounds of massive investments in software and technology. Consider the average age of an automobile on the road these days is 11 ½ years old up from the historical norm of 8 1/2. The refresh cycle for computers is now closer to four years up from two. New drilling techniques (fracking and horizontal drilling) require far fewer workers and equipment to extract ever larger quantities of oil and gas. There are many more examples such as these that are allowing companies and consumers to do more with less. This year the US economy is adding in excess of two hundred thousand jobs per month. Pretty solid but not enough to spark any real wage inflation. Again, we must pose the question are we simply seeing the benefits from prior investment cycles? First let’s see where we are currently.
Jobs. Non-Farm payrolls caught the street by surprise Friday when reported by exploding higher tallying +271,000 where most analysts had anticipated an add of +139,000. There were revisions to the prior two months that tacked on an additional twelve thousand. There was other good news backed in here as well as average hourly earnings ticked up +.4% which gives us a +2 ½% gains over the past year. So, looking at the new three month average we are creating 187,000 jobs per month, good just not great but just maybe enough room to allow the Yellen Fed to hike interest rates that first ¼%.
Leading Economic Indicators(LEI). LEI registered in at a -.2% for September after flat readings the prior two months. This figure while slightly negative still suggests more of the same 2 ½% growth. The big drains from the stock market sell off , manufacturing and housing permits were somewhat offset by gains financial indicators, drops in unemployment claims and consumer expectations. We look for this figure to return to the plus side in the next monthly release.
Purchasing Managers Manufacturing Index(PMMI). PMMI for October came in at +50.1% ( a reading above 50 reflects expansion) which just barely leaves us in expansionary territory but is still the 34th consecutive month of expansion. There were some highlights such as the New Orders Index increasing +2.8% to +52.9%. The Production Index also added +1.1 to +52.9%. The New Export Orders added +1% +47 ½%. Some low lights also as the Import Index dropped 3 ½% to 47% which may not be a bad sign. Slower imports allows US companies to run down that stockpiled inventory build witnessed earlier in the year which bodes well for future restocking. Commentary from respondents were fairly positive:
*Paper Products and Chemicals “saw steady demand with sales impacted by the strength in the US dollar”
*Transportation “business is picking up”.
*Electrical Equipment, Appliances and Components “sales becoming more consistent”
*Machinery “some level of slowing but activity acceptable”.
Purchasing Managers Non-Manufacturing Index(PMNMI). The services sector is booming as PMNMI popped +2.2% to +59.1% reflecting strong growth and the 69th consecutive month of expansion. Activity is accelerating. Positives abound here. The Business Activity Index registered +63% or +2.8%. New Orders also had a strong showing +5.3% to +62% and lastly the employment Index inched up +.9% to +59.2%. Since non-manufacturing accounts for nearly 90% of US output this was a very pleasant surprise.
Housing. Housing starts jumped 6 ½% in September to a 1.2 million annual run rate the best in nine years. We are seeing definitive signs of a strengthening and sustainable pick-up in demand that has seemed so elusive during this recovery. On permits we dipped a bit, -.3. On a year over year basis starts are up over 17% and permits +4.7%.
Industrial Production(IP). IP inched down in September by -.2%. No surprises here as mining was the big drag -2% and manufacturing output -.1%. However, looking at the third quarter as a whole doesn’t paint such a bleak picture as IP rose at a +1.8% annual run rate lead by strong gains in motor vehicles and parts. Capacity Utilization came off some (no surprise) down -.3% to 77 ½%. That utilization rate is 2.6% below its long run average. This can act as a buffer for any surges in future demand and potential inflationary pressures.
Inflation (CPI,PPI). Inflation remains the fly in the Feds Ointment when it weighs whether to hike rates or not. The Federal Reserve stated target is a 2% rate. The headline Consumer Prices Index or CPI figure is right at zero with the core (ex-food and energy) +1.9%. Producer Prices Index or PPI dipped -.5% The biggest drops were in Final demand goods-1.2% with over 80% of the drop attributable to energy. Ex-food and energy the core figure was unchanged.
Where We Are Going
Central Banks. Who will blink first? The US economy is surely able to withstand a ¼% interest rate hike. Since we live and operate in a globally linked economy that rate hike comes with risks and consequences. We appear somewhat handcuffed by those links to Foreign Central Bank policies. We've seen US corporate revenues and profits negatively impacted by the rise of the US dollar. Should the US moved forward unilaterally raising rates while the European Central Bank, The Bank of Japan, Brazil, China, Russia and India continue easing rates or merely holding steady on policy this dollar strengthening will continue further negatively impacting the sales and competitiveness of US exports. This trickles down to lower exports, lower US corporate revenues, less demand for US workers and could potentially tip the scales in favor of the beginning of the next recession. It’s this potential downward spiral that I believe keeps Fed Chief Yellen up at night. I believe she’ll wait as long as possible without hiking rates but will feel pressured to move lest she lose the markets confidence. That being said I believe she will not need to move alone. I see the Bank of England in a concerted move along with the US Federal Reserve make that first ¼% point hike in December. The markets are still grappling with what the implications of the first hike are. The Federal Reserve communicating their strategy clearly will be pivotal. Reinforcing their plan for a long, slow, drawn out time frame for “normalizing” rates will go a long way in easing investor fears of any dramatic policy shift which will benefit investors and the economy.
Now is not the time to be overly aggressive, take big risks and swing for the fences. No, it’s a time for lumber on leather. Keep the line moving. Take our singles and doubles knowing over the long haul we’ll all be winners. For now we maintain our aggressive posture to the markets remaining open to the next catalyst to dictate market direction.
Thank you again for your patience and confidence in these very challenging times.
