US: Why the enthusiasm?

Retail sales are surging, with Retail & Food (ex-Motor Vehicles) growing above 5% a year for the first time since 2012.

Retail & Food Sales

Light vehicles sales are back at their 2000-2006 norm of 17.5 million units a year, reflecting consumer confidence.

Light Vehicle Sales

Housing remains soft but growth in new starts and building permits continues.

Housing

Durable goods orders are also soft but unlikely to remain so if retail sales growth continues.

Durable Goods Orders

Inflationary pressures are likely to rise. Which is why the Fed expects to increase the pace of interest rate hikes in 2017.

Priming the Pump

US stocks are buoyant on hopes that a Donald Trump presidency will benefit business, with major indexes flagging a bull market. But promises come first, the costs come later. While I support a broad infrastructure program and the creation of a level playing field in global markets, the actual execution of these ideas is critical and should not be allowed to be hijacked by the establishment for their own ends.

Erection of trade barriers is a useful negotiating position but is unlikely to be achieved without enormous damage to the global economy. As long as your trading partners think you are crazy enough to do it, they may be more amenable to establishing fair ground rules for international trade. If they don’t believe the threat, they will be happy to continue on their present path. So Trump walks a fine line between reassuring his allies and the domestic market, while keeping others guessing about his intentions.

Before we get carried away with hopes and expectations, however, we need to evaluate the current state of the economy in order to assess the current potential for growth.

The Cons

Let’s start with the negatives.

Construction spending is slow, at about three-quarters of pre-GFC (and sub-prime) levels. It will take more than an infrastructure program to restore this (though it is a step in the right direction). What is needed is higher growth expectations for the economy.

Construction Spending to GDP

Industrial production is close to its pre-GFC peak but has been declining since 2014.

Industrial Production Index

Job growth is slowing. Decline below 1.0 percent would be cause for concern.

Employment Growth

Rail and freight activity also reflects a slow-down since 2015.

Rail & Freight Index

The Philadelphia Fed’s broad-based Leading Index has also softened since 2014. Decline below 1.0 percent would be cause for concern.

Leading Index

One of my favorite indicators, this graph compares profit margins (per unit of gross value added) to employee costs. There is a clear cycle: employee costs (per unit) fall after a recession while profits rise. As the economy recovers and approaches full capacity, employee costs start to rise and profits fall — which leads to the next recession. At present we can clearly see employee costs are rising and profit margins are falling.

Profits and Employee Costs per unit of Value Added

It will be difficult for corporations to continue to grow earnings in this environment. Business investment is falling.

Gross Private Nonresidential Fixed Investment

Plowing money into stock buybacks rather than into new investment may shore up corporate performance for a while but hurts construction and industrial production. Turning this around is a major challenge facing the new administration.

The Pros

Retail sales are rising as increased employee compensation costs lift consumer confidence. Solid November sales with strong Black Friday numbers would help lift confidence even further.

Retail Sales

Light vehicle sales are also recovering, a key indicator of consumers’ long-term outlook.

Light Vehicle Sales

Rising sales and infrastructure investment are only part of the solution. What Donald Trump needs to do is prime the pump: introduce a fairer tax system, minimize red tape and reduce political interference in the economy, while enforcing strong regulation of the financial sector. Not an easy task, but achieving these goals would help restore business confidence, revive investment, and set the economy on a sound growth path.

In the short run, the market is a voting machine
but in the long run it is a weighing machine.

~ Benjamin Graham: Security Analysis (1934)

US Light Vehicle Sales disappointing

June US Light Vehicle Sales came in at a disappointing seasonally adjusted annual rate of 16.689 million vehicles. Light vehicle sales, an important barometer of consumer confidence, have been trending lower since November 2015. Further falls would be cause for concern.

Light Vehicle Sales

Retail sales lift

Retail sales (excluding motor vehicles and fuel) jumped to a 2.96% year-on-year increase for April 2016, climbing back above Core CPI to reflect a real increase.

US Retail Sales ex Motor Vehicles and Fuel

We are still waiting on light vehicle sales for April. An upturn would indicate reviving consumer confidence in the economy.

US Light Vehicle Sales

An upturn in business sales is also needed, to spur new investment.

US Business Sales

Weak US retail sales belie strong fundamentals

Lucia Mutikani at Reuters writes:

U.S. retail sales barely rose in September and producer prices recorded their biggest decline in eight months, raising further doubts about whether the Federal Reserve will raise interest rates this year. The weak reports on Wednesday were the latest suggestion that the economy was losing momentum in the face of slowing global growth, a strong dollar, an inventory correction and lower oil prices that are hampering capital spending in the energy sector. Job growth braked sharply in the past two months.

Readers of the headline Weak U.S. retail sales, inflation data cloud rate hike outlook could be forgiven for believing the US economy is headed for recession. After all, retail sales growth has slowed to a crawl.

Retail Sales

And the producer price index is declining sharply on the back of lower oil prices.

Producer Price Index

But if we strip out food and energy prices, PPI remains close to the Fed’s 2% inflation target. And low energy prices will eventually feed through as a stimulus to the global economy.

Hourly earnings in the manufacturing sector are starting to grow.

Average Hourly Earnings Growth: Manufacturing and Total Private

Deeper in the Reuters article, we find a more objective view:

“The overall message is that consumer spending has remained extremely strong. If sentiment had indeed shifted, it would be hard to explain why sales of cars, certainly among the more expensive items, jumped in September to their highest level since July 2005,” said Harm Bandholz, chief economist at UniCredit Research in New York.

Light vehicle sales continue their upward trajectory.

Light Vehicle Sales

And construction spending is decidedly bullish.

Construction Spending

Not much here to keep Janet Yellen up at nights. When it comes to rate rises, the sooner we get the economy back on a sound footing the better, I say. Otherwise we encourage further capital misallocation and dependency on Fed stimulus. There are no free lunches from central bankers. Everything comes at a price.

It is always important in matters of high politics to know what you do not know. Those who think they know, but are mistaken, and act upon their mistakes, are the most dangerous people to have in charge.

~ Margaret Thatcher: Statecraft (2002)

Weak US retail sales belie strong fundamentals

Lucia Mutikani at Reuters writes:

U.S. retail sales barely rose in September and producer prices recorded their biggest decline in eight months, raising further doubts about whether the Federal Reserve will raise interest rates this year. The weak reports on Wednesday were the latest suggestion that the economy was losing momentum in the face of slowing global growth, a strong dollar, an inventory correction and lower oil prices that are hampering capital spending in the energy sector. Job growth braked sharply in the past two months.

Readers of the headline Weak U.S. retail sales, inflation data cloud rate hike outlook could be forgiven for believing the US economy is headed for recession. After all, retail sales growth has slowed to a crawl.

Retail Sales

And the producer price index is declining.

Producer Price Index

But if we strip out food and energy prices, PPI remains close to the Fed’s 2% inflation target. And low energy prices will eventually feed through as a stimulus.

Hourly earnings in the manufacturing sector are starting to grow.

Average Hourly Earnings Growth: Manufacturing and Total Private

“The overall message is that consumer spending has remained extremely strong. If sentiment had indeed shifted, it would be hard to explain why sales of cars, certainly among the more expensive items, jumped in September to their highest level since July 2005,” said Harm Bandholz, chief economist at UniCredit Research in New York.

Light vehicle sales continue their upward trajectory.

Light Vehicle Sales

And construction spending is decidedly bullish.

Construction Spending

Not much here to keep Janet Yellen up at nights. When it comes to rate rises, the sooner we get the economy back on a sound footing the better, I say. Otherwise we encourage further capital misallocation and dependency on Fed stimulus. There are no free lunches from central bankers. Everything comes at a price.