A solid non-farm payrolls number sent the market to new highs in the first week of May; those gains continued into a second week. The strong rally leg dispelled investors' misgivings about economic data issued late in April, and early in the month. But the hand-wringing over some of that data is misplaced, in our view. We see possible moderation, but no real break, in the solid uptrend in the economy -- probably because of where we're looking (which is at annual rates of change).
Specifically, the S&P 500 in mid-April slid from the 1,580s to the 1,540s -- and tap-danced ever so briefly on the 50-day simple moving average in the wake of the disappointing March non-farm payrolls report. After pushing to just below 1,600 in April's final week, the index hitched lower once again (this time falling only to the 1,580 level) and never really threatened any trend lines. The strong April non-farm data and huge prior-month revisions sent the market soaring out of its brief doldrums. But it is worth reviewing a few government releases that prompted some prognosticators to dust off their "end of recovery" pitch books.
The data points that caused the downward jolts included ISM manufacturing, new vehicle sales, construction spending and ISM services. All these either came in lower than anticipated or trended lower from the prior month. The headline writers couched single-month data points in semi-dire tones: "Manufacturing cools" and "Construction Spending Falters" were typical. The U6 unemployment also went the wrong way, rising by a tick within the generally well-received non-farm payrolls report. Those observations were correct on a month-over-month basis. For a different perspective, let's take a look at annual rates of change in those series.
The data point drawing the most scrutiny is not actually a data point, but a diffusion index. The Institute of Supply Management [ISM] Manufacturing Index declined to 50.7% in April, from 51.3% in March. Readings above 50 signal expanding activity, while readings below 50 signal contraction. The April ISM reading was the lowest so far in 2013. This diffusion index is partly reinforced by the government's hard data. Data from the Bureau of Labor Statistics [BLS] non-farm payrolls report for April 2013, shows just less than 1% change in total manufacturing employees in April 2013 (11.99 million, seasonally adjusted), compared with April 2012 (11.92 million). Still, the number employed in manufacturing is growing, albeit slowly.
Construction spending in March fell 1.7% from February. Digging into the quarter-over-quarter change, we see that the largest single component was a 4.1% decline in public projects as sequestration began to impact government spending plans. When we look at year-over-year data, we see that March construction spending actually rose 4.2%. Total private construction spending rose 9.5% year-over-year in March 2013, while total public spending declined 7.3%. These annual rates of change are lower than the low double-digit annual gains recorded in October-December 2012. But as the construction fundamentals improve, comparables become tougher.
U.S. new light vehicle sales for April came in at a 14.88 million seasonally adjusted annual rate (SAAR), which was below both the 15.22 million SAAR forecast by analysts and the March SAAR. In terms of actual vehicles sold in the year-to-date, however, total vehicle sales (including domestic and foreign brands) of 4.96 million represent a 6.9% year-over-year gain. Of that number, domestic vehicles (representing 79% of the total) were up 9.0%.
The new vehicle industry, like the housing industry, is a disproportionate contributor to national prosperity and jobs creation. Homes are built primarily from materials sourced in North America; the realtors, architects, mortgage bankers, project managers, carpenters and other skilled tradesmen are all part of the U.S. labor force. Vehicles produced in U.S. factories have varying parts content. Vehicles from Japan assembled in U.S. plants feature significant imported content. Big Three vehicles source a higher proportion of content from U.S. parts companies such as (formerly captive) Visteon and Delphi. New vehicle production, again like housing, spreads its tentacles in the U.S. labor community well beyond the house or vehicle being built.
In the general euphoria following the April non-farm payrolls report, a few economists equivocated about the tick up in U6 unemployment, which includes both unemployed and underemployed. The U6 index rose to 13.9% of the labor force in April, compared with 13.8% in March. Call up a chart of U6 and you will see that as recently as August 2011, the index was above 16.0%. After a steep step down from summer 2011, into winter 2012, followed by a relative flattening out, U6 is again heading lower. Note that U6, which got below 14.0% in March 2013, was last below 14% early in 2009. Whether measured by household survey or non-farm payrolls, new hires have averaged more than 170,000 per month over the April 2012-April 2013 period.
Argus Chief Investment Strategist Peter Canelo recently pointed out that real GDP growth in 1Q13 was 4.0% -- not the headline 2.5% -- if you back out the decline in government activity. Peter estimates that real GDP has grown at approximately a 3.0% rate for the past two years, while government spending was declining about 2.0% annually in that period.
Based on the correlation between total GDP growth and unemployment levels, Peter forecasts that a 2.5% real GDP rate could push the unemployment rate down from the current 7.5% to the 6.5% level in about a year. That would meet the Fed's mandate to reduce unemployment and would potentially trigger an end (or at least severe dialing-down) of quantitative easing.
The demise of quantitative easing, in a market addicted to that particular sugar high, would have unpredictable and likely negative consequences for the stock market. But in a nation that has not seen unemployment that low since summer 2008, dealing with a 6.5% unemployment rate is our definition of a high-quality problem.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.