By Hale Stewart
The U.S. consumer, who is responsible for 70% of economic growth, continues to spend. Not only did income increase by .4% but spending rose .3%. Best of all, durable goods purchases, which show a certain level of confidence, have been strong in 3 of the last 4 months:
The ISM index unexpectedly contracted, with the overall reading falling from 52.6 to 49.4. New orders dropped a concerning 7.8 points, falling to 49.1, while production fell 5.8 points to 49.6. There was nothing in the preceding months' reports indicating such a decline was forthcoming. The ISM's decline wasn't confirmed by the last Markit release, which was a positive 52 (but, this report also missed the 2015 industrial contraction). And the latest industrial production numbers have been getting stronger, with two consecutive increases. Only 6 of 18 industries in the ISM report were expanding. Oddly, the anecdotal comments were still largely positive:
- "We have been getting lots of inquiries, but not a lot of sales order placements." (Chemical Products)
- "Business was flat this month overall." (Computer & Electronic Products)
- "Continued strong market demand for our products related to construction." (Nonmetallic Mineral Products)
- "Commercial construction continues to be strong, and therefore our business is very good." (Fabricated Metal Products)
- "New product distribution is increasing." (Food, Beverage & Tobacco Products)
- "This past month, sales increased over the trend from the first half of the year. There seems to be a general, albeit slight, loosening of capital purse strings." (Machinery)
- "Medical device is still strong." (Miscellaneous Manufacturing)
- "Business conditions are generally flat." (Transportation Equipment)
- "Hard to find production associates. Unemployment in the area is around 4 percent. Can't get enough employees [which] leads to lots of overtime." (Plastics & Rubber Products)
- "Oil prices continue to seek a 'footing'; rig count slowly increasing." (Petroleum & Coal Products)
As of now, this is a one-off number. But it does make the next report that much more important.
Finally, Friday's jobs report, with a 151,000 headline number, was a standard, end-of-the expansionary-cycle report. Compared to the previous month, total jobs decreased 99,000. Goods-producing jobs declined 35,000 due to drops in construction and manufacturing hiring. Service producing jobs declined 64,000 thanks to a fall in professional, leisure/hospitality and health care hiring. The 3-month average was a comfortable 232,000. Going forward, with the unemployment rate at full employment, we shouldn't be surprised by a below 200,000 print and should consider it normal
Economic Conclusion: This week's news was slightly positive. The best news was the continued increase in incomes and consumer spending, especially on durable goods. So long as consumers are opening their wallets, a recession isn't in the cards. The employment report was a standard report for a full-employment economy. The ISM reading was negative; but, as of now, it's only one month of data, unconfirmed by other industrial releases.
Market overview: The markets were up last week: the SPY gained .5% and the QQQ was up .29%. The Russell 2000 and Transports, however, provided the best news. The IWM rose a healthy 1.18%. As this average has more risk, the move could indicate investors are willing to push the markets slightly higher. And the transports, which so far haven't been confirming the overall move higher in the broader markets, rose 1.68%. While this average is still far below an all-time high, it's only about 4.55 below its 1-year peak. And, the size of this week's upward move could be a precursor to further advances.
But the markets are (again) running into valuation and earnings issues. The current/forward P/Es of the SPY and QQQ remain elevated (24.71/23.87 and 18.57/21.35, respectfully). And the earnings environment is still difficult. The following graph using BEA data shows that corporate economy-wide corporate profits are down in 5 of the last 6 quarters:
And the estimates for the upcoming quarter are for another decline. From Zacks:
Estimates for the current period (2016 Q3) have come down, following a well-established historical trend. Total Q3 earnings for the S&P 500 index are currently expected to be down -2.8% from the same period last year, which is a decline from expectations of flat earnings at the start of the quarter.
Please note that while the trend of negative revisions to Q3 estimates is in line with the recent past, the magnitude of negative revisions is not. In other words, estimates for Q3 have not fallen by as much as was the case at the comparable stages in other recent reporting cycles.
This means we're back where we've been for the last year and half: an expensive market that needs increasing earnings isn't getting them.