New York (November 2) - The October jobs report printed well above forecast, at 250,000 new jobs. The consensus estimate had been 57,000 jobs less, at 193,000. Upward revisions for August July (+16,000 jobs) exactly offset downward revisions (-16,000 jobs) in September, so a "wash". The average three months job creation was 218,000 jobs. Six months average jobs creation was 215,000. Job creation was down 7.75 percent from the same month last year, which printed at 271,000.
The unemployment rate was 3.7 percent, unchanged from September, but down 0.4 percentage points from the same period last year. The labor participation rate was 62.7, up 20 bps from September to October, but unchanged from September 2017. The U-6 Unemployment, at 7.4 percent, was down 10 bps from September, and down 60 bps from October 2017. It is the lowest U-6 number since April 2001. October job gains were spread over all occupational sectors, save for business and professional services and temporary help, which fell, month to month, by 8,000 and 4,300 jobs, respectively. Manufacturing, durable and nondurable goods increased by (+14,000); Transportation and warehousing (+4000). In the low wage occupations of retail and hospitality sectors, jobs increased, month on month, by 34,800 and 42,000, respectively. Nominal average weekly wages increased by 3.35 percent, year on year, at a rate that is higher than inflation. Real wages increased by 2.45%, assuming the September Trimmed Mean PCE annual inflation rate of 1.99%.
Analysis: Details and Outlook
Overall, this was a just a good, but not a great, jobs report, particularly given that so much of the jobs gains were in the low wage hospitality and health/social services sector. While jobs creation was down 7.75 percent from the same period last year, we're happy to see real wages increasing at a rate higher than inflation. We're always happy to see the 6-month average jobs creation up above 200,000 jobs for eight consecutive months. The three-month average jobs creation is less impressive, but still mostly within about 11,000 new jobs of the 200,000 threshold since last December.
Taking account of this and other factors, we anticipate GDP for 2018 Q4 to print in the range from 2.8 to 3.3 percent, but to print lower in 2019.
Let's look at our exclusive jobs creation by average weekly wages for the October jobs report: October Jobs Creation by Average Weekly Wage Source: The Stuyvesant Square Consultancy, compiled from BLS Establishment Data for October 2018.
The number of people employed increased by about 620,000 and about 711,000 more joined the workforce. The JOLTS survey for August, the latest available data, showed only 59,000 new job openings from July to August, down about 50 percent from the June to July figure of 117,000, but up 1,092,000 jobs from August of 2017.
Oil Pricing and Geopolitical Concerns
We're heartened to see fuel prices continuing below the $3 per gallon threshold. Gasoline prices remain higher than last year and are continuing to climb, eroding what we had hoped last month was a plateau with October prices jumping 11.2 percent higher than last year, compared to a 5.5 percent year-on-year increase in September. But oil prices have fallen to their lowest level since April. With further respect to oil, our concerns over the last few months with Iraq's deteriorating domestic political situation have been somewhat allayed from the recent election Iraq's new consensus secularist leaders as president and prime minister. Both men are respected by both the United States and Iran, so we cautiously aver that the Iraq situation will continue to stabilize in the next year or two. Our concerns were with respect to Iraq's exports of oil to developing economies - particularly India and China - which import about 15 percent and around 9 percent of their oil from Iraq, respectively. Other big importers of Iraqi oil include Italy.
Iran and the Dangerous Situation in the Straits of Hormuz
That said, we're still concerned about Iran's belligerent rhetoric and the tightening noose of sanctions against Iran precipitating some unforeseen flashpoint in the region.
The White House just announced a new round of sanctions this morning; claimed to be the harshest in our 40 year dealing with the Islamic Republic. We anticipate Iran's leadership, together with some of our putative European allies who supported the Joint Comprehensive Plan of Action, will join Venezuela to abandon the USD as the currency for its oil trading, as we discussed in greater detail here last month. Iran has also said several times that they would cease all flow of oil through the Straits of Hormuz if Iran could not sell oil because of U.S. sanctions. The U.S. Navy quietly deployed the Essex Amphibious Ready Group (click link to see the sample makeup of an ARG) to the region back in July. Tellingly, given today's news that the Trump Administration was imposing new and harsher sanction on Iran, the Essex ARG was sitting in the Persian Gulf, just off Qatar as of October 29th. It had been in the Gulf of Aden last month. The Essex ARG has a contingent of VSTOL (i.e., Harrier) aircraft and Marine expeditionary forces. As currently deployed, the Essex ARG not only deters, but should intimidate, Iran's leadership from pursuing misadventures in the Strait of Hormuz. On the other hand, given this morning's announcement, in an effort to rally support against "The Great Satan", Iran's failing leadership might recklessly follow through with its threat to close the Straits. If so, hostilities could break out in with little notice to the markets. We think Iran moving to act to close the strait is less likely than Iran acting to "de-dollarize" its oil trading by trading in, say, euros. The latter would have greater effect and does not amount to a de facto act of war by threatening a vital interest of the United States and our allies.
Dollar Denominated Debt
Corollary to our concerns about oil was and is our concern that higher rates and a stronger dollar impinge developing nations ability to repay dollar - and euro-denominated debt they owe to American and European banks. India's Rupee (INR) is returning to the weak position it had last month vis a vis the USD after recovering, somewhat, since our last jobs report as medium and longer-term US rates move upward again. There will be enormous pressure on developing nations to raise rates (to keep their currencies at relative parity with the dollar and the euro), which will, in turn, will slow those economies. The alternative is to let developing nations' economies to inflate, which will have the same effect. This is why we continue to be circumspect about normalizing rates too quickly; it threatens the economic health and well-being of developing economies and puts additional pressure on the already struggling PIGS in the Eurozone.
Other Macro Data
August freight flows increased substantially, year-on-year, but down from the July increases. We're also heartened that people are taking home more cash from the tax cut, so that debt service will account for a lesser percentage of disposable income. Data released early last month for 2018Q2 continued to support our thesis we expected since the tax bill passed. We note these other developments since our last jobs report:
The wholesale trade report for August, reported October 10th, showed sales up 9.2 percent, year-on-year, and inventories up 5.3 percent from last year. The inventory to sales ratio was 1.30 percent, from 1.32 a year prior, but up from 1.26 percent in September.
Building permits for September, released October 17th, declined, by 0.6 percent, month-to-month, and 1 percent, year-on-year. Housing starts were down 5.3 percent, month-to-month, but up 3.7 percent, year-on-year.
The ISM Manufacturing report for October, released November 1st, showed continuing, but declining expansion of manufacturing at 57.7, down from September's 59.8, The ISM Non-manufacturing report for September, released October 3rd, printed at 61.6, that's up from August's 58.5. (October data should be released November 5th.)
Personal Income & Outlays for September, released October 29th, showed disposable income increased by 0.2 percent in current dollars, down from 0.4 percent in August and down 0.1 percent in chained 2012 dollars. Personal consumption expenditures (PCE) for September decreased 0.1 percent from August at 0.2 percent. They were also down 0.1 percent from August in constant dollars.
As stated above, we are concerned about moving rates too much higher. While inflation for personal consumption expenditures, less food and energy, or "Real PCE", has hit the Fed's target of 2 percent. Nevertheless, we continue to believe that moves toward normalization should take place more slowly and only after growth had become decidedly more robust over several more quarters; at least four of consistent 3.5 percent GDP growth. As we have illustrated in our GDP reports for 2018Q3 and 2018Q2, the better than expected GDP reports for those quarters included a lot of "shifting" from and to earlier or later quarters. We would like to see steady, consistent, growth in each of the four categories of GDP growth. We have long held the view that trimmed mean PCE, produced by the Dallas Fed, is a better measure of inflation in the day-to-day costs of most Americans, it is currently around 2 percent, but it has been volatile. The 2.25 percent rate the Fed has adopted, if increased substantially, and anticipated rate increases, will stifle GDP growth.
We continue to be troubled by the volatility of the yield curve, as we have discussed repeatedly. The 3 Month/10 year curve that we most closely monitor has improved, but it slipped from 100 bps last month to just 82 bps yesterday. We believe it is yet another sign that Fed rate hikes are premature and are outpacing the economy's growth. We started 2017 with a spread of the 3 Month/10 year yield curve two of nearly 200 bps. (The Fed mostly affects short-term rates, principally the 3 month, hence our using that and the ten year versus the 2 year/10 year used by most.) While we are encouraged that the 10 year rate is moving the spread, we think that that increase should be allowed some running room; it should go at least 150 bps above the short-term rate before the Fed considers another rate increase.
That higher 150 bps spread from the current 2.25 percent three month rate would show a holistic appetite for increased risk, as signaled by moving away from Treasuries and into "risk-on" assets. While we dogmatically prefer a strong dollar from a high demand for US goods and services, we're wary of dollar strength that is attributable to the Fed's interest rate hikes more than demand for U.S. goods and services.
Tariffs and Trade Policy
We remain unperturbed by the trade dispute with China, and by the Trump tariffs. In many respects, what we hear and see in media on the matter resemble the "Project Fear" scare mongering that surrounded Brexit. We support the president's more diligent management of trade to defend against cheating and to oppose tariff and non-tariff barriers. We're hopeful, too, that China's President Xi will follow-through with conversations that might lead to a China/US bilateral trade agreement that will address US concerns like mandatory joint ventures Chinese and enhanced protections of US intellectual property. Xi has shown little tolerance for corruption among Chinese officials in his efforts to make China a respected member of the family of nations. We only hope that he will extend that attitude to end China's more egregious trade cheating. That said, we would like to see the president engage America's Asian and European allies to step up to join a "coalition of the willing" to challenge China's decades-old unfair trade practices and thefts of intellectual property because the one-on-one dispute could simply trigger mutual retaliation. There is more power in American dealings with Xi from a multilateral "we" than a unilateral "us". Moreover, China can't afford a restless - or even a rebellious - populace being unemployed. Its leaders need exports to the U.S. and Europe more than the West needs access to China's markets. Losing American sales in Chinese markets might hurt American and European companies bottom line and anger American farmers; losing Chinese jobs to American tariffs might collapse China's government.
While CEOs seem concerned about margins if China manufacturing sites are lost in a trade war, we note that contract producers in most businesses are available in other locations and at lower wages than China and that continuing thefts of intellectual property present a longer-term threat to US businesses. We remain bullish on India and believe it is a much more promising venue for low-wage manufacturing investment over the long term; however, again, the Fed's overly-aggressive rate increases risk a "sudden stop." We're circumspect about the rate of GDP growth reflected in the last two reported quarters. We continue to believe both favorable numbers arose largely from stacking up GDP from prior and later quarters, as discussed here. That view will change only when we see two consecutive quarters of increases in all four categories of GDP (i.e., Personal Consumption Expenditures, Net Exports, Gross Domestic Investment, and Government Consumption Expenditures.) Today's jobs number will likely continue, and possibly increase, the Fed's reported pace of rate increases. We're inclined to predict the Fed may elect to "stand pat" at its December meeting because we think the September increase will slow the economy, and particularly if there are big downward revisions of the September and October jobs data in the November jobs report. We also think unabated rate increases will pressure the earnings of large commercial banks with large developing nation and southern European loan portfolios. We estimate 2018Q3 GDP will print at 2.8 to 3.3 percent, down slightly from 2018Q2. In equities, we think these sectors will perform as follows:
Outperform: Consumer discretionaries in the mid- to high-end retail sector; certain leisure and hospitality, trucking on speculation of consolidation and acquisition; the asset-light hospitality sector on speculation of increasing franchisee property values and higher room rental costs, and
companies or REITs that own real estate in sectors identified as "opportunity zones" under the Tax Cut and Jobs Creation Act of 2017.
Perform: Consumer staples, energy, utilities, telecom, and materials and industrials. Lower-end consumer discretionaries, like dollar stores
Underperform: Healthcare; financials; and technology; currencies of developing nations, such as INR; some of the PIGS currencies, too.
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