Weekly Economic Vital Signs - It's All About Wage Growth

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by: Lawrence Fuller
Summary

This is a weekly series focused on analyzing the previous week's economic data releases.

The objective is to concentrate on leading indicators of economic activity to determine whether the economy is strengthening or weakening, and the rate of inflation is increasing or decreasing.

This week we examine wholesale inventories, housing starts, unemployment claims, consumer confidence, Q4 GDP, and personal income and spending.

Wholesale Inventories

Wholesale inventories rose 1.1% in December, which was the fifth consecutive monthly increase, as sales declined 1%.

This resulted in an inventory-to-sales ratio of 1.33, which looks a lot like what we saw before the slowdown in the rate of economic growth to 1.6% in 2016. Rising inventories and slowing sales growth put downward pressure on prices.

Housing Starts

Housing starts plunged 11.2% in December to an annualized rate of 1.078 million, which was the weakest number since September 2016 and well below the 1.256 million expected. The decline was led by the West, which suggests that the wildfires were a factor. Offsetting this weakness was a 0.3% increase in permits to an annualized rate of 1.326 million. Additionally, 187,000 homes were authorized to be built, but not yet started in December, which was the largest number since 2007. This bodes well for future growth in homebuilding.

According to the GDP report released this week, year-end weakness in housing detracted 0.14% from overall growth in the fourth quarter. Rising mortgage rates, a lack of real-income growth, changes to the deductibility of mortgage interest and available inventory were all headwinds for housing in 2018. Mortgage rates have since declined, and we are starting to see year-over-year growth in real income. Home price appreciation has also moderated. Permits clearly indicate that housing will pick up moving forward, but I don't expect the industry to be a tremendous growth driver in 2019, nor do I think it detracts.

Weekly Unemployment Claims

Initial claims for the week ending February 23 increased by 8,000 to 225,000, while the more important four-week moving average decreased by 7,000 to 229,000. The recent rise in claims is a result of the government shutdown. I won't be concerned about this leading indicator until we see a significant breakout in the four-week average that reverses the steady downtrend. Claims should remain near current levels in coming weeks given the strength in the PMI surveys for February.

Consumer Confidence

The Conference Board's Consumer Confidence Index rebounded sharply in February to 131.4 from January's reading of 121.7. The end of the government shutdown and the rebound in the stock market were the main factors in this coincident indicator's improvement. The significance of this rebound is that it should correspond to an improvement in retail sales.

Q4 GDP

The initial estimate for the rate of economic growth in the fourth quarter surprised to the upside at 2.6%, while the year-over-year rate of growth reached 3.1%. Recognize that this is a lagging indicator, but it does give us information about where we are sourcing our growth.

Consumer spending, as measured by personal consumption expenditures in the chart below, contributed 1.92% to the overall rate of 2.6%. This is a number that I think we can maintain in 2019 so long as the recent improvement in the rate of real wage growth continues. Changes in the real rate of average hourly earnings are the most important factor in determining the rate of change in real consumer spending growth. Still, we no longer have the tailwind of a tax cut for year-over-year comparisons, so I would not be surprised to see some moderation in the number.

The change in private inventories will be a drag on growth over the next couple of quarters, as we work off the huge increase that built up in the third quarter of last year. Trade will be a clear headwind until we have clarity on negotiations with China. Government spending (federal and state) should add very modestly to growth, considering we have no plans to address our deficits or debt anytime soon. Lastly, capital spending should also be a modest contributor to growth, but far less so than in 2017 and 2018, as corporate profit growth slows substantially. I think the economy can grow 1.5% to 2% in 2019, which is a deceleration from the 2.9% rate in 2018.

Personal Income and Spending

Personal income soared 1% in December, but then declined 0.1% in January. The huge swing was a function of a one-time dividend payment from VMware Inc. (VMW) and subsidy payments to farmers in December, followed by a decline in dividend income and subsidies in January. When we focus solely on wages and salaries, the uptrend continues with increases of 0.5% and 0.3%.

Spending plunged 0.5% in December for reasons already discussed. The decline was focused on goods, whereas services were relatively unchanged. We don't have spending numbers for January due to the government shutdown.

Conclusion

The rate of economic growth is clearly decelerating as we approach what will be the longest expansion on record this summer. The question is will this slowdown be a temporary lull in the rate of growth that is met with new forms of stimulus, or will it be a prelude to a contraction in 2020. It is too early to tell. Expansions don't die of old age. They typically end because there is a shock to the system that expunges an excess or bubble. The only bubble I see is in our financial markets. Therefore, it may be a severe decline in market prices that instigates economic contraction. Yet global central banks are hell-bent on preventing that at all costs.

This expansion has also been dependent on the steady accumulation of debt at the consumer, corporate and government levels. The debt itself is not as much of a concern as the ability to service it. So long as interest rates remain low and growth continues, the debt can be serviced. If interest rates rise to the extent that delinquencies and defaults stall the rate of economic growth, then the expansion will come to an end.

One reason interest rates have remained low is that the rate of inflation has been relatively subdued. This is because wage growth has been modest, and the majority of the wealth created during this expansion has been accumulated by the top 1-5%. If we had seen a more equitable distribution of this wealth over the past 10 years, I can guarantee you that we would be seeing the prices of goods and services rise at a much faster pace than 2%.

What we are starting to see now is a meaningful increase in real wages, as measured by average hourly earnings. This welcomed strength in real-wage growth is a precursor to a rising rate of inflation. If the rate of inflation increases, leading to an increase in long-term interest rates, and as the levels of outstanding debt continue to mushroom, financial market valuations will contract, and the expansion will come to an end. That is my current expectation.

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Disclosure: I/we 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Lawrence Fuller is the Managing Director of Fuller Asset Management, a Registered Investment Adviser. This post is for informational purposes only. There are risks involved with investing including loss of principal. Lawrence Fuller makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by him or Fuller Asset Management. There is no guarantee that the goals of the strategies discussed by will be met. Information or opinions expressed may change without notice, and should not be considered recommendations to buy or sell any particular security.