Weekly Economic Vital Signs - Wages Keep Growing

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 construction spending, new home sales and starts, ISM and PMI Services Indices, the trade deficit, and the jobs report for February.
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Construction Spending

Construction spending declined 0.6% in December, when it was expected to increase 0.3%, and the year-over-year rate fell 1.6%, which was the weakest growth rate in three years. What heavily weighed on this number was a 3.2% drop in single-family homes, which I expect to bounce back. Still, this report was weak across the board and reflects a slowing rate of economic growth, as can be seen below.

New Home Sales and Housing Starts

New homes sales rebounded 3.7% in December to an annual rate of 621,000, but the prior two months were revised lower by 71,000, and the year-over-year rate declined 2.4%.

We saw near-term strength in December in what was otherwise a very weak quarter, but I think we will see continued improvement in sales this year as median prices have declined 7.2% year over year.

Housing starts rebounded sharply in January from December’s wildfire-induced decline to an annual rate of 1.23 million. Permits rose 1.4% for the month to 1.345 million. This will give the sequential rate of economic growth a significant boost, but we still have a year-over-year decline of 7.8% for new construction.

I always focus on year-over-year growth rates, and for residential construction and new home sales, I see very modest improvement in 2019. It doesn’t weigh heavily into the rate of economic growth, but it doesn’t detract from it either.

PMI and ISM Services Indices

The service sector remains strong, which I attribute to new expansion highs in real-wage growth.

Markit’s survey of service sector companies in February showed business activity accelerating to a seven-month high. Its PMI services index rose to 56.0 from January’s reading of 54.2.

The survey saw improvement in new business, backlogs, employment and export orders. What I found notable was that inflationary pressures picked up, with faster increases in both input prices and output charges. Companies said that more favorable demand conditions allowed them to raise prices. The service sector is offsetting weakness in manufacturing, but it also dwarfs it in size and importance relating to the rate of economic growth.

The Institute for Supply Management’s non-manufacturing survey rose from 56.7 to 59.7, also indicating an accelerating rate of growth in the service sector. Strength in new orders and exports were the highlights of this report, which confirmed what we saw in the Markit report.

Trade Deficit

December’s trade deficit of $59.8 billion was the largest since October 2008 during the financial crisis. Imports rose, while exports declined, which begs serious questions about the effectiveness of current trade policy. This will lead to a further downward revision in fourth-quarter growth.

February Jobs Report

Payrolls increased by just 20,000 in February according to the establishment survey, but this number will most assuredly be revised upward. It seems like an outlier, especially when the household survey reported an increase of 255,000 jobs and a decline in the number of unemployed by 300,000. This resulted in the unemployment rate falling from 4.0% to 3.8%. January’s payroll number was revised upward to 311,000 and December’s to 224,000, so when we average the past three months, we arrive at a respectable 186,000 per month.

The real story in this month’s jobs report is the 0.4% increase in average hourly earnings, resulting in year-over-year growth of 3.4%. This is an expansion high, and it bodes well for consumer spending and continued economic growth. The decline in length of the workweek from 34.5 to 34.4 hours will temper the gain from the wage increase when weekly income is calculated, but this is still the highlight of the jobs report.

Conclusion

A cornerstone to my investment strategy is always to have exposure to an asset class that is performing well no matter which of the four economic seasons we are experiencing. The rate of economic growth can either be accelerating or decelerating. The rate of inflation can be either increasing or decreasing. My objective is to determine which season is upon us, and then overweight the asset class and investments that are more likely to outperform in that environment.

Today, the rate of economic growth is clearly decelerating, and I expect the fourth-quarter rate of 2.6% to be revised to a figure closer to 2%. The current quarter looks like growth of just 1%. The strength in the economy is coming from the consumer, while manufacturing, construction and trade look to be weakening the rate of growth. My best guess is that the U.S. economy will grow 1-2% in 2019.

Where I am clearly outside the consensus is on my view of inflation. I see continued wage increases putting modest upward pressure on the Consumer Price Index, which will lead to higher long-term interest rates. In my view, higher long-term interest rates will be what tips the scale between expansion and contraction in 2020.

Analyst’s 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.

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.

Comments

[stocks0229]

Good article with lots of relevant information for us institutional investors. We remain positive on the prospects for the economy and the equity markets. The companies that we talk to are actually more positive now than they have been in a very long time. This would be about sixty-seventy predominantly US domiciled companies that we invest in. Thanks for your posts. They are very instructive.

[JHHAlpha]

Agree that modest wage increases (large increase cannot develop while there is yet global competition for products AND services) plus Treasury borrowing to cover a trillion dollar budget deficit, ought to be pushing debt instrument supply over demand, creating higher interest rates, although the long end may be stable as the economy declines.

I do not think it fair to state that trade policy now is not working, "December’s trade deficit of $59.8 billion was the largest since October 2008 during the financial crisis. Imports rose, while exports declined, which begs serious questions about the effectiveness of current trade policy. " There was a binge of importing to beat possibly increased tariffs, and new trade deals are not yet in place. Even with binge buying here, China and the EU (including especially Germany), export levels shrank, reflecting a world economy saturated in debt.

Here in the USA, a new consumer survey found that 80% of wage earners live pay check to pay check, while credit card debt is historically high--implying that our consumer driven economy is on the edge of falling, so your conclusions about pressure toward interest rates and the direction of the economy makes good sense at this time. However, as the economy does decline, we can expect interest rates to decline, including at the long end, with the fed aiding rate reductions.

[Lawrence Fuller]

@JHHAlpha I agree that recent history would dictate falling long-term interest rates with a slowing rate of economic growth, but I think it is possible to see long rates rise in the face of that slowdown. We are at a minimum seeing a repeat of the 2016 mid-cycle slowdown when the 10 year hit 1.6%, but now we are at 2.6%. I think we are going to 3.6 before we see 1.6 again. 3.6 may be all it takes to push us into a contraction given the debt levels at consumer/corporate/gov't levels.