The nonfarm payroll report (commonly known as the job report) released earlier this month was just the latest reminder that the current U.S. economic expansion remains uneven, inconsistent and prone to disappointment.
Although recent data shows a consumer sector in good shape, with home prices rising and household spending accelerating, a sharp deceleration in payroll growth calls into question the case for a consumer-led recovery. Meanwhile, the manufacturing sector is still struggling with last year’s rapid rise in the U.S. dollar and the collapse in commodity prices.
How can investors navigate through this murky picture? Here are three guidelines:
Watch the dollar
U.S. manufacturing has been decelerating for most of the past two years. A number of factors have contributed to the slowdown, including soft overseas growth and a sharp drop in capital spending by energy and mining companies.
But a strong dollar also bears much of the blame. Over the past five years, the level of the dollar index has explained roughly 30% of the variation in the rate of growth in industrial production. The silver lining of this month’s weak payroll number is a greater likelihood that the Federal Reserve will hold off on raising interest rates, which could lead to a softer dollar. That, in turn, should help alleviate the pressure on the manufacturing sector, as well as corporate profits.
Income matters more than confidence
Pay less attention to what consumers say and more to what they’re earning. The best predictor of household consumption is income growth, with wages being the most important component of income. Historically, changes in personal income have been the biggest driver of changes to retail sales. Surprisingly, consumer confidence has had a much weaker relationship with retail spending. Outside of the 2008 recession, the level of consumer confidence has told us very little about spending.
The lesson being: Consumers will spend if their income is rising, regardless of how they answer polls.
Leading indicators do in fact lead
To state the obvious, economies are complex and vulnerable to exogenous shocks. As a result, there are no truly reliable measures of future growth. That said, certain economic statistics have historically led overall growth.
As I’ve discussed in many previous blogs, my preferred measure is the Chicago Fed National Activity Index (CFNAI), which has historically correlated with economic activity one to two quarters ahead. In other words, it won’t provide much information on what the economy will do a year hence, but it has historically done a decent job of signaling an imminent recession. Today, the CFNAI is right where it’s been for most of the past seven years, hovering close to 0. This suggests that growth is likely to remain positive, albeit tepid.
Given the recent weakness in the dollar, the modest acceleration in hourly wages and stable leading indicators, for now my view is that the U.S. economy will continue to expand in the coming quarters. Just don’t expect great things…or consistency.
Russ Koesterich, CFA, is Head of Asset Allocation for BlackRock’s Global Allocation Fund and is a regular contributor to The Blog.