August Macro Update: Slowing Growth in Employment and Consumption

The bond market agrees with the macro data. The yield curve has 'inverted' (10 year yields less than 2-year yields) ahead of every recession in the past 40 years (arrows). The lag between inversion and the start of the next recession has been long: at least a year and in several instances as long as 2-3 years. On this basis, the current expansion will last well into 2018 at a minimum. Enlarge any image by clicking on it.

Unemployment claims are also in a declining trend; historically, claims have started to rise at least 6 months ahead of the next recession.



That said, there are two watch outs that bear monitoring closely:

The first is employment growth, which has been decelerating from over 2% last year to 1.5% now. It's not alarming but it is noteworthy that expansions weaken before they end, and slowing employment growth is a sign of some weakening in the current expansion.
The second watch out is demand growth. Real retail sales (excluding gas) is in a decelerating trend. In June, growth was just 1.4% after having grown at more than 4% in 2015. Personal consumption accounts for about 70% of GDP so weakening retail sales has a notable impact on the economy.


Here are the main macro data headlines from the past month:

Employment: Monthly employment gains have averaged 180,000 during the past year, with annual growth of 1.5% yoy. Full-time employment is leading.
Compensation: Compensation growth is on an improving trend and near the highest in the past 8 years - 2.5% yoy in July.
Demand: Real demand growth has been 2-3%. In June, real personal consumption growth was 2.4%. Real retail sales (including gas) grew 1.2% yoy in June, after making a new ATH in May.
Housing: Housing sales grew 9% yoy in June after making a 9-1/2 year high in March. Starts and permits are flat over the past two years due to weakness in multi-family units.
Manufacturing: Core durable goods growth rose 5.6% yoy in June. The manufacturing component of industrial production grew 1.4% yoy in June.
Inflation: The core inflation rate remains near (but under) the Fed's 2% target.

Our key message over the past 5 years has been that (a) growth is positive but slow, in the range of ~2-3% (real), and; (b) current growth is lower than in prior periods of economic expansion and a return to 1980s or 1990s style growth does not appear likely.

This is germane to equity markets in that macro growth drives corporate revenue, profit expansion and valuation levels. The saying that "the stock market is not the economy" is true on a day to day or even month to month basis, but over time these two move together. When they diverge, it is normally a function of emotion, whether measured in valuation premiums/discounts or sentiment extremes.



Macro data should be better than expected in 2H17. Why? Macro data was ahead of expectations to start the current year. During the current expansion, that has led to underperformance of macro data relative to expectations into mid-year and then outperformance in the second half of the year (green shading). 2009 and 2016 had the opposite pattern: these years began with macro data outperforming expectations into mid-and then underperforming in the second half (yellow shading).

A valuable post on using macro data to improve trend following investment strategies can be found here.
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Let's review the most recent data, focusing on four macro categories: labor market, end-demand, housing, and inflation.


Employment and Wages

The July non-farm payroll was 209,000 new employees plus 2,000 in revisions. This was fine but unexceptional: in the past 12 months, the average monthly gain in employment was 180,000. Employment growth is decelerating.

Monthly NFP prints are normally volatile. Since the 1990s, NFP prints near 300,000 have been followed by ones near or under 100,000. That has been a pattern during every bull market; NFP was negative in 1993, 1995, 1996 and 1997. The low print of 50,000 this past March and 43,000 in May 2016 fit the historical pattern. This is normal, not unusual or unexpected.


Why is there so much volatility? Leave aside the data collection, seasonal adjustment and weather issues; appreciate that a "beat" or a "miss" of 80,000 workers in a monthly NFP report is equal to just 0.05% of the US workforce.

For this reason, it's better to look at the trend; in July, trend employment growth was 1.5% yoy. Until spring 2016, annual growth had been over 2%, the highest since the 1990s. Ahead of a recession, employment growth normally falls (arrows). Continued deceleration in employment growth in the coming months continues to be an important watch out.

Employment has been been driven by full-time jobs, which are at a new all-time high (blue line), not part-time jobs (red line).



The labor force participation rate (the percentage of the population over 16 that is either working or looking for work) had been falling but has more recently stabilized. The overall trend down has little to do with the current recovery; the participation rate has been falling for more than 17 years. Participation is falling as baby boomers retire, exactly as participation started to rise in the mid-1960s as this group entered the workforce. Another driver is women, whose participation rate increased from about 30% in the 1950s to a peak of 60% in 1999.



Average hourly earnings growth was 2.5% yoy in July. This is a positive trend, showing demand for more workers. Sustained acceleration in wages would be a big positive for consumption and investment that would further fuel employment.


Similarly, 2Q17 employment cost index shows compensation growth was 2.4% yoy.



For those who doubt the accuracy of the BLS employment data, federal tax receipts have also been rising to new highs (red line), a sign of better employment and wages (from Yardeni).