It was terrible week for commodities and world equity markets, with no place to hide. Well, except U.S. government bonds, which registered one of their best gains of the year as investors sought safety in U.S. Treasuries.
Even in the face of a potential Fed rate increase next week, the interest rate on the 10-year Treasury moved down from 2.28% last Friday to 2.14%. On Friday alone, the 10-year bond had its best day since July, increasing nearly 1%. The 30-year Treasury did even better, increasing almost 2%. Commodities and world equity markets were down 4%-5% for the week. The selling was mostly nonstop all week, with four of five days down in the U.S. after a week of daily volatility in both directions but little net change.
Emerging markets did even worse on worries about Chinese real estate markets and more devaluation of the Chinese yuan. A falling yuan has the potential to spread deflation throughout the world but especially in other emerging markets.
Other world markets worried about renewed oil selling, as oil had its worst weekly decline in a year, falling to $35.36 at the end of the week. Various inventory reports, last week's "no supply decrease" OPEC meeting, slow economic growth, and warm weather all created more headwinds for an already-devastated oil market. Some of the collateral damage became more obvious this week, with a huge dividend cut at 
Kinder Morgan (KMI) and relentless declines in high-yield bond funds in general. A large, though rapidly shrinking, portion of the high-yield market is related to the energy industry. Fear of how much further energy prices might fall and what other skeletons might be in the energy sector closet weighed heavily on all equity markets. It didn't help matters that the Fed is expected to make its rate decision on Wednesday and no one really wants to step up to the plate before an event that could be market moving.
There really wasn't much economic news this week until Friday's retail sales report. Although the headline number was below expectations, with growth of just 0.2%, the year-over-year data continued to show growth between 3.5% and 4.0%, as we expected. Growth by category finally seemed a bit more balanced, no longer dominated by just autos and furniture. Restaurant sales, clothing, sporting goods, and grocery stores all did well. Some of the bigger-ticket items like cars, furniture, and building-material stores were all down a touch after incredible runs so far in 2015.
Both the job openings report and the National Federation of Independent Business report on small businesses continued to show tight labour. Although openings are no longer growing at a wild pace, the number of unemployed to fill those jobs continues to fall. We continue to believe that 2016 will be the year when labour-shortage issues will bust out into the open. Recent airline and auto negotiations combined with unilateral wage increases at Wal-Mart (WMT) earlier in the year as well as improving hourly wage rates indicate that the labour pendulum is beginning to swing back in the opposite direction.
Solid retail sales figures bolster confidence in U.S. economy
As we mentioned in last week's column, varying category inflation rates, non-price-adjusted gasoline sales, and auto sales often create a real mess when trying to interpret this key report. We will start with our conclusion first. Despite some drastic mix issues, which we will discuss later, retail sales remain on the relatively stable path of the last five years, as shown below. This data excludes those pesky auto and gasoline sales, which are both volatile and better covered in other government reports. We have also averaged the data over a three-month period to eliminate some of the volatility.
Retail sales have been stuck in a very narrow 3.5% to 4.0% range since April. Some unusually strong employment numbers at the end of 2014 combined with much more favorable weather in late 2014 and early 2015 did temporarily inflate the retail sales figures to close to 5% in late 2014 and early 2015. That higher 5% rate was not sustainable. However, given continued decent employment growth and improving hourly wages, we continue to believe that retail sales growth can hold in the 3.2% to 4.0% range for at least the next year, if not longer.
Why higher wage growth and low inflation haven't caused more of an improvement in either consumption or retail data remains a bit of a mystery. We suspect the uneven effects of inflation, concerns about how long inflation can stay low, and an aging U.S. population are all weighing on the data. Still, the data would seem to argue for at least modestly higher consumption growth somewhere in the near future.
Although we aren't fans of sequential data (because of faulty seasonal factors), growth has also been exceptionally stable from quarter to quarter, with perhaps even some very modest improvement. Annualizing the recent quarterly data, core retail sales have managed a growth rate of around 4%, quite consistent with the year-over-year growth rate discussed above.
It also suggests that goods consumption will continue to add to GDP growth rate in the fourth quarter at approximately the same level as the second and third quarters, which underlies our 2.5% to 3.0% GDP forecast for the fourth quarter of 2015.
Total consumption, including services, should grow by over 2.5% (sequentially and annualized and adjusted for inflation) in the fourth quarter. Even hitting that lower bound for consumption, and with all the other categories showing no change, total GDP growth in the fourth quarter would amount to 1.8% (2.5% growth times 70%, the consumption portion of GDP).
Headline retail sales data just misses forecasts
Headline month-to-month sales growth for November was 0.2% (2.4% annualized), which was better than the puny 0.1% growth rate in October but below consensus forecasts for 0.3%. The headline numbers were affected by falling gasoline prices and slower consumer auto sales. Total auto sales have been just about flat for a couple of months after a massive late-summer boom. However, consumer auto sales (that is, excluding fleet and government) have been down a touch for a couple of months. Again, we remind readers that the monthly total retail numbers are very volatile and frequently revised. We talk about the month-to-month numbers only for a sense of completeness, since this is the way most news outlets talk about the data. We also peek at the monthly sector data.
Sector data unusually strong
A lot of categories did unusually well in November. We ran out of room to talk about all the categories that did well for the month. As is typical, several of the big winners were last month's losers (clothing, general merchandise, and sporting goods), so we would not read too much into these. As a relatively more normal November followed an unusually warm October, shoppers returned to stores for their winter attire. Those same weather factors perhaps helped and then hurt sales at general merchandisers and sporting goods and hobby-related stores.
Bars and restaurants continued a string of exceptional months as consumers are clearly splurging on meals away from home. Again, we view restaurant sales as one of the best indicators of short-term consumer confidence. Atypically, grocery stores, which hadn't been doing well, saw a mini surge in November, growing 0.7% despite the strong restaurant sales that usually depress sales in grocery stores.
Conversely several past winners (furniture and building materials) were big losers in November. A lot of housing data, while not eroding, certainly is not showing the kind of growth that it did in early 2015, putting a little pressure on the furniture and building materials category. We were a little surprised that a snowy November didn't help the building-materials category more than it did. The building-material weakness may also presage more mediocre housing numbers next week. Though no disaster, drugstore sales were unchanged in November, after a good string of healthy increases. We guess that a tame flu season may be part of the explanation.
Year-over-year category data begins to converge
The range of performance by category has narrowed sharply over the past several months, with all but the usual problem children growing between 4% and 7%. Gasoline sales look terrible because of falling prices, not end demand. Sales at gas stations are down only 19%, while prices are down over 26%. This suggests that consumers are driving more and using more gas or buying more stuff while they go to fill up the tank. So on an inflation-adjusted basis, gasoline sale are up quite nicely. Electronic sales look terrible, down 3.5%, until one considers that prices are down 7.5%, suggesting that unit sales are up 4%. In addition, electronics sales are being hit by the fact that sales are shifting from electronics stores to online retailers. Clothing stores and department stores (which sell a lot of clothes) are also being hit hard by shifting sales channels and price. These two categories are suffering from adverse weather conditions (too warm) to boot.
Small businesses grow more pessimistic
Though the NFIB Small Business Sentiment Report isn't one of our favorites (more a lagging index than predictive), some key themes are apparent. Small-business sales growth remains limited, while costs, including labour, keep going up, causing earnings to generally trend down. And despite plans to raise prices, small businesses have not managed to pull the trigger. These general themes in addition to the perpetual concerns about regulation and taxes have kept a lid on the overall index for several months. Things managed to get a little worse in November, the index declined to 94 from 96 and compared to the long-term average of just over 100. For November, nine of 10 categories were down (only credit conditions looked better than the previous month). Sales and earnings expectations accounted for more than half of the index decline.
We often like to look at the wage and employment data in this report. The data continues to confirm our labour shortage thesis, with 47% of respondents indicating that they have job openings with few or no qualified applicants. That is statistically the same as the recovery high of 48% registered for October. The index has moved from 24% in 2010 to 47% currently, but hasn't moved much higher lately.
Higher pay offers may be one of the reasons that openings seemed to have topped out, as business people become more attuned to tighter labour market conditions. The percentage of employers planning to pay higher wages in the months ahead has moved up dramatically over the past year, which may explain both why openings have stabilized and profit expectations have decreased.
Also indicating a tight labour market are persistent plans by employers to increase total employment while employment remains relatively unchanged. In November (and very similar in the prior month), a net 11% of all employers were planning to add at least one new worker, while just 1% of all firms managed to increase employment, according to the November report. Finding quality workers is now the third most important impediment to growth, behind just taxes and regulation, according to the November report. The percentage of firms reporting labour quality as the most important business issue has increased from 5% to 10% of all respondents from 2014 to 2015. That is the biggest change among the 10 impediment categories that owners could choose from.
While job openings remain high, quits continue to disappoint (by Roland Czerniawski)
The Jobs Openings and Labour Turnover Survey, or JOLTS, showed that job openings were little changed in October, while they still remain at historically high levels. Openings stood at 5.4 million compared with 5.5 million a month earlier. The relative stability of openings after a huge surge earlier this year is very consistent with the NFIB small-business report discussed above. Hires and quits levels were also unchanged.
Job openings have been outpacing hiring for nine consecutive months, suggesting that the labour shortage forces continue to build up. This appears to be consistent with the recent goldilocks employment report that showed 211,000 jobs added and modestly accelerating hourly wage growth. More robust hiring in categories like professional and business services and healthcare has helped boost the aggregate wage calculation, as these categories tend to be better paid and typically require longer hours.
The number of people who quit their current jobs, on the other hand, has been exposing a weak point in the labour market, as the level of quits has remained stagnant for more than a year. The quits problem illustrates the complexity of offsetting forces that govern the labour market. On one hand, there appears to be an increasing shortage of labour illustrated by the abundance of openings that are not being filled. This phenomenon should theoretically set the stage for inflationary wage pressures, which so far have only slowly materialized.
On the other hand, the employees' willingness to voluntarily leave their current roles to pursue better opportunities has remained muted. While this dynamic remains puzzling, it could point to a mismatch between new job openings' required skill set or pay and the candidates' skills and pay expectations. Eventually, we believe that the equation will shift in favor of the workers, making them less reluctant to quit, and employers might be forced to fight for every single skilled candidate as this labour market recovery continues to age. We believe that the issue of labour shortage will continue to intensify and will be an important theme in 2016.
Budget deficit improvement takes a pause
The first two months of a fiscal year are probably not the best time to fully gauge budget trends. However, a quick read of the October/November data suggests that the overall level of budget deficit improvements may be drawing to a close. The table below shows major receipts (at the top) and expenditures (at the bottom) for the first two months of the year along with the year-over-year growth rate for the first two months of the year. We also include the growth rates for all of fiscal 2015 for comparison purposes.
Looking at the two right columns, receipts grew more slowly for the first two months of the fiscal year compared with full-year trends, while spending grew at a relatively similar pace. With receipts increasing just 2.7% and revenue by 5.7%, the deficit increased by $21 billion, to $201 billion. However, these two months may not be particularly indicative of full-year results, because there are now major tax-collection deadlines in these two months.
December brings major tax deadlines for corporations and individuals, and that data will provide a much clearer picture of tax collections. Payroll taxes, which are paid each month, look to be on trend. Corporate tax data so far is meaningless because there is minuscule collection data. No one likes to pay taxes before they have to. Fears a year ago that the research and development tax credit might be allowed to expire drove an unusual number of tax payments in October and November. Nevertheless, we remain modestly concerned about corporate tax collections given the slump in oil industry profits and the number and size of tax inversion type transactions. The December data will provide a much clearer picture. On the individual side, we believe that bonus payments could be better this year and mutual fund payouts could be higher, but that may be offset by lower capital gains income due to a flattish stock market. Again, December will provide us with a much clearer picture.
The spending side of the equation for the first two months of 2016 looks relatively similar to all of 2015, with about 5.5% growth in both years. Almost two thirds of the spending growth so far this year relates to the major social programs, Social Security, Medicare, and Medicaid. Social Security will begin to grow much more slowly in January as there will be no cost-of-living increase unlike January a year ago. Growth for the rest of the year will primarily reflect growth in the number of people collecting benefits.
Fed decision likely to dominate all else next week
There is a ton of data next week, including the consumer price index, housing starts and permits, and industrial production. Still, all of that will be overshadowed by the well-telegraphed plans for the Fed to increase short-term rates next week. We think the markets are putting way too much emphasis on this decision. More important is what they do with rates longer term, but slow growth and demographics will truly limit their options and need to do much of anything. We suppose that asset bubble fears, services inflation, and tightening labour markets suggest that some upward adjustment in rates might be necessary over the next year. However, low demand for loans stemming from low growth rates, desired and undesired deleveraging, as well as a greater need for fixed-income products from retiring baby boomers will help keep a pretty tight lid on interest rates, no matter what the Fed's intention.
In case one cares about much more than the Fed, oil prices, and China, we suspect that inflation remained muted in November as gasoline prices fell yet again. We forecast that headline inflation will be zero, with some modest risk of deflation due to energy prices. We still suspect core inflation will be up 0.2% on higher prices for shelter and healthcare.
Housing starts had a bad month in October, and permits data and high prices for existing homes suggest that housing starts should rebound from 1.06 million units to about 1.14 million units in November. However, we note that weather and seasonal factors mean that just about anything can happen with the numbers. Remember, permits growth is less volatile and more indicative of future economic results than the weather-inflicted starts data. Still permits didn't see a big dive in October like starts, so we don't expect much, if any, improvement in permits for November.
Recent data has shown some improvement for manufacturing sector results. However, weak purchasing manager data as well as a renewed slump in oil and other commodities now make more improvement look more difficult than we would have expected just a week ago. General expectations are for industrial production to decline 0.4% month to month. While we are slightly more bullish, it's very hard to fight what is going on in world commodity markets.
