Are the bad weather clouds beginning to lift?

The jobs report and initial unemployment claims were much better than expected this week as weather effects began to diminish.

Robert Johnson, CFA 8 March, 2014 | 7:00PM
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Markets were on a yo-yo again this week as the situation in Ukraine sank equity markets in the United States. However, they rebounded once the situation cooled and the S&P 500 ended the week up about 1%.

The bond market was another story. A better-than-expected jobs report for February dashed all hope that maybe the U.S. Federal Reserve would temporarily halt its tapering program. The 10-year U.S. Treasury bond yield jumped from 2.66% to 2.79%, with some bond funds showing hefty losses on Friday.

In economic news, the jobs report and initial unemployment claims were much better than expected as weather effects began to diminish. Auto sales remained soft, but didn't collapse. And the Purchasing Managers report on manufacturing rebounded in February after a collapse in January. Personal income and consumption both looked better than expected, but that was largely because of estimated effects of the Affordable Care Act and massive spending increases on utility bills. Excluding these special factors, consumption would have been down and income gains more muted.

Job report better than expected
The government's employment report for February came in better than expected with the economy adding 175,000 jobs, up from 86,000 in December and 129,000 in January. This was above expectations of 140,000, but still below the 189,000 average of the prior 12 months.

Economists, including me, expected that weather would weigh on the short-term numbers more than it did. I suspect that consumers and industrial concerns may have adapted to the cold and snowy conditions. I thought poor weather would hit retailers and restaurants really hard. Instead, restaurants added 21,000 jobs instead of subtracting 20,000-30,000 jobs, as I expected. Apparently cabin fever caused more consumers to venture out into the cold for a meal.

Long walks across shopping centre parking lots were less popular, resulting in soft retailer sales and the industry losing 4,000 jobs. However, even that was better than I had hoped for, perhaps because auto dealers continued to add employees.

I suspect cold weather didn't have the same effect across the board. Temporary-help jobs jumped 24,000, perhaps because temps were called in to replace workers who were snowed in. Travel, hotels, and restaurants in warm climates likely saw benefits from the cold. Even the construction numbers, which were up a robust 50,000 jobs in January and 16,000 in February, might be a result of repairs and more staff needed due to bad weather.

The year-over-year trends showed that weather appeared to have a minimal impact with only a modest decline in the year-over-year total employment growth rate. Nonfarm payrolls are growing about 1.7% year over year, modestly trailing the 1.9% GDP growth rate reported for 2013. That almost always happens because of productivity growth. Government job losses held back the statistics as the private sector, approximately 84% of all jobs, grew a more robust 2.0%.

The hours worked and average hourly wage data were mixed. In the big picture, hours and wages are every bit as important as the more attention-grabbing jobs numbers. Consumer income growth, which helps determine retail spending levels, is a function of how many people had jobs, how long they worked, and what rate they were paid. Hours worked remained under pressure, falling further from downward-revised data for December and January. Weather caused these statistics on overall hours worked to fall to 34.2, their lowest level since early 2010 when the job market was just coming out of the recession. Prior to winter, hours worked bounced around the 34.4- to 34.5-hour range.

The weakness was relatively broad-based. Leisure and construction saw notable dips, while manufacturing was flat, and mining saw a large increase. Most other groups showed minuscule decreases. The hourly wage rate grew a 0.4%, its highest level since June and following up on a 0.2% gain in January. Unfortunately, the year-over-year averaged wage change hardly budged from its 2.0% average the previous month.

Putting together lackluster employment growth, poor hours data, and muted wage growth, total wage growth deteriorated to 3.6% from a November 2013 high of 4.5%. With the weather-related drop in hours, wage growth would have been about 4%--better, but still trending the wrong way, especially given that inflation is likely to be up some more in February.

Private sector about to recapture all jobs lost in recession
At current trend rates, the U.S. economy is just about to recover all the jobs lost during the most recent recession. In fact, the United States could cross that line as early as next month as the trend is 184,000 jobs per month, and we are just 116,000 short of that mark. However, because government has been losing employees for most of the recovery (government hiring always lags the real economy) we are about three or four months away from crossing that mark for the entire economy. The very large service sector crossed that mark a couple of years ago. The construction industry has still barely made a dent in its job losses, while manufacturing has recovered just 35% of the jobs lost. Sadly, the average manufacturing job has a weekly wage of $1,006 and construction $1,010, while the services sector overall averages just $792.

Auto sales are still in a funk
At 15.4 million units, the annualized, seasonally adjusted auto sales rate for February remained well under the 16-million mark for the third month in a row after getting as high as 16.4 million units in November. Prolonged bad weather may push a number of aging autos over the edge, theoretically increasing auto demand, even in the short run. Sales were basically flat compared to February of last year. Morningstar's auto team still believes that sales for 2014 will be in the 15.9 million-16.2 million ranges, up modestly from 2013's 15.5 million units. That's hardly enough to cause a rocket ship-like performance for the whole economy.

For now the automakers are putting on a brave face. Although weather conveniently reduced short-term production, auto manufacturers are stepping up production schedules and employment--even in the face of slowing demand, which they seem to be convinced is only temporary.

There are just a few chinks in their armor.   Fiat  FIATY announced temporary layoffs recently at its Belvidere plant, and   Ford  F made noises about some production trimming in the first quarter several months ago. Most of the others have made no changes to aggressive plans and are offering incentives to cure short-term inventory issues. As an economist, price cuts and ramped-up production are both good news for consumers and GDP growth, but not such great news for the auto companies.

In other good news, bad weather put a dent production and started to reduce the huge inventory build-up that had grown to worrisome proportions.   GM  GM says inventories dropped from 114 days of supply in January to a still high 87 days in February. Ford's inventories fell from 111 days to 91 days.

Auto production nearing previous high; sales and employment aren't there yet
Domestic auto production is nearing the high that it reached in 2005 as the industry has substantially rebuilt inventories since 2009. Sales of domestically produced vehicles are trailing slightly behind at 89% of 2005 levels. Employment trails substantially behind at just 80% of the high, as the shuttering of plants and new labour agreements as well as efficiencies have kept a lid on employment. That is part of the reason that manufacturing employment has recaptured only about a third of the jobs lost during the recession, as cited above.

Source: BEA, Federal Reserve, BLS, and Morningstar calculation

Trade numbers as expected
The trade number for January wasn't terribly exciting with the deficit basically flat with the previous month at $39 billion and following trade January deficits of $51 billion and $42 billion in 2012 and 2013, respectively.

Oil has been a key to the deficit reduction. Although we have only one month of data for the first quarter, it looks like the two-quarter streak of trade deficits contributing to GDP growth is about to come to an end. Net exports added 0.1% to third-quarter GDP growth and about 1% of the fourth quarter's overall 2.4% growth rate. The lack of any improvement in net exports for January is part of the reason I am forecasting a relatively pessimistic 1.6% growth rate for the first quarter. For exports to become a contributor again in the first quarter, the deficit would have to average $2.5 billion over each of the next two months. This would represent a large but not impossible move. However, to make a 1% contribution, the deficit reduction would need to average a near impossible $5 billion per month in February and March.

Taking a longer view, the year-over-year averaged data, both import and export data showed some signs of softening despite all the excitement about an improving world economy. Both import and export growth rates slowed to their lowest levels since September. Trading partners counting on great sales to the United States might be disappointed as trade is definitely not as robust as it was in the fall, and the Ukrainian situation China's slow growth doesn't help.

ISM Purchasing Managers' Report shows small rebound despite weather
The Purchasing Managers' Index for January seemingly collapsed from 56.5 to 51.3, one of the largest one-month declines of the recovery, though still indicating more slow growth than shrinkage. Things did rebound in February to 53.2, reinforcing the view that weather was the culprit behind the January collapse. New orders looked much better in February, although ratings on current production levels looked abysmal, falling to their lowest level in five years. That would make some sense as weather is likely to have a bigger effect on shipments than orders, most of which are placed electronically.

Again, I worry more about consumers and consumption than manufacturing in general and PMI data in particular.

Consumption and income data less than crystal clear
The month-to-month growth in consumer incomes and consumption both came in stronger than expected because of the Affordable Care Act. Expectations had been for growth of 0.2% for both categories. Retail sales, auto sales, and the employment report--normally great indicators for these reports--seemed to be flashing warning signs. Instead, income grew an acceptable 0.3% (0.2% after inflation) and consumption by an impressive 0.4% (0.3% after inflation), confounding most economists.

The income figures were aided by counting Affordable Care Act subsidies as income, which makes some sense. Then the BEA further assumed that those subsidies were spent and would generate activities within the health-care industry; a little suspect because health-care employment didn't grow much.

The other upside surprise was spending on gas and electricity, up a stunning 11%, even after adjusting for inflation. This added 0.2% to consumption growth. Additional anticipated spending under the Affordable Care Act probably added an even larger amount, about 0.3%. Excluding the assumed Affordable Care Act spending and the large jump in utility spending and adjusted for inflation, consumer spending likely shrank by 0.1%. Not exactly a prize-winning result.

I am skipping my normal consumption and income tables for this month because of comparability issues due to large dividend and bonus payments made in late 2012, designed to beat the anticipated tax increases for 2013. I will say the less-affected year-over-year averaged consumption numbers did increase 2.18%, its best showing since 2012. However, remember that high utility bills and the Affordable Care Act helped those along.

More treasury department data and retail sales on tap for next week
Part of the story for a better GDP growth rate for 2014 is an improvement in government spending. Spending did not rebound in January, and employment data doesn't look much better in February. Next Tuesday, the Treasury will release the official spending and receipts report for February, which should provide some further clarity.

Retail sales, no rebound yet
Retail sales, both with and without the auto sector, are expected to grow about 0.2%. That's better than last month's 0.4% decline, which was largely due to falling auto sales. The trend in the weekly data seems to support that level of improvement and perhaps just a touch more. Higher gas prices in this noninflation-adjusted report will help make the statistics look a little better. The weather factor may be diminished as people adjusted to the cold. No big jump, but the worst of the nasty declines in retail sales may be behind us--at least until everyone starts paying those sky-high utility bills.

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Robert Johnson, CFA

Robert Johnson, CFA  Robert Johnson, CFA, is director of economic analysis for Morningstar.

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