Sunday, 25 of June of 2017

Economics. Explained.  

Industrial Production

June 15, 2017

Industrial production was unchanged in May after having jumped 1.1% in April.  Over the past year this series has risen 2.2% and is clearly on the upswing.

Breaking industrial production down into its three major sub-components,  the Fed indicated that manufacturing production (which represents 75% of the index) fell 0.4% in May after having surged by 1.0% in April. During the past year  factory output has risen 1.4% (red line, right scale).  It has clearly hit bottom.

Mining (14%) output rose 1.6% in May after having climbed by 1.5% in April.   Over the past year mining output has risen 8.3%.

Most of the recent upturn in mining has been concentrated in oil and gas drilling activity  which rose 3.8% in May after having increase 9.0% in April.  It has now risen for twelve consecutive months.  Over the course of the past year oil and gas well drilling has risen 100.5%.  The number of  oil rigs in operation continues to climb.

Utilities output  rose 0.4% in May after having risen 0.7% in April.

Production of high tech equipment was unchanged in May after having climbed by 1.3% in April.  Over the past year high tech has risen 7.0%.   The high tech sector sector appears to have gathered some momentum during the past several months. This may be an early indication that the long slide in nonresidential investment may be coming to an end which would, in turn, signal some upturn in productivity growth.

Capacity utilization in the manufacturing sector declined 0.3% in May to 75.5 after having jumped 0.8% in April.  It is still below the 77.5% that is generally regarded as effective peak capacity but it is beginning to close the gap.  Above that level the factory sector is running too hot and prices begin to rise.  While we are a  ways from that so-called danger level, the reality is that manufacturing capacity is growing by about 0.1% per month while manufacturing output is rising by about 0.4%.

Stephen Slifer


Charleston, SC

Retail Sales

June 14, 2017

Retail sales declined 0.3% in May after having risen 0.4% in April.   The May gain was smaller than expected.  During the course of the past year sales have risen 3.9%.

Sometimes sales can be distorted by changes in autos which tend to be quite volatile.  In this particular instance the unit selling rate for car sales slipped during May and, as a result, the car sales component of retail sales declined 0.2%.

Fluctuations in gasoline prices can also distort the underlying pace of retail sales.  If gas prices rise, consumer spending on gasoline can increase even if the amount of gasoline purchased does not change.  Gasoline sales declined a sharp 2.4% in May.

Perhaps the best indicator of the trend in sales is retail sales excluding the volatile motor vehicles and gasoline categories.  Such sales were unchanged in May after having risen 0.5% in April and 0.4% in March.   In the last year retail sales excluding cars and gasoline have risen 3.6%.  No evidence of a slowdown in this series.

While there has been a lot of disappointment about earnings in the traditional brick and mortar establishments (like Macy’s, Sears, K-Mart, and Limited) the reality is that they need to develop a better business model.  The action these days is in non-store sales which have been growing rapidly. Consumers like the ease of purchasing items on line.  While sales at traditional brick and mortar general merchandise sales have risen 1.4% in the past year, on-line sales have risen a steamy 10.9%.  As a result, their share of total sales has been rising steadily and now stands at 10.9% of all general merchandise sales.  That percentage has risen from 10.3% at this time last year.

We do not believe the recent softness in retail sales represents a change in trend for a variety of reasons.  First of all,  existing home sales are selling at the fastest rate thus far in the cycle.  Consumers do not purchase homes and cars — the two biggest ticket items in their budget — unless they are feeling confident about their job and the future pace of economic activity.  If home sales are holding up well, car sales should  rebound in the months ahead.  As noted earlier, car sales are a particularly volatile category.

Second, the stock market is near a record high level.  That increase in stock prices boosts consumer net worth.

Third, all measures of consumer confidence are at their highest level thus far in the business cycle.

Fourth, cuts in individual income tax rates are likely later this  year.

Finally, the economy is cranking out 170 new jobs every month which boosts consumer income.  Consumers have paid down a ton of debt and debt to income ratios are the lowest they have been in 20 years.  That means that consumers have the ability to spend more freely and boost their debt levels if they so choose.

Thus, in our view, the first quarter weakness is sales is not a harbinger of a consistently slower pace of spending in the months ahead.  We continue to expect GDP growth to quicken to 2.4% in 2017 and 2.8% next year.

Stephen Slifer


Charleston, SC


June 13, 2017

The Producer Price Index for final demand – intermediate demand  includes producer prices for goods, as well as prices for construction, services, government purchases, and exports and covers over 75% of domestic production.

Producer prices for final demand was unchanged in May after having jumped 0.5% in April.  During the past year this inflation measure has risen 2.4%.  It is close to the 2.5% year-over-year increase registered in April which was the largest 12-month increase since February 2012.

Excluding food and energy producer prices rose 0.3% in May after having climbed 0.4% in April.  They have risen 2.1% since March of last year.  This series has not climbed above the 2.0% mark since April 2014.

This overall index can be split apart between goods prices and prices for services.

The PPI for final demand of goods fell 0.5% in May after having risen 0.5% in April. These prices have now risen 2.8% in the past year (left scale).  Excluding the volatile food and energy categories the PPI for goods rose 0.1% in May after having risen 0.3% in April.  During the past year the core PPI for goods has risen 2.2% (right scale).  It has been steadily accelerating for more than a year.

Food prices declined 0.2% in May after having jumped 0.9% in both March and April.  Food prices are always volatile.  They can fall sharply for a few months, but then reverse direction quickly.  Over the past year food prices have risen 1.0%.

Energy prices fell 3.0% in May after having increased 0.8% in April.  Energy prices have risen 7.5% in the past year.  These prices are also very volatile.

The PPI for final demand of services rose 0.3% in May after having risen 0.4% in April .  This series has risen 2.1% over the course of the past year (left scale).  This is the largest 12-month increase in this services index since January 2015.  Changes in this component largely reflect a change in margins received by wholesalers and retailers (apparel, jewelry, and footwear in particular).  The PPI for final demand of services excluding trade and transportation declined 0.1% in May after having surged upwards by 0.8% in April .  It has climbed 2.1% during the past year.

Because the PPI measures the cost of materials for manufacturers, it is frequently believed to be a leading indicator of what might happen to consumer prices at a somewhat later date.   However, that connection is very loose.

It is important to remember that labor costs represent about two-thirds of the price of a product while materials account for the remaining one-third.  So, a far more important variable in determining what happens to the CPI is labor costs.  With the unemployment rate currently at 4.3%, the labor market is beyond full employment.  As a result, wages pressures are sure to rise, and once that happens firms are almost certain to pass that along to the consumer in the form of higher prices.

Some upward pressure on labor costs, rents, and medicare care will further increase the upward pressure on inflation.  We expect the core CPI to increase 2.0% in  2017 and 2.2% in 2018.

Stephen Slifer


Charleston, SC

Small Business Optimism

June 13, 2017

Small business optimism was unchanged in May at 104.5.  This is slightly lower than the cycle high reading of 105.9 set in January which was the highest level for this index since 2004.  Indeed, with the index hovering close to this same level for the past six months the NFIB notes that that represents a hot streak that has not seen since 1983.

NFIB President and CEO Juanita Duggan said, ”The remarkable surge in optimism that began last year right after the election shows no signs of slowing down.  Small business owners are highly encouraged by the President’s regulatory reform agenda, and they remain optimistic there will be tax reform and health-care reform. This is a policy-driven phenomenon.”

In our opinion the economy is bouncing along at a respectable pace and should gather momentum in coming months as the new Trump Administration produces a number of significant policy changes.  Specifically, we believe that later this year we will see both individual and corporate income tax cuts, legislation that will allow firms to repatriate corporate earnings currently locked overseas back to the U.S. at a favorable 10% rate, elimination of all unnecessary, confusing and overlapping federal regulations, and re-vamping of our health care system to a less expensive and less complicated health care system consisting of tax-advantaged health savings accounts combined with a high deductible health insurance plan to ensure against catastrophic problems.  These changes should boost our economic speed limit should from 1.8% or so today to 2.8% within a few years.

Already we see the stock market at a record high level.   Jobs are being created at a reasonably robust pace.  The unemployment rate is  at full employment.  The housing sector is booming.  And now investment spending should pick up after essentially no growth in the past three years.  We expect GDP growth to climb from 2.0% in 2016 to 2.2% in 2017 and 2.7% in 2018.  The core inflation will  probably quicken from 2.2% in 2016 to 2.4% in 2017 and 2.7% in 2018.  The will will continue to raise short-term interest rates very slowly.  Accelerating GDP growth, low inflation, and low interest rates should propel the stock market to new record high levels..

Stephen Slifer


Charleston, SC

Steadily Tightening Labor Market Will Boost Inflation

June 9, 2017

Most economists believe the labor market is at full employment. However, it is at least possible that it is not yet there. But, however one wants to measure it, it is close and it is steadily tightening with each passing month. Hourly wages have risen less rapidly than expected thus far, but that is likely to change in the months ahead. As that transpires, there should be additional upward pressure on the inflation rate.

At 4.3% the unemployment rate is below virtually every economist’s estimate of “full employment” which is the point at which everyone who wants a job presumably has one. The Fed believes full employment is between 4.7-5.0%. But full employment is unobservable. Economists have to estimate it. Could it be lower? Sure. As low as 4.0%? It is a long shot, but yes. After all the unemployment rate was at the 4% mark for a long while prior to the 2001 recession with only moderate upward pressure on the core inflation rate.

In the past Fed Chair Yellen suggested that the labor market was not at full employment because there were still a large number of “underemployed” workers. There are two types of such workers. First, there are “discouraged workers”. These people would like to have a job but have been out of work so long they have given up looking. As one might expect the number of discouraged workers has been steadily falling and is now essentially where it was prior to the recession.

Second, additional workers are currently employed part time but would like full time employment. This series has also been steadily declining but remains somewhat above where it was going into the recession.

Yellen’s preferred measure of unemployment includes both unemployed and underemployed workers. That rate is currently at 8.4% which is lower than the 8.8% it was going into the 2007-2008 recession. However, going into the 2001 recession it was 7.4%. Is the economy at full employment using this broader measure of employment? Maybe. But one can certainly make a plausible case that the full employment threshold for this measure is lower than its current level of 8.4%.

The bottom line is that there is no “magic level” of full employment. Economists make guesses. Most believe the economy is already at full employment, but it is possible that is not the case. However, it is close and getting closer with each passing month.

Economists are so concerned with full employment because, once attained, employers will have increasing difficulty finding an adequate supply of workers. They will ask existing employees to work longer hours. They will require them to work overtime. Eventually they will offer higher wages and/or more attractive benefits to attract the workers they need. But those actions boost labor costs and, eventually, put upward pressure on the inflation rate. All of that is already happening to some degree.

The number of job openings today exceeds the number of hires. That has never happened before. Jobs are available but they remain unfilled. Why? Workers may not have the appropriate skills. Many may not be able to pass drug tests. Others may be content to receive welfare benefits and are unwilling to work. Whatever the case, jobs are available and employers are unable to fill them.

The nonfarm workweek is already quite long. There is little room for employers to further lengthen the workweek to boost output. They need bodies.

That is particularly true in the manufacturing sector where at 40.7 hours the workweek is far longer than the 40.0 hour workweek that prevailed prior to the recession. Factory officials may be asking their employees to work longer hours because they cannot find enough qualified workers.

Overtime hours are also quite high. Factory owners are running out of options to boost output. They need more workers and will have to pay up to get them.

As labor demand intensifies one should expect wage rates to accelerate and that is the case. They had been climbing steadily at a 2.0% rate a few years ago, but have recently climbed into a range from 2.5-2.8%.

After a first quarter slump the economy appears to be re-accelerating. That will create jobs and all measures of the unemployment rate will fall further. As unemployment rates decline wage pressures will intensify.
The final piece of the puzzle has to do with productivity gains and “unit labor costs”. If wages rise 3% and workers are 3% more productive, employers do not care. They are getting 3% more output. Labor costs adjusted for productivity are known as “unit labor costs”. This is the relevant metric for measuring the upward pressure on the inflation rate caused by tightness in the labor market. Thus far, unit labor costs are rising at a 1.0% pace which is perfectly consistent with the Fed’s 2.0% inflation target. But will unit labor costs remain benign?  Probably not.

Whether the economy has reached full employment or not, it is close and labor costs will be steadily picking up. Can productivity keep pace? That may be more challenging. As we see it, the direction for labor costs and inflation is clear. They are going to accelerate but the speed of ascent has yet to be determined, and that is critical for determining how quickly the Fed will need to raise interest rates in the months ahead.

Stephen Slifer
Charleston, S.C.

Consumer Net Worth

June 8, 2017

Consumer net worth rose $2.4 trillion in the fourth quarter.  That works out to an annualized rate of increase of 10.1%.  Over the past year consumer net worth has increased 8.3%.

Net worth declined sharply during the recession but has long since recovered all that was lost and is actually 40.0% higher than it was prior to the recession.  The rebound reflects, in part, the steady increase in stock prices during the course of the past 7 years and in home prices which have been climbing steadily.

This high and climbing level of  net worth should encourage consumers to spend at  roughly a 2.5% pace in the quarters ahead.

Stephen Slifer


Charleston, SC

Corporate Cash

June 8, 2017

Corporate cash holdings  rose $51 billion in the first quarter to $2.64 trillion (above) , and  continues to be quite high at 10.2% of non-financial assets (below).

As the recovery first began in mid-2009 corporate CEO’s needed to increase cash holdings for defensive reasons.  They had no idea if the expansion would be sustainable.  Similarly, they could not anticipate the likely pace of growth.  By the end of 2010 they appear to have become confident that they had ample cash on hand to weather almost any economic upset that might occur.  But given considerable concern about the high corporate tax rate, the inability to repatriate overseas earnings to the U.S., unhappiness about the onerous regulatory burden, and a failing health care program in serious need of revision,  corporate leaders have been reluctant to deploy these ample cash holdings.

But it is important to remember that all of these cash holdings — checking account balances, CD’s, holdings of government securities and municipal securities — all yield less than 1.0%.  It is not good management to have a considerable portion of your assets earning so little.   As we go forward and the stock market continues to climb and the economy continues to expand at a moderate pace firms should become more willing to invest.  The prospect of cuts in the corporate tax rate, an ability to repatriate earnings at a favorable 10% tax rate, relief from the onerous regulatory burden, and revisions to Obamacare, they might be more willing to loosen their purse strings by putting more money into technology to boost productivity.  Or they might build a new factory.  Whatever they choose to do, putting these cash holdings back into the economy will support GDP growth and boost productivity in 2017.

Stephen Slifer


Charleston, SC

Unemployment vs. Job Openings

June 6, 2017

This release in generally rather obscure.  But. Fed Chairwoman Janet Yellen often refers to data from it so its importance has increased in recent years.

The  Labor Department reported that job openings jumped 7.1% in April to 6,044 thousand after having declined 1.1% in March.    It is worth noting that there are more job openings today than there were prior to the recession.   There were 7.1 million people unemployed in April.

As shown in the chart below, there are currently 1.` unemployed workers for every available job.   Prior to the recession this ratio stood at 1.7 so the labor market (at least by this measure) is in better shape now than it was prior to the recession.

In  this same report the Labor Department indicated that the quit rate was unchanged in declined 0.1 in April to  2.1 after having risen .01 in March.  It remains within an eyelash of being the highest reading thus far in the business cycle.  This is a measure of the number of people that voluntarily quit their jobs in that  month.  It is another series that Janet Yellen likes to talk about.  During the height of the recession very few people were voluntarily quitting because jobs were scarce.  So the more this series rises, the more comfortable workers are in leaving their current job to seek another one.  The quit rate today is 2.1; at the beginning of the recession it was at 2.0.

There is one other point that should be made about this report.  Janet Yellen claims that there are a large number of unemployed workers just waiting for jobs if only the economy were to grow fast enough.  She is assuming that these people have the skills and are qualified for employment.  We tend to disagree.  There are plenty of job openings out there.  What is not happening as quickly is hiring.  Take a look at the chart below.  Job openings have been rising rapidly (and are higher now than they were prior to the recession); hires have been rising less rapidly.

Indeed, if one looks at the ratio of openings to hires the reality is that this ratio has not been higher at any point in time since this series began in 2000.  There are plenty of jobs out there, but employers are having a hard time filling them.  Why is that?

A couple of thoughts come to mind.  First and foremost, many unemployed workers simply do not have the skills required for the jobs available.  If they did, why aren’t they being hired?  Why aren’t some current part time workers stepping into the void for those full time positions? Why haven’t discouraged workers begun to seek employment with so many jobs available?  Why haven’t long-term unemployed workers bothered to go back to school and acquire the skills that are necessary to land a  job?

Or perhaps many of these people flunk the drug tests.  They might not be qualified for employment for a variety of possible reasons.

Perhaps also some people in this group find that the combination of unemployment benefits and/or welfare benefits sufficiently attractive that there is little incentive to take a full time job when you can sit at home do nothing and make almost as much.

Whatever the case, it appears that the decline in the unemployment rate in the past year is not simply a reflection of workers dropping out of the labor force.  Jobs are plentiful and the only reason the unemployment rate is not falling faster is because the remaining unemployed/discouraged/part time workers do not have the skills required by employers today, flunk the drug tests, or are unwilling to take the jobs that are available.

Stephen Slifer


Charleston, SC

Purchasing Managers Index — Nonmanufacturing

June 5, 2017

The Institute for Supply Management not only publishes an index of manufacturing activity each month, they publish two days later a survey of non-manufacturing firms — which largely consists of services. The index declined 1.7 points in May to 60.7 after having jumped points in April.   At its May level the ISM group estimates GDP growth of 3.1%.

The orders component  fell 5.5 points in May to 57.7 after having jumped 4.3 points in April.  The April level for orders was  highest level since July 2005  and suggests that the service sector will continue to grow briskly for some time to come.  Comments from respondents include: “New projects starting up.”

The ISM non-manufacturing index for employment climbed 6.4 points in May to 57.8 after having declined 0.2 point tin April.  However, this series has been fairly volatile in other recent months with big increases followed by big declines a rather common occurrence.  Jobs growth should continue in upcoming months at about the same pace we  have seen of roughly 170 thousand per month. Comments from respondents include: “increased demand for services” and “business expansion and seasonal growth”.

Finally,  the price component fell 5.4 points in May to 59.2 after having risen 4.1 points in April.  Thus, prices rose fairly sharply in April.  All sixteen industries surveyed reported higher prices in April.  After several months of climbing steadily higher, price inflation amongst non-manufacturing firms took a breather in May.

Stephen Slifer


Charleston, SC

Nonfarm Productivity

June 5, 2017

Nonfarm productivity was unchanged in the first quarter after having risen 1.7% in the fourth  quarter.   During the course of the past year productivity has risen 1.2%.  The 1.3% increase in the first quarter consists of a 1.7% increase in output and a 1.6% increase in hours worked.

Clearly, productivity growth has slowed. For example, from 2000- 2007 (when the recession began) nonfarm productivity averaged 2.7%.  In the past three years it has been even slower at 0.9%.

Some suggest that productivity is not properly capturing productivity gains in the service sector, particularly with respect to the internet.  For example, apps allow people to book airfares, hotels, and cars from their living room and get directions all at the same time.  But such gains do not appear to be captured anywhere in the productivity data.  The problem with that assertion is that manufacturing productivity  — which can be more accurately measured — has experienced a similar slowdown.  From 2000- 2007 (when the recession began) manufacturing productivity averaged 5.0%.  In the last three years it has been unchanged.

Another part of the problem could be that retiring baby boomers could be leaving both their jobs and the labor force, and taking some of their knowledge with them which is adversely impacting the growth rate for productivity.

The basic problem however, in our view, is that businesses remain reluctant to invest despite a record stockpile of cash, near record low interest rates, and a booming stock market.  Investment is the primary driving force behind rapid gains in productivity.  Unfortunately, business leaders appear to be bothered by uncertainty about future tax rates (will the corporate tax rate get cut and, if so, what deductions might be disallowed), the inability to repatriate overseas earnings to the United States, the rising cost of health care which firms with more than 50 employees have to provide,  and an avalanche of onerous, confusing, and sometimes conflicting regulations.  After several years in which nonresidential investment has been essentially unchanged, it had a dramatic  surge to a 11.4% pace in the first quarter of this year which could be Trump-related.

President Trump appears likely to bring about change to all of these concerns.  Trump hopes to lower the corporate tax rate from 35% to 15%.  He will allow firms to bring overseas earnings back to the U.S. at a favorable 10% tax rate.  He will revamp health care to consist of tax-advantaged health care savings accounts combined with a high deductible health insurance policy (which will almost certainly cost less then Obamacare).  And he intends to completely revamp the regulatory environment with the elimination of all unnecessary, overlapping, and confusing regulations.  These major changes in policy should unleash a wave of corporate investment spending, and because the pace of investment spending largely determines the rate of growth in productivity, the economic speed limit should climb gradually from 1.8% today to 2.8% within a couple of years.  If these regulatory changes actually happen they would represent the most significant economic events that  have occurred in years!

Stephen Slifer


Charleston, SC