Economic Data - Mixed Bag Of Reports
If you were looking for some clarity on the direction of the economy then today's releases of economic reports wasn't it.
The report on retail sales from the Commerce Department showed that consumer spending was moderately strong in December. This is good news because expectations were for a pretty dismal report. For the month retail sales gained 0.5% after an upwardly revised 0.4% increase the month before. Auto sales, which were a major contributor, was primarily due to year-end fleet purchase for capital expenditures by businesses. We are also still dealing with auto replacements from the losses due to Hurricane Sandy.
However, even ex-auto sales, retail sales posted a decent 0.3% following a 0.1% dip in November. Sales were slowed by a decline in gasoline prices. Excluding both autos and gasoline components, sales advanced 0.6% which matched November's downwardly revised pace.
The problem with reporting the data this way is that it masks the trend of the data over time. The chart below shows the annual percentage change in retails sales which is highly volatile from one month to the next. To clarify the data trend I have smoothed the monthly annual rate of change with a 3-month average.
As you can see retail sales clearly peaked at the beginning of 2012 which has coincided with many of the weaker economic and income reports. Once official CPI is released we can look at this data on an inflation adjusted, or "real," basis to see the impact that it will have on upcoming GDP reports.
The ICSC-Goldman Sachs release on retail sales this morning, which is reported weekly, is showing weakening trends in same-store retail sales in the first couple of weeks of January. In December the index showed a monthly gain of 0.5% which aligned with the Commerce Department's report. However, for the first two weeks of January retail sales have fallen 4.7% from December's closing level.
The chart above shows the ISCS report in the same format as the Commerce Department data. I have also included the average change in wages and salaries as a narrative on the impact declining incomes on retail sales. With paychecks getting clipped by 2% in January, going forward, the impact to sales could be larger than currently anticipated. We will want to watch this data closely in the weeks ahead.
The not so great report today came with the release of the Producer Price Index (PPI). Energy, food, and capital goods clipped the report for 0.2% decline in December following a 0.8% drop in in November. The core rate, which excludes both food and energy, rose 0.1% following a rebound of 0.1% in November.
The good news in the report is that food inflation fell 0.9% after 1.3% surge in November easing pressure on producers trying to pass on costs to already weak consumers. Energy costs also helped by falling an additional 0.3% following a sharp drop of 4.6% in November, as well as gasoline declining 1.7% further after plunging 10.1% November. Overall, this drop in cost pressures should help alleviate some of the squeeze in profit margins.
The reason that I drop this report into the "bad" category is due to the ratio of crude goods to finished goods as shown in the chart below.
Notice that sharp spikes in the ratio have led to weakness in the overall economy. There is an obvious lag effect between the rise in the ratio of crude to finished goods which at current levels may show up in further economic weakness in Q2 reporting.
The worst report of the day came from the New York Federal Reserve Region in its most recent manufacturing survey. The report also contained revisions to the data back to the beginning of the report in 2001. The "Empire Index" is the first release of manufacturing surveys for the month of January and there was simply no real positives in the data.
Despite expectations that conditions would turn back towards expansion - the survey showed continued contraction instead. This is a bit surprising giving the rebuilding in the region as the recovery from Hurricane Sandy continues. For the month the general conditions index is little changed in the January reading, at minus 7.78 versus a revised minus 7.30 to indicate monthly contraction at a slightly deeper rate than December. The good news in the report is that future expectations of manufacturers, who always seem to be an optimistic bunch, turned higher giving a slight boost to the composite index. The composite index is currently at levels seen in mid-2011 just post the debt ceiling debate.
At that time the plunge was offset by Fed intervention, plunging energy prices, an unseasonably warm winter and a restart of manufacturing post the Japanese earthquake/tsunami shutdown. With the debt ceiling once again looming, a more normal winter in progress and energy prices rising back towards the century mark will QE 3/4 from the Fed be enough to turn manufacturing back up?
If we dive down into the data, as shown in the chart above, we see that new orders, as well as unfilled orders, are especially weak which point to problems for future production and employment in the region. New orders fell sharply to a -7.18 this month versus the prior month's -3.44. Unfilled orders also extended declines to -7.53 compared to -6.45 to extend a long run of contraction. Prices paid increased much more sharply than prices received showing the problem for manufacturers to pass on costs to customers while will continue to drag on already weak profit margins.
Other details show contraction in shipments falling from 14.18 in November to -3.08 in January. Employment has continued to contract, albeit at a slower rate this month, improving from -14.61 in November to -4.3 in January. The destocking of inventories also slowed from -12.36 in November to -8.6 in January which may point to a leanness in inventories that could produce a short term pop for restocking.
The Tie That Binds
Stepping back a moment from the individual reports we can see a common thread between each of them - the consumer. Retail demand has been weakening since the peak of the recessionary recovery in 2011. In an economy that is based 70% on consumption the slide in aggregate end demand has impacted profit margins for businesses which have kept them on the defensive with hiring and wages.
Of course, the problem with weak employment is that wages do not keep up with inflationary pressures. As discussed previiously, and shown in the chart below, as inflation erodes purchases power it further impaires consumption which in turn keeps businesses on the defensive. It is a virtual spiral that is very difficult to break.
The issue over the next few months will be the real impact of recent tax increases that will sap more out of consumer's paychecks. It is possible that the effect on the economy could be worse than current estimates anticipate. In such an environment the drag on the economy could keep growth suppressed for the next several quarters.
As we discussed recently the impact of the Fed's interventions are keeping asset prices elevated currently but the effect of current monetary policy has been largely muted as compared to previous programs. However, as opposed to previous operations, earnings are weak, valuations are high and optimism is exuberant - these are hardly the conditions required for a sustainable bull market going forward.