Is the U.S. economy starting to ramp up? Employment growth moderates, inflation expectations picking up
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Third-quarter GDP growth was revised up 0.3% to 3.5% in the final reading from the Bureau of Economic Analysis. Most of the upward revision was due to better than expected PCE and business fixed investment results. In other components, net exports rose $36B and inventory investment rose $17B. The PCE index rose at a 1.5% annual rate in the third quarter, while the core PCE price index increased at a 1.7% rate, down from 1.9% over the first two quarters of 2016. Most economists expect the economy to grow around 2% in Q4 and between 2-2.5% in Q117. While the Fed expects three rate hikes in 2017, higher inflation could lead to a faster/steeper rate hike schedule and this could derail growth and the markets.
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U.S. employers added only 156K new jobs in December, below the 178K forecast, but November’s report was revised higher by 26K. The unemployment rate ticked up to 4.7% in December and the 0.4% jump in average hourly earnings was slightly more than expected. Employers added nearly 2.2M new jobs to the economy in 2016 although the monthly trend has been on the decline over the past few months. Wages have risen 2.9% over the past year as the labor market has tightened with near full employment conditions (cited by the Fed). The broader U6 unemployment rate was 9.2% in December and the labor participation rate remained near a 40-year low at 62.7%.
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U.S. CPI moderated a bit in November, but the underlying trend continued to point to firming inflation pressures and the potential for more rate hikes in 2017. Consumer prices rose 0.2% in November as food and gasoline prices softened. Over the past year, inflation has risen 1.7%, the largest jump since October 2014. Core inflation gained 0.2% in November which equates to a 2.1% annualized rate. While inflation remains below the Fed’s 2% target, it is expected to rise in 2017 due to near full employment conditions in place and the potential inflationary impacts from Trump’s proposed pro-growth agenda.
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Orders for durable goods declined 4.6% in November, driven by the highly volatile aircraft segment. Civilian aircraft orders were down 73.5% M/M and overall orders for transportation equipment tumbled 13.2%, the sharpest decline in two years. October’s report was revised slightly higher and the all important core/business investment segment rose for the second consecutive month (+0.9%). Business investment is still down almost 4% YTD, but the trend is at least heading in the right direction.
Earnings ultimately drive stock prices, U.S. Small caps benefiting from domestic focus
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At the start of 2016, analysts were projecting earnings growth of 5.3% and revenue growth of 4.4% for the year in the S&P 500. Earnings and revenues declined during the first half of the year, but they are expected to be positive in the final two quarters. Based on current estimates for Q4, earnings are projected to grow 0.1% in 2016 with seven sectors expected to show earnings growth and four expected to show a decline. Revenues are expected to grow 2.2% for the full year with 9 of 11 sectors expected to show growth. The energy sector has been a huge drag over the past year and earnings growth jumps from 0.1% to 3.4% if energy is excluded and revenue growth rises from 2.2% to 4.2%.
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U.S. equities, particularly small caps, were the standout performers in 2016. Value significantly outperformed growth and Europe and Japan were substantial laggards. Emerging markets fared well for most of the year, but they struggled in Q4 as the strong dollar, rising rates and the Fed rate hike were headwinds. Small caps are more domestically focused businesses so they are less impacted by a strong dollar. U.S. multinationals are impacted the most by a strong dollar and most of those businesses are larger cap companies.
Housing market is solid despite rising mortgage rates
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New home sales increased 5.2% in November to a seasonally-adjusted annual rate of 592,000 units (October sales were unchanged at 563,000 units). Sales have risen 16.5% Y/Y and experts believe some buyers have come into the market in anticipation of higher borrowing costs (30-year mortgage rates have jumped 70 bps since the election) under Trump. Sales jumped 43.8% in the Midwest and 7.7% in the West, but they were flat in the Northeast and fell 3.1% in the South. Inventory levels rose a bit in November to 250,000 so it would take 5.1 months to clear out the current supply based on November’s sales pace.
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Existing home sales rose 0.7% to an annual rate of 5.61M units last month, the highest pace since February 2007. Supplies of existing homes dwindled further in November and this pushed up prices. A six-month supply is viewed as a healthy balance between supply and demand, but the level was only 4 months in November.
BoJ holds the line on monetary policy, Eurozone PMI accelerates to a 67-month high
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The BoJ maintained the -0.1% interest rate imposed on banks for some excess reserves, left the 10-year JGB yield target at around 0%, and kept annual rises in JGB holdings at ¥80T ($677B). While the BoJ left monetary policy unchanged at its December meeting, it upgraded its economic outlook to reflect better conditions abroad and a pickup in exports that have resulted from the weaker yen. Until Japan shows signs of a sustained cycle of rising wages and consumer prices, the BoJ should continue its highly accommodative monetary policies.
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The Eurozone Markit Composite PMI expanded at its fastest pace in December since May 2011. The 54.4 reading was well ahead of expectations and November’s 53.9 reading. Manufacturing led the growth acceleration, but service sector activity also expanded at a very solid rate. Economic expansions were apparent across the big four countries of Germany, France, Italy and Spain with the fastest growth coming from Spain and Germany. Eurozone growth/activity clearly accelerated to end the year, driven by weakness in the euro that has made exports and tourism/travel more attractive. Q4 GDP is projected to be 0.4% and a key question will be if the momentum can be sustained in 2017.
China has stabilized
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Economic data in China have firmed in recent months as the world’s second largest economy appears to be back on stable footing. Manufacturing and services PMI reports hit multi-year highs in November and retail sales and trade data have also been solid. A recent report on inflation showed a 2.3% Y/Y increase last month, but more importantly, producer prices surged 3.3%. The PPI increase was the fastest since October 2011 and recent gains come on the heels of
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