I remain positive on the United States economy despite disconcerting news last week on the employment front and continued interest rate increases around the world. However, readers should understand that the bearish case is building, and the world has got a bit more uncertain over the last week. The employment report was truly awful: No employment growth to speak of, no growth in hours worked, and no wage growth whatsoever. This is on top of an already poor report for May that was revised downwards. I had been bracing myself for a lot of negative data this month, but the employment report was not one of my big worries.
The piece of the puzzle that just doesn't seem to fit with the employment report is that consumer spending, as reported by the International Council of Shopping Centers, accelerated sharply in May and June even as the official employment data took it on the chin. If the employment numbers are right, where are consumers finding the cash?
The whole situation with the Japanese automakers further complicates the interpretation. It is certainly weighing on the employment side, particularly since Toyota (TM) and Honda (HMC) were both near the very bottom of their production curves during the week of the employment survey. (Toyota has subsequently boosted production in a very big way with Honda expected to do the same by August.) This in turn created shortages that caused even United States auto makers to raise prices, scaring away auto buyers in droves. Sales fell from over 13 million units in April to 11.8 million in May to an even more dismal 11.4 million units in June. But sometimes when auto sales falter, consumers have more cash to spend on shorter-term needs; chances are some of the strong shopping numbers may be at least a little inflated. Even so, the shopping data look impressive, and within the monthly reports the weekly data accelerated sharply during the last two weeks of June.
For now, I am giving the spenders the benefit of the doubt and staying generally positive on the economy. There are enough questions and contradictions in the employment reports to not weight the problems as heavily. I do caution that we probably have a few bad reports in front of us. The worst of these will be the second-quarter real GDP report due on July 28. Given some very poor auto production numbers, it is very hard for me to get to anything much over 1% growth. Autos were responsible for 1.2% of the total 1.9% growth we got for the first quarter. This quarter, I estimate auto production may take away as much as 1% from GDP (a swing of 2.2%). Other than decreased imports and maybe a little more defence spending, there just isn't much to offset the auto loss. But I fear these categories are too small to make a meaningful difference. Consumer spending (70% of GDP) looks to be slower than in the first quarter, even excluding the auto effect. In fact, one can't rule out the possibility that there will be no GDP growth at all. However, the worse things are in the auto sector in the second quarter, the greater the third-quarter bounce will be as production (and sales, one would hope) return to more normal levels and auto prices fall.
The other underlying reasons I am remaining generally bullish are falling commodity prices, a return to more normal weather conditions, and the aforementioned return to normal auto production levels. These premises are not sure things, which is why I am out on kind of a long limb.
Last week's video highlights and discusses the employment report in depth. The key takeaway is that after surging to near normal levels above 200,000 jobs per month, both the May and June reports averaged just over 20,000. This represents annualised growth of 0.2%, which just isn't consistent with my growth forecast of over 2.5%. Data from the separate household survey showed even more dour results. Wages and hours were also basically flat, which would also be consistent with the crummy employment numbers. And individual sectors were uniformly sluggish, with only the leisure sector showing meaningful improvement in trend. Even a retail sector that has seen better sales of late couldn't eke out anything but a small gain.
However, a report the day earlier from ADP, the payroll people, suggested a more bullish 157,000 jobs were added, showing an accelerating trend in hiring, not a decelerating trend as seen in the official government report. The two reports do often differ, but today's magnitude and direction of error were out of the ordinary. The positive Manpower Employment Outlook Survey for the second and third quarters and falling unemployment claims both suggested a better government employment report, too.
The other issue I mentioned last week is a massive seasonal adjustment factor for the months of April, May, and June. The private sector did add 834,000 jobs in June. However, as June is always a big month for hiring, the government subtracts about 777,000 jobs to seasonally adjust the data so they are comparable across months. This tends to be a big quarter of high school- and college-related hiring and for seasonal businesses like swimming pools and resorts. However, I believe that more hiring is occurring out of the pool of unemployed (and not recent grads) and more businesses have turned to year-round operation over the past several years. Therefore, the seasonal adjustment factors, which are developed over a much longer period of time, may not keep pace with the rapidly changing economy. This phenomenon could represent an overadjustment in some months and an underadjustment in others. Note that seasonally adjusted job growth was also at its lowest levels of the year in May and June of 2010, suggesting that the seasonal adjustment people may be going a little overboard in May and June on a consistent basis.
I am not saying to throw out the whole adjustment factor, or that the June numbers were wonderful. But even a small 10% error in the seasonal adjustment factor could potentially more than double the reported number of jobs added (10% of 777,000 equals 78,000, compared to the reported gain of 57,000).
Auto Sales Stumbled in June; Look for a Better Second Half
Dave Whiston, our auto analyst, sees short-term weakness but a better second half for auto sales, as summarised below:
June auto sales were weak, but we still expect a strong second half. New light-vehicle sales in June show that loyal Toyota and Honda buyers are waiting on the sidelines until inventory is restocked. Automotive News put the seasonally adjusted annualised selling rate (SAAR) for the U.S. at 11.43 million, the lowest since June 2010 and below May's 11.78 million. Last year's June SAAR was 11.1 million. The good news is we see the shortage as a supply problem rather than a demand problem, and we are looking for improvement in July as Toyota's North American production is nearly back to full output. California instituted a sales tax cut effective July 1, so it is also possible that some would-be June buyers decided to wait a month. Ford's senior U.S. economist also cited data that the average U.S. vehicle age is now more than 11 years old. This fact, combined with record used-vehicle prices making trade-ins more valuable, supports our opinion that industry sales should get back at least close to a 13 million SAAR once inventories at the Japan Three rise. It is also encouraging to hear the commercial fleet business is still strong and that full-size pickup share increased to more than 11% in June from a low of 9.3% in April.
Retail Sales Shock on the Upside
As implausible as the badness of the June employment numbers was the goodness of the various individual retail chain store sales reports. Same-store sales growth of 6.9% was almost double expectations.
If I look back over the last 16 months, only two reports--both of which were inflated by an Easter holiday and subsequently reversed the very next month--showed higher growth rates. What's more is that it appears the growth has become more broad-based, with luxury and discount sales converging after many months of luxury goods domination. Lower stock prices and cheaper fuel could explain some of the convergence. Better weather, lower petrol prices, and heavier discounting were cited by the ICSC for the improved retail same-store sales growth.
Data also showed a sharp acceleration in spending during the second half of the month, with levels of weekly gains not seen since Christmas. As an economist, I love to see lower prices and better volume growth, but I can't blame retailers for not sharing my enthusiasm. I do caution that retail sales are not adjusted for inflation. Also, as noted above, depressed auto sales have the perverse effect of leaving more cash in the pockets of consumers, driving up non-auto sales. So when (or if) auto sales ramp up, expect the retail sales numbers to slack off some.
Another oddity in the data is that employment in the retail sector was one of the real lowlights of the employment report. Retail employment fell in May and barely budged in June despite some hefty volume gains. I can only guess that fears of lower margins caused retailers to stifle new hiring. Still, the divergence in volumes and retail hiring remains a puzzle.
Next Week's Government Retail Sales Report May Not Be as Robust
For its official retail sales report, the government throws in home centres, autos, and restaurants as well as a wider array of retailers--things that aren't included in the ICSC data discussed above. The headline report is likely to show down retail sales due to lower fuel prices, lower fuel usage, and the recent collapse in auto sales. Adjusting out the auto sector but not petrol, sales are expected to gain just 0.1%.
Inflation: Good News at Last
The headline forecast for the consumer price index for June is a decline of 0.1% due primarily to falling energy prices. It will be interesting to see if the discounting reported by retailers at the end of the month provided any further fuel to the price declines. One month of deflation might actually turn this flat wage number into an inflation-adjusted growth number. That would be a piece of good news that we could all use.
Manufacturing Reports a Tough Call
This week, industrial production data and the Empire State Purchasing Managers' Report are scheduled for release. Auto production should look at least a little better as Toyota gears back up and warm weather might finally help the utility portion of the index. The expectation is for a gain of 0.5%. The Empire State report has been very negative for a couple of months. With better auto numbers (though as Japan comes back online, Detroit is going on its usual summer vacation), I suspect this report may not be as negative this time around.
