US Economy: The Slow March Forward Continues

The Slow March Forward Continues
While I was out over the past six weeks I was surprised that not much had changed either relative to the Greek situation or the general economy, despite incredible volatility in the stock market. Overall GDP numbers for the third quarter were a lot better than most had expected back in mid-September.  A lot of the commentary seemed to use words like, "a strong rebound off of weak data earlier." No way. The real U.S GDP growth rate was neither as weak as the 0.4% and the 1.3% of the first two quarters of the year indicated, nor as strong as the 2.5% in the third quarter (and the odds favor another upward revision) and a potentially strong fourth quarter will suggest. Auto-supply-chain- and weather-related issues and sky-high gas prices all artificially reduced first-half numbers and are inflating second-half statistics. The real underlying inflation-adjusted growth rate in the economy appears to be an anemic but steady 1.75%-2.25%.

Employment, Manufacturing, and Auto Data Indicate Slow but Steady Growth
Outside of Europe, the biggest news was a healthy dose of employment data that was generally moving in the right direction. Year-over-year employment growth remained at a slow but steady 1.7% rate, initial unemployment claims approached their recovery lows, the Challenger, Gray layoff report showed a healthy drop in layoffs, and even the Monster online employment index managed its best improvement of the year.

However, government-related employment continued to act as a drag on the economy. Manufacturing data this week were mixed, with reported new orders in the U.S. looking particularly good. Meanwhile, Purchasing Manager Index data both in the U.S. and the rest of the world remain stuck in neutral (though there was some meaningful deterioration in Europe).

Auto industry news was decidedly better, as October sales jumped to a seasonally adjusted annual rate of 13.2 million units, with Japanese cars beginning to appear on dealer lots and the incentives flowing once again.

U.S. Payrolls Grow by 80,000 in October
Overall, I was pleased with the Bureau of Labor Statistics employment report, even though net employment growth of 80,000 people fell at the low end of the estimate range of 70,000-110,000 (on a base of 131 million nonfarm payroll employment). The more representative year-over-year data show job growth in the private sector of about 1.7%. While satisfactory, the growth remains too low to make much of a dent in the unemployment rate, which fell to 9.0% from 9.1% this month.

Large Revisions to Prior Months' Data Are Even Better
As I noted in this week's video, the seasonal factor was a relatively large negative subtraction from the actual number of jobs that were added, which was the reason for my relatively weak outlook. Substantial revisions to the two previous reports were the real highlights.

Net job growth for August was revised to 104,000 from 57,000, and September was revised to 158,000 from 103,000. These huge revisions are a not-so-subtle reminder of the dangers of reading too much into any one monthly report.

I still think the best way to analyze the employment data is to look at the year-over-year percentage change using a three-month average. This has the benefit of trimming out changing seasonal patterns and the effects of one odd month. Through this lens, employment growth has been surprisingly stable for the last six months, as shown in the table below.

Adding in the positive effects of productivity, I suspect that this type of employment growth is consistent with GDP growth in the range of 2.0%-2.5% over the next six to 12 months.

October's Employment Data Included a Meaningful Seasonal Adjustment
The table below shows whether the seasonal factor represents a headwind or tailwind to the employment data. This month it was headwind that reduced reported employment, while the September report was aided by a large seasonal addition (summer jobs end; kids go back to school). Again, we need these seasonal factors to compare monthly data, but my contention is that the government seasonal adjustment factors are woefully out of date.

Job Growth Sources Drastically Different Than Usual
Now, over two years into the recovery, it appears that both government and construction have failed to make their usual contributions to the recovery while the manufacturing and the service sectors have been the real stars.

The table below shows the percentage of total job gains coming from each of the major sectors during the current recovery. The average represents the recoveries that began in 1982, 1990, and 2001. (The total of the four sectors is 100%.)

The government number is a negative number because we have lost almost 500,000 government jobs during this recovery. The only good news here is that the pace of government job losses appears to be slowing at the same time some government revenues appear to be improving.

The construction industry normally represents a meaningful portion of job creation. Not this time, however--the industry remains in the doldrums. While the prognosis for an eventual recovery is excellent, the short term remains threatened by cheap foreclosures and lack of consumer confidence.

On the other hand, a strong export market for capital goods, a rebounding auto industry, and gas shale related jobs have made manufacturing (a perennial poor performer) into a superstar industry. Within that sector, though, durable goods  fared better than nondurable goods. As I explain below, the manufacturing sector has cooled a bit over the past several months. Service-related businesses have generally done well, too, though the performance has been very uneven as education and health care have done well, while information services jobs have fallen and the finance industry has been flat.

Mixed News from the Manufacturing Sector This Month
At this point in the recovery, manufacturing growth has a natural tendency to slow as inventories are restocked and initial panic buying comes to a close. Meanwhile, the services sector usually begins to do more of the economic heavy lifting. It's not unusual for the manufacturing sector to boom and bust two or three times over a normal economic cycle.

During the month, the China PMI Index moved back above 50 (more managers saw improvements than declines) to 51 for October, an improvement from September's reading of 49. The U.S. also stayed above the 50 mark with a reading of 50.8. However, that reading represented a decline from the previous month's reading of 51.6.

Meanwhile, Europe and the U.K. both fell this month, and both were below that 50 demarcation point between growth and shrinkage. The Greek crisis is clearly taking its toll on European economies that appear to be moving toward a recession. It seems the European Central Bank shares those fears, as it cut its key lending rate to 1.25% from 1.5%.

Details of the U.S. PMI Report Are Highly Positive
I am not particularly troubled by the fall in the headline number in the U.S. PMI. Many of the key components, including the new orders and employment components, showed improvement. The biggest contributor to the decline in the headline number was falling inventories. The PMI counts this as a negative because it assumes falling inventories mean that businesses are less willing to bet on future sales. However, I think inventories have gotten too low. In particular, auto industry inventories were depressed by Japanese supply chain issues. Continued strong consumer demand combined with overly cautious business leaders may have contributed to relatively weak inventories, too. Given strong new order rates and rising employment, I wouldn't read a lot into the very depressed inventory figure.

That said, a little more weakness in the overall PMI metric for the U.S in the months ahead would not surprise me, as overseas markets remain lethargic and some U.S. regional reports have been weak. Another few weak readings wouldn't change my overall assessment for continued slow but steady growth in the overall U.S economic recovery. But new order trends and low inventories seem to indicate an eventual turn, at least in the U.S.

More moderate price increases were another key highlight in the report. In fact, more vendors reported price decreases than increases. The index dropped an astounding 15 points to 41 from 56 after spending the early parts of this year above 80 (where 100 is the maximum). Hopefully, some of the declines will work their way through to consumers in the months ahead.

Government Report on New Factory Orders Shocks on the Upside
While most analysts had feared that factory orders in the U.S. would decline by 0.1% in September, the actual result was a 0.3% increase. This is a volatile indicator, but it is a little surprising that analysts missed the improvement by that much. Inventories grew a much more modest 0.1%, indicating that production probably needs to be stepped up to match the 0.3% increase in both shipments and new orders.

Auto Industry Posts Second-Best Month of the Year, Japan Can't Catch a Break
Auto sales continue to be a bright spot in the economy. Auto sales in October jumped to an annualized rate of 13.2 million units, well above the recession low of around 9 million cars but below normal levels of 16 million to 18 million units.  Unfortunately, floods in Thailand may begin to slow Japanese production increases (many electronic parts are sourced in Thailand) just as dramatic improvements were getting under way.

Quiet on the Economic Front Next Week
Next week's holiday-shortened economic calendar remains nearly empty--the usual weekly initial unemployment claims number and the monthly balance of trade number are the only releases of note. The consensus for the balance of trade is a drop of $1 billion, to $45 billion in September from $46 billion in August. Given the trend in oil prices and reports of relatively soft import activity in the PMI report, I suspect the deficit could be slightly smaller. The government estimated that the deficit for September would increase in its most recent GDP report. If the consensus is correct, the GDP for the third quarter could potentially be revised upward.