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Weekly Commentary by Dr. Scott Brown

Retail sales figures

On the other hand…
May 23 – May 27, 2016

“Give me a one-handed economist!”

– Harry S. Truman

The minutes of the April 26-27 Federal Open Market Committee meeting has returned monetary policy to the list of financial market worries. However, while most Fed officials believe that a June rate hike could be in the cards, that doesn’t mean that rates will be raised next month. On the one hand, there are reasons to resume policy normalization. On the other hand, there are reasons to delay. The end results will depend on how the Fed balances the data and the risks.

“Participants agreed that their ongoing assessments of the data and other incoming information, as well as the implications for the outlook, would determine the timing and pace of future adjustments to the stance of monetary policy. Most participants judged that if incoming data were consistent with economic growth picking up in the second quarter, labor market conditions continuing to strengthen, and inflation making progress toward the Committee's 2 percent objective, then it likely would be appropriate for the Committee to increase the target range for the federal funds rate in June. Participants expressed a range of views about the likelihood that incoming information would make it appropriate to adjust the stance of policy at the time of the next meeting.

– FOMC Minutes (April 26-27)

As with recent monetary policy meetings, the June 14-15 FOMC meeting will be a “live” meeting. That means that Fed officials will discuss a possible increase in the federal funds target rate. However, the decision will depend on the economic data between now and then. A majority of Fed officials believe that if economic growth shows signs of picking up, the labor market continues to improve, and inflation appears likely to head higher, then it will be appropriate for the Fed to raise rates. However, officials differ in their expectations of whether that criteria will be met. It’s still a judgement call. The FOMC minutes showed that “several participants were concerned that the incoming information might not provide sufficiently clear signals” that a rate increase would be warranted. On the other hand, “some participants expressed more confidence that incoming data would prove broadly consistent with economic conditions that would make an increase in the target range in June appropriate.” Some officials thought that financial market participants had not properly assessed the likelihood of a June rate hike and stressed the importance of communicating clearly how the Fed would respond to economic and financial developments.

The risks of a policy error remain significant and one-sided. The upside potential for growth appears limited, but the Fed could easily tighten policy more rapidly if needed. While there are moderate downside risks to growth, there are limited policy options to address a weakening in the economic outlook. This is why the Fed has adopted a cautious stance on raising rates.

Market participants have consistently foreseen a much shallower glide path for short-term rates than Fed policymakers have expected. At the same time, the dots in the dot plot (Fed officials’ expectations of the appropriate level of the federal funds rate for the next few years) have drifted lower quarter after quarter (the next update of the dot plot is set for June 15). In other words, the Fed has gradually moved closer to market expectations rather than the other way around. Yet, the markets may be lured into a false sense of complacency, perhaps believing that rates can’t be raised because doing so would unsettle financial conditions. The Fed can try to have it both ways, by talking tough, but at some point it would have to follow through with an actual rate increase to insure credibility.

The Fed needs to normalize monetary policy over time, no doubt, but the arguments for tightening sooner rather than later are not especially compelling, while the arguments for delaying policy action are. One line of reasoning for delay is especially persuasive. It’s very difficult for the Fed to raise rates when business fixed investment (capital spending) is contracting.

May 16 – May 20, 2016

Who are you going to believe, me or your lying eyes?

– Groucho Marx

Economic data reports are subject to measurement error, statistical noise, and seasonal adjustment difficulties. They should always be taken with a grain of salt. However, that’s not to say that the figures are useless. Rather, they are subject to interpretation. What then do we make of the situation when the hard data conflicts with the anecdotal information?

Last week, a number of retailers reported disappointing results for April. Yet, the Bureau of Census reported strong sales, with upward revisions to the figures for February and March. What gives? The BoC figures are subject to revision, but that’s not it. Rather, the government’s retail sales data are more comprehensive; they cover a wider range of spending than a few specific retailers. Sales do bounce around from month to month. Adjusted data have to account for seasonal variation, the number of weekends in the month, and floating holidays.

First quarter figures were generally soft. Usually, that’s due to bad weather, but weather wasn’t much of a factor in 1Q16. In fact, temperatures were generally warmer than average, which is usually supportive for consumer spending growth. In the absence of adverse weather, it’s easier to get to the malls, or so the thinking goes. Yet, consumers have become less enamored with bricks and mortar shopping. Department store sales fell 1.7% y/y in April, continuing a downward trend.

Nonstore sales, which include mail order and internet retailers (such as Amazon), rose 10.2% y/y in April, continuing a strong upward trend. There’s a lot to be said for convenience. We’re also seeing strong sales gains at restaurants and bars, supported by the drop in gasoline prices, but also reflecting the long-standing trend of households taking more meals outside the home (again, there’s a lot to be said for convenience). Consumers are also paying more for their medical prescriptions. Sales at pharmaceutical and drug stores are reported with a lag, but they were up 7.9% for the 12 months ending in March.

Many of the economic reports for March appear to have been distorted by the early Easter. Figures are adjusted for the timing of Easter, but it’s difficult to get it right (as there are interactions between the holiday and weather). Softer March figures should then be followed by a rebound in April. That was the case with unit auto sales and the retail sales numbers, and we should see a similar pattern in other economic data reports. Given this noise, how do we gauge the underlying strength of the consumer? We can take the average of March and April, but figures for May will help to confirm whether the economy is strengthening or simply trending at a moderate pace.

Beyond the numbers, it’s clear that there is economic angst out there (reflecting dissatisfaction with the Washington establishment). While the economy is improving in aggregate, it’s not necessarily advancing for the average citizen.



A closer look at the April employment report
May 9 – May 13, 2016

The Employment Report is by far the most important data release for the financial markets. However, investors aren’t always aware that the figures are statistics, reported with a fairly large degree of uncertainty. That raises the possibility of overreactions to what may just be noise. That said, the broad range of job market data is consistent with further improvement in labor conditions. At the same time, we can expect the pace of job growth to slow over time, simply because it has to.

Prior to seasonal adjustment, the economy added over one million jobs in April (seems a little silly to worry about the nearest 40,000 or 50,000 in the adjusted figure). Payrolls were reported to have risen by 160,000 after adjustment. That figure is subject to revision, of course, and is reported accurate to ±115,000 (this represents a 90% confidence interval for those of you who remember that class in statistics). We can be 90% confident that the true monthly change was between +45,000 and +275,000. The bottom line is that one should take the monthly figures with a grain of salt. One can reduce the impact of noise in the payroll data by taking the three-month average. Payrolls averaged a 200,000 gain over the last three months – still fairly strong (+192,000 for private-sector payrolls).

The household survey data are based on a sample of about 60,000 households. That may seem small, and it doesn’t provide good estimates of employment (reported accurate to ±300,000), but it’s large enough to yield reasonably accurate estimates of ratios, such as labor force participation or the unemployment rate (reported accurate to ±0.2%). The unemployment rate held steady at 5.0% in April, but labor force participation fell from 63.0% in March to 62.8%, and the employment/population ratio fell to 59.7% from 59.9%. Those declines are well within the usual amount of statistical noise. We would need further data to confirm a change in trend.

It’s a presidential election year, so that means we will hear various claims about the strength or weakness of the economy. One assertion is that growth has been substantially lower in this recovery than in past recoveries. That is true. Another claim is that GDP growth can easily be boosted to 4% per year. Demographics played a big part in the past and will also play a big part in future economic growth, but this also brings us back to the topic of productivity growth.

Labor force participation rose significantly from the 1960s to the 1990s, reflecting women entering the workforce in greater numbers. That trend has played itself out – so jobs should rise more or less in line with the growth in the working-age population. In the 1990s, we also started to see a trend of lower participation (beginning first with men). It’s estimated that a half to three-quarters of the drop in participation since 2007 has been due to the aging population. Looking ahead, the Bureau of Labor Statistics expects the labor force to rise about 0.5% per year over the next 10 years. Hence, this is largely a story of faster labor force growth in the past, and slower labor force growth in the future.

Economic growth is also dependent on productivity (output per worker). The preliminary estimate of 1Q16 productivity growth was terrible. These data can be quirky, but the year-over-year trend remained soft, in line with the weak pace that has prevailed over the last five years. Since the demographic outlook is set (save for immigration), political candidates should then focus on what they will do to boost productivity growth. Efforts to lift capital spending make sense, but borrowing costs are already low. This doesn’t appear to be a problem with supply. Rather, firms won’t want to expand unless they are confident that the demand will be there for the goods and services they produce. The whittling away of the middle class likely plays a part in that moderate demand outlook.



Who wants pie?
May 2 – May 6, 2016

“We ought to make the pie higher.” – George W. Bush

Productivity growth is perhaps the single most important factor in the economy. Increased output per worker facilitates improvements in the standard of living over time. It’s how our children have a better future. It also helps support corporate profits. What to make then of the current situation, where productivity growth has slowed to a crawl in the U.S. and around the world? Will there be enough pie to go around?

As a statistic, productivity is quirky. Those who have studied the hard sciences know that when you start multiplying and dividing statistical estimates, the uncertainty can get unruly. Productivity is nominal output, divided by a price measure, then divided by a labor input measure – each is estimated. As a consequence, quarterly productivity figures are choppy and subject to large revisions. Given all that, the trend in recent years has been unusually weak. Figures are somewhat better for the nonfinancial corporate sector, but still slower.

Economists had long puzzled over the slowdown in productivity growth from the late 1970s to the early 1990s. Nobel Laureate Robert Solow said, during that time, that computers were everywhere in the economy except in the productivity figures. Scanners and inventory management software were just getting going in the early 1980s, but took some time to perfect (you’re welcome, Amazon and Walmart). In the late 1990s along came cell phones, networking equipment, and the Internet. Productivity surged, first in the production of these technologies, then in their application. Firms discovered they could do more with fewer workers and the early 2000s. It was not just a jobless recovery, but a “job loss” recovery. Productivity growth after the Great Recession has been anemic, likely because of weaker (productivity boosting) capital spending in the early part of the recovery.

The slowdown in productivity growth is a puzzle. No one seems to know the exact cause, but there are theories. As noted, weaker business fixed investment was a likely factor. Some have suggested that this is really a measurement issue. Real GDP is likely a lot stronger because it doesn’t properly account for the fact that I have dictionaries, encyclopedias, maps, restaurant and film reviews, and so on in the palm of my hand. Others argue that productivity is lower because people are watching cat videos instead of working.

If the issue is capital investment, that may take care of itself over time (as long as capital investment picks up). If it’s more permanent, then the longer-term outlook is more troublesome.

In the 1950s and 60s, real wage growth rose in line with productivity. Since the early 1970s, most (not all) of the growth in productivity has gone to profits. What will then happen if the slower trend of productivity growth is more permanent? Much will depend on the amount of slack in the labor force. If the job market tightens, labor could take a larger share of a smaller pie (actually a more slowly growing pie).

California and New York are now in the process of raising their minimum wages to $15 per hour (over five years in CA, steeper but strangely inconsistent across NY). Many will argue whether this is good or bad. Typically, minimum wage increases aren’t all that important (it’s usually very low to begin with and you rarely see much impact on employment, or poverty for that matter). Yet, California will be more of an experiment. Going from $10 to $15 is a large increase as far as minimum wages go.

Waitress, a new musical opened on Broadway last week. Before the play begins, someone actually bakes a pie, so the smell wafts through the theatre during the play. To enhance the aroma, the recipe is altered. The result smells great, but tastes “wrong.” Yet, that doesn’t stop the stage hands from eating it.



The opinions offered by Dr. Brown should be considered a part of your overall decision-making process. For more information about this report – to discuss how this outlook may affect your personal situation and/or to learn how this insight may be incorporated into your investment strategy – please contact your financial advisor or use the convenient Office Locator to find our office(s) nearest you today.

All expressions of opinion reflect the judgment of the Research Department of Raymond James & Associates (RJA) at this date and are subject to change. Information has been obtained from sources considered reliable, but we do not guarantee that the foregoing report is accurate or complete. Other departments of RJA may have information which is not available to the Research Department about companies mentioned in this report. RJA or its affiliates may execute transactions in the securities mentioned in this report which may not be consistent with the report's conclusions. RJA may perform investment banking or other services for, or solicit investment banking business from, any company mentioned in this report. For institutional clients of the European Economic Area (EEA): This document (and any attachments or exhibits hereto) is intended only for EEA Institutional Clients or others to whom it may lawfully be submitted. There is no assurance that any of the trends mentioned will continue in the future. Past performance is not indicative of future results.

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