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Weekly Commentary by Dr. Scott Brown

A Mixed Bag, But Optimistic on the Consumer
November 17 – November 21

Inflation-adjusted consumer spending growth, 70% of Gross Domestic Product, rose at a lackluster 1.8% annual rate in the advance estimate for 3Q14. That figure is likely to be revised higher, but the pace is expected to remain disappointing relative to job growth (this year, we are on track to post the largest increase in jobs since 2005). The main restraint on spending appears to be the weak trend in average wages. Until the job market tightens a lot more, we’re unlikely to see a significant pickup in wage growth. However, lower gasoline prices will add to consumer purchasing power in the near term.

Prior to the recession, motor vehicle sales were fueled partly by the extraction of home equity (which dried up during the downturn). Motor vehicle sales have improved gradually since the recession ended, reflecting a simple story: 1) Cars get old and have to be replaced, and 2) banks are willing to make auto loans (it’s a lot easier to repossess a car than a home). With the pace of vehicle sales now back to the pre-recession level, it’s unclear whether we’ll see that trend level out.

Core retail sales have risen at a moderate pace in recent months. The October retail sales report showed a modest upward revision to figures for August and September. Obviously, there’s a significant seasonal pattern in unadjusted sales, with a sharp spike in December. As a rough rule of thumb, the back-to-school season is a good predictor of holiday sales. This year’s back-to-school results were relatively lackluster.

Inflation-adjusted wage growth has been weak in recent months, but lower gasoline prices are adding to purchasing power. As noted previously, the impact on the consumer depends on how low gasoline prices go and how long they stay low, but it also arrives with a lag. While lower gasoline prices restrained the retail sales total for October, the added purchasing power should help to support inflation-adjusted spending in November and December. Yet, it’s important to remember that gasoline prices normally fall about 12% from May to December. This year, they’ve fallen a little over 20% since late June. So, the decline in gasoline prices is not as impressive as one might think. Moreover, lower gasoline prices may simply offset the impact of sluggish wage growth, leading to only moderate spending growth in the near term.

One area where we may be seeing an impact of lower gasoline prices is in consumer sentiment. Consumers don’t spend confidence. Spending is driven primarily by income, although wealth and the ability to borrow are also factors. Still, attitude measures are often a reflection of consumer fundamentals in general. Hence, this is still a positive story.

Gasoline futures are suggesting that there is more room for retail gasoline prices to fall and that they are likely to stay relatively low in the first half of 2015. That’s helpful for the consumer spending outlook. We still need to see a greater pickup in wage growth, but we should get there in the months ahead as the labor market continues to improve.


The October Employment Report
November 10 – November 14

The headline figures from the September jobs report were better than expected. However, the details were more consistent with moderate growth and a continued high degree of slack. Fed officials aren’t going to jump to any conclusions.

Payrolls rose by 248,000 in the initial estimate for September, while figures for July and August were revised a net 69,000 higher. Part of September’s strength reflects a rebound from two special factors that reduced the August total (a seasonal adjustment quirk in autos and labor difficulties at a New England grocery chain). One can ex-out this impact, by averaging the last two months (a +215,000 average, vs. a +261,000 pace over the four previous months). Private-sector payrolls averaged a 217,000 monthly gain in 3Q14 (+216,000 over the 12 months).

Seasonal adjustment adds some uncertainty to the headline payroll figures for September. Prior to adjustment, we added 1.487 million education jobs (vs. +1.416 million in September 2013), and shed 786,000 non-education jobs (vs. -823.000).

The unemployment rate fell to 5.9% in September (from 6.1% in August), the lowest since July 2008. However, most of the drop was due to a decrease in labor force participation (which may have reflected seasonal adjustment issues at the start of the school year). The employment/population ratio was flat at 59.0%, up just 0.4 percentage points from a year ago. The participation rate is now at its lowest point since October 1977.

Some short-term job market measures, such as weekly claims for unemployment benefits and the percentage of people out of work for less than half a year, are at levels we normally associate with an economy that has fully hit its stride. However, other gauges, such as the employment/population ratio, long-term unemployment, and involuntary part-time employment, continue to suggest that a lot of slack remains.

For Fed policymakers, the September employment figures tell us nothing new. The job market is improving, but we’ve a long way to go. The Fed has plenty of time to decide when to begin raising short-term interest rates. The economic figures over the next several months should dictate that decision, but we didn’t really learn much that was new last week.


FOMC, GDP, GOP, and NFP
November 3 – November 7

The Federal Open Market Committee’s October 29 policy statement wasn’t terribly hawkish, but it wasn’t as dovish as many anticipated. The advance estimate of GDP growth (a 3.5% annual rate) was stronger than expected, but details were a lot more moderate. On Tuesday, voters are expected to turn control of the Senate over to the Republicans, but we could go into election overtime. If the Republicans are successful, the question is what they may be able to accomplish. The October Employment Report arrives on Friday, and once again, seasonal adjustment has the potential to generate some noise.

Let’s start with the Fed policy meeting. As was widely anticipated, the FOMC made its final taper, bringing large-scale asset purchases (QE3) to an end. The FOMC made some changes to the wording of the economic assessment, noting that labor market slack is “gradually diminishing” (in the mid-September statement, labor market slack was described as “significant”). Fed officials seemed to downplay concerns about low inflation, suggesting that “inflation in the near term will likely be held down by lower energy prices and other factors” and repeating that “the likelihood of inflation running persistently below 2% has diminished somewhat since early this year.” Early this year, the Fed policy statement cautioned that “inflation persistently below its 2% objective could pose risks to economic performance.” With the core PCE Price Index at 1.5% y/y, many observers thought that this phrase might return (implying that the Fed’s initial increase in the federal funds target rate would be delayed), but importantly, it did not.

Policymakers added new language to suggest that the initial Fed rate hike would come sooner if economic growth is stronger than anticipated, or later if the economy disappoints. Fed Chair Yellen had already said as much in her press conferences in March, June, and September. Essentially, we’re back to what we knew before the Fed policy announcement – that is, future monetary policy decisions will be data-dependent.

Third quarter GDP growth was stronger than anticipated, but the headline figure (3.5%) was boosted by a narrower trade deficit and a spurt in defense spending. Domestic Final Sales (GDP less net exports and the change in inventories), a better measure of underling domestic demand, rose at a 2.7% annual rate, but would have been about 2.0% if not for the spike in defense spending (which is often uneven from quarter to quarter). Real consumer spending, 70% of GDP, rose at a 1.8% annual rate. Moreover, the monthly spending figures showed a 0.2% decline in September, very poor momentum heading into the fourth quarter. Lower gasoline prices ought to provide some support for consumer spending growth in the near term, but almost certainly not as much as many are predicting.

As a reminder for those who slept through civics class in high school (and do they even have civics class anymore?), all 435 seats in the House and about a third of the 100 seats in the Senate are contested every two years (there are also some very close gubernatorial races this year). Due to three vacancies, 36 Senate seats will be contested this year. The key question is whether the Republicans will gain control of the Senate. This outcome has been widely expected. More Democratic seats are being defended this year (21 Democratic seats to 15 Republican seats), Democratic voters have a tendency to stay home in the mid-term elections, and the president’s approval ratings are low. However, it’s not a done deal and we could have runoffs in Georgia and Louisiana. If the Republicans do win control of the Senate, the question is then what they can accomplish given sharp divisions within the party and the threat of presidential vetoes. Moreover, the Republicans will not have a super-majority (60 seats) in the Senate, which means that their efforts can be easily thwarted by the minority party.

The stock market is expected to rally if the Republicans take over the Senate, but we’re likely to end up with another two years of gridlock. Note that in two years, the backdrop will shift sharply in the other direction. Republicans will have roughly twice as many Senate seats to defend as the Democrats and the Democratic turnout should be a lot higher.

One of the biggest concerns in the economic outlook is that we could see another manufactured crisis over the budget deficit or debt ceiling. Privately, Republican leaders claim to have “learned their lessons” from the debt ceiling debacle of 2011 and last year’s failed attempt to rescind the Affordable Care Act by shutting down the government. However, with the federal budget deficit now down to 2.8% of GDP, such showdowns seem a lot less likely. Still, the debt ceiling will have to be raised some time in 2015. So you never know.

On Friday, the Bureau of Labor Statistics will release its initial estimate of job market activity in October. Nonfarm payrolls are expected to post a moderately strong gain, but there may be seasonal adjustment issues related to the school year. Weekly claims for unemployment insurance are trending remarkably low, consistent with a limited pace of job destruction. New hiring has generally expanded this year, but there may be some concerns that worries over what’s happening in Europe and the rest of the world could make U.S. firms more cautious in their hiring intentions and capital spending plans. Most likely, domestic economic strength will offset worries about the rest of the world. For Fed policymakers the key issues are the amount of slack in the job market, how rapidly that slack will be taken up, how much upward pressure on wages that slack implies, and how well firms might be able to pass along higher wages.


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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