Farewell to the Holidays

“A quarrelsome Man has no good Neighbours.” – Benjamin Franklin (ed.), Poor Richard’s Almanack

Markets rallied back from their end-of-year weakness last week, with the first two days of the year bringing an end to the slump and bailing out the “Santa Claus rally” period. In the end, this year’s Santa rally was only worth about a half-percent on the S&P, but December did manage a gain of about one and-a-half percent. It’s likely we are in for mostly sideways trading until after the inauguration.

Things to watch going this month are the tenor (and tweets) of the incoming administration, in particular the first day or two after inauguration; the retail sales report this Friday; the next Fed meeting at month-end; and of course the beginning of fourth-quarter earnings season in the coming week. Current estimates imply expectations for an increase of about 5%-6% growth year-over-year, the first positive expectation in nearly two years. The December jobs report (about which more below) came out with a moderate total that while below consensus, was still above the 100K level. Below that line is when markets start to worry, though growth continues to slow.

The Economic Beat

The highlight of the week was the December jobs report. The headline total was below consensus, at 156,000 (156K) vs. an expected 175K. The ADP report of 153K private sector jobs a day earlier had already tempered expectations. The unemployment rate edged up to 4.7%, with the more volatile household survey showing a gain of only 63K (seasonally adjusted). It is unwise to make book on one month’s data, particularly in the household survey, but the survey’s average over the last five months is about 120K per month. Growth in the not-in-labor-force category slowed in 2016, while the sub-category of “want a job now” continued to shrink to what could be cyclically low levels.

The jobs number I have heard cited the most from the report is the increase in hourly earnings, to 2.9%, probably because it was the most encouraging number in what was otherwise a very mediocre month. It featured on public radio and in all of the mainstream reports as a sign that the economy is accelerating again – just as it has been has been reported to be so doing nearly every month for the last three years, without ever actually doing so. The growth in average weekly earnings – which is what people have to spend every week – remained flat at 2.3%. Both categories are subject to mix issues, but the flatness in weekly earnings was persistent throughout 2016. If the hourly data follow the pattern shown in 2016, the next hourly earnings number will be nearly flat.

The most important number that you didn’t hear about is the year-on-year growth in unadjusted establishment payrolls. Although December is as likely to be revised as every other month, the year-year numbers do not vary much upon revision. Currently the December figures stands at 1.41%, marking the third year of declining growth after five years of expansion. It looks to me as if the cycle has run its course. Weekly claims, however, after being nearly flat throughout December, shrank (seasonally adjusted) notably in the final week, possibly reflecting a bit of timing in both the month and the major holidays (both Christmas and New Year’s falling on a Sunday).

Perhaps the most telling number of all for investors was the Labor Department’s comment that the current streak of claims below 300K (seasonally adjusted) is now 96 weeks, the longest streak since 1970. So ask yourself – do you really want to bet that that number will stretch on another two years?

Surveys continue to suggest a case of post-election euphoria is running ahead of actual activity. The ISM manufacturing survey of purchasing managers in December rose to 54.7 from 53.2, with new orders rising sharply to 60.2. You may have heard reports talking about manufacturing rising at “the fastest pace” in two years, but that’s not what these indices mean. They are diffusion numbers, measuring breadth of improvement rather than volume. In the current cycle, PMI readings in the mid-50s have consistently failed to translate into significant activity down the road.

Two qualifications to the numbers came in the form of the sector score and supplier delivery times. The sector score was 11-6 growth versus contraction, good but not great. Supplier delivery times also shortened, which runs counter to strengthening activity. Input prices did seem to rise very broadly, but while that can be a very good sign in the service sector, in the present case it is largely due to the rallies in energy and other commodity prices.

Manufacturer comments were positive, but the last manufacturing survey was positive as well, with coincident national measures of actual industrial activity showing flat to declining activity. I don’t doubt the jubilation in corporate suites over the prospects of luscious tax cuts at both the corporate and personal level, but the money may not get there as quickly or as deeply as people think. I will be looking at the next reports on wholesale sales to see if optimism is translating into firm sales. It’s also worth noting that manufacturing has been reported as breaking out several times over the current cycle, but the bumps have never been long-lived.

The non-manufacturing survey was also at a good level, 57.2% with an activity index of 61.6%, both measures virtually unchanged from the previous month. The comments were less ebullient, however, despite the better sector score of 12-3. The price measure improved modestly, while the employment measure flattened considerably, from 58.2 to 53.8.

Factory orders were down 2.4% in November, seasonally adjusted, up 0.1% excluding transportation but down 3.4% excluding defense. As usual, it is the year-year patterns that matter more, with new orders down 1.8% overall on a year-to-date basis, or a bit more than 2% when excluding either transportation or defense. It was claimed that strength was seen in a seasonally adjusted increase in capital goods orders, but what I saw was a year-over-year decline of 1.5%, the ninth consecutive negative monthly comparison, and a widening in the trailing-twelve-month decline to 4.0% from 3.8%. More strength like this and we will soon be in big trouble.

The FOMC minutes revealed little that was new. If the economy gets better, there will be more rate increases. If it doesn’t, then there won’t be. Hot stuff indeed.

Next week kicks off with the Labor Market Conditions index, widely ignored by the media, followed by the labor turnover report (JOLTS) on Tuesday, a report that doesn’t get much attention either. It still gets more than wholesale sales (also Tuesday), though the latter are perhaps more telling. Thursday brings import-export prices and Friday producer prices, but the main report will be December’s retail sales report on Friday. Consensus is for a big bump of 0.7%, though given the weakness of November the number might well be higher, as it is the two months combined that define holiday spending.

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