In every poker game, there comes a moment after all the dealing has been done and bets have been made when all the remaining players have to show their cards and a winner is decided. The same is true in financial markets but with the game being built up over a period of months and sometimes years and the winners being the people who were best able to interpret the data along the way. Right now, we have a complex game unfolding between the Fed, investors, and the economic data itself. On one side, we have the Fed trying its best to jawbone markets into believing that it can manage economic policy without actually physically doing anything. On the other side, we have some economic data that if taken in the context of non-ZIRP eras would have the Fed funds rate in the 4 or 5% area. Then in the middle of things are investors trying to figure out what to make of all of it.
In terms of economic data, we have some reports that are getting to such extreme levels that they almost can’t coexist with the reported levels of some of the other data points. For example, take weekly unemployment claims data. The most recent reading in initial claims (IC) is the lowest print since March 18, 2000 and after that you have to go all the way back to November 18, 1972! In the box below I’ve compiled a comparison of some important data points that coincide with the three low IC prints.
Things start to not make sense when we look at GDP and inflation. Our most recent GDP data for Q1 has come in at minus .2% from last quarter. Some people who keep up with current economic data know there is a debate going on over the legitimacy of Q1 GDP readings because of a possible statistical error. The report from the SF Fed basically says Q1 GDP could be significantly stronger than what is reported if it’s adjusted properly. This is where common sense comes into play. First off, let’s forget the winter and cold weather excuses for a low GDP. Winter has come at the same time every year for the 40 years I have been alive and it has always been cold. Next, let’s take a real world look at the things that drive GDP. The most important fundamental factor is people working. Depending on what combination of labor metrics you want to use, there are arguments to make that we are actually at full employment. If we aren’t at full employment, then we are very close. Either way, the labor market is strong and we know that wages are also rising. Furthermore, given that we are a consumption and services based economy, it’s important to note that professional & business services (PBS) jobs are leading the pack in job creation. Being that PBS is composed of lawyers, accountants, engineers, architects and advertising executives to name a few occupations, I think it is fair to say that business growth is broad-based in order to have such gains in that type of group. PBS along with education and health services were the top two job creating sectors in last month’s Nonfarm Payroll report. They also account for 40% of total earnings generated in the labor force.
See the breakdown from last month’s NFP report:
Since we know people are working, the question is are they spending money? The answer is yes. Before we get to retail sales, let’s first look at the elephant in the room which is housing. The most recent existing home sales (EHS) print came in at 5.35 million units which is 9.2% above last year. I use EHS because they capture 90% of total housing transactions as per NAR. Historically speaking, EHS are back to where they were prior to the artificial boom.
I call the boom artificial because the transactions that drove the 2004-2007 housing mania were done on mortgages that had virtually zero underwriting standards. Whereas todays mortgages are done with very tight lending standards. Speaking as someone who has gotten a mortgage post 2007, I can assure you that the process is rigorous to the point of falling just short of outright interrogation. Fed Chair Yellen also pointed out in her May 22, 2015 speech that mortgages were “still very hard to obtain for would-be homeowners without pristine credit records.” Which is not a bad thing. In my view, what we have now is a sustainable housing market which will lead to ever greater financial stability in the long run. With the strong housing market, it’s not rocket science to make the connection between home sales and all the downstream business in goods and services created from those purchases. It is that downstream business which also makes the disconnect between stated and true GDP that much more apparent. Clearly stores like Home Depot and Lowe’s have demonstrated through strong sales and earnings that a healthy housing market creates business. The homebuilders themselves like D.R. Horton (DHI), Lennar (LEN) and KB Home (KBH) have all reported stellar quarterly earnings that include large increases in their order backlogs. This is right in line with the most recent building permits report which showed a 25% gain from May 2014! We could be looking at significant gains in construction jobs which may manifest itself in next week’s jobs report. In addition to healthy transaction levels, prices are also nearing all-time highs. The most recent FHFA housing price index report shows prices sitting just 2.3% off their all-time high set back in March 2007. All in all when you have such an important section of the economy like housing doing so well, while lending standards are so strict, I find it nearly impossible to say the overall economy is not doing just as well.
With housing out of the way, let’s take a look at retail sales. Up until the May report, the headline data had been on the soft side for retail. The soft headlines had all the bears saying that most consumers were saving money or paying down debt with the break from lower gas prices. Some even went so far as to say the drop in oil/gas prices didn’t even matter. Clearly those people have either never paid for their own gas or have never known anyone from the Northeast. So instead of just going with the headlines, I dug down into the line items of the reports for the last few months and could see that restaurant & food services, building materials, home furniture and even sporting goods were all posting solid gains. So finally in May the headline number came in +1.2% with nearly all the sub categories showing strong gains and the main drag, gasoline stations, rebounding with the recent move up in oil prices. Below are the top performers for the May report:
The above gains in retail sales are not consistent with a weak economy.
We also just had Nike (NKE) report earnings on June 25th that handily beat expectations on revenues and earnings. Nike stated that it was able to raise its average selling prices and that it also incurred higher input costs. If a global retailer / manufacturer like Nike is incurring higher input costs, I can assure you they aren’t the only ones.
The news from Nike is a good segue into looking at our inflation data. The most recent headline CPI print came in at 0.0% gain year over year. However once we look at the actual line items, we can see that things which matter in the real world are clearly going up.
Right off the bat, we can see three (shaded green) necessary areas are already well over the Feds 2% threshold. Then we have the food away from home category rising 3% as consumers enjoy increasing discretionary income. The rise in shelter is certainly not surprising given the strength in the housing market. I think we can expect that category to rise steadily into the foreseeable future given the current housing data. Even still, this CPI data is understating things when we look at real everyday prices of things that come out of our pockets.
Going back to our economic data grid at the beginning, I think it’s safe to say that GDP and CPI will be in line with previous year’s data even if the official data doesn’t say so. A basic exercise in common sense shows that what is really going in the economy is not being accurately reflected in the data. So just like in poker, we have an opportunity to look at what’s on the table and figure out who’s bluffing and who’s got the aces.