The Economy – A Look Back and A look Ahead

Economics

Last Week

The economic data and central bank announcements last week were expected to help provide greater clarity on the three major questions in the market right now:  When will the Fed taper?  Is the European economy stabilizing? Is the slowing of China’s growth getting worse?

Despite almost universally better-than-expected economic data (the jobs report being the notable exception), what we got was more clarity on the latter two questions, but surprisingly more confusion on the outlook for Fed “tapering,” which is by far the most important topic in the markets right now.

In Europe, manufacturing PMIs rose back above 50 and largely the economic data signaled the EU economy is finally stabilizing.  In China, the data wasn’t any worse than expected, and Chinese officials were again saying they will defend economic growth as needed. So, bottom line was last week was good for both Europe and China and, with regard to Europe, the numbers point to continued potential outperformance.

Looking at the economic data domestically, last week was a good week and further implies that the economy is continuing to recover.  ISM Manufacturing PMI was a very strong number not only on the headline (which hit a multi-year high), but the details of the report were also strong. They further confirmed what we’ve been pointing out here for over a month: that the manufacturing sector of the economy is finally recovering, and this recovery is starting to accelerate.

Lost in the jobs report hysteria Friday was a strong personal income and outlays report, which showed consumer spending beat expectations for June. (The weak retail sales report of two weeks ago raised some concerns about the health of the consumer, so Friday’s report is helping alleviate those concerns, somewhat.)  Additionally, the “Core PCE Deflator,” which is the Fed’s preferred measure of inflation, ticked a bit higher. It shows year-over-year inflation at 1.3%, up from 1.0% in May, and core inflation up 1.2%, up from 1.1% in May.  This is important because if inflation ticking up, as it appears to be doing, then that is a good thing for the economy.

The one disappointment last week was, of course, the jobs report.  The report itself wasn’t particularly good in that, not only did the headline miss, but “leading indicators” of the jobs market were also surprisingly weak. Average hourly earnings and average workweeks were flat to down from the May report (both move higher ahead of jobs gains as employers increase current employees’ pay and hours before adding new employees).

For all the gnashing of teeth Friday morning, though, the miss itself wasn’t really all that bad (162K jobs added vs. (E) 185K) and I’d characterize it as a “ho-hum” report, not a “weak” report.

Finally, the biggest “event” of last week was the Fed meeting, and this is where things got confusing.

The Fed statement was “dovish” in that they lowered their commentary on economic growth, and also cautioned on low inflation and an uptick in mortgage rates, and the dovish message surprised markets.

Last week the economic data continued to show the economy is recovering, which would imply “tapering” is on schedule for September.  But, the Fed has thrown that into doubt with the newest statement. Bottom line is this: Despite the whiplash caused at the end of last week by a dovish Fed, strong data and then a ho-hum jobs report, the expectation remains for tapering of QE to start in September, although that’s not as concrete as it was this time last week.

This Week

Domestically it is very quiet this week.  The three things to watch are: non-manufacturing (service sector) PMIs this morning, the Mortgage Bankers Association’s purchase application data Wednesday morning, and jobless claims Thursday.  The MBA purchase applications will take on added importance because the Fed singled out higher mortgage rates last week as a potential headwind on the economy.  So, a weak purchase application number, one that further implies the housing recovery is losing steam, will be “dovish” … and not positive for stocks.  Finally, jobless claims hit a new, multi-year low last week, and if that trend can continue, it will help alleviate some of the concerns about the labor market raised by last week’s jobs report.

Internationally, it’s a much-busier week. Most importantly, we get the latest round of Chinese inflation and economic data Thursday night/Friday morning. Clearly, given concerns over Chinese economic growth and whispers of potential stimulus from Chinese officials, these numbers are important.  If Chinese growth can level off, that’s a big positive for risk assets.

In Europe, there will be a lot more insight into whether the EU economy is indeed stabilizing.  Composite PMIs and retail sales this morning—and UK and German industrial production tomorrow  and Wednesday—will be watched closely to see if economic data further improves.  The big event is the Bank of England’s “Inflation Report,” which will be issued Wednesday. This is important because the BOE will elaborate more on their use of “forward guidance” as a monetary policy tool to help keep interest rates low.  No one knows exactly what they will say, but the expectation is they will use forward guidance and, on balance, be dovish. This should be good for UK stocks.

Bottom line is it’s an important week for China and Europe, but domestically, with regard to the Fed, none of the data will change current shaky expectations of “tapering” in September—we will have to wait for the FOMC minutes for more color there.

Finally, keep this in mind:  The market is “OK” with tapering in September as long as the data stays good (which it is).  If “tapering” is delayed, it will be because of a weak economy or threat of deflation, and neither are good for stocks.  So, if tapering of QE is delayed, it  will not be bullish for equities.