The Economy: A Look Back and What’s Ahead (1.13.14)
This Week
Economic data last week was disappointing, highlighted by the big jobs report miss on Friday. But, the important takeaway is that the soft economic data did not change the general expectation that GDP in 2014 should be 3% or higher.
Starting with the jobs report, the right way to look at Friday’s big miss (74K vs. estimates of 205K) is more confusing than outright negative. The miss was so big, and so divergent from all other recent economic data and employment indicators, that the market (rightly or not) is dismissing the jobs report as a statistical anomaly based on weather, seasonality, holiday hiring, etc.
The bulls will say that’s the right way to look at the number, while the bears will view it as a classic example of investors “whistling past the graveyard” and simply dismissing numbers they don’t like.
Time will tell who is right, and we’ll get a good idea over the next few weeks as more data comes out, but for now the benefit of the doubt goes with the bulls. (The number is so far off that it makes more sense on the surface that this is an anomaly.)
While everyone focused on the miss, the more-important part of the jobs report was actually the 6.7% unemployment rate, down from 7%. I know the unemployment rate (UR) fell because the labor participation rate sank, making it not the positive it seems to be. But, the reason the number is important is because the UR rate is now within striking distance of the 6.5% UR threshold the Fed has cited as potentially warranting an increase in interest rates.
Now, no one thinks the Fed will raise rates when the UR hits 6.5%, but the point is that this may require the Fed to provide more clarity on its “Forward Guidance.”
Remember, forward guidance is all a confidence game— it only works as long as the market believes it. If we hit 6.5% and the Fed doesn’t clarify or lower the UR threshold (say from 6.5% to 6.0%), then it may serve to discredit “Forward Guidance,” which may then result in a spike higher in interest rates. And, that would be bad for equities. So, what the Fed says about the UR threshold going forward will be important to watch.
Outside of the jobs report, the ECB meeting last Thursday was the next most “important” event. Draghi did his best to verbally “ease” policy by specifically pointing out that there is an increasing risk that the EU could suffer from an extended period of very low inflation, and he specifically clarified that the ECB mandate is for price stability both on the upside (inflation) and downside (deflation). He also tried to strengthen the ECB’s forward guidance by further emphasizing that rates will be very low for very long.
But, while that did result in a temporary dip in the euro, the bottom line is nothing Draghi said made it any more likely that the ECB will actually act to combat the growing trend of dis-inflation. So from an investment standpoint, the major question facing all European investments (both equity and debt) remains: “Is Europe becoming Japan of the 2000s?” Despite Draghi’s dovish tone, that question remains very much unresolved, and the answer remains the critical aspect of whether we’re about to see a big bull market in European equities or European bonds (especially higher-yielding bonds).
The one other data point to note last week was that the ISM Non-Manufacturing PMI missed expectations. The important thing was that new orders, the leading indicator of the report, dropped below the 50 level for the first time in months. It was largely ignored by the market, but if that trend extends to January, stocks will notice.
This Week
Most of the reports this week are “second tier” economic indicators, so although there will be numerous reports, it’s actually a relatively quiet week on the economics front, compared to last week.
The two biggest reports will be the Empire State Manufacturing Survey (Wednesday) and Philly Fed Survey (Thursday), because they are the first two economic reports for January.
Also, a new round of housing data kicks off this week with the Housing Market Index (Thursday) and Housing Starts (Friday). Keep in mind that the recent housing data has implied the recovery is stabilizing, after slowing late last year in the face of higher interest rates. More evidence of that occurring will be welcomed by the market, as housing remains key to the economy.
Finally, December Industrial Production comes Friday and investors will be looking for further confirmation of strong manufacturing PMIs in December, further solidifying that manufacturing is seeing an uptick in activity.
Bottom line this week: None of the data releases will materially change the outlook for the economy. But, keep in mind the economy has seen several false starts over the past few years in the first quarter, and if the economic data for December and January starts to come in a bit weaker than expected, this will make the market a bit nervous that we may be seeing another “false start,” and that’s even more important in the context of Fed tapering. So, although none of the “big” economic reports are this week, it doesn’t mean the data can be ignored, either.