U.S. Economy: Counting on the Consumer to Help Keep Growth Going
Heading into the final month of 2018, the U.S. economy’s second longest expansion in history continues. There are signs, though, that conditions may be bumpy in 2019. The most recent payrolls report showed that the job market might be cooling. There are also concerns over global trade (particularly U.S.-China business ties) and the potential negative impact of waning support from expansionary monetary and fiscal policy (like the expansionary effects of the tax cut) cutting into economic growth.
Despite those concerns, the U.S. consumer, who has helped underpin the economy since the recovery got going back in June 2009, appears to still be in a good position. With job and wage growth, and higher asset prices (albeit the volatility in stock markets during the fourth quarter is cause for concern) lifting the wealth effect, consumers’ participation in the economy seems set to continue.
And while consumer sentiment toward future conditions has declined, according to recent measures, and the housing market appears to be flat as higher mortgage rates and home price appreciation cut into sales, lower oil prices are helping with inflation expectations. Combined with a higher savings rate, and maybe still some positive effects from the tax cut, the U.S. consumer appears not yet ready to call it quits.
Going into the holiday shopping season, consumer spending in October rose 0.6% from the previous month, representing the highest month-over-month increase since March. Spending was up by nearly 3.0% from a year ago. Real (inflation-adjusted) disposable incomes rose 0.5%, the highest since January, and by 2.8% from a year ago, according to data released by the Bureau of Economic Analysis.1
Inflation measures also remained muted. The personal consumption expenditures (PCE) price index, the Federal Reserve’s preferred inflation gauge, came in at 2.0% in October, compared to a year ago. The core PCE index, excluding food and energy, was 1.8%, down slightly from 1.9% in September. Something to watch for in 2019 will be whether a tightening labor market and ensuing wage pressures tip the balance of inflation higher and lead the Federal Reserve to raise interest rates sooner or more aggressively than investors expect. (See this December 3 post in the Market News section of BCJ Insights.)
In a note to clients in early December, reported by CNBC, Goldman Sachs highlighted that key drivers of consumer spending send a positive message for the near-term outlook. Real disposable income is “likely to continue its strong growth due to accelerating wage growth, and recent declines in the oil price are likely to be a significant tailwind to spending in 2019,” Goldman said. In addition, the savings rate “looks elevated relative to the high level of household wealth, even after the recent sell-off.”2
Slower Pace of Jobs Growth but Wages on the Upswing
The pace of job growth slowed in November, though the overall unemployment rate remained at its lowest point since 1969. Seasonally-adjusted total nonfarm payrolls increased by 155,000 in November, according to the Bureau of Labor Statistics (BLS).3 That compared to an average monthly gain of 209,000 over the prior 12 months, according to BLS data. Revisions to September and October data resulted in employment gains in those two months being 12,000 less than previously reported.
Average hourly earnings rose by 6 cents to $27.35. Over the year, average hourly earnings have increased by 81 cents or 3.1%, the same percentage increase as the previous month and the best rate since December 2009. The number of people participating in the labor market remained the same as the previous month with the participation rate at 62.9%. The U-6, or underemployment rate, rose to 7.6% from 7.4% the previous month, though it is still below the 8.0% level reported for November 2017.
A pickup in wage growth and some signs of emerging largescale layoff and buyout announcements from big U.S. employers (General Motors, Verizon Communications and Wells Fargo, are among those with announcements in recent weeks) may be an indicator that the U.S. economy could be setting up for a downturn in 2019.
According to global outplacement and executive coaching firm Challenger, Gray & Christmas, Inc., monthly job cut announcements averaged under 35,000 in all of 2017 and just under 44,000 in 2016. In 2018, cuts are averaging nearly 45,000 per month, with the last four months averaging over 55,000. “This upward trend is indicative of a potential economic shift and could spell a downturn,” the firm said in its November job cuts report.4
Consumer sentiment, however, remains strong, though signs of caution are becoming evident. The Conference Board’s Consumer Confidence Index fell slightly in November to 135.7, compared to 137.9 in October – remaining at historically strong levels. The Expectations Index, based on consumers’ assessment of current business and labor market conditions, fell from 115.1 the previous month to a reading of 111.0 in November, primarily due to a less optimistic view of future business conditions and personal income prospects.
“Overall, consumers are still quite confident that economic growth will continue at a solid pace into early 2019. However, if expectations soften further in the coming months, the pace of growth is likely to begin moderating,” said Lynn Franco, senior director of economic indicators at The Conference Board.5
The University of Michigan’s Index of Consumer Sentiment was unchanged from the previous month with a 97.5 preliminary reading for December – its average for the January 2017 through December 2018 period. Consumer sentiment hasn’t been this high on a consistent basis since 1997-2000, with a four-year average for the index of 105.3.
Chief economist Richard Curtin noted that the differences between the two periods mostly revolve around job and wage prospects. “As long as job and income growth remain strong, rising prices and interest rates will not cause substantial cutbacks in spending,” he said. Similar to the Conference Board’s report, an index which measures consumer’s expectations fell for the third-straight month. “In the early December survey, however, consumers did mention hearing more negative news about future job prospects,” Curtin said.6
What’s Ahead for GDP?
The Commerce Department’s second estimate of gross domestic product (GDP) growth for the third quarter was unchanged at 3.5%. That compared with the 4.2% surge the U.S. economy experienced in the second quarter. As the employment figures and other recent economic data suggest, the picture may be getting cloudy for what’s expected for the fourth quarter.
The Atlanta Federal Reserve’s GDPNow model for real GDP growth for the fourth quarter stood at 2.4% as of December 7. The model is updated generally on a weekly basis as economic data flows in and is available here. The New York Federal Reserve’s Nowcasting Report of real GDP growth also forecast a 2.4% rate for the fourth quarter as well as the same pace for the first quarter of 2019. It is also updated typically from week to week and is available here.
Real Estate: U.S. Housing Market Looking More Like a Fixer Upper These Days
The U.S. housing market is showing signs of needing repair and some upgrades. Despite the strong employment market, rising mortgage rates and home prices are keeping more would-be home buyers on the sidelines.
Sales of newly built single-family homes fell 8.9% in October from the previous month to a seasonally-adjusted annual rate of 544,000, the Commerce Department reported in late November.7 Compared to a year ago, sales in October were 12.0% lower. October’s sales pace was the lowest since December of 2016.
While there was some good news in the report – September figures were revised upward to an annual rate of 597,000 – the seasonally-adjusted estimate of new home sales on the market of 336,000 at the end of October was 4.3% higher than September and 17.5% higher compared to the previous year. The inventory of new homes for sale represented a supply of 7.4 months at the current level – the highest since February 2011.
“As we close in on the end of 2018, it is abundantly clear with the benefit of hindsight that the new home sales market took a turn this year, and not for the better,” Aaron Terrazas, director, economic research at Zillow, said in a research post. “Since the end of 2017, new home sales volumes have endured their longest slide since 2010, when the market was still very much in the grips of the recession.”8
While the new home sales market doesn’t make up near as much as that of the existing home sales market, it does impact other areas of the economy, including construction, household durable goods sales and industry sectors such as homebuilders.
Those homebuilders which are publicly traded and tracked in the S&P Homebuilders Select Industry Index have trailed the broader market this year as concerns over slower sales and rising material and labor costs have pressured profit margins. The index was in correction territory year-to-date through November, down 20.0%, compared to a gain of 3.2% for the broader S&P 500.
Though home price appreciation remains above 5.0% annually, with sales measures and other housing data trending downward, appreciation continues to moderate. Figures released in November show that home prices as tracked by the S&P CoreLogic Case-Shiller National Home Price Index rose 5.5% in September compared to the previous year – the six consecutive month of slowing home price growth and the lowest level since January 2017. The top 20 metropolitan areas posted a 5.1% gain year-over-year, down from 5.5% in August.9
The outlook for the housing market for 2019 from Freddie Mac is for modest growth, according to its forecast released in late November. “The biggest unknown about the housing market next year is whether the recent negative trends will persist or the market will adjust to the shock of higher mortgage rates and resume modest growth,” Freddie Mac said. “Our forecast favors the latter – modest growth.” (See the chart below published online by Freddie Mac on November 27.)
In its forecast, Freddie Mac cited continued economic growth (a forecast of 2.4% annualized GDP growth in 2019) and the strong labor market as the primary factors. And while it forecasts that 30-year fixed-rate mortgages will average 5.1% in 2019 and 5.6% in 2020, up from an average of 4.6% in 2018, a moderation in the rate of increase in mortgage rates “may be just enough to let the housing market catch its breath and resume growth.”10
Mortgage rates as of early December declined amid the selloff in stocks. Lower Treasury yields helped provide some respite from the recent surge in mortgage rates. Thirty-year fixed-rate mortgage rates were 4.75% as of December 6, well below the 4.94% rate which Freddie Mac reported as part its primary mortgage market survey in mid-November.
An uptick in inventory in the existing home sales market, meanwhile, helped to lift sales in October though similar trends impacting the new home sales market still remain. Sales increased 1.4% compared to September to a seasonally-adjusted rate of 5.22 million in October – representing the first monthly increase in six months. Sales, though, are still down 5.1% from a year ago, according to the National Association of Realtors (NAR).11
Total housing inventory fell month-over month, but at 1.88 million in October, inventory was up from 1.80 million a year ago – or at a 4.4 months supply at the current sales pace, compared to 3.9 months of supply a year ago. “As more inventory enters the market and we head into the winter season, home price growth has begun to slow more meaningfully,” Lawrence Yun, NAR’s chief economist said. “This allows for much more manageable, less frenzied buying conditions.”
Markets: Bumpy Ride for U.S. Stocks; Bonds Catch a Bid
The major U.S. stock-market benchmark indexes managed to eke out gains in November amid one of the most volatile trading periods in recent years. December trading has proven to be volatile as well. Small capitalization stocks in the U.S., meanwhile, are nearing bear-market territory (generally defined as a decline of at least 20% from a recent high).
For November, the Dow Jones Industrial Average (DJIA) gained 1.68% from its end-of-the-month closing value in October. The S&P 500 rose 1.79%, while the Nasdaq increased by 0.34% compared to the previous month. Year-to-date through November the Dow, S&P 500 and Nasdaq remain in positive territory (see below).
U.S. stocks, as tracked by the indexes, got off to a poor start in the final month of the year, with the DJIA and S&P 500 falling by about 4.5% and 4.6%, respectively, in the first week of December. The Nasdaq, meanwhile, fell by nearly 5.0% during the same period.
Market volatility thus far in the fourth quarter has been driven, in part, by concerns over whether tariffs will impact global growth at a time when market participants appear to be cautious going into 2019 about economic growth and potentially higher interest rates. News on December 12 that China may be preparing trade policy which will provide more access for foreign companies did help lift market sentiment, however. Earlier in the week, Chinese trade officials indicated the country planned on lowering auto tariffs and increasing purchases of soybeans and other crops.
In the small cap space, the Russell 2000 ended November up by 1.4% compared to the previous month. From an all-time high at the end of August, however, the index is down by 16.8% through December 7. After being among the market’s best performers, particularly amid uncertainty with trade policy, shares of small cap stocks have declined dramatically. Current concerns also include the higher debt levels that companies in the small cap space tend to carry.
Lindsey Bell, an investment strategist at CFRA Research, told CNBC on December 12 that a big market risk that could impact stocks is the more than $9 trillion in corporate debt on companies’ balance sheets. On an aggregate basis, the Russell 2000 is 2.5 times more levered than the S&P 500.
“What investors really need to do is make sure they’re starting to look at balance sheets and cash flows. Look at those levels of debt and their ability to pay off the interest expense,” she said.12
Market Turbulence a Favorable Climate for U.S. Treasurys
Treasury yields fell last month as volatility in global stock markets led to some rotation out of stocks into safer government debt. The Treasury market also benefited from comments by Federal Reserve officials during the month, including from Chairman Jerome Powell, which indicated that the central bank may not move to raise interest rates in 2019 as aggressively as market participants had thought.
Longer-dated maturities along the yield curve have also caught a bid from market participants with the collapse in oil prices, which is partly helping lower inflation expectations.
The benchmark 10-year Treasury note finished November with a yield of 2.99% compared to 3.14% as of the end of October. Earlier this past month, the 10-year yield had been trading as high as 3.23% ─ a seven-year high. The 30-year Treasury bond has also declined in recent weeks, ending November with a yield of 3.31%, compared to 3.41% at the end of October.
With the Federal Reserve raising interest rates periodically since December 2015, shorter-dated Treasury bills and notes have been favorable among investors seeking yield. This, in part, has led to a flatter yield curve periodically during this period, and again in recent weeks, on concerns about investments in riskier assets. In broader terms, inverted yield curves, in which shorter-dated Treasury securities yield more than longer-date maturities, tend to curtail banks’ profits and lending activities, and have been past predictors of recessions.
Longer-dated Treasury maturities, though, are now being viewed as a way to diversify out of stocks, balance portfolios amid market volatility and headline news from trade tensions or other market moving dynamics. They are also seen by some as protection as the U.S. economy continues heading into the late stages of the current economic cycle.
BlackRock recently upgraded its view of U.S. government bonds to neutral, citing them as playing a greater role in portfolios. “For one, they can help cushion against any late-cycle selloffs of risk assets. In addition, the Federal Reserve’s policy path may create a relatively benign environment for Treasuries,” Richard Turnill, BlackRock Global Chief Investment Strategist, wrote in a December 11 blog post.13
Earlier in the post, Turnill noted the worry some investors may be having with the inverted yield curve and its foreshadowing of recessions in the past. “We caution against that view. Our analysis would put recession probabilities as low for 2019 but rising to just above 50% by the end of 2021.”
A Look at Markets Overseas
Political tensions in France related to the “yellow vests” protests and government concessions which may lead to new spending measures and higher budget deficits have pressured that country’s financial markets in recent weeks. Shares tracked by the S&P Broad Market Index (BMI) in France fell by 2.0% in November, according to S&P Dow Jones Indices.14
Shares in Germany as tracked by the S&P BMI fell 2.1% in November and are down by 19.4% year-to-date. Partly due to sluggish auto production and sales, Germany’s economy contracted in the third quarter by 0.2% compared to the previous quarter.
The flash estimate of third-quarter gross domestic product (GDP) represented the first decline in quarter-on-quarter performance since the first quarter of 2015, according to Germany’s Federal Statistical Office.15
Emerging markets as tracked by S&P Dow Jones Indices were up by 4.53% in November, following a 7.69% decline in October. Developed markets, excluding the U.S., fell marginally by 0.02%.
Commodities: Finding a Bottom for Oil’s Slippery Slope
Continuation of low prices would pressure U.S. oil & gas companies’ margins
What a difference a few months make. As the third quarter ended, crude oil appeared to be poised to move to $100 a barrel on expectations of shortages stemming from U.S. sanctions on Iran and global demand. At the time, Brent crude was trading at nearly $83.00 a barrel, while West Texas Intermediate (WTI) crude was above $73.00 a barrel. Prices continued to march upwards to four-year highs in early October, settling above $86.00 and $76.00 a barrel, respectively, for Brent and WTI.
But after finishing its worst month in a decade in November, Brent Crude prices hover just above about $60.00 a barrel and WTI crude is slightly above $52 a barrel. Forecasts for global growth have been trimmed and with it concerns over demand.
The numbers look like this: Brent and WTI prices fell by about 22.0% for the month of November compared to the previous month. It doesn’t look as bad from the start of the year, with Brent futures down by about 7.8% and WTI futures 12.9% lower this year through December 7. But from early October, oil prices have crashed 28.5% for Brent and by 31.1% for WTI through December 7.
Stumbles like this haven’t gone unnoticed. The 15 countries within the Organization of the Petroleum Exporting Countries (OPEC) and key allies outside the cartel, including Russia, agreed at a December 7 meeting in Vienna, Austria to cut production by 1.2 million barrels per day for the first six months of 2019.
OPEC plans to curtail production by 800,000 barrels per day, with Russia and other allied producers expected to reduce output by 400,000 barrels per day. The agreement included exempting Iran, the target of current U.S. sanctions, from production cuts.16
The price of oil matters on a number of fronts. Among the balancing acts countries within OPEC face is the price its producers need oil to be at for domestic budgets and economies to prosper. That price is much higher than what U.S. shale drillers require to knock out production and be commercially viable. U.S. drillers pumped 11.7 million barrels a day in November, a record, according to data from the U.S. Energy Information Administration.17
Yet, while U.S. producers can achieve profitable returns with an oil price of about $45 to $50 a barrel, depending on where its being extracted, the concern for oilfield service companies is that exploration and production companies could curtail capital spending. That would result in less demand for equipment, services and other supplies, putting downward pressure on profitability.
Markets have taken note with the PHLX Oil Service Index, an index of 15 companies in the sector, losing 12.4% for the month of November. Year-to-date through December 7, that index has declined by 34.5%. The overall energy sector also constitutes among the largest portions of the high yield or junk bond market, companies with below investment-grade credit ratings. Risk premiums, or the spread above safe U.S. Treasury securities, investors are willing to pay to hold these bonds have widened with the onslaught of the oil price bear market.
Oilfield services firms’ financial conditions have improved somewhat since the 2014-2016 period when oil prices collapsed. Cost and production improvements and higher prices have helped their balance sheets. They’ve also been able to raise debt amid favorable capital markets and less restrictive covenant terms for their bond and loan offerings.
The oilfield services sector, however, has the “preponderance” of negative outlooks within the overall global oil and gas sector rated by S&P Global Ratings. “Despite the improvement we’ve seen in the sector and the overall price increases they’ve initiated, price increases and volume are insufficient to garner adequate rates of return and healthy credit ratios,” S&P Global Ratings said in a November trends and outlooks report on the sector.18
1 U.S. Bureau of Economic Analysis (2018, November 29). Personal Income and Outlays, October 2018 [Press Release]. Retrieved from: https://www.bea.gov/system/files/2018-11/pi1018.pdf
2 David, J. (2018, December 9). Goldman Sachs: As long as consumers keep shopping, there’s hope for the economy. CNBC. Retrieved from: https://www.cnbc.com/2018/12/09/goldman-sachs-consumer-spending-to-keep-hopes-on-economy-alive.html
3 U.S. Bureau of Labor Statistics. (2018, December 7). The Employment Situation – November 2018 [Press Release]. Retrieved from: https://www.bls.gov/news.release/empsit.nr0.htm
4 Challenger, Gray & Christmas Inc. (2018, December 6). 2018 November Job Cut Report: Cuts Hit 53,073, YTD Up 28 Percent [Press Release]. Retrieved from: http://www.challengergray.com/press/press-releases/2018-november-job-cut-report-cuts-hit-53073-ytd-28-percent
5 The Conference Board. (2018, November 27). The Conference Board Consumer Confidence Index Declined in November [Press Release]. Retrieved from: https://www.conference-board.org/data/consumerconfidence.cfm
6 University of Michigan. (2018, December 7). Surveys of Consumers – Preliminary Results for December 2018. Retrieved from: http://www.sca.isr.umich.edu/
7 U.S. Department of Commerce. (2018, November 28). Monthly New Residential Sales, October 2018 [Press Release]. Retrieved from: https://www.census.gov/construction/nrs/pdf/newressales.pdf
8 Terrazas, A. (2018, November 28). October New Home Sales: The 2018 Slide Continues. Zillow Research, Zillow.com. Retrieved from: https://www.zillow.com/research/october-new-home-sales-2018-22187/
9 McLaughlin, R. (2018, November 27). Despite Slowing Home Price Growth, Investors Can Remain Confident in the Market. CoreLogic Insights Blog, CoreLogic. Retrieved from: https://www.corelogic.com/blog/2018/11/despite-slowing-home-price-growth-investors-can-remain-confident-in-the-market.aspx
10 Freddie Mac. (2018, November 27). Expect Modest Housing Market Growth in 2019. Freddie Mac Research Forecast. Retrieved from: http://www.freddiemac.com/research/forecast/20181127_economic_growth.html
11 National Association of Realtors (2018, November 21). Existing-Home Sales Increase for the First Time in Six Months [Press Release]. Retrieved from: https://www.nar.realtor/newsroom/existing-home-sales-increase-for-the-first-time-in-six-months
12 Lahiff, K. (2018, December 12). This is one of the biggest market risks that investors aren’t giving enough attention, CFRA strategist says. CNBC, Trading Nation. Retrieved from: https://www.cnbc.com/2018/12/12/investors-arent-paying-attention-to-one-of-the-biggest-market-risks.html
13 Turnill, R. (2018, December 11). Why we upgrade U.S. government bonds. BlackRock Blog. Retrieved from: https://www.blackrockblog.com/2018/12/11/us-government-bonds-upgrade/
14 Silverblatt, H. (2018, December 3). U.S. Equities Market Attributes November 2018. S&P Dow Jones Indices. Retrieved from: https://us.spindices.com/documents/commentary/market-attributes-us-equities-201811.pdf?force_download=true
15 Federal Statistical Office. (2018, November 14). Gross domestic product in the 3rd quarter of 2018 down 0.2% on the previous quarter [Press release]. Retrieved from: https://www.destatis.de/EN/PressServices/Press/pr/2018/11/PE18_440_811.html
16 DiChristopher, T. and Meredith S. (2018, December 7). OPEC and allies agree to cut oil production by 1.2 million barrels per day. CNBC. Retrieved from: https://www.cnbc.com/2018/12/07/opec-meeting-saudi-arabia-and-russia-look-to-impose-production-cuts.html
17 U.S. Energy Information Administration (2018, December 6). Weekly Supply Estimates. Retrieved from: https://www.eia.gov/dnav/pet/pet_sum_sndw_a_epc0_fpf_mbblpd_4.htm
18 Watters, T., Grande M. and Redmond S. (2018, November 12). Industry Top Trends 2019 Oil and Gas. S&P Global Ratings. Retrieved from: https://www.spratings.com/documents/20184/5670590/Industry+Top+Trends+2019+-+Oil+and+Gas/38501bb9-510d-0b18-e4ef-5c145f002562
Sources for Financial Data:
Dow Jones Industrial Average:
West Texas Intermediate:
S&P Homebuilders Select Industry Index:
PHLX Oil Service Index:
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