Economic rocket ship still stuck on the launch pad

Short-term job volatility continues, long-term trend perfectly intact
Sometimes I wonder why I even look at the monthly jobs report. The figures are unbelievably volatile, contain seasonal factors that swamp raw data, are affected by weather and strikes, and are revised with clockwork-like regularity. Needless to say, I was laughing pretty hard on Thursday when many breathless media pundits were saying that it would all come down to Friday's job report. Well, the report was disappointing, and equity markets went up; so much for make-or-break.

Looked at more objectively and on a year-over-year averaged employment data basis, it was more of the same stodgy growth, as shown below.

In my weekly reports, I have always used the private-sector data instead of the more inclusive nonfarm data that includes government workers. I did this because ups and downs of various stimulus programs, ongoing issues at the post office, and continued Defense Department cuts distorted the government data and the more comprehensive nonfarm payroll report. But now, even that data has settled into a pattern. Given that the government represents about 16% of all employment, the nonfarm data, which includes government workers, is probably more representative of the economic activity than the private sector data alone.

The nonfarm data is now nearly as stable as the private sector report, albeit at a much lower rate of growth. Given productivity growth, these numbers are consistent with GDP growth of 2.0%-2.5%.

Monthly sector data soft and troubling
Although I can brush off many of the negatives in monthly data, some sector issues are worrisome. Health care and education continued to be soft, adding almost no jobs for the second month in a row, after being the bulwark of job growth for a large part of the economic recovery. These are generally decent-paying, normal-hour types of jobs that really were instrumental in keeping the economy moving. Cost controls and fear of Affordable Care Act provisions seem to have really kept a lid on health-care hiring. There certainly wasn't a January rush to hire health-care workers to serve newly insured citizens. Unless health-care employment turns the corner, it will be a major impediment to employment growth in 2014.

Education employment (private school and universities, not including government) saw a 7,000-employee decline. This sector has been getting weaker for some time as better employment prospects work against people's desire--and even opportunities--to go for more schooling. Tightening federal oversight isn't helping, either. At its peak in January 2012, health care and education added almost 90,000 jobs to the monthly employment statistics. This month it subtracted 6,000 jobs.

The other sector showing a big change that may not reverse itself easily is retail, which lost 13,000 jobs in January. In mid-2013, retail was accounting for a meaningful portion of overall job growth. Given the shift to more online shopping (worsened recently by bad weather), I am surprised that retail employment did as well as it did in 2013. It may be hard for retailers to dodge that bullet in 2014.

The good news and the bad news is that construction and manufacturing had a great January. The good news is that these are great-paying, high-hour kinds of jobs--and at 69,000 combined jobs added, it is one of the best performances of the recovery. The bad news is that the report will be hard to match in months ahead, and may represent a bounce from weather-afflicted December data. The other bad news is that these are the two sectors often the most affected by weather. Strong results in these categories suggest that weather was not a factor in the sloppy top-line employment growth figure.

Better economic growth in 2014 is coming down to homebuilders
Ongoing issues in health care, education, and retail mean that growth in manufacturing--especially construction employment--will be the key to employment growth improvement. Construction jobs in particular have a huge multiplier effect into a lot of other categories. Government housing data has been terrible lately, but that may be because of the weather and data collection issues during the government shutdown. Homebuilders seem to be a lot more optimistic than the government data suggests, perhaps because of mortgage rates that are again falling and the fact that builders now have better-positioned properties to build on.

Not a good week for government estimators of GDP
The first run of the GDP report for a given quarter comes out one month after the end of the quarter and is revised twice based on new or revised data. Inventories, net exports, and construction data for the last month of the quarter are not available at that time and are estimated by the government. Those estimates are published for all to see in a supplementary report to the GDP release.

For the fourth quarter, estimators didn't do so well, as much of the actual data released this week severely contradicted those estimates. Net exports, state and local government capital spending, and private residential spending all fell well short of internal estimates. Even one of the smaller inventory categories showed a less positive contribution than expected. Only private nonresidential spending did better than expected, but not by enough to move the needle.

Fourth-quarter GDP estimates may be too high by close to 1%
When all the misses are added together, they could take as much as 0.9% off of the original GDP estimate, meaning the economy potentially grew a slower 2.3% in the fourth quarter, instead of the 3.2% originally reported. I do caution that cuts in some areas often pop back as gains in other categories. Higher imports often mean higher inventory levels (a help to the GDP calculation). The full set of inventory data will not be available until next week. Also, slower home construction may mean inventories of lumber are stacked up at home sites. Another big swing factor in the next GDP revision will be the retail sales report, also due next week. Unlike some of the other reports, preliminary December data was available, but it is often sharply revised and factors back into the GDP revision due at the end of February.

Economic rocket ship still stuck on the launch pad
I might not normally mention this minutia, but I think two months of weak employment reports and softening in both manufacturing and housing suggest the economic rocket ship that many were predicting for 2014 is still sitting firmly on the launch pad with the countdown clock on hold. I say "on hold" for now, because weather may indeed be causing some issues. But it's just too hard to tell for sure. Weather seems to me to provide some helps including: utilities, winter apparel, snow removal personnel and equipment; in addition to hindrances: housing starts, restaurant sales, auto sales, and gasoline.

Trade data worsens in December; still, a great fourth quarter
The headline trade deficit widened markedly in December to $38.7 billion, up from $34.6 billion in November, which was unusually good. However, it wasn't far off of the average for all of 2013 of $39.3 billion. (A smaller trade deficit is positive for the economy.) That full-year average represents a huge improvement from $46.4 billion in 2012 and $44.6 billion in 2011.

During an economic recovery the trade deficit almost always widens as exports and imports usually grow at relatively similar rates, and imports are far larger than exports. Decreased oil imports and oil-related exports are clearly making a difference. However, it's not just about oil. The table below shows that imports, excluding oil, have increased, as they often do in a recovery. Still, exports of nonoil-related goods have done even better.

The year-over-year, averaged trade data, including both oil and nonoil-related goods, shows a nice acceleration in the fourth quarter, despite the somewhat poorer data for the single month of December. The report is also good news for countries importing goods to the United States, with some higher, but not too high, growth rates. In general, the data seems to indicate a stronger world economy and a better environment for trade.

Trade data explains better manufacturing data and strong GDP
I have often worried that better U.S. manufacturing data was not supported by U.S. consumption growth. The growth in exports would seem to be part of the reason for the disconnect between consumption and manufacturing. Unfortunately, some of the world data, especially emerging-markets economies, are looking a little softer, which may end the mini-export boom that the U.S. saw in the fourth quarter.

Softer-than-estimated trade data could mean a meaningful downward revision in fourth-quarter GDP
As good as the trade numbers have been lately, they did deteriorate some between November and December. Worse, the data softened considerably more than the government estimated when it constructed the first estimate of the fourth-quarter GDP. Recall that net exports contributed 1.4% of the 3.2% growth recorded in the original report. If no other areas of the report were revised, GDP would be slightly less than 2.9%.

Purchasing manager data soft, but doesn't scare me
Given that the U.S. economy needs construction and manufacturing to do well in order to support job growth, this week's ISM Purchasing Managers' Index was not welcome news and sent the market into a tizzy on Monday.

The PMI data lately has not been helpful and has shown little predictive value. The index strengthened last winter just before industrial production data began to falter. This summer it did properly forecast a fall production increase but completely missed a winter plateau, even forecasting near-boom conditions. Therefore, I am not terribly worried about the recent softness, especially as there may be some weather-related issues. And there are still more companies reporting improving rather than deteriorating conditions.

Unfortunately, industrial production figures next week may not shed much more light on the issue, as this is one report that bad weather can devastate. One day of lost production is a 5% hit to the production report. Even if only one third of the country was affected, the overall impact is still more than 1%. Weather doesn't affect labor data as much because a worker has to work only one day of one particular pay period to be counted as employed. A day of lost production is a day of lost production, no matter when in the month it occurs.

Auto data lays another egg
Auto sales have been another huge driver of the recovery. Nevertheless, the past two months of data have shown considerable softness. Though some of this is clearly weather-related, back-to-back weakness diminishes the argument. With more online sales, bad weather pushing aging cars into the junk heap, and consumer demand for all-wheel-drive vehicles, it's hard to argue that bad weather is a one-way street for auto sales. And some of the most active markets for cars this time of year are not affected by weather, namely Florida and California. Also casting a little doubt on the weather thesis is that as late as Jan. 24, knowing full well how bad the weather was, the major automotive industry forecasters were trumpeting potential January sales levels of 15.9 million in a recent Automotive News article. Only days later the industry reported that just 15.2 million cars were sold.

In any case, the data below shows that auto sales growth has been slowing for some time, though recent months look quite bad. Morningstar's auto analysts continue to believe that full-year 2014 sales will fall in the 15.9 million-16.2 million unit range compared with 15.5 million units in 2013. Aging fleets, new model rollouts, and relatively low interest rates should all provide a short-term boost, even if growth won't be as good as it was in 2013.

Federal budget news this week was good
The Congressional Budget Office rolled out its semiannual, 10-year budget outlook this week. The new report has the deficit shrinking in raw terms and as a percentage of GDP for the next two years, then some stabilization, and then modest increases. Current projections show that even as far out as 2024, the budget deficit will be no bigger than it was in 2013 as a percent of GDP.

Also of note is how drastic the deficit reduction was in 2013 with a record $0.4 trillion trimmed in just one year. Higher taxes and lower spending contributed to at least some of the economic softness in 2013. The pain continues in 2014, although at a much less constrictive rate ($0.15 trillion deficit reduction).

For those who think the deficit cuts are all smoke and mirrors, take a quick look at the year-over-year cuts in spending and increases in taxes shown below.

Those cuts would look even more significant if adjusted for inflation. Looking forward, even if spending turns out to be higher than expected, I think tax receipts (especially capital gains) and overall economic growth are underestimated, making the deficit look a little worse than what I would forecast. At 4% deficit rates in the out years, the deficit is still higher than we would all like to see, with the 3% level of deficits generally demarcating the line between fiscally conservative economies and spendthrift/troubled economies. At levels much above 3%, interest charges alone begin to drive deficits far higher even without much of an increase in spending. Overall the report isn't that much different from recent reports; near-term growth in GDP is much lower, but smaller medical-cost growth estimates offset some of that negative impact of slower growth.

Data flow slows next week; retail sales, inventories, and industrial production Due
This week, economic forecasters were wide of the mark and far too optimistic. There isn't much data for the week ahead, and even the normally helpful retail sales report and industrial production report will be nearly useless because of weather effects. Retail sales are expected to decline by 0.1% in January compared with 0.2% growth in December. Continued auto weakness and poor weekly shopping center data combined with slow employment growth suggest that forecasters' pessimism is not misplaced. Analysts will also be looking closely to see if there are any revisions to December's report. Consumers looked unusually strong in the fourth-quarter GDP report, especially in light of recent employment reports. December adjustments to retail sales will flow directly into the next GDP report. Revisions to retail data have been unusually large in recent months, in both directions.

Healthy improvement in utility (and maybe mining) data, even as core manufacturing data looks soft, will buffet industrial production in both directions. In this week's employment report, manufacturing hours worked for January suggest that core manufacturing output may have even declined that month. Given the weather, I would be more concerned by a consumer slowdown than any weird spike or dip in industrial production.

I usually don't comment on inventory data, but this is the last of the missing pieces of actual data used to construct GDP. And growing inventories should be the natural fallout of slowing export and construction data, offsetting at least some of the negative GDP potential of these same items. Next week's data should either assuage or compound worries about a potentially large, negative GDP revision. Expectations are for total inventory growth of 0.4% for December, the same as in the previous month.