More light, less tunnel

Marie M. Schofield, CFA, Chief Economist and Senior Portfolio Manager | October 31, 2013

  • After a data vacuum of almost three weeks, government agencies have started to gear up again with key reports; unfortunately, they present a picture of economic activity in the third quarter that ended on a soft note.
  • While the third quarter is typically the weakest in a given year, the current trend in employment is disappointing.
  • It appears the elusive turn in capital spending will await 2014 and then see only a modest build at some point next year.

After a data vacuum of almost three weeks, government agencies have started to gear up again with key reports out this week on labor markets and manufacturing orders. Unfortunately, both reports present a picture of economic activity in the third quarter that ended on a soft note well before the government shutdown. Consumer sentiment measures slipped and housing demand cooled. Next week we will see reports on industrial production and consumer spending for September giving us a fuller picture of Q3 activity. But so far, growth appears little changed from the tepid 1% to 2% pace seen in the first half, particularly in light of the fourth quarter drag owing to the shutdown. Without some miracle between now and year end, the Fed will wait for further clarity on the economic situation once the dust settles in 2014.

As to the details, I found the employment report soggy with payroll gains near the lower end of three-year ranges. At net gains of 148,000, the weakness was centered in service industries. Among these, leisure & hospitality, retail, health care and business service had been the source of above trend gains earlier this year and now are the source of the softer reads. In particular, Restaurants (part of leisure) saw a cut of 11,000 jobs, the first decline in three years. Finance also saw job losses, as mortgage refinancing activity fell due to the rise in interest rates.

Countering this somewhat, goods-producing industries saw above average gains in construction (both residential and non-residential sectors), manufacturing, and mining. More worrisome was the slide in consecutive quarterly payroll count with the Q3 monthly average at 143,000, versus Q2 at 182,000 Q1 at 207,000 and Q4 (last year) at 209,000. While Q3 is typically the weakest of the year, the trend here is not the Fed’s friend. The unemployment rate fell to 7.2% for the right reason (more entering the labor force and employed, fewer unemployed), but the participation rate is unchanged at 63.2%. Furthermore, the entire drop in the unemployment rate this year is explained by the drop in participation rate. Average hourly earnings rose a touch with the annual gain at 2.1%, but unchanged after inflation. Interestingly, part time workers have dropped by 800,000 in the last two months with like increases in full-time employment. This coincides with the surprise announcement by the White House of a one-year delay in business penalties related to the implementation of Obamacare—anecdotal but noteworthy. Next month’s data might be weaker still as the government shutdown will hit many industries in the October report. So clarity on the employment situation will wait a few more months with the Fed on taper delay.

Friday’s report from the Census Bureau on durable goods was also a disappointment. The headline gain of 3.7% for September was entirely due to Boeing orders. The volatile aircraft segment surged 57% and defense rose 13%. Forgiving this, core durable goods orders (ex-aircraft and defense and representing 91% of total durable goods orders) was flat. Motor vehicle orders, a driver for core orders this year, ticked slightly lower. And the proxy for capital spending, something everyone has their eye on, also sank. This measure, non-defense capital goods orders, fell 8.7% in Q3, the weakest in a year. Non-defense capital goods Shipments fell 2.9% in Q3 implying a weak (at best and possibly negative) print in business investment when the advance read on GDP is reported on November 7. The only positive here was growth in inventories which had been flat most of this year, but gives a small push to GDP in Q3. The main takeaway here is that the manufacturing pipeline (outside of aircraft) was softening heading in to the government shutdown and that demand for core capital goods (the broadest measure) ended the quarter on a weak note.

The outlook remains muted for advances in capital spending near term, but positive leading indicators remain in place. Recent growth trends in business equipment spending are unusually slow near 3%. Regional Fed lending surveys and many business outlook surveys point to increased capex. Global demand too is beginning to gear up. However, CEO capital spending surveys are more guarded. The question remains one of timing, and this is related to business confidence and continued uncertainty. It appears the elusive turn in capital spending will await 2014 and then see only a modest build at some point next year.

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