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Brian Wesbury
Chief Economist
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Bob Stein
Deputy Chief Economist
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 | Drudge, Tyler Durden and Economic Ignorance - By Brian S. Wesbury |
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| Posted Under: Data Watch • Employment • Research Reports |
We have pushed back hard in recent years against the bearish conventional wisdom. Many analysts have argued that the US economy is on the verge of collapse, a double-dip or some other kind of calamity, like hyper-inflation.
We have disagreed. In most of these debates we are crossing swords with articulate analysts who are knowledgeable about economics, mathematics and data. They have the best of intentions.
However, there is a group of influential people (meaning that they get lots of hits on their blogs or websites) who may be articulate and have an ax to grind, but at the same time know little about economics, mathematics and data. A classic example is the Drudge Report link today to a headline and blog post by Tyler Durden that says, "Record, 1.2 million people fall out of labor force in one month..."
Nothing about this headline is true, and it starts with the byline. Tyler Durden is a made up name, an alias. Tyler was a character in the movie "Fight Club," played by Brad Pitt. The character is a figment of the protagonist's imagination, an alter ego. Maybe Tyler is Drudge himself? Second of all, the labor force actually increased in January from its December level. To say anything else is to ignore the truth.
The reason Tyler and Drudge are confused about this is because they are looking at a statistic that measures the number of people of working age who are "not in the labor force." This number did jump by 1.2 million in January. However, any analyst should look deeper into the data before making outrageous claims. After all, the jobs report was very good and the labor market has been getting better for almost two years. A huge and massive drop in the labor force would be weird.
It turns out that something weird did happen, just not what Tyler Durden reports.
Every once in a while the Bureau of Labor Statistics (BLS) makes catch-up adjustments to its underlying data. Often, but not always, this happens in January. This time the BLS added 1.7 million people to its estimate of the working age population. To get a sense of how huge this is, the average monthly increase in population estimates over the past two years (2010-11), was 159,000. In other words, the January population estimate adjustment was normal; it was catch-up for the past.
But this change has add-on effects. When the BLS estimates a new level of the population, it then estimates how many of those people are in the labor force. For the month of January, the BLS said that of the 1.7 million new people it counted, 500,000 were in the labor force and 1.2 million were not. To say, as Drudge and Tyler Durden did, that the labor force fell by 1.2 million is a basic and frightening misuse of statistics. It's simply not true and it is leading many people astray.
For the record, the employment-population ratio was 58.5% in January, the same as it was in December and November and up from its level of 58.2% in September. In other words, even though the government estimated a big jump in the working-age population, the share of the population that has a job is actually flat to higher.
Private sector jobs have increased for 23 consecutive months, total cash earnings are up 4.6% in the past year and previous months' data are being revised upwardly, not downwardly. The bottom-line is that the economy is getting better, even as politically motivated Internet traffic is getting so desperate that it has to resort to a misuse of statistics to make its point.
Click here for a printable version.
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| | The ISM non-manufacturing composite index increased to 56.8 in January |
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| Posted Under: Data Watch • ISM Non-Manufacturing |
Implications: Great news on the service sector this morning! The ISM services index blew away consensus expectations, coming in at 56.8, the highest level since February 2011. The service sector has now shown expansion for 25 straight months. The business activity index, which has a stronger correlation with real GDP growth than the overall index, boomed in January, coming in at 59.5. The new orders index also took off, rising to 59.4, the highest level since March. Perhaps the best news from today's report was that the employment index rose to 57.4 in January from 49.8 in December. This is the highest reading on the employment index since February 2006 and helps back up the great numbers we saw in this morning's Labor Department report. On the inflation front, the prices paid index rose to 63.5 after falling slightly to 62.0 last month. The index remains at elevated levels, indicating upward price pressure. In other recent news, January same-store chain store sales were up 4.8% from a year ago, according to the International Council of Shopping Centers. These figures, along with strong auto sales as well as other data, suggest a very strong January for overall retail sales. The new year is off to a fast start as the economy continues to pick up steam.
Click here for a printable version.
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| | Blowout Employment Report Today |
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| Posted Under: Data Watch • Employment |
Implications: There is only one word for it – Blowout! This makes the second consecutive month that the employment report surprised big-time to the upside and was the best report since the start of the recovery. Private payrolls were up 257,000, crushing the consensus expected gain of 160,000. Revisions for the past two months added another 66,000 and an annual "benchmark" revision added 143,000 for the year ending in March 2011 (+165,000 including government workers). Total hours worked were up 0.2% in January and were revised up for December. The jobless rate dropped to 8.3%, down from 9.1% a year ago. Moreover, the drop happened despite an increase in the labor force of 249,000, which more than outweighed the losses of 167,000 in November/December.
The labor force is now up 907,000 from a year ago. As you can imagine, seeing this data tempts us to take a victory lap; our forecast of nonfarm payroll gains of 180,000/month this year may now be too low. However, our euphoria is tempered slightly by the impact of the weather, which has been unusually mild. The household survey shows that weather in January kept 206,000 people away from their jobs – in a typical January, this number averages 430,000. But, wait a minute. You can't take this difference of 224,000 and subtract it from the payroll survey. The weather stuff comes from the household survey, which showed a 631,000 job gain in January. Without the weather it would have been more than 400,000 and the unemployment rate would have still fallen. In other words, it's still a great report, but we expect a payback if and when the weather gets worse.
The bottom line for monetary policy is that a third round of quantitative easing, which we always believed was very unlikely, now looks even less so. The bottom line for the economy is that consumer purchasing power keeps growing. Hours worked in the private sector are up 2.7% in the past year, while average hourly earnings are up 1.9%. This translates into a 4.6% gain in cash earnings (excluding fringe benefits, like health insurance), which is more than enough to outpace inflation. The "growth deniers" need to develop a new narrative.
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| | Low Labor Force Participation Rate?...Not So Fast |
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| Posted Under: Data Watch • Employment • Research Reports |
In his response to the State of the Union Address last week, Indiana Governor Mitch Daniels said that the "percentage of Americans with a job is the lowest in decades." This echoes the focus of many bearish analysts on the labor force participation rate, which is the share of the population that is either working or looking for work. Participation was only 64.1% in 2011, the lowest since 1983.
The bears don't care that in 2011 private payrolls increased 160,000 per month and the unemployment rate fell almost a full percentage point. They don't even care that the labor force actually grew. They argue that the labor force isn't growing fast enough and if it had grown as fast as population growth, the unemployment rate would be significantly higher.
But, even though the labor force participation rate is the lowest in a generation, it is not the negative silver bullet that bearish analysts think. Data from 1995 and 2005 suggest the participation rate is right about where it should be.
The second chart shows the participation rates in 1995, 2005, and 2011, both overall and broken down into thirteen different age groups. Notice how participation tends to rise rapidly until people hit their late 20s, plateaus until around age 50, and then starts to decline into older age groups.
As our society ages, these demographic and behavioral shifts become more important. For example, the population of older Americans has increased significantly between 1995 and 2011 (see the third chart). What's really interesting is that the increase in population is occurring in age groups that typically experience reduced labor force participation.
Back in 1995, the overall participation rate was 66.6%. However, using participation rates by age group and the number of people in each age group, we can calculate what the overall participation rate would have been in 2011 if people in each age group in 2011 participated just as they had back in 1995. The answer is 64.7%. (Click the link below to see the addendum on the second page of the report for a more detailed description of the calculation.)
But the participation rate is also influenced by the business cycle. In general, when the unemployment rate is higher, participation rates tend to be lower, and vice-versa. In the past 20 years, a one percentage point change in the jobless rate is, on average, associated with a 0.133 change in the participation rate in the opposite direction. Back in 1995, the unemployment rate averaged 5.6%, compared to 9% in 2011. So the higher unemployment rate of 2011 should have pushed down the participation rate by an additional 0.5 percentage points.
In other words, if we had been asked back in 1995 what the participation rate would be in 2011 if the jobless rate were 9% and if every age group maintained the same participation rate as in 1995, we would have said 64.2%, almost exactly the 64.1% that actually prevailed in 2011.
Using numbers for 2005 generates similar results. If every age group had the same participation rates in 2011 that they had back in 2005, the participation rate would be 64.9%. Applying the increase in the unemployment rate between 2005 and 2011 suggests a further reduction in the participation rate to 64.4%, again very close to the 64.1% we actually experienced.
The US labor market is far from perfect. Better public policies during the past several years would have generated a much lower unemployment rate. These include less government spending, less political direction of capital investment, and less regulation. But there's nothing about the participation rate that says the labor market is operating worse than the official statistics show.
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| | Nonfarm productivity (output per hour) increased at a 0.7% annual rate in the fourth quarter |
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| Posted Under: Data Watch • Productivity |
Implications: Forget about productivity for a moment. Automakers reported January sales yesterday and they blew away consensus expectations. Autos and light trucks were sold at a 14.2 million annual rate, versus a consensus expected pace of 13.5 million. Sales were 4.6% higher than December and up 11.7% from a year ago. In fact, sales were the strongest since early 2008, even beating the temporary surge in sales in August 2009 due to cash for clunkers. Consumers don't buy big ticket items like this when they see the economy getting worse. Also, in other news today, initial claims for unemployment insurance fell 12,000 last week to 367,000. Continuing claims for regular state benefits declined 130,000 to 3.44 million, the lowest level since late 2008. The employment picture is definitely improving and can also be seen in the report on productivity for Q4. It is not unusual for productivity growth to slow temporarily after the initial stages of an economic recovery, as firms start to hire more workers and give their workers more hours. Nonfarm productivity increased at a 0.7% annual rate in the fourth quarter. Output continues to accelerate, but the number of hours worked is catching up. On the manufacturing side, productivity fell 0.4% at an annual rate as the number of hours worked rose faster than output. Over the past few years, manufacturers have gotten very lean, being able to produce more with fewer workers. Now hours are starting to come back and output will continue to move higher as more workers are hired. Unit labor costs (how much companies have to pay workers per unit of production) rose at a 1.6% annual rate in the manufacturing sector. We believe the long-term trend in productivity growth will remain strong, part of the technological revolution since the early-1980s. The result will be higher living standards.
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| | The ISM manufacturing index increased to 54.1 in January from 53.1 in December |
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| Posted Under: Data Watch • ISM |
Implications: Great reports again today on manufacturing and construction. The ISM manufacturing index was lower than expected, but the consensus was gathered before the ISM released annual revisions that lowered the overall level of the index. The consensus was expecting an increase of 0.6 points; instead there was an increase of 1.0 points. So the change was larger than expected. In other words, the manufacturing sector improved in January and just in case you still think a double-dip is possible, the new orders index came in at a very strong 57.6 in January suggesting more growth in manufacturing ahead. The employment index ticked down slightly to 54.3 but remains solidly above 50. This confirms other positive news on employment. The one sub-index that remains weak is inventories. The reluctance of manufacturers to accumulate inventories may hold back GDP in the short term, but we view this reluctance as temporary and indicative of better future growth. On the inflation front, the prices paid index rose to 55.5 in January. Monetary policy is very loose and, in effect, getting looser as the economy accelerates. In other news this morning, the ADP Employment index, a measure of private sector payrolls, increased 170,000 in January, close to consensus expectations. We anticipate the official Labor Department report (released Friday morning) will show a private sector gain of 155,000. Construction increased 1.5% in December (1.1% including slight downward revisions for home building in prior months). The gain in December was led by manufacturing facilities and power plants. Both commercial construction and home building are trending upward, with commercial building up 11.4% versus a year ago and housing up 4.9%.
Click here for a printable version.
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| | Real GDP Excluding Government Grew at a 4.5% Annual Rate |
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| Posted Under: Data Watch • GDP |
We recently received a very good question from one of our readers.
In our Data Watch on GDP last week we wrote that although real GDP grew at a 2.8% annual rate, real GDP excluding government grew at a 4.5% rate. This seemed to contradict our table, which showed that government was a drag of 0.9 percentage points on the growth rate of overall real GDP. If government was a drag of 0.9 points and the overall growth rate was 2.8%, shouldn't that mean real GDP ex-government grew at a 3.7% rate, not 4.5%?
The table was accurate and means that all sectors of the economy excluding government contributed 3.7 points to the real GDP growth rate.
But government purchases (think ships, roads, desks, not transfer payments or salaries) at all levels – federal, state, and local – are equal to about 20% of GDP. In order for 80% of the economy to contribute 3.7 pts to the overall GDP growth rate, that 80% of the economy has to grow at about a 4.5% rate. (We know that 3.7 divided by 0.8 suggests a 4.6% growth rate, but, for simplicity's sake, all of these numbers are rounded to the nearest tenth of a percent, which leads to some minor error.)
To make it even easier to follow, imagine if 90% of the economy was unchanged but some sector representing 10% of it grew at a 10% rate. Then overall GDP would grow 1% and we would say that small segment contributed 1 point to the overall real GDP growth rate.
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| | Fed Forecasts Depend on Data |
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| Posted Under: Monday Morning Outlook |
The Federal Reserve is doing everything in its power to hold down long-term interest rates because it thinks that doing so will help lift economic growth. In addition to quantitative easing I & II, the Fed is buying long-term Treasury bonds and also promising to hold short-term interest rates low for an extended period.
Since long-term interest rates are just a series of short-term yields strung together, promising to hold short-term rates down can influence long-term interest rates. The Fed thinks that this will help lift housing and the economy and push down unemployment.
Last summer, the Fed promised to hold rates down through mid-2013. Headlines from last week suggest that the Fed now thinks 2014. But, how committed is the Fed to this strategy? What will it take to change course? Some analysts argue that this is an ironclad commitment and there will be no course changes.
We believe this is a misreading of the Fed's intentions. There are 19 potential economic views that are important at the Federal Reserve – 7 are on the Board of Governors and 12 are Presidents of regional banks. Right now, two Governorships are un-filled, which means there are 17 forecasters (12 Regional Bank Presidents and 5 Governors). Of these, six expect a rate hike before the end of 2013. Of the 11 who think rates will end 2013 where they are today, five expect a rate hike before the end of 2014. In other words there is more disagreement at the Fed than meets the eye.
In his press conference after the release of these forecasts, Fed Chairman Ben Bernanke said that if the economic data proves the Fed either too optimistic or too pessimistic, it would most likely change its forecast and alter policy expectations.
In other words, faster growth, lower unemployment, and higher inflation – like we anticipate – would move up the start of rate hikes before late 2014, possibly even before mid-2013.
Within the Fed's new and more transparent communication of its economic beliefs there are some very important pieces of data. While members forecast their near-term expectations for growth, inflation and interest rates, they also put figures on what they deem to be the long-term, steady-state, equilibrium world.
Every single one of the 17 forecasts put the long-run forecast of an appropriate (equilibrium) federal funds rate at or above 3.75%. This is not a surprise. Fed forecasters judge the equilibrium growth rate for long-run nominal GDP to be 4.3% to 4.6% - about 2% inflation and 2.3% to 2.6% real GDP.
We look at these two long-run forecasts as consistent with our models which use nominal GDP growth as a target rate for the federal funds rate. The only problem is that nominal GDP grew 3.7% in 2011 and 4.2% at an annual rate over the past two years. In other words, the current economy is already very close to the Fed's long-run forecast. This means that the federal funds rate is currently too low. A zero percent rate with growth already near 4% makes no sense from a monetary policy perspective. The funds rate should be much higher if the goal is keeping inflation stable.
But the Fed is convinced that it can keep rates below its long-run levels without risk of inflation because the economy has unused potential (high unemployment and unused capacity). The Fed thinks the housing market needs zero percent interest rates to heal and to grow again.
We think this is a mistake. For example, a zero percent interest rate may not even be low enough to boost housing, but the same zero percent rate is already too low for manufacturing or farming or commodities. In the 1970s, when the Fed unwisely attempted to bring unemployment back down to levels it thought were sustainable, the US experienced its worst inflation ever. We side with those members of the Fed who want rates up sooner rather than later. However, the Fed is a democratic organization and right now those hawkish members are outnumbered by the ones who think the economy can be manipulated.
As a result, look for growth and inflation to continue heading higher. This is a short-term positive for stocks and the economy, but it comes with a long-term downside. It's called inflation.
Click here for a printable version.
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| | Personal income increased 0.5% in December while personal consumption was unchanged |
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| Posted Under: Data Watch • PIC |
Implications: Despite surveys showing strong consumer spending in December; government data show a temporary lull, but this should not last. Purchasing power is up, even if you exclude government transfer payments. Excluding transfer payments, "real" (inflation–adjusted) personal income was up 0.4% in December and up 2.4% from a year ago. Real spending remains near record highs and will continue to move higher. Private-sector wages and salaries are up 4.6% from a year ago, which is faster than inflation. There were additional benefits paid to some social security beneficiaries in December which was due to retroactive payments to recent retirees based on a recalculation of the earnings base. In addition to the gain in wages and salaries, consumer spending is being supported by the large reduction in households' financial obligations the past few years. Recurring payments like mortgages, rent, car loans/leases, as well as other debt service, are now the smallest share of after-tax income since 1993. Also, autos are still selling below the pace of scrappage and growth in the driving-age population. This should lead to continued demand in the auto sector in the months ahead. On the inflation front, overall consumption prices are up 2.4% in the past year, above the Fed's supposed target of 2%. "Core" prices are up 1.8% from a year ago, the most since 2008. But, given the loose stance of monetary policy, we expect inflation to accelerate in the year ahead, both overall and for the core.
Click here for a printable report.
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These posts were prepared by First Trust Advisors L.P., and reflect the current opinion of the authors. They are based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.
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The information presented is not intended to constitute an investment recommendation for, or advice to, any specific person. By providing this information, First Trust is not undertaking to give advice in any fiduciary capacity within the meaning of ERISA, the Internal Revenue Code or any other regulatory framework. Financial professionals are responsible for evaluating investment risks independently and for exercising independent judgment in determining whether investments are appropriate for their clients.
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