September Business Conditions Monthly

Indicators at a Glance
Capital Market Performance
Consumer Finance Rates
Leading Indicators (1950–2017)
Roughly Coincident Indicators (1950–2017)
Lagging Indicators (1950–2017)
AIER’s Leading Indicators Increase Again: The Calm Before the Storm’s Impact

The AIER’s Leading Indicators Index increased again in August to a reading of 88 from 83 in the prior month. The Coincident Indicators Index remained at a perfect 100 for a sixth month while the Lagging Indicators Index held at 50 (see chart below). The gain in the AIER’s leading indicators shows the economy had broader momentum midway through the third quarter compared to the latter part of the second quarter, when the Leading Indicators Index touched 75.

Economic growth in the second quarter was revised up to a 3.0 percent pace compared to just 1.2 percent in the first quarter. Overall, the outlook remains favorable, with continued economic expansion and moderate price increases. However, economic data over the next few months are likely to show some weakness, reflecting the impact of Hurricane Harvey (and possibly IRMA). Natural disasters tend to have a negative but short-term impact followed by positive contributions to economic activity from clean-up and rebuilding.

Nine indicators were expanding in August while three were neutral and none were declining. That compares to eight expanding, none declining, and four neutral in July. August marks the second month that no indicators were trending lower.

Just one indicator changed direction in August. The improvement came in the average workweek in manufacturing. It moved up from a neutral trend to a positive trend in the latest reading. The other labor indicator, initial claims for unemployment insurance, maintained a positive trend for the month. Both indicators are at risk of weaker results in the months ahead due to Hurricane Harvey. The length of the average workweek may return to a flat or negative trend as businesses in the Houston and surrounding areas remain shut down. Likewise, initial claims for unemployment insurance could rise with restricted activity. The claims data may also be hampered by the inability of newly unemployed workers to file claims if state government offices are closed.

For the two business-investment-related indicators, real new orders for core capital goods and unit heavy-truck sales maintained their positive trends for the latest month. These two indicators may be somewhat less negatively impacted in the very short term, but both are likely to be beneficiaries over the medium term as capital equipment destroyed in the storm and flooding is replaced.

Housing permits remained in a neutral trend in the latest update. Like the initial-claims data, applications for new-home construction may be hit by both a drop in activity and by the closing of government offices. Over the longer term, housing—either new construction or improvements and repairs—should be one of the biggest beneficiaries.

Among the financial indicators, all three indicators—real stock prices, the yield curve, and real balances in margin accounts—remained in favorable trends in August. These indicators may prove to be the most resistant to impact from Harvey. Stock prices remain near all-time highs, helped by strong corporate earnings. Companies that participate in clean-up and rebuilding efforts may show some relative outperformance in the future, but in aggregate, there appears to be little negative current impact. 

For the yield curve, the yield on the one-year Treasury bill has been drifting higher since the Federal Reserve began raising the federal-funds target rate in late 2014. The yield on the one-year T-bill was close to zero at that time and now is around 1.25 percent. The yield on the 10-year Treasury note dipped below 1.4 percent in mid-2016 then surged to over 2.6 percent by the end of the year. Since December, however, the yield on the 10-year note has fallen back down to below 2.2 percent, leading to a flatter yield curve.

Among the consumer-related indicators, consumer expectations about future economic conditions has been flipping back and forth between positive and neutral trends over the past few months. The movement has been largely attributed to political factors, but regardless of the cause, consumer sentiment remains at relatively high levels, driven primarily by the strong labor market. Real retail sales has been one of the strongest and steadiest of the leading indicators, registering a long string of favorable results. Even with a softer month or two in real retail sales, the trend appears well established. Real new orders for consumer goods has been trending flat over the past few months. A significant share of consumer spending goes to imported goods, and both imports and domestic production are likely to benefit as clean-up and rebuilding efforts accelerate. 

The Coincident Indicators Index registered a perfect 100 for the sixth month, as all six of the indicators continued expanding. The six-month run of perfect readings is the first such run since November 2014 to April 2015. All six of the coincident indicators are now showing strong expansion trends. 

The AIER’s Lagging Indicators Index held steady in August, posting a reading of 50 for the second month. Overall, two indicators are trending higher, two are now trending flat, and two are in a downward trend.

Wage growth remains modest amid a tight labor market
Despite a robust labor market, hourly-earnings gains remain modest. The employment report for August from the Bureau of Labor Statistics shows payrolls rose by 156,000. That is a solid gain, though it is below the average monthly gain of 175,000 over the past year. The government sector lost 9,000 jobs in August while private-sector employers added 165,000. Within the private sector, goods-producing-industry payrolls added 70,000 new workers, the largest monthly gain since February and double the average monthly gain of 34,000 over the past year. Gains were particularly strong for construction and durable-goods manufacturing.

Private-service-producing payrolls added 95,000 jobs in August. While that is a decent gain, it is below the 140,000 average gain over the past year. The disappointing areas within services were health care, which added 17,000 new workers compared to the average monthly gain of 33,000, and leisure and hospitality, which added just 4,000 employees compared to an average of 27,000. Professional and business services added 40,000 new workers, though none were in the temporary-help subcategory. Over the past year, professional and business services have added an average of 50,000, helped by an average gain of 11,000 in the temporary-help category.

Though employers continue to add workers at a pace fast enough to drive the unemployment rate down to 4.4 percent, average hourly earnings rose by just 0.1 percent in August, and are up 2.5 percent from a year ago, about the same pace as the past four months. Two forces may be contributing to the relatively modest pace of growth in hourly earnings. First, the low-inflation environment makes it difficult for businesses to raise selling prices. That restraint forces employers to keep a lid on pay raises unless offsetting non-labor costs can be reduced or productivity increases help reduce unit labor costs. The flip side to slow wage gains in a low-inflation environment is that real wage gains are more significant. Real average hourly earnings (measured in 1982–1984 dollars) hit a peak of $9.37 in 1972. Real earnings began a multiyear decline dropping to a low of $7.75 in 1995. Since then, real hourly earnings have been rising at an annualized rate of about 0.8 percent over the last 20 years, putting real earnings at $9.29 as of July 2017, less than 1 percent below the all-time peak. While the trend from 1972 through 1995 was extremely negative, the period since 1995 has brought real earnings back to prior peak levels. Just getting back to levels from 40 years ago may not be anything to cheer about, but it is progress and there is far more to measuring living standards than just hourly earnings.

The second major force that may be impacting the nominal average hourly-earnings measure is demographics. As the large wave of baby boomers retire, higher-earning older workers are being replaced by lower-earning younger workers. An alternative measure of earnings from the Atlanta Fed shows median-wage growth among U.S. workers has been rising between 3 and 4 percent since early 2015. It may be that earnings are growing more than the average hourly-earnings data from the monthly employment report suggest.

Corporate sales and earnings are supporting equity prices
Second-quarter sales and earnings for the Standard & Poor’s 500 posted solid gains. With 498 companies reporting results as of September 1, earnings are up 12.1 percent over second-quarter 2016. That result was helped by a strong recovery in energy sales and earnings. Excluding the energy sector, S&P 500 earnings were up 9.5 percent. Among the individual sectors, technology posted earnings gains of 16.7 percent followed by the financials with a rise of 12.1 percent from a year ago. In the middle of the pack were health care (+8.7 percent growth), materials (+7.7 percent), industrial (+7.3 percent), and utilities (+6.1 percent). At the bottom were telecom (+4.8 percent), real estate (+4.6 percent), consumer staples (4.5 percent), and consumer discretionary (4.1 percent). No sector posted a decline in earnings from a year ago,

The bottom-line growth was helped by a 5.2 percent increase in topline revenue. Excluding the energy sector, revenues were up 4.3 percent over the prior year. Data from the national income and product accounts from the Bureau of Economic Analysis show after-tax corporate profits (excluding inventory-valuation adjustments and capital-consumption adjustments used by the BEA for national income accounting) rose 8.1 percent from a year ago. These data include not just the S&P 500 but all corporate entities in the United States.

Looking ahead, current consensus expectations for S&P 500 earnings according to Thomson Reuters show third-quarter earnings are expected to post a 6.5 percent gain from the prior year, followed by 12.2 percent growth in the final quarter of 2017. Estimates for the first two quarters of 2018 show 10.2 percent and 10.0 percent gains. Certainly, expectations are subject to revisions as economic events unfold, but the current trends in economic activity, impacts from Harvey (and possibly IRMA) notwithstanding, appear to support expectations for continued growth in both topline revenue and bottom-line earnings.

Indicators at a Glance
Capital Market Performance
Consumer Finance Rates
Leading Indicators (1950–2017)
Roughly Coincident Indicators (1950–2017)
Lagging Indicators (1950–2017)

Robert Hughes

Robert Hughes joined AIER in 2013 following more than 25 years in economic and financial markets research on Wall Street. Bob was formerly the head of Global Equity Strategy for Brown Brothers Harriman, where he developed equity investment strategy combining top-down macro analysis with bottom-up fundamentals. Prior to BBH, Bob was a Senior Equity Strategist for State Street Global Markets, Senior Economic Strategist with Prudential Equity Group and Senior Economist and Financial Markets Analyst for Citicorp Investment Services. Bob has a MA in economics from Fordham University and a BS in business from Lehigh University.

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