Last updated: June 30, 2017
The economy added 138k jobs in May, a level below consensus estimates but significantly above the rate needed to maintain the current unemployment rate. The 6-month average of monthly gains is 177k with wages growing at an annual rate of 2.5%. The unemployment rate has been at or below 5% for the past 21 months with a current reading of 4.3%. This is the lowest level since 2007 and compares to the 50 year average rate of 6.1%. A strong labor market bodes well for consumer confidence and consumer spending and is a positive factor for GDP growth and corporate earnings.
Source: Bureau of Labor Statistics May 2017
The final estimate for Q1 GDP came in at 1.4%. This compares to 2.1% growth in Q416. The deceleration in growth reflected a slowdown in consumer spending and a downturn in private inventory investment, along with seasonal factors. These items were partially offset by an upturn in exports and acceleration in both business spending and housing. Current economic estimates call for U.S. GDP to be 2.2% in 2017 and 2.5% in 2018. World GDP growth is expected to increase by 3.4 % in 2017 and 3.6% in 2018.
The PMI U.S. Manufacturing Index has shown improvement over the past year, with a recent reading of 52.7. Manufacturers have noted stronger optimism for demand alongside solid new order growth. Weaker readings a year ago were driven by the strong dollar, lower energy sector investment, and slower growth both in the U.S. and abroad. Outside the U.S., Eurozone manufacturing data has been solid and improving over the past year, with a recent reading of 57.3. In China, the data has likewise shown improvement, with readings at or above 50 for 10 of the past 11 months. Historically, readings above 50 are associated with an expanding manufacturing sector and healthy GDP growth, while readings below 50 can signal contraction. Chinese data is closely watched given its importance to many emerging market countries.
Survey results for S. non-manufacturing (services sector) have moderated, but the longer term trend remains solidly above 50. The most recent reading was 53.6, down from a 14-month high of 55.6 in January. Survey respondents have recently commented on improving domestic economic conditions and a general upturn in willingness to spend among clients. Readings above 50 indicate the non-manufacturing economy is generally expanding. The non-manufacturing sector represents approximately 88% of the U.S. economy.
The latest consumer sentiment reading came in at 95.1, near post-recovery highs. Consumer sentiment has been helped by low interest rates, strong jobs numbers, and low energy prices. Since 1970, this index has averaged 85.3 with average peak levels of 99.9 and average trough levels of 62.3. A confident consumer would be expected to increase spending. This is important because consumer spending accounts for almost 70% of GDP.
Retail sales data slowed somewhat in May, but remains solid at 3.8% y/y growth overall and 4.0% ex-auto. Discretionary spending across several categories has been strong, including furniture stores, internet, and home improvement. Sectors that have been notably weak include sporting goods and music stores, department stores, and electronics. These areas continue to lose sales to online retailers. Retail sales are a major indicator of consumer spending trends as they account for almost half of consumer spending and one-third of GDP. A strong retail sales number factors positively into GDP.
Monthly sales data for both new and existing homes has improved, but continues to be choppy on a monthly basis. Housing starts and permit data have been relatively healthy and tend to be leading indicators of overall strength in the housing sector. Housing prices have been steady with the most recent Case-Schiller Index showing 5.9 % y/y growth across 20 major metropolitan areas. Periods of rising home values encourage new construction as well as consumer spending.
Inflation at both the wholesale and retail levels has shown improvement over the past several months, after being been held down by lower energy prices and low inflation abroad. The latest reading for wholesale inflation as measured by the Producer Price Index showed 2.1% y/y growth ex-food and energy and 2.4% overall. Retail inflation, as measured by the Consumer Price Index, has moderated recently, with the latest reading showing 1.7 % y/y growth on a core basis and 1.9% overall. The PCE Price Index, preferred by the Federal Reserve to measure inflation, has also softened somewhat at 1.4 % y/y growth on both a core and headline basis. This compares to the Federal Reserve’s long term target of 2.0%. Low levels of price inflation have been a concern for policymakers in both the U.S. and other developed economies. As such, modest levels of price increases are viewed favorably.
Corporate Earnings & Valuation
After being negatively impacted by weakness in the energy sector and a strong dollar for much of the past 18 months, U.S. corporate earnings have improved. This trend is expected to continue for the next several quarters, with high single digit earnings growth currently estimated for both 2017 and 2018. The current 12–month forward PE ratio is 17.6 versus the 25 year average of 15.9. When taking current low interest rates and low inflation into account, valuation multiples are at average levels versus history. International and emerging market stocks currently trade at a discount to the U.S. market. Corporate earnings are the key driver of stock prices over the medium-long term. The chart below shows this relationship for the S&P 500.
Source: Factset, June 23, 2017
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