The US is on pace for its best year ever for auto sales. Could that…
Happy New Year! The year just ended will no doubt be missed by some, but good riddance may be the prevailing sentiment for many more. The US economy under-whelmed us, with no pick-up in economic activity from the 2.3% rate of GDP growth that has been the norm since the end of 2009. Despite the smiles that $2 / gallon gasoline brought to consumers, the pain it caused energy with new producers was more pronounced than we anticipated. Corporate bonds were particularly hurt by the energy sector, as high-yield bonds sold off sharply. Commodities slumped along with China and energy prices. Stocks ended the year about where they began. The bright spots were real estate – both commercial and residential – and the US Dollar, which rose 10% versus other major currencies.
As 2016 begins, expectations are low. By that we mean that the markets anticipate little change in the pace of economic growth from 2015 (or 2014, 2013, 2012 …). With such a low bar set, it will not take much for the US economy to beat those expectations. Tepid economic growth may also play into the November elections unless there’s some noticeable improvement by mid-year. On the flip side, we see little concern for a recession any time soon. This should keep the Fed on pace to raise short-term rates about once each quarter – the next one expected by April.
Since the last update, the final revision to Q3 GDP put growth at 2.0% for the quarter. A dip in inventories edged GDP down from the 2.1% prior reading, but lower inventories should boost growth in Q4. Business investment in equipment grew at the fastest pace in a year, despite less investment in oil rigs and drilling equipment. Nominal GDP (real growth plus inflation) is up 3.1% from a year ago (rising at a 3.9% annual rate over the past two years). This means the Fed can raise short rates (Federal Funds) at least to 2.50% before they can even hint at being restrictive (too tight) in monetary policy.
Existing Home Sales fell 10.5% in November to a 4.76 million annual rate, pushing sales down 3.8% from a year ago. The decline was aided by a change in regulations – not the housing market itself. According to the National Association of Realtors (NAR), a new federal rule called “Know Before You Owe” altered the documents needed at closing and pushed into December many closings that would normally have happened in November. The NAR said that 47% of realtors reported longer timeframes to close in November compared to a year ago. As a result, we should expect a sharp rebound in December closings before they return to trend early in 2016. Lack of supply remains an impediment, as existing homes for sale are down 1.9% from a year ago, leaving buyers with few choices and rising prices (the median sales price is up 6.3% from a year ago).
New Home Sales increased 4.3% to a 490,000 annual rate in November, and are up 9.1% in the past year. Unlike existing home sales, which are counted at closing, new home sales are counted when a contract is signed, so they weren’t affected by new lending rules (above). Despite the solid gains in this sector, the current pace of 490,000 new homes sold is still low relative to history. Given population growth rates, sales should roughly double to about 900,000 over the next few years.
The FHFA Index (which measures prices for homes financed by conforming mortgages) increased 0.5% in October and is up 6.1% from a year ago. That’s a pick up from the 4.7% gain in the year ending in October 2014. Over the past year, price gains have been the fastest in the Mountain Time Zone (Montana, Idaho, Wyoming, Nevada, Utah, Colorado, Arizona, and New Mexico), while price gains have been the slowest in New England.
New orders for Durable Goods were unchanged in November after a strong 2.9% rise in October. Civilian aircraft orders fell 22.2% in November, but the dip was more than offset by gains in autos and defense aircraft. Orders excluding the transportation sector were down 0.1%.
Personal Income rose 0.3% in November, and is up 4.4% in the past year. The increase was once again led by private-sector wages and salaries, which was helped by a large one-time bonus to United Auto Workers employees as part of recent contract ratifications.
Personal Spending is up only 2.9% from a year ago, despite torrid auto sales. Since wages are staying ahead of spending, the rise in consumer spending isn’t relying on some sort of credit binge. Rather, it reflects higher purchasing power by American workers who are producing more, earning more, and spending more as a result. Private-sector wages and salaries rose 0.5% in November and are up 4.9% from a year ago.
So, the S&P 500 ended the year down less than 1% (0.75%), after three years of double-digit returns, but it beat gold as an investment (down 10%). The 10-year Treasury note had a total return of about 1.5%. Oil was down over 30%, while European stocks and emerging markets slumped as well. The NASDAQ was up over 5% and Japanese stocks rose over 8%. We continue to see daily prognostications for another stock market crash, as we have for the past five years. Yes, US stocks took a breather in 2015 after six years of increases, but it’s too soon to throw in the towel. The shockwaves from the 2008 financial crisis linger. Investors fret that Fed rate hikes will choke economic growth, but monetary policy remains extremely accommodative and will not hinder growth in 2016.
The Fed is expected to lift short rates (Fed Funds) to 1.50% by year end (from 0.50% today, but what does that mean for longer rates? The Fed projects that nominal GDP (growth plus inflation) will hover around 4% per year over the long term, which is consistent with a 10-year Treasury yield of 4%. Historically, the 10-year Treasury yield tends to equal nominal GDP growth. However, given the slow, patient pace of Fed rate hikes, it may take a while to get there.
Employment could grow another 2.5 million this year, similar to 2015, with continued wage growth. Rising wages should pull more workers into the workforce and, thus, temper improvement in the headline unemployment rate (but should show greater improvement in the wider U-6 unemployment rate).
The wild card in all this is inflation. The Fed’s still-accommodative monetary policy could cause a spike in inflation as soon as energy prices bottom out. Other prices are heating up behind the scenes. For example, housing costs (rent – which makes up close to 30% of the CPI) are up 3.2% from a year ago and has sped up over the past five years. Medical care is up 2.9% in the past year. An unexpected jump in inflation would force interest rates to rise faster than the markets currently anticipate.
The year starts off with a busy economic calendar this week, capped by the December Employment report on Friday. Let’s get started.