LEIPLINE Newsletter - August 2014 The Jacksonville Economy in the Third Quarter of 2014

Introduction

This is the thirty-second installment of the LEIPLINE.  Our primary focus here as in the past is the four variables for which we collect data and the implications of those data for the Jacksonville MSA overall.  We begin this installment, like the others, with a brief discussion of the national macro economy.  The third quarter of 2014 like the second was an above average quarter in terms of growth and improvements in unemployment.  The first and second estimates of real GDP growth suggest another positive movement in the third quarter to above average levels.  Inflation is still amazingly below historical averages despite improving loan demand and enhanced growth, in large regard related to falling oil and gasoline prices.  While the European Union is flat and China, Brazil, and India along with other emerging nations are seeing their growth slow, the U.S. economy is acting in its historically driving role towards expansion.

 

In this edition of the LEIPLINE, we report our sixth formal numerical forecasts of the data we collect, for the three months of the fourth quarter of 2014, plus January 2015.

 


The National Macro Economy

Both the first and second estimates of real GDP for the third quarter of 2014 were well above historical norms at 3.5% and 3.9% respectively.  The latter estimate surprised many economists who anticipated a revision downward.  On the heels of 4.6% growth in 2014.2, this reflects the best back-to-back growth in real GDP since the third and fourth quarters of 2003!  This sizable growth surge was driven primarily by consumer purchases of durable goods (respectively by 14.1% and 8.7% in the second and third quarters). Fixed investment in equipment of 11.2% and 10.7% respectively contributed significantly along with goods exports of 14.3% and 6.7%, and a deluge of national defense expenditures in 2014.3 of 16%.  In addition, state and local government spending rose by over 4% in aggregate over the two quarters. 

 

The November 25th release from the BEA indicated that “[t]he increase in real GDP in the third quarter reflected positive contributions from PCE, nonresidential fixed investment, federal government spending, exports, residential fixed investment, and state and local government spending that were partly offset by a negative contribution from private inventory investment.  Imports, which are a subtraction in the calculation of GDP, decreased.  The deceleration in the percent change in real GDP reflected a downturn in private inventory investment and decelerations in exports, in nonresidential fixed investment, in state and local government spending, in PCE, and in residential fixed investment that were partly offset by a downturn in imports and an upturn in federal government spending.”

Third quarter inflation reversed much of the surge in May and June with the overall inflation rate in the quarter absolutely flat.  October’s inflation rate was also zero defying predictions that as the economy expanded that inflation would arise. Clearly, the reason for the stable prices is primarily derived from the significant drop in energy prices in virtually all categories for the entire quarter.  For example, gasoline prices were off collectively by over 8.4% from July through October (5% total for the last 12 months) while fuel oil was down collectively over 14% from April through October.  Despite some increases in electricity prices, energy prices were 1.6% lower overall in October 2014 than a year before.  The categories with higher prices include food which rose one percent over the last four months (particularly food at home) and shelter prices which are up 1.7% cumulatively since April.  Medical care services prices also grew moderately in the last four months at less than one-half of one percent.  Overall, the inflation rate for the last twelve months has grown only 1.7%. 

 

The third quarter unemployment rates were consistently falling from 6.2% in July to 6.1% in August to 5.9% in September.  The October rate of 5.8% was 1.4% lower than the 7.2% unemployment rate in October 2013.  The implication of the most recent data is however, that 9 million people remain unemployed, 2.9 million who have been unemployed for 27 weeks or longer or 32% of those who are unemployed.  The civilian labor force participation rate remained very low compared to the last forty years at 62.8%, reflecting departures from the labor force and particularly unfortunately, very slow assimilation of new entrants recently graduated from high school and college.  The largest component of the reported unemployment rates, U-6 is still 11.5% reflecting those marginally connected to the labor force plus those working part time that would prefer to work full time.  The biggest drag on our economy’s growth right now is underemployment driven by baby boomers who cannot acquire suitable employment, young people who are having trouble breaking into the labor market due to the elimination of many entry level programs, and those boomers who cannot retire, thus who are standing in the way of the young people because interest rates are so low that the earnings on their retirement income are insufficient to allow them to depart.  The trend in unemployment is definitively in the right direction, but way too slowly for substantial enhancement of standards of living.

 

Interest rates continue to remain way below historical norms.  For example, the average yield on three year treasury bonds (an intermediate term, virtually riskless asset) for the period identified as the “Great Moderation,” i.e. 1986-2005 was 5.69%.  This period was after the intervention of Paul Volker as Chairman of the Federal Reserve Board of Governors, but reflective of the time frame when inflation rates moderated and growth was relatively strong.  The most recent three year rate from this past Friday was 0.97% and it has not been above even 1% since April of 2011.  Naturally, this is the FED’s doing and it is our opinion that contrary to conventional wisdom, rates this low are slowing growth not assisting it.  The largest commercial banks are allocating very sizeable portions of their portfolios to investments in financial assets instead of loans.  Major corporations are massively cash rich, but the real engine of our economy, small and medium sized businesses, are cash poor without the means to either employ the financial markets for capital resources or their traditional partnership agreements – i.e., bank loans, to finance their expansion.  The Wall Street Journal reported this past week that loan growth is up, but as is the custom, most of the money is going to customers who need it less.  The bottom line is that bank spreads on loans to smaller customers are too anemic with current interest rates to justify the lending

What Does It All Mean?

The third quarter of 2014 was another very strong one implying that the U.S. economy is moving in the right direction.  While many economists have concluded that oil and gasoline prices are not as important as they once were, it is difficult not to recognize that the acceleration of growth over the last seven months has corresponded to declining energy prices with significant correlations.  The stance recently taken by Saudi Arabia and the decision by OPEC to maintain current output levels is extremely supportive of the likelihood that U.S. growth will continue its acceleration and will likely hasten recovery in Europe.  Maintaining our tendency toward cynicism, we expect that OPEC recognizes that global weakness is not in their long term best interest as innovations in energy are hurrying the time period when fossil fuels will be obsolete, so they are choosing a path that is both most advantageous for world economies and the oil producing countries as well.  Adam Smith strikes again!

The Local Data

Since many of the data change for at least one month after we first report them, we have decided to wait until at least the middle of the following quarter to report each quarter’s implications.  Since the local CPI is the most significant variable that we analyze, we will start with it.

The 2014.3 Jacksonville CPI (add chart)

 

The 2014.3 Jacksonville CPI

 

 

 

 

The LEIP CPI has been down each of the last three months (through October) and down four of the last five months.  As mentioned above, the driver has been lower energy prices, but there have alternatively been price reductions in new cars and trucks, alcoholic beverages, recreational products and educational books and supplies.  The overall inflation rate thus far this year at an annualized rate is only 0.15%.  Like has been the case for most of the existence of LEIP, the local inflation rate is well below the national average, partly because we believe that inflation tends to be lower in Jacksonville relative to many other cities, but also due to the downward bias in our methodology compared to the BLS procedures.  However, since the economics literature implies that the national CPI is biased upward by around one percent, we perceive that our calculations may to spot on.

 

 

 

Below is a chart that reveals the actual (annualized) inflation rates for the first, second, and third quarters of 2014 (plus October), with our forecasts through January 2015 reported in red. The procedure employed to produce these forecasts is called vector auto regression or VAR.  It employs two periods of lags of past values of the variable being forecasted to estimate the future values.  The forecasts for the fourth quarter of the year and January suggest inflation much higher than we saw in the third quarter, averaging almost exactly 3%.  Whether this comes to fruition will depend on whether the FED raises its target interest rate and whether doing so causes improved use of funds and bank loans that promote growth.  Most pundits do not believe that the FED will raise rates until the middle of 2015, but we believe that the FED is already at least a year overdue to generate the best outcomes for the macro economy.  It is interesting that the inflation rate is expected to decelerate (called disinflation) from November through January.  Clearly our forecasting methodology did not account properly for the declines in oil and gasoline prices that drove the third quarter inflation rates.

 

 

 

 

 

Year Month Actual Inflation Monthly in Percent Forecast Inflation Monthly in Percent
2014 1 -3.77 2.61 
2014 2 1.13 2.31 
2014 3 1.45 3.38 
2014 4 2.41 3.03 
2014 5 2.26 2.49 
2014 6 1.13 3.41 
2014 7 1.25 3.36 
2014 8 -0.72 3.04 
2014 9 -3.22 3.21 
2014 10 -0.52 2.66 
2014 11   5.39
2014 12   2.39
2015 1   1.23

 

 

 

 


Unemployment (add chart here)

The Jacksonville unemployment rate has bounced somewhat more than the national numbers over the last four months. The summer was worse locally than nationally which we attribute to the large influx of high school and college students into the local job market this past solstice.  Now that fall is about to turn into winter, the unemployment rate has settled just below the national number for the last two months and is forecasted to continue to decline even into January.  Each of the last couple of months has revealed major declines in the numbers of workers unemployed while the workforce has general increased and so too has the number of workers employed.  Help wanted advertising is up (and not just for seasonal employment) but the climate for recent graduates still lags behind historical norms. 

 

In the chart below, our forecasts for the seasonally adjusted unemployment rates are once again statistically superior to those for inflation, but are still biased towards a more optimistic view relative to the fourth quarter plus January.  If our estimates are correct, the local MSA unemployment rate is headed towards the low 5% range by the latter part of the year. We were overly optimistic for the third quarter, particularly in September, but we were very close in our prediction for a normally low seasonality month in October.

 
Year Month Actual Unemployment Rate Monthly In Percent Forecasted Unemployment Rate Monthly In Percent
2014 1 5.50 5.75 
2014 2 6.00 5.94  
2014 3 6.18 5.80
2014 4 5.69 5.70
2014 5 6.00 5.66
2014 6 5.66 5.62
2014 7 6.17 5.62
2014 8 6.49 5.40
2014 9 5.76 5.26
2014 10 5.76 5.73
2014 11   5.51
2014 12   5.32
2015 1   5.12


Leading Indicator (LEI)

The LEI was generally positive with the exception of June and August, with October up near the highest the LEI has been ever.  Building permits have been pretty stagnant, but help wanted advertising is solid and consumer confidence is significantly higher than earlier in the year.  We have forecasted a continued decline in initial claims for unemployment insurance, but the reality is that the Department of Economic Opportunity for the state of Florida has once again taken down their data for this component and we have had to forecast these numbers from statewide numbers.

The chart below reveals our forecasts for the leading indicator.  After consistently under forecasting the LEI earlier in the year, we over estimated what the LEI would achieve in the last three months.  November is forecasted to generate a small correction, but December and January are forecasted to reveal improvements that hopefully signal a strong spring business sector.

 

Year Month Actual LEI Monthly (2001.12=100) Forecasted LEI Monthly (2001.12=100)
2014 1 114.58 113.58
2014 2 116.55 114.95
2014 3 116.26 114.91
2014 4 116.25 114.81
2014 5 116.53 115.25
2014 6 115.75 115.29
2014 7 116.37 115.37
2014 8 115.28 116.56
2014 9 116.27 116.83
2014 10 116.45 117.02
2014 11   116.66
2014 12   117.17
2014 1   117.36

 


Stock Price Index

The local stock index implies that local stocks have been generally on an upward trajectory, but perhaps not as much so as the DOW.  More specifically, since weak July and August numbers, the local stocks have generated gains in both of the last two months. 

 

The final chart below presents the forecasts for the stock price index through the end of the fourth quarter of 2014, plus January 2015. We did very well in October after frequently over-predicting the stock index for most of the year.  November is not anticipated to be a very good month, but December and January look rosier.

 

Year      Month Actual Stock Price Index Monthly no change = 100  Forecasted Stock Price Index Monthly no change = 100 
2014 1 96.60 101.77
2014 2 102.3 102.80
2014 3 103.9 101.94
2014 4 98.7 100.00
2014 5 100.2 104.02
2014 6 101.7 102.11
2014 7 98.2 101.60
2014 8 91.1 101.17
2014 9 112.9 101.38
2014 10 101.8 101.78
2014 11   99.30
2014 12   102.90
2015 1   102.50

 


The Bottom Line, Locally

The CPI was decidedly lower in the last quarter plus October, which in the last six years has been indicative of relative weakness.  However, those who contemplate basic economic principles know that deflation can result from either a very weak economy or one that is growing strongly.  We prefer and perceive that the latter is what is dominating as we approach the end of 2014.  The LEI has been positive for the last three months, local stocks are holding their own, and unemployment is continuing its downward trend.  With perpetuation of moderating oil and gasoline prices and what seem to be consumer preferences for buying this holiday season (as this is being written on Black Saturday), the outlook is as positive as it has been in the last seven-plus years.