LEIPline Newsletter - August 2015 The Jacksonville Economy in the Second Quarter of 2015

Introduction

This is the thirty-fifth 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, yet again, with a brief discussion of the national macro economy.  The first quarter of 2015 was disappointing, but with further revisions, not as bad as reported in the last LEIPLINE based on the second release of the data.  The first two estimates for the second quarter are closer to historical norms, with the second estimate actually robust.   Inflation continues to persist at below historical averages despite improving U.S. growth, but there has been some increase in inflation in durable goods areas and food prices.  The rest of the world is accelerating their expansionary monetary policy movements because of slow or declining rates of growth.  Of course, as of this writing, world equity markets are trying to recover from a week long free fall, blaming the movements on the weakening Chinese economy, but more likely concealing their concern for rate hikes by the FED. 

 

In this edition of the LEIPLINE, we report our ninth formal numerical forecasts of the data we collect, for the three months of the third quarter of 2015, plus October and November 2015.  


The National Macro Economy

While the first estimate for real GDP growth in 2015.1 was 0.2 percent growth, the revised data released on May 29th suggested that the movement was actually substantially negative at 0.7%.  However, the third report in July reversed itself again and ended at positive 0.7% growth.  This outcome, which is likely to be close to final (although the revisions can occur for up to three years), is less than a third of the preferred growth, but positive growth is far superior to the alternative both in terms of actual implications and its impact on consumer expectations.  While there is no systematic measure of world real GDP growth that is consistent across countries, a combination of slower growth in the big three outside of the United States (China, Japan, and India) and weak U.S. growth is not advantageous for future expansions in consumer and business well-being. 

 

The first estimate for the second quarter was much closer to the desirable level of growth at 2.3% but the revised estimate was excellent at 3.7%.  Last quarter we analyzed the last few years of first quarter growth and noted general relative weakness.  Since the end of the Great Recession, Second quarter growth has averaged just over 2.7%, smack in the middle of the range that economists argue is optimal for annual real GDP growth. 

 

Specifically, the second quarter report implied that “[t]he increase in real GDP in the second quarter reflected positive contributions from personal consumption expenditures (PCE), exports, state and local government spending, nonresidential fixed investment, residential fixed investment, and private inventory investment.  Imports, which are a subtraction in the calculation of GDP, increased.

The acceleration in real GDP in the second quarter reflected an upturn in exports, an acceleration in PCE, a deceleration in imports, an upturn in state and local government spending, and an acceleration in nonresidential fixed investment that were partly offset by decelerations in private inventory investment, in federal government spending, and in residential fixed investment.” http://bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm  Ultimately, the second quarter of 2015 reflected a return to more normal growth in the traditional areas with very positive news relative to exports, symbolizing a more robust Europe and improved U.S. trade elsewhere as well.

 

Second quarter inflation averaged between 2.5% and 3% for the second quarter.  The last time inflation was that high in the April to June time period was 2011, and before that one has to go back to 2008 and 2006.  The July inflation rate fell by tenth of a percent, but this was due to the beginning of the major drop in oil and gasoline prices.  That trend has continued through August with oil landing below $40 per barrel and gasoline averaging in the $2.30 range.  Naturally, the decline in oil prices is the result of increased U.S. production, Saudi Arabia’s willingness to circumvent OPEC restrictions, and the improvement in the value of the dollar (the oil market base currency).  However, reflection on prior declines in oil to the $40 per barrel level reveals gasoline prices below $2, not the $2.30 level currently.  A more global economic perspective leads to the realization that oil prices have found their level in a far more competitive marketplace than during the OPEC domination, and even the attempts by speculators and refiners to boost prices has not been very successful.

 

If inflation is going to increase between now and the end of the year it will be on the back of improving labor markets.  New job creation is ratcheting upward and initial claims for unemployment insurance are moderating.  The California drought and the impacts on fruit, feed, and grain prices is raising beef and chicken prices and eventually these markets will be more successful in passing on these higher costs to consumers.  We still believe that inflation will be higher in 2015 than any time since 2007, and we have mentioned several times before, justification for the FED to raise interest rates.

 

The unemployment rates for the second quarter and July continued their downward trend which has taken them to 5.3% for both June and July.  The July rate was nine tenths lower than the 6.2% unemployment rate in July 2014.  The most recent number is also 3.5% lower than in July 2009. Clearly, labor markets are considerably better off today than six years ago, but the labor force participation rate is extremely low which makes the headline unemployment rate look better than it would appear on an apples-to-apples basis.  Some economists believe that we have returned to full employment, but it is very clear that even given present propensities to not participate in the labor market by older workers and young people, we are not back to full employment as it occurred before 2007, and the evidence is overwhelming that we do not feel like the economy is healthy even if the data suggest that it is relatively so.

 

After hitting bottom in May of 2014, one year Treasury bill rates have rebounded by 30 basis points to 0.39%.  This level is still exceptionally low, but the trend is upward despite FED idleness.   Three year Treasuries have now been over 1% for eleven of the last twelve weeks after hitting bottom at 0.53% in October 2010. Thirty year Treasuries were in the low 3% range in June and July, but have fallen into the high 2% range since.  The reality is that rates are still very low, but an increase in inflation, or a sense by the FED that it is time to quell monetary easing will likely push both short term and long term rates up, but the former more so than the latter.  Pundits and those active in equity markets are dreading such a move (witness the over 2,000 point drop in the DOW last week), but interest rate normalcy is in our opinion the golden goose to stimulate growth, not the continuation of impotent quantitative easing that has been unsuccessful in the U.S. over the last six years, in Japan over the last 25 years, and just as unsuccessful as such policies will be in China and the EU in the near future.


What Does It All Mean?

We are quite well aware of the perspective that economics is the dismal science and of the countercyclical nature of interest in economic prognostications.  However, even the most Eyor-like economists (Dr. Mason’s nick-name within his immediate family) get tired of discussing bad news and diminished growth and productivity.  The U.S. and world economies are still not growing anywhere close to the desirable levels associated with business cycle expansion.  Consumer expectations are better than business ones and this is a fundamental driver of pervasive weakness.  Although basic macroeconomic analysis recommends that low interest rates will provide enhanced investment opportunities for business firms, which can only happen if the firms see increased consumer demand for their products and services in the near future.  As long as consumers are uncertain about employment and continuation of non-pecuniary benefits, as long as corporate dominance makes markets anti-competitive, and as long as governments spend billions in currency and tax dollars on ineffectual policy initiatives, the climate that will generate true expansionary pressures will be a long way off.  There is no denying that macroeconomic conditions in many countries in the world are better than six years ago, but robust expansion is still eluding us.

The Local Data

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 2015.2 Jacksonville CPI

 

Although there was some retrenchment in July, unlike prior second quarters, the inflation rate remained high in the April through June quarter.  Prices increased very significantly in June due primarily to a major escalation in housing prices and sales by over 19% annualized.  The annualized average inflation rate projected for all of 2015 based on January through July was 3.75%.  However, July revealed a small decline in the inflation rate due to slower housing growth and some diminutions in used car and truck prices and a few of the food price categories.  Overall, the outlook is for more inflation than Jacksonville has experienced since before the great recession, an indicator of improving economic conditions.

 

Below is a chart that reveals the actual (annualized) inflation rates for the quarters of 2014 (plus January through July, 2015), with our past forecasts and those from August through November 2015 reported in bolded 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 third quarter of the year through November suggest inflation diminishing relative to the actual events in the second quarter but at least twice what we have seen on average in past years.  The outlook for inflation is higher than normal, although we have to admit that we have not been particularly accurate predicting monthly inflation up to this point.  More specifically, we have over predicted inflation by double in aggregated since the beginning of 2014 (2.64% versus 1.34%).


year month actual inflation monthly in percent forecasted inflation monthly in percent
       
2014 1 -3.33 2.61
2014 2 3.81 2.31
2014 3 2.35 3.38
2014 4 3.86 3.03
2014 5 1.42 2.49
2014 6 -3.54 3.41
2014 7 1.33 3.36
2014 8 -0.74 3.04
2014 9 -3.16 3.21
2014 10 1.66 2.66
2014 11 -2.56 5.39
2014 12 0.70 2.39
2015 1 3.20 1.23
2015 2 0.99 0.80
2015 3 2.68 0.84
2015 4 3.23 1.70
2015 5 4.47 1.86
2015 6 9.09 1.64
2015 7 -1.29 2.19
2015 8   1.76
2015 9   2.85
2015 10   2.23
2015 11   2.50
 

 


Unemployment

The Jacksonville unemployment rate has bounced around on either side of the national average so far this year, with four months above the national number and two below.  However, three of months in excess were collectively higher by only one tenth of a percent and overall for the six months of 2015 collectively Jacksonville is slightly lower than the national average.  The summer so far has revealed an escalation in the size of the local labor force compared to prior summers with greater employment percentages as well.  We are not back to full employment but we are moving in the correct direction with improved employment not just in lower skilled jobs but better paying jobs as well.

 

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 most of 2015.  We forecast less unemployment in August through November.  If our estimates are correct, the local MSA unemployment rate is headed towards below 5% by October.  Summer is always tricky relative to unemployment with the flow of high school and college students into the labor market temporarily, and graduates in more permanent positions.  However, the evidence is pretty conclusive that employment and the labor force are both expanding with only small changes in the unemployment rate in the right direction.

 

year month actual unemployment rate monthly in percent forecasted unemployment rate monthly in percent
       
2014  1 5.78 5.75
2014  2 6.16 5.94
2014  3 6.33 5.8
2014  4 5.8 5.7
2014  5 6.11 5.66
2014  6 5.75 5.62
2014  7 6.26 5.62
2014  8 6.54 5.4
2014  9 5.79 5.26
2014  10 5.79 5.73
2014  11 5.47 5.31
2015  12 5.38 5.21
2015  1 5.50 5.08
2015  2 5.56 5.40
2015  3 5.61 5.26
2015  4 5.39 5.73
2015  5 5.69 5.22
2015  6 5.20 5.04
2015  7 5.32 4.84
2015  8   5.20
2015 9   5.09
2015 10   4.99
2015 11   4.85

 


Leading Indicator (LEI)

Despite negative implications for February and April, the LEI has been up for the year overall, and eight of the last ten months.  The local LEI is still not advancing as much as at the national level but it is up almost three points since December. Building permits jumped in June to over 1,000 for the months with local stocks following the national waves and initial claims for unemployment insurance in the 2,500 to 3,000 range as opposed to over 10,000 in the depths of the recession.  Consumer confidence is now around 90, which is far better than six years ago as well. 

The chart below reveals our forecasts for the leading indicators.  It should be evident that the forecasts are for continued slow growth in the LEI.  Since the LEIP LEI seems to forecast best 2-3 months out, we see a strong early fall season setting us up for a solid Christmas selling period.  


year month actual  LEI Monthly (2001.12=100) forecasted LEI Monthly (2001.12=100)
       
2014  1 114.6 113.58
2014  2 116.57 114.95
2014  3 116.28 114.91
2014  4 116.27 114.81
2014  5 116.53 115.25
2014  6 115.76 115.29
2014  7 115.68 115.37
2014  8 115.31 116.56
2014  9 116.34 116.83
2014  10 116.59 117.02
2014  11 117.29 116.66
2015  12 116.63 117.17
2015  1 118.32 117.36
2015  2 118.18 117.69
2015  3 118.55 118.20
2015  4 117.93 118.59
2015  5 118.60 119.209
2015  6 118.65 119.4586
2015  7 119.53 119.8382
2015  8   119.22
2015 9   119.62
2015 10   119.66
2015 11   119.88

Stock Price Index

After two of the first four months this year generated performances below the DOW, we are forecasting better growth in the next four months (with the possible exception of November.  Because our local companies are generally smaller than those in the DOW, it perhaps is not surprising that in a climate whereby bigger is viewed to be better, local stocks are being outperformed.

 

The final chart below presents the forecasts for the stock price index through the end of the third quarter of 2015, plus October and November. Let’s hope that we are right about the forecasts for local stocks for the benefits of those companies, their stockholders, and the local economy.  Given the events of last week, we are optimistic despite the sell-off.

 


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  2 102.30 102.80
2014  3 103.90 101.94
2014  4 98.70 100.00
2014  5 100.20 104.02
2014  6 101.70 102.11
2014  7 98.20 101.60
2014  8 91.10 101.17
2014  9 112.90 101.38
2014  10 101.80 101.78
2014  11 102.30 99.30
2015  12 101.30 102.90
2015  1 97.60 102.50
2015  2 101.97 100.20
2015  3 99.00 101.32
2015  4 98.90 100.94
2015  5 101.60 101.12
2015  6 100.00 100.86
2015  7 101.80 100.99
2015  8   98.99
2015 9   101.03
2015 10   100.75
2015 11   100.76

The Bottom Line

We are generally optimistic as we move into the 2015-16 school year and start the holiday season.  Inflation is up, which while painful for purchasing power, generally signals increased consumer demand and willingness by sellers to pass on costs through price increases.  Unemployment is still somewhat higher than most desirable, but moving in the right direction, all be it slowly.  The events of last week in the stock market could have been the result of declining growth in China, but we perceive that concern over FED policy changes towards tightening were the primary hidden culprit.  Contrary to what appears to be conventional wisdom based on historical precedent, we believe that higher interest rates will generate market improvement as banks increase lending and firms find their confidence again resulting from increased consumer demand.  Eventually policy-makers will discover that the 2010’s are not the 1970s or the 1930s and let markets find their own levels without disruptive discretionary policy interruptions.