This is the thirty-sixth 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 with a discussion of the national macro economy. The first quarter of 2015 was quite weak with only a 0.6% increase in real GDP. However, in the last few years first quarters have lagged behind latter quarters, and weather is once again partially to blame. The third estimate for the second quarter was very strong with growth of 3.9% with much of it deriving from non-residential investment, a traditional sign of substantial expansion. The third quarter was not as strong, but the second estimate reported last week was 0.6% higher than the original value at 2.1% annualized. The average growth thus far in 2015 is about 2.3% which is just below the historical trend in annual real GDP growth over the last three decades.
The national inflation rate so far this year reflected in the CPI-U (for urban residents) produced very weak growth, with the annual increase for November 2014 through October 2015 at only 0.2% total. Particularly muted have been price changes in food and most durable goods areas, with gasoline and other oil related product prices the major driver in the negative direction. Like we mentioned last quarter, the rest of the world continues to accelerate their expansionary monetary policy because of slow or declining rates of growth (following the U.S. lead that we believe has been largely ineffectual). Of course, as of this writing, the long expected interest rate hikes by the FED seem almost a certainty for December.
The average national unemployment rate is continuing its very slow decline towards below 5%. However, what appears to be a movement towards full employment is not necessarily such given other labor market factors. The continuing declines in the labor force participation rate conceals the reduction in the unemployment rate, with substantial numbers of people leaving the workforce (or not entering). A disproportionate number of these individuals are dropping out from the ranks of the unemployed, generating the perception that the labor market is improving considerably when it only appears that way. As a consequence, the positive news relative to unemployment is accompanied by undesirable reductions in production and output capacity.
In this edition of the LEIPLINE, we report our tenth formal numerical forecasts of the data we collect, for the three months of the fourth quarter of 2015, plus January 2016.
It is instructive to reminisce regarding real GDP growth before and since the Great Recession. For the years 2003-2007 real GDP averaged 2.88% growth per year, unswervingly within the 2.5% - 3% range that economists believe is optimal for a healthy U.S. economy. Since the end of the recession in 2009, the five years through 2014 have only averaged 2.04% growth per year with no year above 2.5% growth. The weak growth since the end of the recession is driven by numerous factors. Among them are the strong relative value of the dollar promoting imports and hurting exports, the weakness in the EU that is much of the cause of the movement in both trade components, the declining labor force participation rate stifling output, the unwillingness of corporations to invest (preferring financial asset accumulation instead of real productivity growth), reluctance of consumers to re-incur the household debt that drove the pre-recession economy, and household income growth at extremely low levels amongst the poor and middle class as wealth has shifted to more affluent households at the expense of the masses. In addition, the greater reliance on government support through extended unemployment insurance, social security disability, and welfare is creating a culture of dependence that is also diminishing production and growth. Unfortunately, 2015 has been little better so far, but quite frankly, not surprisingly given the political climate.
Specifically, “[T]he increase in real GDP in the third quarter primarily reflected positive contributions from personal consumption expenditures (PCE), nonresidential fixed investment, state and local government spending, residential fixed investment, and exports that were partly offset by a negative contribution from private inventory investment. Imports, which are a subtraction in the calculation of GDP, increased. The deceleration in real GDP in the third quarter primarily reflected a downturn in private inventory investment and decelerations in exports, in PCE, in nonresidential fixed investment, in state and local government spending, and in residential fixed investment that were partly offset by a deceleration in imports.” http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm. These numbers clearly indicate that while most of the components of real GDP improved in the third quarter, they did so at declining rates, supporting the deceleration in growth.
Third quarter inflation was actually at an annualized rate of -2.4% with both July and August registering downturns. The fundamental driver of this deflationary movement was once again oil and gasoline prices. Oil prices in November are right around $40 per barrel and gasoline is averaging in the low $2.00 range. As we indicated last quarter, 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). We continue to believe 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. It is also instructive to realize that despite forecasts last year of substantially higher beef and vegetable prices for 2015, they have not materialized due to bumper crops and declining feed prices. If November and December generate the same declining prices as at the end of 2014, the annual inflation rate may end up negative for one of the few years since the 1930s. It is this reality that is forestalling the FEDs willingness to raise interest rates, but we continue to believe that the FEDs stance regarding interest rates has generated abnormal market conditions that are dissuading banks from lending, firms from expanding productive capacity, and consumers from spending. Traditional Keynesian policy suggests that lower interest rates spur growth, but after at least six years of this policy from the FED, the evidence suggests otherwise.
The unemployment rates for the third quarter and October have now hit their lowest levels since January 2008 at 5.0%. Clearly, as we mentioned last quarter, 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. There is a fundamental concept in economics called Okun’s Law that implies that for every increase in real GDP by 2.5% above its historic trend, unemployment tends to fall by 1%. We have definitively not seen real GDP growth anywhere near the average of 5% growth for four consecutive years necessary to cause unemployment to fall from the 9% level in September 2011 to the 5% today. Although Okun’s Law does not necessarily imply the causality between the two, it appears likely that unemployment has fallen due to factors other than growth and we believe that the most relevant factor is the large number of workers departing the labor force at higher age groups and fewer workers entering at younger ages. Unlike the Japanese economy, although our population is also aging, the problem in the U.S. is not a shortage of younger workers, but few jobs for college graduates because of corporate cutbacks. Unfortunately, the departures at retirement ages are inevitable, and this effect will be much larger over the next fifteen years due to the aging of baby-boom generation, but young people are not filling in the gaps due to weak hiring by firms seeking mergers instead of expansion, and investment primarily limited to financial instruments instead of real ones. Technological advances have become a double-edged sword, enhancing productivity, but diminishing the demand for labor, particularly for those with limited technical experience.
Interest rates are still tremendously below historical norms but they rebounded somewhat in the third quarter despite the FEDs unwillingness to intervene. Although October produced a small decline in one year Treasury rates from the 0.37% level established in September, longer term rates revealed some significant advances. Seven year rates went back over 2% in July 2015 after not having been there since November of last year. Ten year rates were over 2.3% in July, and 20 year rates hit 2.85% at the beginning of the third quarter. Finally, 30 year rates almost hit 3% in the third quarter as well. Despite the fact that these rates are still hundreds of basis points below historical norms, and the realization that all of these rates have fallen since July, the market has begun to move towards higher rates despite the FEDs inactivity. December appears to be the month that the FED finally pulls the trigger on rate increases. Despite what pundits in the markets say almost daily, we expect that the return to normalcy will override the negative implications implied by outdated Keynesian policy, and the economy will be better off as a result. When it happens, we will be happy to say that “we told you so.”
The U.S. and world economies are still not growing anywhere close to the desirable levels associated with business cycle expansion. Consumer expectations continue to lead business ones and the consequences are weak growth and limited enlargement of productive capacity. As long as businesses are pessimistic and consumers are uncertain about employment and continuation of non-pecuniary benefits; as long as corporate mergers continue unchecked and markets become even more anti-competitive, and as long as the federal government borrows and then spends billions on current consumption as opposed to capital investment (e.g., infrastructure, land, and capital acquisition) the climate that will generate true expansionary pressures will not arise. The malaise has lasted long enough. It is time for policy-makers to throw away antiquated policies from the 1930s in favor of more modern perspectives on growth. Recall that it was Keynes, himself that was quoted as saying that
“[P]ractical men who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.”
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 2015.3 Jacksonville CPI
The third quarter plus October universally suggested declining prices that totaled in excess of 0.8%. It was very clear that declining oil and gasoline prices were the primary drivers, but food prices also fell along with several commodity prices and those for services. The traditional inflationary pressures of excess demand and shortages of output were not prevalent during the last four months. However, the annualized average inflation rate projected for all of 2015 based on January through October was still higher than most years since LEIP began in 2002, at 1.79%. Despite perceived improvements in the labor markets and leading indicators which suggest that the local economy is improving, prices are declining in many markets as consumers withhold spending and companies discount to reduce inventories.
Below is a chart that reveals the actual (annualized) inflation rates for the quarters of 2014 (plus January through October, 2015) with our past forecasts, and those from November 2015 through January 2016 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 fourth quarter of the year through January suggest inflation returning in November at a sizable rate, but slower inflation in December and January.
The Jacksonville unemployment rate fell below the five percent level in October for the first time since April of 2008. Unfortunately, the same influences that have plagued the national labor force have occurred in Jacksonville as well. Throughout the third quarter, but particularly in October 2015, the labor force and the number of workers employed both fell, while the number unemployed also declined. The labor force departure rate is similar in Jacksonville to that of the nation as a whole, and just as debilitating. The same issues that high school and college graduates are having elsewhere in the country breaking into the job market are problematic for Jacksonville students too. While the unemployment rate numbers look positive and the trend is moving towards full employment, the reason why is not optimal.
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 November through January. In the last LEIPLINE we correctly predicted that the local MSA unemployment rate would fall below 5% in October. Our forecasted estimates suggest that unemployment rates after adjustment for seasonality will fall toward 4.75% by January 2016, and presumably beyond.
Despite a poor start for the year from February to April, the LEI has been up almost three points for the year overall, and nine of the last twelve months have revealed positive LEI numbers. Building permits are at levels three times what they were during the Great Recession with local stocks up substantially in October 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 above 90, which is far better than six years ago as well. The LEI suggests that this will be a very merry Christmas for retailers, although the trend towards more Internet purchases and less in stores will accelerate this year again.
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.
So far in 2015, the local stock price index has had five months above the DOW and five months below. It is unequivocally the case that local stocks have been outperformed by the DOW for most of the years that LEIP has existed, and 2015 is no exception. The first three years of LEIP this was not the case, but we perceive that month after month more recently, the local stocks lag. More careful perusal of the stock data suggests that those stocks in service industries locally perform better than those in alternative industries, but that the major retail companies lag behind.
The final chart below presents the forecasts for the stock price index through the end of January 2016. Unfortunately, our forecasts exceed the actual outcomes by month more often than not.
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