Economic Notes for the Week of March 12th

The ISM Non-Manufacturing index increased in February from 56.8 to 57.3, which was somewhat of a surprise as consensus estimates assumed a small to modest decline.  It reflected solid strength in service sector activity, as new orders and general business activity were both up at the highest levels since early 2011.

Factory orders fell -1.0% for the month, which was slightly less than expected, and some of the components were positive for the near-term.  Core durable goods orders were revised upward, as were core shipments.  Non-durable goods inventories were also up a bit.

Mid-week, the big headline was not from the U.S., but was the Chinese government trimmed their annual growth target down to +7.5% (from +8.0% in 2011, although the actual GDP figures have typically exceeded these ‘estimates’).  Of course, still dramatically higher growth than we’re seeing in the developed world (and many emerging economies), but the concern is centered around the ability of officials to engineer an effective ‘soft landing,’ being that a good portion of the world’s expected GDP in coming years is originating from China.  Then again, the Chinese government has ample resources to provide stimulus, should their economy need it.

The ADP private sector report on Wednesday foreshadowed the news and was in line with expectations of a reported increase of +216,000 jobs.  Manufacturing was up by the largest percentage amount, construction also rose, while service jobs led the way in terms of actual job number volume.  A nice component was that job gains were concentrated in smaller employers (which was a missing element earlier on in this recovery cycle).  Nonfarm productivity growth was revised upward from +0.7% to +0.9% for Q4-2011, which was slightly higher than forecast.  Unit labor costs also received a revision for the quarter of +1.2% to +2.8% quarter-over-quarter.

What is significant about productivity is the impact on hiring.  The long-term productivity rate is roughly 2.0-2.5% in the U.S. (it was at +4.0% in 2010 in the midst of the early recovery, which is not unusual, then dropped to +0.4% for 2011).  The trend in a recovery is for productivity to rise as initial activity increases with existing workers, but no new workers are yet hired.  Then, if/as employers deem a recovery sustainable or are at the limit of what can be accomplished through existing employees, more are hired.  That appears to be the point we find ourselves at now.

On Thursday, initial jobless claims were slightly higher than expected, with a rise from 354,000 to 362,000.  The four-week moving average stayed at 355,000 and continuing claims rose a bit, by 10,000.

Despite the early reports last week, Friday’s employment report was the piece of domestic news everyone has been waiting for.  It was an encouraging one, although the underlying unemployment rate didn’t budge from its 8.3% figure from last month.  Nonfarm payrolls were up by +227,000 month-over-month, which was much higher than forecast, and the earlier two months were revised upward fairly significantly, by +61,000 jobs.  The best gains were seen in manufacturing, business services, education/health, leisure/hospitality and temporary employment in general, while construction jobs continued to slip.  This was despite the relatively good weather over the course of the last few months.  Other statistics were fairly neutral:  the workweek and earnings were flat.  The household survey showed an increase of +428,000 jobs.

It was also interesting to note that the employment participation rate increased, which is prone to occur when the job market begins to improve—this larger ‘denominator’ can cause the unemployment rate to tick back upward again a few notches while discouraged unemployed and underemployed reignite their job searches under perceived better conditions.

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Stocks lost some ground early in the week—on Tuesday—after doubts surfaced about the Greek debt deal not getting enough bondholder support.  By Thursday, a sufficient number of holders, including several large European banks, provided their consent to get over the threshold needed to make this debt deal occur (the largest ever).

Just to keep things in perspective, and as we were reminded on Tuesday, a bit of a pullback wouldn’t be unexpected considering the strong run we’ve had.  Of course, timing these little ‘pull-backs’ is easier said than done, which is why we don’t make any attempts to time them.  As we all know, market results in the very short-term are driven by psychology to a large part.  In recent months, this psychology has improved.  When this better psychology is coupled with large amounts of ‘safe’ assets remaining on the sidelines, cash flows alone could push markets higher over time.

U.S. stocks were up on the week, although Dow stocks lagged broader large-cap; mid- and small-cap issues were up more significantly and continue their run of strong returns year-to-date.  Foreign stocks generally performed negatively on the week with emerging markets bearing the brunt of it.  Coincidentally, this was as Brazil overtook the U.K. as the sixth-largest economy in the world this week.  The line between ‘developed’ and ‘emerging’ nations are becoming increasingly blurred.  U.S. and foreign REITs performed largely in line with other equities.

U.S. bonds were generally down over the week with the successful Greek restructuring and better payroll data, while foreign debt, led by emerging markets, gained.  Of note this morning, the ISDA reversed its earlier decision from last week and has now classified the Greek restructuring as a default—for the purposes of triggering credit default swap contract payments.  For all the concern about these contracts a year ago, the updated news is almost a non-event.  The worst-case scenario for Greece has appeared to have already been priced into many markets.

In the municipal world, the ratings agencies are again tinkering with the methodology for how they evaluate state and local municipal bonds—the impact of which is expected to be an upgrade for about a third of current muni bonds rated.

In commodities, natural gas rallied as did crude oil a bit.  Cotton futures rose to the maximum amount allowed one day after India imposed an immediate ban on all cotton exports.  Cotton futures for May delivery spiked almost 5% before coming back to earth.  Sugar futures plummeted, as supply is expected to outstrip demand by nearly 8 million metric tons this year.

Have a good week.

Karl Schroeder, RFC, CSA, AACEP

Investment Advisor Representative

Schroeder Financial Services, Inc.


Sources:  FocusPoint Solutions, Barclays Capital, Bloomberg, Deutsche Bank, Goldman Sachs, JPMorgan Asset Management, Morgan Stanley, MSCI, Morningstar, Northern Trust, Oppenheimer Funds, Payden & Rygel, PIMCO, Reuters, Schroder’s, Standard & Poor’s, U.S. Federal Reserve, Wells Capital Management, Yahoo!.  Index performance is shown as total return, which includes dividends, with the exception of MSCI-EM, which is quoted as price return/excluding dividends.  Performance for the MSCI-EAFE and MSCI-EM indexes is quoted in U.S. Dollar investor terms.

The information above has been obtained from sources considered reliable, but no representation is made as to its completeness, accuracy or timeliness.  All information and opinions expressed are subject to change without notice.  Information provided in this report is not intended to be, and should not be construed as, investment, legal or tax advice; and does not constitute an offer, or a solicitation of any offer, to buy or sell any security, investment or other product.  Schroeder Financial Services, Inc. is a registered investment advisor.