Confused and disappointed, but sticking to our guns

by: Han de Jong

Last week’s set of economic indicators from around the globe must be described as disappointing for an “optimist” like myself. Although we were expecting some moderation in growth, a couple of indicators were remarkably weak. In my opinion we are looking at a temporary development, partly driven by special factors such as adverse weather conditions in the US. Some indicators simply look so odd and are so out of line with logic and other data, that it is hard to believe they signal a change in trend. Luckily, last week also produced some data more in line with our long-held views. As a result, we stick to our guns that the global economy is on an upward trajectory that will deliver economic growth this year above trend in some countries, and around or above trend for the world as a whole. Ours is an above-consensus view.

Very odd US data or am I in denial?

Two important US data releases turned out to be significant disappointments last week. The authoritative ISM index, measuring business confidence in the manufacturing sector, fell sharply in January, and the number of jobs created in January also disappointed. Recent quarters had seen a material gain in momentum in the US economy, and while we are optimistic about the outlook for 2014 as a whole, we knew that some moderation was always likely. The expectation that growth might moderate a little was based on several considerations. US companies have been building up inventories in recent quarters, and that process will cease and reverse at some stage, leading to a temporary phase of slower growth. In addition, higher borrowing costs since May last year are probably still affecting some parts of the economy. The unrest on financial markets in Emerging Economies and the slide in many currencies in that group of countries surely isn’t helping either. Last, but not least, the polar vortex which led to extreme weather in large parts of the US is surely affecting the performance of the economy, though it seems that some indicators are more affected than others.

The US manufacturing ISM fell from 57.0 in December to 51.3 in January, the lowest level in eight months and a huge monthly drop. Accompanying commentary pointed out that the weather had played a role, but it is hard to gauge to what extent. Another point to make about the ISM is that this confidence indicator had got ahead of similar indicators, so the drop was perhaps also partly a correction, bringing the ISM more in line with other indicators.


The US employment report was truly confusing. A mere 113,000 jobs were added in January, after a likewise disappointing 75,000 in December. The statisticians had indicated that the December total had been negatively affected by weather conditions, but stated this time that the January total had been flattered by the weather. This is hard to square with our memories of January weather conditions, but who am I to know better than the guys with the data. The disappointment of the low total number of job gains was somewhat moderated by some of the detail of the report. Cyclically-sensitive sectors did well, while weakness dominated in both health care and the government sector. In addition, as many readers will know, there are two surveys dealing with labour market conditions published at the same time. Sometimes they give diverging messages. The so-called establishment survey is the more stable one that people tend to focus on. Its January 113,000 rise in jobs contrasts with the gain of 638,000 according to the so-called household survey. My conclusion is that we need to keep a sharp eye on the job numbers but that the January report looks out of sync with other indicators. I therefore continue to expect an improvement in the data to come through in the months ahead.

Other US data was actually more encouraging. The non-manufacturing ISM rose from 53.0 in December to 54.0 in January, and some regional business confidence indices were also stronger. Jobless claims fell in the most recent week. Perhaps the most interesting piece of US economic news came from the report on productivity and unit labour costs. Productivity increased by 3.2% at an annualised rate in Q4, following a gain of 3.6% in Q3. There is a lot of confusion over productivity trends. Gains in productivity are the ultimate basis for an improvement in living standards. In the longer term, productivity is driven by innovation and investment. In the short term, productivity is volatile and is simply driven by differences in output growth and employment growth. Looking at the Q3 and Q4 data, we must conclude that output growth has accelerated while employment growth has lagged. That really only confirms what we knew already. The result has been that unit labour costs have fallen: by an annualised 1.6% in Q4 after a drop of 2.0% in Q3. This translates into a widening of profit margins. I suspect that this trend is likely to continue in 2014. After the initial weakness around the turn of the year, we expect output growth to accelerate and, typically, employment growth tends to lag that development. The result will be that profit margins can widen in the course of 2014 even though they are already wide by historic standards.

German disappointments

Europe also saw some disappointing data. Eurozone retail sales were down 1.6% mom in December and down 1.0% yoy, after November’s +1.3%. I do not want to ignore these facts, but one must consider that retail sales data in Europe is volatile and that the disappointing December numbers do not change the improving trend that has been evident since early 2013.


German factory orders and industrial production data for December also disappointed. Orders fell 0.5% mom, though they were still up a healthy 6.0% yoy, after +7.2% in November. The orders series is volatile on a monthly basis, and December’s drop of 0.5% can actually be read as positive as it follows a rise of 2.4% in November. A big monthly gain tends to be followed by a significant drop. One element of the German orders report to highlight is that orders for capital goods from other eurozone countries are rising strongly, suggesting that economic conditions elsewhere in the eurozone are improving and that corporate investment spending is on the rise. The selection of graphs on Greece, Ireland, Portugal and Spain confirms that overall economic conditions in the periphery are improving.

German industrial production was also soft in December, dropping 0.6% mom, after +2.4% in November. The yoy rate of growth dropped from 3.8% to 2.6%. Here too, the upward trend is not broken by the December data. Other eurozone countries produced better numbers last week. Industrial production in the Netherlands was up 2.6% mom in December, the strongest reading since March 2010. Industrial sales were up 4.9% yoy, the best since early 2012.

Mixed picture in Asia

Business confidence indices weakened in China in January, suggesting that the economy might be losing some momentum after it had actually gained impetus in the second half of last year.

Business confidence indices in several other Asian countries improved in January. Taiwan, Korea, Singapore and Hong Kong all saw their PMIs rise in January. They are, of course, smaller than China, but these economies are strongly linked to the industrial and trade cycle of the global economy. The consistent picture in these countries is encouraging. Japan’s economy continues to gain momentum, ahead of the moment suprême when the sales tax is raised. Japan’s leading index of business conditions continued to strengthen in December, while vehicle registrations were stronger in January and up 27.5% yoy, while Tokyo office vacancies continued to decline. It is clear that Japanese authorities have managed to push economic growth up, but it remains to be seen what happens when the sales tax is raised from 5% to 8% in April.

Recent discussions about China have been dominated by concern over an imminent collapse of Chinese growth or threats to financial stability. We think such concerns and fears are overdone. Admitted, Chinese growth has moved to a lower gear compared to several years ago and the policymakers are trying to bring the credit cycle under control. We think that they have a good chance of being successful and achieving an orderly taming (and certainly not killing) of the credit cycle and the shadow-banking system. We also believe that Chinese authorities have the means to support economic growth should that become necessary and the capacity to deal with any problems that might arise in the financial sector. I would also like to point out that people have been talking about the imminent implosion of the Chinese financial system for ten years or so. It has never paid to bet on it. Why would it pay now? Famous last words……..