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– January 11, 2018

AIER’s Business Cycle Conditions Leading Indicators index held at 92 in December, matching the highest level since 2014 and the best multi-month performance since a run of four readings of 100 between October 2013 and January 2014. The Roughly Coincident Indicators index held at 100 for a second month after seven consecutive months at 100 were interrupted by a reading of 92 in October. The Lagging Indicators index weakened to 42 after two months at 50 (see chart below).

New economic data released over the past month confirm the AIER leading indicators that suggest continued economic expansion in the months and quarters ahead. Though economic conditions are favorable, the current expansion is old by historical measures. At 102 months, it is the third-longest on record and is likely to move into second place in the second quarter of 2018. Economic expansions do not die of old age, but given the longevity, it is worth reviewing some of the key aspects of the economy’s performance over the past year.

Leading Indicators Remain Strong
Over the first 10 months of 2017, the Leading Indicators index fluctuated between 75 and 88, averaging 80. The index finally broke out above that range over the final two months, coming in at 92 in both. For all of 2016, the index averaged 51, below the average of 59 for all of 2015 and the lowest annual average since the recession. For the eight full calendar years since the recession ended in 2009, 2015 and 2016 have been the only years to average below 80. For all of 2017, the leading index averaged 82.

Two of the leading indicators changed signals in December, leaving 10 indicators expanding while 2 were neutral and none declined. Initial claims for unemployment improved to a positive signal in December after moving up to neutral in November. As noted last month, the extremely low level of initial claims is widely viewed as a sign of strength for the labor market. However, there is a natural lower bound, suggesting that this indicator may return to a flat trend in the near future and therefore become a neutral signal in our model.

The University of Michigan index of consumer expectations moved to a flat trend in December. Trends in consumer sentiment have shown some divergence recently as attitudes toward current economic conditions continue to become more optimistic while expectations about future conditions reflect some caution. Strong labor market conditions and increases in wealth have helped boost sentiment for current conditions, while uncertainty over recent tax legislation was a key driver of weakening expectations for future economic prospects. Sentiment remains sharply divided along political-party lines, reflecting the deepening partisanship in Washington and growing polarization of the populace. Severe partisanship and polarization could introduce an economic risk at some point in the future.

The Coincident Indicators index held at 100 for a second month after a reading of 92 in October. That wobble broke a string of seven consecutive perfect readings, the longest run since a string of 40 consecutive 100s from January 2012 through April 2015. All six of the coincident indicators show strong expansion trends.

AIER’s Lagging Indicators index declined to 42 in December from a neutral 50 reading in the prior month. Two indicators are trending higher, three are trending lower, and one indicator was neutral. The indicator that changed in December was commercial and industrial loans, which moved to neutral.

2017 in Review: Part 1
Only a few of the major data reports have been updated through December. Among the most important is the Employment Situation report from the Bureau of Labor Statistics. The December report was released on Friday, January 5. The report showed payrolls in the United States rose by a disappointing 148,000 in December. The 148,000-job gain was below consensus expectations of 190,000 additional jobs for December. However, the December gain follows a 252,000-job increase in November and 211,000-job increase in October. Combined, the three-month average gain was 204,000, a very solid result.

Over the entire year, payrolls grew by an average of 171,000 per month, or a total of just over 2 million. Gains for the year were widespread among the private sector industries, though additions in some private services industries were notably slower in December. Among the private sector gainers, construction added an average of 18,000 jobs per month, bringing the 12-month total to 210,000, and manufacturing industries added an average of 16,000 jobs per month, resulting in a 12-month total gain of 196,000.

Private services industries added just 91,000 jobs in December compared to a 12-month average of 129,000 per month, or a total of 1.55 million for all of 2017. Among the private services industries, professional- and business-services payrolls rose by 19,000 last month and have added 527,000 workers over the past year; health care added 29,000 employees in December, bringing the 12-month total to 374,000; and leisure and hospitality added 29,000 jobs for the month and a total of 306,000 over the past year.

The solid pace of job creation attracted 64,000 more people into the labor force in December and a total of 869,000 in the past year. Those new entrants have pushed the labor force participation rate up to 62.7 percent. Despite the added people in the labor force, the unemployment rate held at 4.1 percent for the third month in a row in December, holding at the low for the current expansion and below the 4.4 percent low of the prior expansion.

Average hourly earnings rose 0.3 percent in December, maintaining the 12-month change at 2.5 percent. Combined, the gains in payrolls and hourly earnings resulted in a 4.5 percent increase in the aggregate-payrolls index, a proxy for take-home pay. This index has been growing in the 4 to 4.5 percent range for most of 2011–17, which provides a solid base to support consumer spending.

The weak points in the labor market in 2017 were the retail industry and information services. The retail industry saw a 20,000-employee reduction in payrolls in December and has lost a total of 67,000 jobs for the year. Information services added just 7,000 jobs in December but lost 40,000 jobs for the year.

Two other well-known economic reports have been updated for December: the Manufacturing Report on Business and the Nonmanufacturing Report on Business, both from the Institute for Supply Management (ISM). These two reports survey purchasing managers in the two major sectors of the economy. The indexes are constructed with 50 being neutral. For 2017, the ISM Purchasing Managers’ Index (PMI), the composite index, finished the year at a strong 59.7 level, bringing the average for the year to 57.6. That is up from a barely favorable 51.5 in 2016. Among the individual indicators, new orders ended the year at 69.4, lifting the annual average to 62.7, both very strong results. Production registered a 65.8 level in December and a 61.2 average for the year. Supplier deliveries, employment, new export orders, and backlogs of orders all posted results in the upper 50s for December and for all of 2017. These data all suggest a positive outlook for the manufacturing sector. The one area of concern in the report remains rising input costs. The prices index ended 2017 at 69.0, lifting the annual average to 65.8, suggesting upward pressure on input-materials prices.

The ISM’s nonmanufacturing survey had results that were a bit less robust than the manufacturing survey but were still solidly above the neutral 50 level and still point to expansion in the services sector. The composite index came in at 55.9 in December, with an annual average of 57.0. New orders and activity were 54.3 and 57.3 respectively in December. The annual averages were 59.3 and 60.2, both higher than the 57.5 and 58.0 annual averages for 2016. Other details of the report likewise suggest a positive outlook for services in 2018.

More review of 2017 will be included in the February report.

Prices, Money, and Credit Measures Remain Moderate
Prices of personal consumption expenditures (PCE), the measure preferred by the Fed, rose 0.2 percent in November. Durable-goods prices were down 0.2 percent while nondurable-goods prices jumped 0.5 percent and services prices rose 0.2 percent. The core PCE index, which excludes volatile food and energy components, rose a more moderate 0.1 percent in November.

The PCE price index is up 1.8 percent from a year ago while the core PCE prices index is up just 1.5 percent over the last year. The core PCE price index has been rising at less than 2 percent annually for most of the past 20 years. That stretch of sub-2 percent increases is about as close to price stability as the United States has ever experienced. An alternative measure, the market-based PCE price index excluding food and energy, is up just 1.1 percent over the past 12 months. (Market-based indexes include only goods and services with observable prices and exclude imputed transactions—those furnished without payment—such as certain financial services.)

Money supply, as measured by the M2 aggregate, is growing at a 3.6 percent annualized rate over the last three months and a slightly faster 4.7 percent pace over the 12 months ending in November. Over the last 20 years—the period during which price increases have been relatively low and stable—M2 has grown at an average rate of 6.4 percent.

Bank lending rose 5.3 percent in November and is up just 3.7 percent over the past year. Among the major segments, commercial real estate loan growth led the way with 6.1 percent growth over the past year. That pace has been decelerating since peaking at 11.6 percent growth in the middle of 2016. Consumer- loans growth was second among the major components, rising 5.5 percent from a year ago. That pace has been picking up since hitting a low in August 2017. Residential real estate loans grew 1.6 percent from a year ago and have been the slowest-growing segment over the past four years. Commercial and industrial loans rose just 0.9 percent over the past year after leading all the other segments over the four-plus-year run from the middle of 2011 through 2015.

The credit cycle is a critical component of every economic expansion, particularly as the cycle grows longer in duration. AIER will be monitoring money and credit conditions closely, particularly as interest rates continue to rise.

Capital Markets
The Standard and Poor’s (S&P) 500 large-cap index hit 66 new record highs during 2017, closing the year at an all-time high, and has more than tripled since the market low in 2009. The S&P 400 midcap index hit 37 new highs while the S&P 600 small-cap index notched 21. Combined, the S&P 1500 made 65 new record highs for the year. All four benchmarks finished the year at a record high.

While U.S. equity markets have been hitting new highs, bond yields ended the year about where they started. The benchmark 10-year Treasury yield ended 2017 around 2.41 percent, though yields fell around midyear, touching a low of 2.06 percent in September before recovering to current levels. Crude oil and gold closed the year higher. Meanwhile, the dollar weakened largely because of strength in both the euro and the British pound.

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