If you are an investor the good news is that productivity growth improved sharply. Unit labor cost fell in the third quarter and the spread between pricing and labor cost widened nicely. This implies that earnings growth is accelerating and that my earlier fears that earnings expectations were too high is no longer a problem.
The bad news is that with strong productivity, hours worked and income growth weakened. In the third quarter, nominal personal income expanded at under a 1% annual rate, a sharp slowing from the roughly 5% growth over the past year. Moreover, average hourly earnings growth continues to slow. Now at 1.56%, it is approaching an all time record low.
The recent improvement in consumer spending did not stem from improved real incomes. Rather it was financed by a drawing down of savings. While the headlines are dominated by Europe’s problems and the market is reacting strongly to these headlines, SEER continues to believe that the biggest market-economic threat is the extremely weak income growth.
With such weak income growth, it will be difficult for the consumer to sustain the stronger consumption growth of recent months. Yet increased personal consumption expenditures accounted for 1.72 % of the 2.5% growth in third quarter real GDP. This is especially true if the lower social security tax is not renewed for 2012 and/or if oil prices continue to rebound. SEER’s real retail sales model implies that real retail sales growth should be approaching zero.
Capacity utilization at 77.4 seems to indicate that manufacturing has significant excess capacity. But over time, capacity utilization has trended down and it is now at the long term trend line. This implies that maybe the economy does not have as much slack as generally believed.
Interestingly, while everyone seems to be worried about the impact of Europe’s problems on US financial institutions, quality spreads actually improved last month. This implies that at least the bond market is not expecting too severe an impact.