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US Economy

More Upside for Equities

By Elliott H. Gue, on Nov. 11, 2013

The biggest takeaway from October’s employment report: The government shutdown and battle over raising the debt ceiling didn’t constrain economic growth to the extent that many analysts had expected.

The Bureau of Labor Statistics (BLS) classifies furloughed government workers as employed, so partial closure of the federal government didn’t show up in the official employment numbers. However, most economists expected private companies to slow their hiring because of the uncertainty in Washington, DC.

But the US still added 212,000 private-sector jobs last month, well above the consensus estimate of 125,000 net new jobs.

Source: Bloomberg

Even better, the BLS revised its August and September estimates of job gains by 60,000.

This strength was broad-based. The leisure and hospitality segment–a category that relies on disposable income for growth–added 53,000 jobs last month, while employment in the retail trade category ticked up by 44,000. Manufacturers took on 19,000 new employees in October, with the auto industry accounting for 6,000 of these new jobs–a strong number when you consider that manufacturing employment had been flat since February 2013.

The improvement in private, nonfarm payrolls wasn’t the only encouraging economic data released last week.

My favorite barometer of the US economy’s health–the Institute for Supply Management’s Purchasing Managers Index (PMI) for manufacturers–surprised to the upside and climbed to 56.4, its highest level since early 2011.

PMI readings greater than 50 indicate an expansion in economic activity, while values less than 50 correspond with a contraction.

Digging into the guts of this month’s manufacturing PMI reveals another reason for optimism: A strong New Orders Index. An uptick in new orders usually presages an increase in production.

Source: Bloomberg

A simple regression of the ISM’s manufacturing PMI against US economic growth over the past half-century suggests that the current reading implies a 4.25 percent increase in gross domestic product (GDP).

Source: Bloomberg

Of course, the trend rate of US GDP growth has declined significantly as the economy has matured over the past 50 years. This simplistic calculation likely overstates growth.

Factoring in the tax hikes and cuts to government spending instituted earlier this year, we expect the US economy to grow by 1 percent to 1.5 percent in 2013.

Nevertheless, October’s elevated PMI reading suggests that economic growth will continue to accelerate through year-end and into 2014, likely at a rate of about 3 percent.

Despite the endless scaremongering in the financial media, we regard a sudden increase in interest rates as unlikely.

Although the yield on the 10-year US Treasury note jumped to almost 2.75 percent after the stronger-than-expected October employment numbers, the Federal Reserve likely will wait until early 2014 to taper its quantitative easing program.

Likewise, the surge in inflation predicted by the familiar coterie of broken-clock pundits has yet to materialize. And we haven’t seen any evidence that the market shares these concerns.

The five-year forward break-even inflation rate stands at almost 2.6 percent–below prevailing levels in late 2012 and early 2013. This measure quantifies the market’s inflation expectations by comparing the yield on five-year Treasury securities to inflation-protected securities.

We don’t expect a Federal Reserve headed by current nominee Janet Yellen to become overly concerned about inflation until the five-year forward break-even rate spikes significantly.

Stronger US and global economic growth and the Fed’s still-accommodative monetary policy spells further upside for equities.

To that end, our Wealth Builders Portfolio remains overweight industrials and other cyclical sectors that stand to benefit the most from an expanding economy. In the most recent issue of Capitalist Times Premium, we highlighted at a company that’s leveraged to several long-term trends, including increased use of cheap US natural gas as a transportation fuel.  

Elliott H. Gue is editor of Capitalist Times and Energy & Income Advisor.

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