On Wednesday two great economic reports were released. The January ISM and ADP reports showed the economy likely had a great month. While it is true that much of the stimulative measures Trump will enact will start to affect the economy in 2018, he didn’t need to do anything other than promise deregulation and tax cuts to see early benefits. Businesses have responded with increasing production and hiring in anticipation of these measures. The key will be getting them passed through Congress. I don’t see this as a new phase of growth which will cause accelerated growth in 2017, but I must remain objective. These reports were great.
Before I get into the reports, I must mention that Trump’s rhetoric has also affected the dollar. The dollar had its worst January in 30 years. As you can see from the chart below, the dollar is down 2.6% year to date and is down 4.1% since the peak in mid-December. Policy does not need to be put in place for Trump to cause the dollar to fall. Rhetoric has historically shown to be enough to affect it. I had called the dollar a bubble near the peak, so I have been expecting this fall. It will be a positive tailwind for multinational corporate earnings. It will also boost commodity prices which will cause increased inflation. It may decrease the size of the oil price decline I’m expecting. It will also help American exports. Exports may be hurt by reactionary tariffs, but that’s another aspect I won’t get into in this article.
The ADP private sector jobs report for January was fantastic as there was 246,000 jobs created which blew past the expectations for 165,000 jobs created. It will cause economists to increase their projections for the Friday monthly non-farm payrolls report. As you can see from the chart below, the 246,000 jobs gained was the 2nd best month in the past 12. There were job gains across most sectors and business sizes. Small businesses created 62,000 jobs. Mid-sized businesses created 102,000 jobs and large businesses created 83,000 jobs. The goods producing sector created 46,000 jobs and the service providing sector produced 201,000 jobs.
As you can see, the hiring increased by almost 100,000 jobs month over month. The ADP stated seasonal issues with retail and the warm weather may have helped the report, but, in my opinion, this shouldn’t take away from the great number. The chart below shows the historical differentiation between the ADP report and the BLS report. The ADP report generally hasn’t swayed too far outside of the range of the BLS report, so I expect a decent report on Friday. We’ve witnessed the market rally on both good and bad reports, so it would be a shock to see a moderate rally in response to what should be a good one. A good report would reverse the trend of slowing year over year growth in hiring.
The final chart from the ADP report is the historical breakdown of the size of the firms creating the jobs. Lately the largest firms have taken the lead on a relative percentage basis which I consider to be a bad trend. Small businesses are the backbone of the economy, creating about 2/3rds of the new jobs. The economy started to weaken last year which is why small business hiring slowed. At the end of this year, large businesses were the most capable of hiring new workers in response to the business and consumer optimism. I think the small businesses will have to see the regulatory cuts before they are able to benefit from them and hire more workers.
The ISM manufacturing report was great across the board with the worst industries showing a maintenance of growth and the best industries showing accelerated growth. The PMI of 56% was driven by growth in new orders, production, and employment. This is historically consistent with 4% GDP growth. It’s only a month of data, so this doesn’t imply that 4% growth in Q1 is necessarily going to occur. 56% is the highest it has been in the past 12 months as it increased 1.5% from the December report. The New Orders Index reached 60.4% which was an increase of 0.1% from last month and the highest rating in at least 4 months. This indicates to me that the future looks bright. The Employment Index increased 3.3 points from last month to 56.1%. This is consistent with the ADP report which showed 15,000 jobs gained in the manufacturing industry. The one weakness I see in the report is the increase in prices. The Prices Index rose 3.5 points to 69%. 44% of respondents reported seeing higher prices. If this continues, the Fed must act to raise interest rates. The chart below breaks down the entire report.
In December I made the point that we’d have to wait and see more data to tell if the acceleration in growth was temporary or if it had follow through. With these two reports, I can say the economy has rebounded because of optimism about Trump’s election. I still think the economy is at risk of heading into a recession this year, but my only point cannot be that it’s been 8 years since the last one. There needs to be a catalyst for a decline in the economy. There still is a chance Trump’s policies don’t live up to their expectations, but that is looking less likely by the day. I am still concerned about corporate debt being too high and the auto loan bubble, but I have to acknowledge that Q1 may see faster GDP growth than the economy has experienced in long time.
Conclusion
The ADP and ISM reports are consistent with the narrative that the economy is strong. If January’s metrics are indicative of how the year will go, the economy will exceed my expectations. It’s still tough to buy stocks at these levels because the multiples are outrageously high. However, they may get higher in the next few months, so it could be a worthy trade to make.
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