US Economic Data Continues to Show Strength

The U.S. manufacturing sector remained very strong in August with the ISM Manufacturing Index jumping from 58.1 in July to 61.3 in August. The components of the report were all healthy with only prices paid and new export orders registering slower rates of growth. New orders, production and employment all showed strength, consistent with a strong economy and very healthy business conditions. Tariffs, trade uncertainty, and higher raw material prices continue to be cited as concerns for the business community.

The services sector surged higher in August as the ISM Non-Manufacturing Index rose from 55.7 in July to 58.5 (well above the 56.8 expectation). Prices continue to increase across the services sector, but this was more than offset by strength in business activity/production, new orders and employment. CPI inflation fell to a 2.7% annual rate in August, down from July’s 2.9% level. Core CPI inflation also declined last month to 2.2% from July’s 2.4% rate that was the highest since September 2008. Inflation has moved higher in recent months, but the Fed’s preferred gauge of inflation, the Core PCE Index, just recently hit the 2% target level. Core PCE increased from 1.9% in June to 2% in July, consistent with the Fed’s 2% symmetric target that should allow for some flexibility. Inflation and wage growth readings going forward will be crucial in determining future Fed interest rate policy. Gradual interest rate increases are likely, but the Fed needs to balance the risks associated with rising inflation/wage pressure and the vulnerability of EMs.

August retail sales increased 0.1%, the smallest increase in six months. July’s reading was revised higher and core retail sales gained 0.1% after jumping 0.8% in July. Core retail sales are closely aligned with consumer spending in the GDP report and they continue to post solid gains fueled by tax reform and tighter labor market conditions that are helping to push up wages. Q2 GDP was recently revised higher from 4.1% to 4.2%, led mainly by an upward revision in trade. Economists expect the U.S. economy to grow 3-3.5% in Q3 although there are forecasts as high as 4.4%.

Durable goods orders fell 1.7% in July, but orders for non-defense capital goods excluding aircraft, a closely watched proxy for business spending plans, rose 1.4% after an upwardly revised 0.9% gain in June. Core capital goods have risen 7.2% Y/Y and the last few months have seen strong core capital goods shipments which bodes well for Q3 GDP. Trade tensions are a significant concern for the business community, but sentiment remains strong and we have yet to see any substantial impact to the economy and business conditions.

On September 21st, 10% of the S&P 500 will be reclassified from consumer discretionary, technology and telecom to communication services. Netflix and several other media names will move from the consumer discretionary sector to the new communications sector and the same will occur with tech giants such as Facebook and Alphabet. Telecom currently represents less than 2% of the S&P 500 and the new communications sector is projected to increase above 10%. The tech sector should fall from roughly 26% to 20% and Cons. Disc. should fall from 13% to 10%.