Productivity Growth Accelerates As The Economic Cycle Fully Matures

Economic News

Let’s continue looking into the NFIB survey to get a complete grasp of the state of small businesses as of July. The chart below is the most important one in the survey as it shows the credit conditions small businesses face. Credit conditions remain solid as they inch up to the highs made in the early 2000s. The trend in all these graphs is that the economy is getting back to the pre-recession levels. As much as the bears like to think that’s ominous, I don’t think that is necessarily the case. There needs to be a catalyst to bring the economy to its knees, namely rising rates. It’s amazing to see how bad the economy got in 2008. The few years where credit was tough to come by gave the economy pent up demand in terms of good businesses needing loans. The best time to buy IPOs is right after a recession as only the best businesses can raise capital when the economy is rough. Now we have weak firms like Snap and Blue Apron selling stock because credit conditions have been great for years.

The availability of loans index mimics the credit conditions index as it was -3 in July which is tied for the best reading since 2012. Obviously, low interest rates play a strong role in the ability to access capital cheaply. One of the few indicators which still has room to run in terms of getting to pre-recessionary levels is capital expenditures. As you can see in the chart below, capex is lower than it was in the early 2000s. It appears that small businesses are just like large firms which aren’t putting much money into fixed investments. This means small businesses are also partially to blame for productivity growth problems. One interesting part of this survey is that retailers are the number one category which participated. It’s surprising to see such positivity coming from them since retail has been a tough category this year. Some are probably online retailers, but Amazon makes competition in that space tough as well.

Not only are the job openings looking good for the small business economy, but they’re also looking great overall. As you can see from the chart below, openings spiked to a record high. The JOLTS increased 461,000 to 6.163 million. The job opening rate of 4% tied for a record high. As you can see, the hires and quits dipped slightly, but that’s nothing to worry about.

As you might be aware of, the most difficult part of this recovery has been getting productivity growth. That’s what generates standard of living improvements because it allows employers to pay workers more without raising prices. Put another way, it is the only lever that boosts real wages. We got good news on the labor productivity front this week as the non-farm productivity annual run rate from April to June was 0.9% which was a bump from the 0.1% growth in the first quarter. The first quarter initially showed 0% growth which is emblematic of the weak recovery we have seen thus far. On a year over year basis, Q2 productivity grew 1.2% which beat estimates for 0.7% growth.

We’re still far from at a healthy growth rate, but this is a step in the right direction. Output per worker was up at a 3.4% rate, but that’s partially due to the 2.5% gain in hours worked. We want people to be more efficient, doing more in the same amount of time. Surprisingly, unit labor cost was only up 0.6%. That’s good news for the economy because it means inflation didn’t come from the labor market. However, looking at the April-June results is old news. The next few quarters should show increases.

On the negative side, the wholesale inventory report showed a 0.7% gain which is the quickest gain in 6 months. May was revised higher to 0.6% from 0.4%. The acceleration was driven by the auto sector as the sales growth has dried up, leaving firms with too much inventory. The next step is slowing production which has started to occur recently with GM extending its normal shut-in. This is the part that hurts the economy as workers earn less money forcing them to spend less. The inventory to sales ratio for vehicles was 1.79 which was up from 1.76 in May and 1.67 in January.

Geopolitical

The stock market sold off again on Wednesday because of the geopolitical risk with North Korea. President Trump drew a red line with North Korea saying it can’t threaten America; North Korea promptly ignored that and threatened America. Luckily, this has mainly been a war of words with a not much action.

Some investors are wondering why the stock market isn’t down more. Back of the envelope guestimates would say there’s about a 10% chance North Korea attacks Guam which would cause a 10% drop in the stock market. That means the stock market should be down 1%. The S&P 500 is only down 0.25% off the high. The reason it looks like the stock market is ignoring the geopolitical news is because it is being inundated with mostly positive economic reports. There’s also the aspect of index funds putting money into the stock market. If nothing has stopped investors from putting money into stocks this year, it’s unlikely that a low probability event will do so. It’s still worth following this story because real action would cause a correction.

Conclusion

Small businesses are probably in as good of a position as they will ever be. The labor market is strong as the number of job openings hit a record high. The only thing that can stop this bull market from roaring higher in the next 3 weeks is the North Korea issue. Once September starts, I will be more negative because the focus will move to the Fed’s unwind and the debt ceiling. There’s also seasonal weakness in that month which is moderately worrisome.