Service sector, wages still lagging

INDICATOR: December Supply Managers' Non-Manufacturing Survey

KEY DATA: ISM (Non-Manufacturing): -0.9 point: Orders: -7.0 points; Employment: +3.3 points

IN A NUTSHELL: "The lagging component of the economy has been the service sector and that will continue as long as wages are stagnant."

WHAT IT MEANS: It's beginning to look like December was not one of the better months for the economy. The latest softer number was the Institute for Supply Management's Index of Non-Manufacturing activity, which fell. But this report was really weird. On the one hand, the new orders index was off sharply and contracted for the first time in 4.5 years. Why? You tell me and we both know. Both export and import orders increased a lot more slowly than they had been, as well. So, facing a collapse in demand, what did firms do? They hired more people at a faster clip. Huh? Yes, I am confused, especially since order books thinned again. The one explanation, other than a bad seasonal adjustment factor, is that the December slowdown was viewed as temporary and firms are still bullish on the future. Let's hope that is the case.

In a separate report, factory orders were up sharply in November, but half of that gain came from aircraft demand. Those don't create a whole lot of new jobs in the near term. Still, the report indicates that the manufacturing will continue to lead the way.

MARKETS AND FED POLICY IMPLICATIONS: The services sector may have moderated but it hasn't fallen apart. It's just that we are not seeing any acceleration in this key component. Consumer spending on services has been lackluster and it is likely to remain that way for the first half of this year. While people may be buying vehicles and some electronics, that is helping mostly the manufacturing sector. Meanwhile, two-thirds of consumer spending and forty percent of the economy is services and that is soft. Friday we get the December employment report and I still expect it to be similar to the November one: Job gains in the 200,000 range and the unemployment rate near or at 7%. The ISM employment indices for both manufacturing and non-manufacturing showed stronger gains despite a slowing in activity. If job gains continue to run at a 200,000 or greater pace, wages increases will likely start accelerating by mid-year and that would lead to stronger service and overall growth. As for the markets, this report is a warning that reproducing the 2013 increase is going to be awful difficult unless irrational exuberance takes hold, and we really don't want to go there again.