Central Bankers’ New Clothes

Central Bankers’ New Clothes

In this week’s musings:

  • Earnings Season Kicks Off 
  • Central Bankers’ New Clothes 
  • Debt Ceiling – I’m Baaack
  • Trade Wars – The Gift that Keeps on Giving
  • Domestic Economy – More Signs of Sputtering
  • Stocks – What Does It All Mean

It’s Earnings Season

Next week banks unofficially kick off the June quarter earnings season with expectations set for a -2.6% drop in S&P 500 earnings, (according to FactSet) after a decline of -0.4% in the first quarter of 2019. If the actual earnings for the June quarter end up being a decline, it will be the first time the S&P 500 has experienced two quarters of declines, (an earnings recession) since 2016. Recently the estimates for the third quarter have fallen from +0.2% to -0.3%. Heading into the second quarter, 113 S&P 500 companies have issued guidance. Of these, 87 have issued negative guidance, with just 26 issuing positive guidance. If the number issuing negative guidance does not increase, it will be the second highest number since FactSet began tracking this data in 2006. So not a rosy picture.

Naturally, in the post-financial crisis bad-is-good-and-good-is-bad-world, the S&P 500 is up nearly 20% in the face of contracting earnings — potentially three quarters worth — and experienced the best first half of the year since 1997. In the past week, both the S&P 500 and the Dow Jones Industrial Average have closed at record highs as Federal Reserve Chairman Powell’s testimony before Congress gave the market comfort that cuts are on the way. This week’s stronger than expected CPI and PPI numbers are unlikely to alter their intentions. Welcome to the world of the Central Bankers’ New Clothes

Central Bankers’ New Clothes

Here are a few interesting side-effects of those lovely stimulus-oriented threads worn in the hallowed halls of the world’s major central banks.

https://www.tematicaresearch.com/wp-content/uploads/2019/07/2019-07-12-EU-EM-Neg-Yields.png https://www.tematicaresearch.com/wp-content/uploads/2019/07/2019-07-12-Greek-below-UST.png

Yes, you read that right. Greece, the nation that was the very first to default on its debt back in 377BC and has been in default roughly 50% of the time since its independence in 1829, saw the yield on its 10-year drop below the yield on the 10-year US Treasury bond. But how can that be?

Back to those now rather stretchy stimulus suits worn by the world’s central bankers that allow for greater freedom of movement in all aspects of monetary policy. In recent weeks we’ve seen a waterfall of hints and downright promises to loosen up even more. The European Central Bank, the US Federal Reserve, the Bank of Canada have all gone seriously dovish. Over in Turkey, President Erdogan fired his central banker for not joining the party. Serbia, Australia, Dominican Republic, Iceland, Mozambique, Russia, Chile, Azerbaijan, India, Australia, Sri Lanka, Kyrgyzstan, Angola, Jamaica, Philippines, New Zealand, Malaysia, Rwanda, Malawi, Ukraine, Paraguay, Georgia, Egypt, Armenia, and Ghana have all cut rates so far this year, quite a few have done so multiple times. From September of 2018 through the end of 2018, there were 40 rate hikes by central banks around the world and just 3 cuts. Since the start of 2019, there have been 11 hikes and 38 cuts.

That’s a big shift, but why? Globally the economy is slowing and in the aftermath of the financial crisis, a slowing economy is far more dangerous than in years past. How’s that?

In the wake of the financial crisis, governments around the world set up barriers to protect large domestic companies. The central bankers aimed their bazookas at interest rates, which (mostly as an unintended consequence) ended up giving large but weak companies better access to cheap money than smaller but stronger companies. This resulted in increasing consolidation which in turn has been shrinking workers’ share of national income. For example, the US is currently shutting down established companies and generating new startups at the slowest rates in at least 50 years. Today much of the developed world faces highly consolidated industries with less competition and innovation (one of the reasons we believe our Disruptive Innovators investing theme is so powerful) and record levels of corporate debt. It took US corporations 50 years to accumulate $3 trillion in debt in the third quarter of 2003. In the first quarter of 2019, just over 15 years later, this figure had more than doubled to $6.4 trillion.

Along with the shrinking workers’ share of national income, we see a shrinking middle class in many of the developed nations – which we capitalize on in our Middle Class Squeeze investing theme. As one would expect, this results in the economy becoming more and more politicized – voters aren’t happy. Recessions, once considered a normal part of the economic cycle, have become something to be avoided at all costs. The following chart, (using data from the National Bureau of Economic Research) shows that since the mid-1850s, the average length of an economic cycle from trough to peak has been increasing from 26.6 months between 1854 and 1919 to 35 months between 1919 and 1945 to 58.4 months between 1945 and 2009. At the same time, the duration of the economic collapse from peak to trough has been shrinking. The current trough to (potential peak) is the longest on record at 121 months – great – but it is also the second weakest in terms of growth, beaten only by the 37-month expansion from October 1945 to November of 1948.

https://www.tematicaresearch.com/wp-content/uploads/2019/07/2019-07-12-Economic-Cycles.png

Why has it been so weak? One of the reasons has been the rise of the zombie corporation, those that don’t earn enough profit to cover their interest payments, surviving solely through refinancing – part of the reason we’ve seen ballooning corporate debt. The Bank for International Settlements estimates that zombie companies today account for 12% of all companies listed on stock exchanges around the world. In the United States zombies account for 16% of publicly listed companies, up from just 2% in the 1980s. 

This is why central bankers around the world are so desperate for inflation and fear deflation. In a deflationary environment, the record level of debt would become more and more expensive, which would trigger delinquencies, defaults and downgrades, creating a deflationary cycle that feeds upon itself. Debtors love inflation, for as purchasing power falls, so does the current cost of that debt. But in a world of large zombie corporations, a slowing economy means the gap between profit and interest payments would continue to widen, making their survival ever more precarious. This economic reality is one of the reasons that nearly 20% of the global bond market has negative yield and 90% trade with a negative real yield (which takes inflation into account).

Debt Ceiling Debate – I’m baack!

While we are on the topic of bonds, the Bipartisan Policy Center recently reported that they believe there is a “significant risk” that the US will breach its debt limit in early September if Congress does not act quickly. Previously it was believed that the spending wall would not be hit until October or November. As the beltway gets more and more, shall we say raucous, this round could unnerve the markets.

Trade Wars – the gift that keeps on giving

Aside from the upcoming fun (sarcasm) of watching Congress and the President whack each other around over rising government debt, the trade war with China, which gave the equity markets a serious pop post G20 summit on the news that progress was being made, is once again looking less optimistic. China’s Commerce Minister Zhong Shan, who is considered a hardliner, has assumed new prominence in the talks, participating alongside Vice Premier Liu He (who has headed the Chinese team for over a year) in talks this week. The Chinese are obviously aware that with every passing month President Trump will feel more pressure to get something done before the 2020 elections and may be looking to see just how hard they can push.

Trade tensions between the US and Europe are back on the front page. This week, senators in France voted to pass a new tax that will impose a 3% charge on revenue for digital companies with revenues of more than €750m globally and €25m in France. This will hit roughly 30 companies, including Apple (AAPL), Facebook (FB), Amazon (AMZN) and Alphabet (GOOGL) as well as some companies from Germany, Spain, the UK and France. The Trump administration was not pleased and has launched a probe into the French tax to determine if it unfairly discriminates against US companies. This could lead to the US imposing punitive tariffs on French goods.

Not to be outdone, the UK is planning to pass a similar tax that would impose a 2% tax on revenues from search engine, social media and e-commerce platforms whose global revenues exceed £500m and whose UK revenue is over £25m. This tax, which so far appears to affect US companies disproportionately, is likely to raise additional ire at a time when the US-UK relationship is already on shaky ground over leaked cables from the UK’s ambassador that were less than complimentary about President Trump and his administration.  

That’s just this week. Is it any wonder the DHL Global Trade Barometer is seeing a contraction in global trade? According to Morgan Stanley research, just under two thirds of countries have purchasing manager indices below 50, which is contraction territory and further warning signs of slowing global growth. This week also saw BASF SE (BASFY), the world’s largest chemical company, warn that the weakening global economy could cut its profits by 30% this year.

Domestic Economy – more signs of sputtering

The ISM Manufacturing index weakened again in June and has been declining now for 10 months. The New Orders component, which as its name would imply, is more forward-looking, is on the cusp of contracting. It has been declining since December 2017 and is at the lowest level since August 2016. Back in 2016 the US experienced a bit of an industrial sector mini-recession that was tempered in its severity by housing. Recall that back then we saw two consecutive quarters of decline in S&P 500 earnings. Today, overall Construction is in contraction with total construction spending down -2.3% year-over-year. Residential construction has been shrinking year-over-year for 8-months and in May was down -11.2% year-over-year. Commercial construction is even worse, down -13.7% year-over-year in May and has been steadily declining since December 2016. What helped back in 2016 is of no help today.

While the headlines over the employment data (excepting ADP’s report last week) have sounded rather solid, we have seen three consecutive downward revisions to employment figures in recent months. That’s the type of thing you see as the data is rolling over. The Challenger, Gray & Christmas job cuts report found that employer announced cuts YTD through May were 39% higher than the same period last year and we are heading into the 12thconsecutive month of year-over-year increases in job cuts – again that is indicative of a negative shift in employment.

Stocks – what does it all mean?

Currently, US stock prices, as measured by the price-to-sales ratio (because earnings are becoming less and less meaningful on a comparative basis thanks to all the share buybacks), exceed what we saw in the late 1999s and early 2000s. With all that central bank supplied liquidity, is it any wonder things are pricey?

On top of that, the S&P 500 share count has declined to a 20-year low as US companies spent over $800 million on buybacks in 2018 and are poised for a new record in 2019 based on Q1 activity. Overall the number of publicly-listed companies has fallen by 50% over the past 20 years and the accelerating pace of stock buybacks has made corporations the largest and only significant net buyer of stocks for the past 5 years! Central bank stimulus on top of fewer shares to purchase has overpowered fundamentals.

This week, some of the major indices once again reached record highs and given the accelerating trend in central bank easing, this is likely to continue for some time — but investors beware. Understand that these moves are not based on improving earnings, so it isn’t about the business fundamentals, (at least when we talk about equity markets in aggregate as there is always a growth story to be found somewhere regardless of the economy) but rather about the belief the central bank stimulus will continue to push share prices higher. Keep in mind that the typical Federal Reserve rate cut cycle amounts to cuts of on average 525 basis points. Today the Fed has only about half of that with which to work with before heading into negative rate territory.

The stimulus coming from most of the world’s major and many of the minor central banks likely will push the major averages higher until something shocks the market and it realizes, there really are no new clothes. What exactly that shock will be — possibly the upcoming debt ceiling debates, trade wars or intensifying geological tensions — is impossible to know with certainty today, but something that cannot go on forever, won’t.

Empire Fed Joining Recent Economic Data Downhill Slide

Empire Fed Joining Recent Economic Data Downhill Slide

Today’s Empire Manufacturing report came in (are you ready for this?) below expectations. Shocker, right? This has been the accelerating norm of late, yet we keep hearing some in the mainstream financial media claiming the economy is strengthening. Go figure. Expectations were for the index at 15 but it came in at 9.8, with expectations for conditions six months from now also down from 41.7 to 34.9 – the lowest level since prior to the election.

Internal breadth was also weak, with more companies reporting decreases than increases in seven out of the nine components, namely: New Orders, Shipment, Unfilled Orders, Delivery time, Inventories, Number of Employees and Average Employee Workweek. Only Prices Paid and Prices Received saw increases. (Hat tip to Bespoke for the chart)

Those declining Number of Employees and Average Workweek don’t exactly support the narrative of rising wages with an increasingly tight job market.

As we head into the August lull, the economic data continues to point to an economy that is decidedly weaker than was anticipated earlier in the year. Expectations for accelerating growth in the second half of the year, which is necessary for those S&P 500 earnings expectations to be met, is becoming increasingly less likely. That means that either stock prices will need to fall or valuations will be stretched even further. We do not yet see signs that the stock market is getting ready to change direction, but these fundamentals cannot be ignored. Downside risks are rising while upside potential continues to fade.

Yield Curve Flashing Warnings Sign

Yield Curve Flashing Warnings Sign

The spread between the 30 year Treasury yield and the 2 year Treasury yield is back down to the lows of last year. The only time in over a decade that we saw the yield curve this flat was back in 2007 when all hell was breaking loose.

Look a little further up the curve, the spread between the 30-year and the 5-year is down to levels last seen in 2007: the bond market is making a statement here.

The yield on the 10-year Treasury, which is a measure of future economic growth expectations, is down to 2.16 percent today, which is astounding when you consider we are repeatedly hitting record highs in the U.S. stock markets with a 4.3 percent unemployment rate!

10 Year Treasury Rate Chart

Lest we forget that the Atlanta Fed GDPNow forecast for the second quarter was just lowered to 1.9 percent, after a painful 1.2 percent in Q1, then back down to 1.5 percent for Q3 – accelerating economy?

Oh yes, and manufacturing production is lower today than it was in December 2005.

Economic Data Continues to Paint Peaking Picture

Economic Data Continues to Paint Peaking Picture

This view never gets old.

This view never gets old.While this was a shortened week with the Memorial Day holiday, it was certainly packed with economic data. Yours truly fell a bit behind coupled with the short week and another one of my trips from Southern California back to my other home base in Italy, so this is a longer than usual post. No matter how many times I do that trip, and my frequent flier miles balance can attest to the level of insanity, I am endlessly amazed at how I can get into a steel tube in one part of the world and end up, after just one tube change in London, roughly 7,000 miles away without much fuss. Hat tip to British Airways for a lovely trip despite the pain felt by tens thousands over the holiday weekend – our thoughts on that calamity were shared on last week’s Cocktail Investing Podcast. The view from 30,000 this week was quite useful given the onslaught of data!

The week started with the Bureau of Economic Analysis inflation report which was in-line with expectations, showing the Personal Consumption Expenditures, price index was up just 1.7 percent on a year-over-year basis.

The Core PCE Price Index, which excludes food and energy, was also lower from prior periods, up just 1.5 percent year-over-year versus an increase of 1.8 percent at the beginning of the year. As we expected and called out a few times, the base effects are wearing off.

Real Personal Consumption Expenditures, which is a measure of consumer spending, weakened on a year-over-year basis, down from 3.1 percent in March to 2.6 percent in April. The peak for these expenditures during the current business cycle was back in January 2015 at 4 percent, which was below the prior business cycle peak of 4.7 percent in February 2004. We see this as confirming our Cash-Strapped Consumer theme remains solidly in the forefront of the economy.

Yes spending has been muted, but more concerning for the longer-term growth potential of the country is the ever-weakening population growth rate. The Bureau of Economic Analysis’ most recent data showed yet another drop in the growth rate to the lowest level on record with the BEA, at 0.7 percent, reinforcing our Aging of the Population theme. Over 600,000 people dropped out of the labor force just last year.

Keep in mind when you hear talk about expanding GDP growth rates that,

There are only two core factors that impact the potential growth of an economy, growth of labor and improvements in productivity.

Shipping looks to be strengthening, which is a good gauge of growth in the overall economy, but remains below longer-term normal levels and is still within the muted growth rate we’ve seen during this business cycle.

 

The Conference Board measure of Consumer Confidence fell more than expected in May, after having declined in April as well, although overall optimism is still relatively high. The index dropped to 117.9 in May versus expectations for 119.8, down from its peak of 125.6 in March, the highest level since December 2000.

The exceptionally large spread between “soft” sentiment data and the actual hard data has been narrowing, but that has been primarily driven by declining sentiment data.

 

 

Housing prices remain strong with the S&P/Case-Shiller Home price index coming in with 5.9 percent annual growth rate versus expectations for 5.7 percent, driven in part by exceptionally low inventories. We’d argue that this is consistent with our Asset-Light investing theme, as Millenials, in particular, show a great affinity for renting homes and using ride-sharing services than owning such assets, particularly those like cars that have inherently low utilization levels.

 

 

The US Pending Home Sales number disappointed in April, falling below last year’s levels with a 1.3 percent decline. The National Association of Realtors Existing Home Sales index was 3.3 percent lower this April than in April 2017.
source:


source: tradingeconomics.com

The rate of price increases in homes is well above the annual rate of wage growth, which makes the current pace unsustainable unless we see wages start to catch up. We may just start to see that with the improvement in job creation we saw this week from ADP, with Private Nonfarm payrolls rising 253,000 versus expectations for 180,000. The report saw jobs in construction and professional/business services rise notably, with the later experiencing is the largest one-month increase in around three years.

So things were looking pretty good on the jobs front until Friday’s payroll report from the Bureau of Labor Statistics which came in well below expectations at 138,000 new jobs versus expectations for 185,000. The Labor Force Participation rate dropped from 62.9 percent to 62.7 percent and to add insult to injury, the BLS revised the April job creation numbers down from 211,000 to 174,000.

While payrolls in construction rose in the ADP report, the Census Bureau was more in line with the weaker BLS report when it reported a month-over-month decline in US Construction Spending, falling 1.4 percent versus expectations for an increase of 0.5 percent. On a year-over-year basis, spending is up 6.7 percent, with that increase coming from residential, which rose 15.6 percent in April on a year-over-year basis while total public construction spending was down 4.4 percent in April on a year-over-year basis. Residential construction is rising on a year-over-year percent basis, but the overall level is still subdued compared to what we’ve seen in prior business cycles.

 

Despite weaker inflation data and the weaker jobs report, the CME fed fund futures market is still predicting, with over 90 percent probability, that the Fed will raise rates at the June meeting to a target of between 100 and 125 basis points. The probably of an additional September hike is now below 25 percent. YOU SHOULD SAY WHY YOU AGREE THE FED WILL HIKE EVEN THOUGH THE EMPLOYMENT REPORT WASN’T “GOOD ENOUGH” (OR WAS IT?)

The manufacturing PMI from the Institute for Supply Management (ISM) came in slightly better than expectations, at 54.9 from 54.8 in April versus expectations for 54.5 with New Orders, Employment and Inventories rising versus weaker Production.
source: tradingeconomics.com


source: tradingeconomics.com

However, the Markit survey presents a slightly different picture, with US Manufacturing PMI down to 52.7 in May from 52.8 in April, sitting at the lowest level in 8 months with a moderate improvement in New Business.
source: tradingeconomics.com


source: tradingeconomics.com

Both surveys agreed on falling input prices for manufacturers as inflation looks to be easing across the board. That sound you hear is falling prices, not us patting ourselves on the back for seeing this ahead of the herd.

Auto sales continue to decline in May with sales coming in at the second weakest in the past 26 months, surpassed only by March’s weaker read. Unit volumes are at a roughly 11 percent decline versus Q1, which experienced a 17.5 percent decline.

 

Bottom Line on the economy is that the data is still mixed, but when we distil it all down, we see an economy that is highly unlikely to accelerate to the upside from here with distinct indications that we are nearing the end of this business cycle. This view is further reinforced when we see President Trump’s approval rating at 40 percent with a disapproval rate at 54 percent. Much hope was based on campaign promises that will be difficult to pass through Congress without support from the other side of the isle, support that is less likely with those kinds of approval ratings given the number of Democrats up for reelection at the mid-term.

Once Again the Fed Overestimates the Strength of the US Economy

Once Again the Fed Overestimates the Strength of the US Economy

Looking at the moves in the stock market, one would likely think all is right with the world and the US economy is back on track after bobbing and weaving around 2 percent GDP for much of the last several years. That is until we got the most recent reading on the health of the economy.

Friday’s estimate for fourth quarter 2016 GDP came in below expectations at 1.9 percent quarter-over-quarter, seasonally adjusted, versus the consensus expectations for 2.2 percent and the Atlanta Fed’s GDPNow estimate for 2.8 percent. The Fed’s consistently excessive expectations never cease to impress. To put 2016 in context, going all the way back to 1950, only four other years were as weak and they were all recessionary (1954, 1958, 2008, 2009).

This reading was a material decline from the 3.5 percent posted in Q3, but then that was primarily driven by an increase in inventories and exports. The net export contribution in Q3 was the largest since late 2013 was due in large part, and we are seriously not making this up, to soybean exports to South America where the weather decimated their soybean crop, adding a full 0.9 percent to the Q3 GDP growth. Exports in Q4 dropped -4.3 percent with goods declining -6.9 percent, revealing the headwind presented by a strong and strengthening dollar as net exports overall subtracted 1.7 percent from the fourth quarter’s growth. We’ve heard comments from a growing number of companies about the impact of the dollar and foreign currency translation in the current earnings season, but to put it in context, Q4 was the largest trade-related drag on overall growth since Q2 2010.

The U.S. economy decelerated in the final three months of 2016, returning to a lackluster growth rate that President Donald Trump has set out to double in the face of challenging long-term trends.

We are seeing some recovery in fixed investment, with fixed investment in mining, shafts and well structures contributing to GDP for the first time since Q4 2014, thanks to rising oil prices. While this contribution was relatively small, the removal of the headwind of low oil prices in this sector had allowed it to start contributing to GDP. We remain cautious here as the number of rigs coming online is rising week after week (see today’s Monday Morning Kickoff for more), and we remain skeptical that the OPEC deal on production cuts will survive given all the, shall we call them, colorful relationships involved.

Real investment in industrial equipment is at an all-time high, totaling more than $200 billion in 2009 chained dollars and looks to be still rising. On the other hand, investment in manufacturing structures is slowing a bit, which isn’t shocking given that capacity utilization rates are at levels normally seen around a recession.

We have also now seen Consumer Spending decline over the past three consecutive quarters despite all the euphoric talk.

This brings full-year 2016 GDP growth to just 1.6 percent, putting the U.S. growth now in 2nd place within the G7 group with the U.K. delivering growth of 2 percent for the year. We are no longer the cleanest shirt in the laundry. This is the worst growth rate for the U.S. since 2011 and down from the 2.6 percent in 2015. America has now experienced a record eleven consecutive years without generating annual 3 percent GDP growth going all the way back to 1929. Is it any wonder there is a lot of frustration in the country?

 

Despite what we keep hearing from the Fed, this is not an economy that is accelerating. While over 80 percent of the survey data has come in above expectations, giving investors a sense of security, the actual hard data, rather than the more sentiment-oriented survey data, has seen over 50 percent come in below expectations.

With the recovery in oil prices and inventories back on the rise, two major headwinds have been removed, but the biggest and potentially most lethal remains – a rising dollar. The Fed still appears to be confident that it will raise rates three times this year which increases the dollars’ relative strength. Any trade barriers that result in fewer imports into the US, such as a 20 percent tax on fruits and vegetables from Mexico, would also serve to strengthen the dollar; the less we buy from the rest of the world, the fewer dollars are outside the country. That scarcity bids up the price of the dollar, particularly given the effectively massive short position in the dollar due to the over $10 trillion in dollar-denominated emerging market debt.

Mr. Trump has argued the U.S. can achieve stronger growth by overhauling the tax code, boosting infrastructure spending, rolling back federal regulations and cutting new trade deals that narrow the foreign-trade deficit.

The two big hopes that Wall Street has been relying on to boost the economy have been President Trump’s infrastructure plan and his tax cuts. This past week we saw signs that our concerns over when these would actually be enacted are warranted. Last week senior congressional aides revealed that the spring of 2018 is a more likely target for passage of tax reform legislation. According to Reuters, as the days passed at the annual policy retreat for Republicans last week in Philadelphia, leaders were also discussing that it could take until the end of 2017 or even later to pass fiscal spending legislation. Trump has taken office with the lowest approval rating in modern history and the level of controversy surrounding him isn’t declining, which will likely make passage of legislation he wants more challenging.

Putting it all together, despite the headlines over more sentiment-oriented reports, the economy does not look to be accelerating and the expectations around the timing of Trump’s infrastructure spend and tax reform plans are likely overly enthusiastic. Even the Wall Street Journal’s survey of over sixty economists projects GDP growth of 2.2 percent in the first quarter of 2017 and 2.4 percent in the second. We will continue to monitor the data to see how likely that consensus view becomes in the coming weeks. We believe the market is also incorrectly discounting the potential negative impact of a strengthening dollar and the degree to which this strengthening may occur.

Source: U.S. Economy Returns to Lackluster Growth – WSJ

With May @MarkitEconomics manufacturing PMI for #Japan @ 40 month low @AbeShinzo plans more stimulus

With May @MarkitEconomics manufacturing PMI for #Japan @ 40 month low @AbeShinzo plans more stimulus

Despite all the central bank intervention to date, Japan’s manufacturing economy continues to contract.  May MarkitEconomics manufacturing PMI for Japan came in at a 40 month low with falling output and orders, which of course means Abe Shinzo sees it as a call to further stimulate the Japanese economy… sounds like more of the same (more debt, low to no growth) to us. 

Japan will delay its planned sales tax hike for a second time, Japan’s Prime Minister Shinzo Abe announced Wednesday, while also detailing a new stimulus package for the economy this fall.

Source: Japan Prime Minister Shinzo Abe plans large stimulus package this fall

US Economy Still Wobbly

US Economy Still Wobbly

The US economy is still pretty weak, reminding me of how I feel towards the end of my weekly “long run,” with occasionally short bursts of energy that quickly peter out into awkward limping along – getting older is not for whiners.

Housing 

Earlier this month new single family home sales missed expectations, coming in at a seasonally adjusted annual rate of 511,000 versus expectations of 520,000, for a year-over-year decline of -1.92%. That miss was slightly offset by an upward revision to the prior month’s data, from 512,000 SAAR to 519,000 SAAR. While total sales for new homes remain in an uptrend, they haven’t made a new high in well over a year.

New single family home prices have also softened, with median price falling 1.8 year-over-year and 6.4% month-over-month.  In addition, both months current supply and median months on the market have risen which indicates weaker new home markets across the country than we have previously seen.

Mid month we also received the NAHB/Wells Fargo Housing Market Index, which came in at 58 in May, unchanged from the three previous months versus expectations for the index to inch up to 59. Much like what we are hearing from the National Federation of Independent Businesses with respect to the biggest concerns for small business, “builders are facing an increasing number of regulations and lot supply constraints,” according to NAHB Chairman Ed Brady. Tuesday the Commerce Department will release a separate report on new residential construction for April.

Bottom Line: Housing is doing pretty well overall, but builders are reporting being constrained by the availability of land due in large part to land-use regulation, particularly in the geographies with the greatest demand. We are also seeing a lot less inventory available than is typical at this point in the cycle, meaning fewer people are putting their homes on the market, which is pushing prices up.

Manufacturing & Services

U.S. durable goods orders rose just 0.8% in March missing expectations for 1.8%, as demand for cars, computers and electrical goods slumped. This after a downwardly revised decline of -3.1% in February, previously reported as a -3.0% decline. Excluding transports, durable goods declined -0.2% versus expectations for an increase of +0.5% with prior month revised downward as well to -1.3% from -1.0%.

All the regional Fed Surveys all came in weaker than expected and are in contraction territory. Empire State was expected to be +6.5, but came in -9.02. Philadelphia was expected to be +3.0, but came in -1.8 and Richmond was -1 versus +8 expected. Finally Kansas City Fed was -5 versus -3 and Dallas was the worst offender at -20.8 versus expectations for -8.0.

Markit’s April US Manufacturing PMI points to weakest performance since September 2009. At 50.8 for the month (down from 51.5 in March), manufacturing activity in the current quarter started off at an even slower pace than the 1Q 2016 average of 51.7. Six of the ten subcomponents declined in April with Customer Inventories and New orders showing the largest declines while Prices Paid increased to its highest level since September 2014, up 7.5 points to 59.0. The Employment component is still below 50, indicating contraction, but did reach its best level since November.

Markit’s April US Services Business Activity Index rose to 52.8 in April, up from 51.3 in March, but we’d caution excitement as it was only the second month above the expansion/contraction line at 50.0. Despite the softening of the US dollar since early February,  new work from abroad decreased at the fastest pace for nearly one-and-a-half years.

Bottom Line: Manufacturing continues to be weak and given the tight correlation between the ISM Purchasing Manager’s Index versus the S&P 500, this is not something to be ignored. 

ISM v SP500

Employment

Both the ADP and Bureau of Labor April job creation figures were well below expectations. According to the Challenger Grey data on layoffs, the pace of downsizing in April rose by 35% percent to 65,141, from the 48,207 layoff announcements in March. In the first four months of 2016, employers have announced a total of 250,061 planned job cuts, up 24% from the 201,796 job cuts tracked during the same period a year ago. Job creation was a big miss at +160,000 versus an expected +200,000 after +215,000 in March. This is the fourth month without a print over +250,000, the worst such streak since 2013, indicating softening. On the other hand, the share of the labor force that’s been looking for work for at least 27 weeks and those who can only find part-time work have fallen, which is a sign of improvement. The employment-to-population ratio remains far below where it sat during the peak of the last two expansions and fell again 0.3% month-over-month. Overall, not a great picture, but not an alarmingly bad one either.

When we are talking about the employment situation, keep in mind that given the low-to-no-growth environment and low interest rates, companies are likely to utilize M&A activity to bolster revenue and profits. The issue there is layoffs are one of the quickest means to achieve cost savings or “synergies” to use the finance lingo.


Retail Sales

You’ve probably heard about the serious pounding the retail sector took this earnings season, with the headlines mid-month mostly dominated by dour news from the retail sector, with a set of bleh (technical term) earnings reports coming from the likes of Macy’s, Dillards, Kohl’s, Gap, and Nordstrom, all of which are trading down between -45% and -52% over the past year as of today’s close. Meanwhile Dollar General, Dollar Tree and Walmart all exceeded expectations, further emphasizing our Cash-Strapped Consumer theme. But it isn’t just about struggling brick and mortar retail, with Disney reporting its first earnings miss in five years. The next chart hows how retail spending is still in recessionary territory.

3mma retail sales

Challenges

America has for centuries been a nation on the cutting edge of change, with a highly flexible workforce, both in terms of geography and skills, that led the world in innovating. But that has been changing:

  • Between the 1970s and the 2010, the rate of Americans moving between states dropped by more than 50%, from 3.5% a year to 1.4% a year.
  • The fraction of workers required to hold a government-issued license has sextupled since the 1950s, from less than 5% to just under 30%, making the labor market less flexible because it is now more difficult to switch into an industry or to move from one state to another when licenses are required.
  • The rising costs of health care on top of the tax incentives for employer health-care subsidies versus tax disadvantages for individual plans has made it more costly and risky for individuals to leave their company and start their own entrepreneurial ventures.
  • Traditionally Americans have moved from poorer states to wealthier states, but the rise in federal taxes and federal regulation has muted the benefits from leaving one state for another. This has also reduced the need for states to compete with one another by fostering growth friendly environments.
  • High land-use regulations in wealthier metro areas are making housing more expensive so that now we see more people moving from richer areas to poorer ones due to housing costs.
  • In the past, high rates of migration served to reduce income inequality within the nation, but today the low migration rates have become a drive of such inequality.
  • Entrepreneurship and innovation are contagious. In the past, smaller counties used to lead the nation in the growth of new businesses, even through the early 1990s, but since then, small counties have lost businesses with innovation and entrepreneurship becoming more concentrated in a few areas as regulations concerning angel/venture capital investing has concentrated capital allocation for such into fewer and fewer hands. Today Silicon Valley alone accounts for 40% of all venture investments and the addition of Los Angeles, Boston and New York City brings that to 2/3rd of the total in the nation.

Botton Line: The US is facing strong demographic headwinds as the largest generation, the Baby Boomer, move into retirement, and has a plethora of structural headwinds, a few of which I discussed above. Monetary policy could never address these problems, which is partially why it has been of limited use and of questionable efficacy, leaving us with an economy that is growing at a rate well below historical norms.

Great jobs number but…

Great jobs number but…

Friday we saw a great jobs number but… were the knock-it-out-of the ballpark numdr+evil+villainbers really indicative of a (finally) robust economy?  Hmmmm, methinks there is more to it all.  You’re shocked right?

I spoke with Matt Ray yesterday on America’s Morning news about the jobs report and how I thought the data could be misleading.  You can listen to our chat by clicking here. Today, after seeing the NFIB report, I decided the topic deserved a thorough analysis, so I’ve added a lot here to what we discussed.

To start with, this number can be quite volatile, so if we look at a three-month rolling average, the current gain is still 26,000 less than the average during the first six months of the year.  We did like to see a 0.4% rise in average hourly earnings last month, bringing the annual rate up to 2.5%, which is the strongest in the past six years. That bodes well for holiday spending, which ought to have companies like Amazon pleased as punch.  If we look at the labor-force participation rate however, that remained unchanged at 62.4%, which is 0.5 lower than in January.  This data point is one that causes yours truly much angst.  Think of this as a measure of what percentage of the population is rowing the economic row boat.  The more that row, the faster we can go.  Today we have roughly the same portion we had in the late 1970s, not exactly a robust growth period for the nation!

 

The news of the strong jobs report sent the markets into a tizzy as the probability of the Fed kicking off the first interest rate hike in more than nine years at their next meeting in December soared to 68%, which is almost double the odds of such a hike just one month ago.  One of the arguments for such an increase is that it would provide some assistance to savers, who have been struggling to earn much of anything on their savings.  Hmmmm, if the Fed raises rates, and yours truly still considers that unlikely given the bigger picture of the US economy and slowing global growth, it will likely only raise rates initially by 0.25%.  Over perhaps the following year it could theoretically get to 1%, which would in reality still do very little to help savers. The true beneficiaries would be those providers of money market funds that have been forced to eat the cost of overhead to give investors in such funds even the tiniest of yields.  This led to soaring share prices of companies like Charles Schwab, E*Trade Financial and TD Ameritrade Holdings on the jobs news Friday.

In contrast to Friday’s robust report, today’s report from the National Federation of Independent Businesses revealed that job creation came to halt in October, with owners adding a net 0.0 workers per firm in recent months.  55% reported hiring or trying to hire, which was up 2%, but 48% reported few or no qualified applications for the positions they wanted to fill.

If we look at other economic indicators, we see that things really aren’t as rosy as Friday’s job report would lead one to believe.

Last week started with the weakest headline ISM (Institute of Supply Management) Manufacturing report since December 2012 at 50.1, however many economists were expected a reading below 50, (which is a contraction) so this was actually better than expected. Whoop, whoop!  But, a painful portion of the grim report came from ISM Manufacturing employment, which is now at its lowest reading since August 2009 – good times! Thankfully manufacturing is a relatively small share of the total US economy, but we’d prefer to see more upbeat data. Overall manufacturing just looks awful, with everything but customer inventories lower year-over-year, as this next chart illustrates.

ISM manufacutring

If that didn’t drive it home, this next chart on US Industrial Production ought.  The Industrial Production index shown below is an indicator that measures real output for all facilities located in the United States manufacturing, mining, and electric, and gas utilities.  This index is generated using 312 individual data series.  The chart below shows how its longer-term upward trend from the depths of the financial crisis stalled towards the end of last year and is now trending downwards.

IP Trends

In fact, on a global level, manufacturing has been under pressure with the Global Manufacturing Purchasing Manager’s Index, (an indicator of the economic health of the manufacturing sector based on new orders, inventory levels, production, supplier deliveries and the employment environment) down to 51.4 from 52.2 a year ago. Remember that anything below 50 is a contraction. On the bright side, the number is a seven-month high.  In the US, the Manufacturing Purchasing Manager’s Index is down to 54.1 from 55.9 a year ago, but up from 53.1 last month.

Speaking of inventories… this next chart almost speaks for itself.  The wholesale inventory-to-sales ratio is at a level not seen out of a recession in decades, but  I’m sure that’s nothing to be concerned over!  Looking back at history, keep in mind the strides made in inventory management in order to keep inventories as low as possible to maximize returns. In a perfect world, the second a business gets an item into inventory, a customer grabs it right off the shelf.  The longer items sit on the shelf, the more money the business has sitting idle.  It is best to look at inventories relative to sales, as if sales double, it would be reasonable for a business to need to keep more inventory on hand. When we see inventories relative to sales rise dramatically though, that means that businesses are having more items sit on the shelves for longer, which is never a good sign.

Inventories to Sales

On a more upbeat note, the ISM non-manufacturing beat expectations mightily, coming in at 59.1 versus expectations for 56.5, down from last month’s 56.9. So the manufacturing sector is continuing to weaken while the services sector strengthens.  The good news is the service sector counts for a larger portion of the economy, however the fly in the ointment is that these two tend to move along much closer together and are now diverging to a point not seen since late 2000/early 2001.  This is cause for concern as we have every reason to believe the two will return to their historical relationship.  Given the global picture, at the moment it looks more like services will move towards manufacturing than the reverse.

If we look at construction, it is also struggling. Residential construction spending rose 61 basis points in September, driven primarily by gains in private residential spending, without which, the spending number would have actually declined month-over-month.

Recently the Federal Reserve released its Senior Loan Officer Survey reported that for the first time since early 2012, a net 7.3% of bankers reported tightening standards for large and mid-size firms based on a less certain economic outlook.  Most banks also reported weakening demand for most categories of mortgages since the second quarter while seeing credit card credit demand increase.  In response, banks reported having eased lending standards on loans eligible for purchase by Fannie Mae and Freddie Mac.  Tightening credit conditions are a headwind to economic growth, of which Chairperson Yellen and her team are highly aware.  We’re quite sure they are watching this data very closely.

Looking at the Global Economy…

Monday morning the OECD, (Organization for Economic Cooperation and Development) lowered its global growth forecasts for 2015 and 2016 to 2.9% and 3.3% versus 3.0% and 3.6% previously.  This comes just a few weeks after the International Monetary Fund predicted that the world economy would, in 2015, grow at its slowest pace since the financial crisis. We are particularly concerned with global exports as world trade has long been a strong indicator of global growth and so far in 2015, trade levels have been at levels typically associated with a global recession.  To further drive home our concerns on global trade, we looked at the reports coming from the largest shipping company in the world, A.P. Moeller-Maersk, which handles about 15% of all consumer goods transported by sea.  The CEO of A.P. Moeller-Maersk recently stated that, “The world economy is growing at a slower pace than the International Monetary Fund and other large forecasters are predicting.”  Err, wait, what?!  They just reported trade levels that are typically seen during a global recession and this guy thinks it is even worse? Argh!  The company reported recently a 61% drop in third quarter profit as demand for ships to transport goods across the world hardly grew from a year earlier.

China, the world’s second largest economy, reported that its exports declined 6.9% year-over-year versus expectations for 3.8% and marked the fourth consecutive month of declines.  In India, exports of the top five sectors including engineering and petroleum fell by about 31% in September on a year-over-year basis. Keeping a wary eye out here!

To put the chart below in perspective, world trade grew by 13% in 2010, but has been slowing considerably since then.  The WTO (World Trade Organization) lowered its forecast in volumes to 2.8% from 3.5%, which is well below the 7% average for the 20 years leading up to 2007.

World Imports

Bottom LineWe are seeing diverging data coming out on the domestic economy and continue to be concerned with the weakness we see in global commodities, transports and particularly in global exports as they typically lead global GDP trends. The combination of new trade barriers being introduced faster than existing ones are being removed coupled with cyclical problems that include falling commodity prices and debt overhang are acting as headwinds to global trade, which harms economies all over the world.  While the US is the largest economy and is driven to a large degree by internal demand, it is not immune to the fates of the global economy.  As is such, the US manufacturing sector is teetering on the brink of a recession. Whether the service sector, which is typically correlated with the manufacturing sector, can remain strong is yet to be seen.

P.S.: It isn’t only global trade that is suffering from too much government intervention.  Today The National Federation of Independent Businesses released its Small Business Economic Trends Report which revealed that the single most important problem facing small businesses is (1) Government Regulation and Red Tape followed by (2) Taxes. The government could do a lot to stimulate the economy, by getting the hell of out it!