Despite all the central bank intervention to date, Japan’s manufacturing economy continues to contract. May manufacturing PMI for 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.
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.
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.
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.
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.
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.
China isn’t the only country slowing, as we are sure you’ve all been hearing, the global economy is slowing to a level that ought to make everyone pay attention. Earlier this month the International Monetary Fund (IMF) cut forecasts for 2015 yet again, projecting 3.1% versus its prediction in July for 3.3% and its April prediction for 3.5%. This means that this year, despite the unprecedented level of monetary stimulus injected all over the world by government desperate to get things moving… the world economy will grow at its slowest pace since the global financial crisis.
Last week, Citibank cut its global growth forecast for 2016 for the fifth consecutive month, predicting 2.8% versus the previous forecast of 2.9%. Keep in mind that Citibank’s chief economist William Buiter has stated previously that global growth below 3% coupled with a significant output gap effectively represents a global recession. Now that’s just one person’s opinion, but it conveys the importance of these numbers.
If we take a brief tour around the globe, we’ll see that the Eurozone in 2014 finally posted positive growth of 0.9%, after having contracted in 2012 and 2013. The first quarter’s growth rate came in at 0.5% with the second quarter slowing slightly to 0.4%, giving the economy about 1.2% growth year-over-year.
In mid-November, we’ll get the first estimate for the third quarter, which so far is likely to be at around the same pace as the second. On Friday, we got some good news when the Eurozone Markit Composite PMI (Purchasing Manager’s Index) came in at 54 (above 50 is expansionary). The data for services came in nicely at 54.2 with manufacturing unchanged from the prior month at 52. So there is some growth in the region, though from a historical perspective it is still relatively weak. So let’s dig into the details.
If we dig a bit deeper, we see that the Eurozone’s largest economy, Germany, is suffering from the slowing in China and Russia, two major export partners with its 2nd quarter GDP coming in at 0.4%. Consumer confidence has been falling since the first quarter, but it still maintains an enviable unemployment rate of less than 5%, with a youth unemployment rate of 7%, which bodes well for the nation’s productivity in the future.
France, the Eurozone’s second largest economy, on the other hand experienced no growth in the second quarter, versus expectations for a 0.2% increase with an unemployment rate of just under 11% and a youth unemployment rate of nearly 25%.
Italy, the Eurozone’s third biggest economy experienced just 0.2% growth versus 0.3% expected. Unemployment has remained stubbornly high at nearly 12% with youth unemployment over 40%, which is a devastating number for the future of the country. However, Prime Minister Matteo Renzi has made a lot of progress in reforming the government, so despite those rather dour numbers, consumer confidence is higher today than it has been over the past 12 years! Directions are important – we can’t just look at the numbers in isolation.
So things aren’t great in Europe, but they aren’t horrible either… however, significant growth seems perpetually illusive with rising concerns that the slowing in China and the emerging markets could be a tipping point for the area, which is likely why the head of the European Central Bank, Mario Draghi, hinted last Thursday that the ECB (Europe’s version of the Fed) is willing and ready to inject more quantitative easing into Europe’s economy. More QE, the now omnipresent heroin of the stock market was promised and equity indices all over soared!
So what about China? How bad it is there? Truth is, no one really knows. The country is based on an ideology that requires opacity at all levels of government, so accurate data or even an honest attempt at accurate data is something we are unlikely to ever get from official sources.
Those sources recently reported that China’s growth in Q2 was 6.9%, close enough to the official target of 7.0%, but being below, it provides a wee bit of cover for some stimulus. And wouldn’t you just know it! The People’s Bank of China, essentially their Fed, just lowered lending rates…a coincidence we’re sure!
Taking a step back, China has cut their 1-year interest rate 6 times since November of 2014, lowering the rate from 5.6% to 4.35%… but we’re sure everyone there is quite calm! The Required Deposit Reserve Ratio for Major Banks has been lowered 4 times since February, from 19.50% to 17.50%. This ratio determines how much leverage banks can have, which translates into loans. The lower the ratio, the greater the leverage which means more loans… more of nothing to see here folks? We don’t think so.
Here are a few more interesting data points:
- China’s export trade has fallen -8.8% year to date.
- China import trade is down 17.6% year to date.
- Railway freight volume is down 17.34% year over year.
- China hot rolled steel price index is down 35.5% year to date
- Fixed asset investment is up 10.3% sounds great? (averaged +23% 2009-2014)
- Retail sales are up 10.9%, the slowest growth in 11 years
- China Containerized Freight Index, which reflects the contractual and spot market rates to ship containers from China to 14 destinations around the world, has just hit its lowest level in history, now 30% below where it was in February and 25% below where it was at its inception 17 years ago.
You get the point. It is slowing and we suspect it is slowing a lot more than the official GDP numbers would indicate.
Why should those of us outside China care? Because China has been a major supporter of global growth since the financial crisis. When all hell broke loose in 2007 & 2008, China put its infrastructure spending into high gear. That meant that those economies that supply commodities had a backup buyer for their exports when everyone else was crashing, which put a vital floor under the global economy.
But China couldn’t keep it up indefinitely, and we are seeing the consequences of that nation’s shift from a primarily export driven, massive infrastructure-building economy to a more domestic demand-driven economy with a lot less infrastructure spending.
China has been Germany’s fourth-largest export partner, with Russia not that far behind. Falling oil prices and sanctions have crippled Russia’s economy, so it also isn’t buying much from Germany. If Germany sells less, it’ll buy less from other nations… and keep in mind that all those Eurozone countries are just barely eking out positive growth, so small changes will have an impact.
Onto those emerging economies, many of which were benefiting from China’s infrastructure spend as they are primarily commodity exporters. If we look at what has happened to commodity prices over the past twelve months, you can get an appreciation for just how painful this has been for many of these countries. Keep in mind that 45% of global GDP comes from commodity export nations – commodity prices crater and these nations can buy less stuff from other nations – more headwinds to growth.
In fact, 2015 will be the fifth consecutive year that average growth in emerging economies has declined. This is a serious drag on the advanced economies, which on the other end of the spectrum, will likely post their best growth since 2010 – albeit growth that isn’t all that spectacular.
Japan… well it’s still stuck between barely growing and contracting, regardless of how much the Bank of Japan tries to kick start the economy. Japan’s industrial output unexpectedly fell in September, raising concerns that the nation may be slipping back into another recession. Production declined 0.5% in August following a 0.8% decline in July versus economists’ expectations for a 1% gain. Inventories rose 0.4% in August over July, and expanded in five of eight months this year, which is a hindrance to future growth as with rising stockpiles of unsold goods, companies are less likely to expand output in the future.
As for Latin America, Argentina is still a mess and Brazil is in a recession, with many of the other countries doing alright. Chile is expected to be around 2.5% for 2015. Colombia 2.8%… like we said, ok, not great.
In the US, things aren’t awful, but not exactly robust, which is why I had been predicting for months that the Fed would not hike rates in September.
- For example, the Industrial production index came in with another decline of -0.4% in September versus expectations of -0.2%, which makes it the 5th decline out of 8 reported figures in 2015.
- Capacity utilization, which measures to what degree the economy is taking advantage of its ability to make stuff, was expected to drop from 78% to 77.8%. Instead, it fell further to 77.6%, for the 7th decline out of 8 readings in 2015. This means the U.S. continues to use less and less of its capacity to make stuff – hardly shocking given the wide misses in manufacturing data reported by regional Federal Reserve banks for August.
- September retail sales came in below expectations, rising a seasonally adjusted 0.1% from August versus expectations for 0.2%. The good news is the increase came from a 1.8% month-over-month increase in auto sales. Overall retail sales, when we exclude autos and gasoline, have not grown since January.
- U.S. producer prices in September posted their biggest decline in eight months, at a drop of -0.5%, as energy costs fell for the third month in a row. This means that the Producer Price Index is now down 1.1% year-over-year as of the end of September.
- U.S. total business sales also declined in September, down -0.58% month-over-month and down -3.09% year-over-year as of August.
Going forward, I still remain very skeptical that the Fed will raise rates. The fact that China is continuing to loosen its monetary policy and comments out of the ECB concerning it likely embarking on further easing only add to our skepticism as the moves by China and the ECB will already put upward pressure on the dollar, harming U.S. exports. A rate hike would only exacerbate the dollar strengthening against other currencies.
Fed tightening has been a trigger in nine of the last eleven recessions, so you can see yet another reason for the Fed to be cautious.
The tough thing now is that with a Fed that can’t seem to make up its mind, investors are left wondering what to do, so they end up selling the good and the bad when they get nervous. This will make for increased volatility, but that also means more opportunities for those that keep focused on the goal and don’t get distracted by shorter-term market dramatics.
On Monday March 3rd, the NASDAQ closed above 5,000 for the first time since 2000, while the S&P 500 and the Dow Jones Industrial Average also reached new record highs, which would lead one to think that things are going pretty darn well. According to Chris Verrone of Strategas Research Partners, 70% of US stocks are currently in an uptrend. In comparison, at the NASDAQ’s previous March 2000 peak only 25% of stocks were in an uptrend.
Unfortunately outside of the US, central bankers don’t look like they are feeling quite as rosy as American equity investors. So far in 2015 at least 21 central banks have lowered their key interest rates in an attempt to strengthen their economies. China surprised the markets with a rate cut last weekend, after having early in February made a system-wide cut to bank reserves. India cut its main interest rates just last week for the second time in less than two months followed by Poland, which cut rates March 4th. So much for a growing global economy, and our view is if the guys in the center of it all think the punch bowl needs to be spiked, perhaps we need to look deeper.
Just what data is the Fed seeing?
Last week Janet-I’m-not-tellin-Yellen reported the domestic economy is looking better, not great, but better. We’re wondering just what data she was looking at because so far this week alone we’ve seen the following:
- Monday we learned that Personal Income rose less than expected, (0.3% vs. expectations of 0.4%) while Personal Spending came in below expectations, (-0.2% vs. expectations of -0.1%) in January. That’s two in a row for spending whiffing it.
- Markit Manufacturing PMI beat expectations, up from 53.9 to 55.1 vs. expectations of 54.3.
- ISM manufacturing index fell in February to 52.9 from 53.5, for the fourth consecutive monthly decline
- ISM non-manufacturing index beat expectations at 56.9 in February vs. 56.5 estimates.
- Construction spending unexpectedly fell1% in January.
- Six of the top seven auto manufacturers on Tuesday reported year-over-year sales increases in February, but all fell short of expectations.
- This morning we learned private-sector job creation for February was below expectations with companies adding 212,000 positions versus expectations of 220,000 while also dropping from the 250,000 in January.
- U.S. crude oil supplies rose to yet another record high last week, with crude-oil stocks at their highest level since 1982 on a weekly basis. Stockpiles rose by 46,000 barrels during the week versus expectations of a 1.8 million drop; keep in mind we’ve already seen operational oil rigs drop by about 1/3.
Well what about prior reports? From the economic data released during the month of February, forty-two were below expectations, (the aforementioned personal spending, construction spending, factory orders, retail sales, business inventories, housing starts, building permits, industrial production, and capacity utilization) while only six beat expectations, (including nonfarm payrolls, Case-Shiller Home prices and Markit Manufacturing PMI). Kinda makes one wonder exactly what Yellen was looking at let alone feeling good about.
Oh wait, there’s the love! Turns out there is no lack of (at least) self-love in the markets as companies last month announced a record $104.3 billion in planned repurchases, which is the most since TrimTabs Investment Research began tracking the data in 1995 and nearly twice the $55 billion from last year. To put that number in context, buybacks will amount to about $5 billion in purchases every day, which is about 2% of the value of all shares traded on U.S. exchanges, according to Bloomberg, which also estimates that earnings from S&P500 members will decline by at least 3.2% this quarter and next, with full year growth at 2.3% versus 5% in 2014. With executive pay often linked to share price, it shouldn’t come as a surprise that companies in the S&P 500 spent about 95% of their earnings on repurchases and dividends in 2014… oh did we just say that out loud?
In the bond market, negative bond yields currently account for about $2 trillion of debt issued across Europe. Just this week Germany sold five-year bonds at a negative rate for the first time ever. Why would anyone buy bonds with negative yields? The ECB is set to begin rather large purchases of sovereign bonds in the coming months, which will likely push yields even lower. That could allow a negative yielding bond to actually experience a capital gain as bond prices are pushed lower. The ECBs move is also likely to push the euro even lower against the dollar, and as we discussed at the opening of this piece, central banks around the world are lowering their rates, which devalue their currencies… at least relative to currencies that aren’t lowering rates, which right now is basically the dollar. All this is a surreptitiousness form of monetary tightening, of which we are sure the Fed is well aware.
But what about last Friday’s (March 7th release) February Employment report. The headline for the jobs report boasted 295,000 jobs being created during February, a big beat relative to the 240,000 jobs economist forecasted. The second headline pointed to a drop in the Unemployment Rate to 5.5%. That got everyone in an excited tizzy that the economy is finally really going strong and oh goody-goody-goody we can’t wait to see the next retail sales report!
As always, it pays to dig a bit deeper. When we do, we find a lot of people continued to drop out of the labor force in February and that was the real driver behind the drop in the unemployment rate. Tough to argue that the jobs situation is all champagne and roses when lots of people decide it just isn’t worth it. The chart below says it all – unemployment rate falling right along with those who simply leave the workforce.
Additionally, wage growth was once again modest in February with a pittance 0.1% increase. Hours worked during February declined, which could be thanks to the snowy weather and port disruptions – we continue to hear from companies like Macy’s (M), Gap (GPS) and others that both will weigh on growth in the current quarter. The number of construction jobs created in February fell 40% month-over-month.
Most importantly the quality of jobs created remains problematic as leisure & hospitality was the big winner in February, continuing the trend we’ve been watching for some time as a good portion of the post-crisis job creation has been of lower quality than the jobs that were lost. For example, mining/logging lost 8,000 jobs, (which tend to be higher paying) while retailers (which tend to be lower paying) contributed 32,000 jobs. Makes you think about just how many “Do you have this in a small” jobs it takes to replace one highly skilled mining job. On that note, if the job situation is so rosy, why has personal spending declined for two months in a row?