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!

Risk On?

Risk On?

This morning I spoke with Matt Ray on America’s Morning News about the recent market action. Are we back to risk on? Here is a bit more detail on our discussion.

Equity markets have rebounded to an impressive extent after the recent correction, with the S&P500 less than 5% away from its all time highs, last seen in late May, while the VIX, the measure of volatility has closed in on a two-month low after having spiked up in August.

So were all those machinations between the summer and today much ado about nothing?  To answer that, we need to understand what drives returns.  The answer, like most things in life, is it’s complicated. Over the long-term, investment returns are based on fundamentals – ideally finding a company with an excellent management team that has products or services that are in high demand for a growing demographic with shares at an attractive price. But, in the short to medium-term, returns are all about risk – are investors seeking risk or withdrawing from it?

Today, the answer to the question of affinity for risk relies more and more upon bureaucrats, which makes the investor’s job an awful lot like a fortune-telling gazing into her crystal ball.

Fig-2-1-Fortune-teller

 

Who the hell knows what insanity will get blurted out next… particularly if Donald Trump has access to a mic or a twitter feed!

The Fed has now become a primary source of uncertainty, (contrary to what they claim is their intent) while politicians and bureaucrats muddy the waters in countless ways, such as when Hillary Clinton took to twitter to bash biotech pricing.  I understand her outrage, but in today’s world of instant communication via social media, a few words can have an enormous impact and countless unintended consequences.

We’ve seen high profile investors like David Einhorn with Greenlight, John Paulson, and Michael Novogratz of the flagship Fortress macro fund, (which is now liquidating) struggling to live up to their reputations as fundamentals are easily overwhelmed by bureaucrat commentary and the market’s tendency to try to read central bank tea leaves.

So where are we today?  The S&P 500 is again closing in on its all-time high, but if we look a bit deeper we see that 63% of the stocks in the S&P 500 are still below their 200-day moving average and credit spreads remain elevated. When I see lack of breadth like this, meaning that indices are moving up based on a small group of stocks, and we see credit spreads still indicating that investors aren’t running towards risk, I remain cautious.

If we look at history to get an idea of probabilities, the S&P 500 has found itself below its 200-day moving average with more than 50% of the stocks within it also under their 200-day -moving average 24% of the time.  Annualized returns when the market has been in this position have been 9.7%, which sounds pretty good, except the maximum interim loss during those times has been 50%! (Hat tip to John Hussman for his data) So you may get decent returns, but there’s a good chance you’ll lose your lunch in the process.

If we look at the economic fundamentals, we have more cause for concern:

  • Total US business sales are down 3.09% year-over-year
  • US capacity utilization is also down year-over-year, (we are using less of our ability to make stuff than we did last year)
  • Industrial production contracting in 8 of the last 9 months
  • The producer price index is down 1.1% year-over-year, not exactly a sign of impending inflation)
  • Retails sales fell yet again in September
  • The Federal Reserves GDPNow currently estimates 3Q GDP to be 0.9%, (not exactly an overheating economy)
  • This morning we also learned that China’s GDP growth rate slowed to 6.9%, which is the weakest since the Great Recession. That will hurt Germany (major exporter to China) which is already suffering from Russia’s slowdown (big exporter to them as well) as it tries to keep the rest of the Eurozone afloat.  Mario Renzi is doing his best to get Italy turned around, but give the man a break!

If we look at earnings so far with 58 companies having reported, it isn’t exactly inspiring either

  • The percentage of companies beating on earnings is above the average, which sounds pretty good until…
  • The percentage of companies beating on revenues is below average
  • This means that earnings beats are coming from cost-cutting and financial engineering with things like share-buybacks – no indicative of long-term growth
  • As far as valuations, today the forward price-to-earnings ratio is 16, which above the 5-year and 10-year average of 14.1, which means that despite the dour fundamentals, stocks are still rather pricey.
  • Within the S&P 500, nine companies have offered weak December quarter outlooks compared to only one that has raised expectations

With fundamentals not giving us much to go on, in the short-to-near term it is all about that risk, which means investors need to be focused on how will the major indices behave as they approach their 200-day moving averages?  If they blow right past the 200-day AND if we see credit spreads (the different between the risky stuff and the safer stuff) get narrower, then it is back to game on, likely through the rest of the year, regardless of what is happening under the covers.

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China's Crashing Markets

Every Monday morning I have the great pleasure of speaking with Matt Ray on America’s Morning News and try to break down the latest market developments for listeners.  On August 24th we talked about the recent pullback in the U.S. markets, rising volatility, and China’s crashing markets and what it may mean for the U.S.

Click here to listen to our discussion.