Note: Now that equity markets have declined 10%, the risk/reward ratio for equities looks more appealing but I need a bit more time to complete the analysis and finalize my thoughts. The update on equity valuation should be posted Tuesday or Wednesday. Here’s the background.
We can’t recall a worse week for US economic indicators. While it was only a four-day week, there were a large number of indicators released — 21 to be exact. As shown below, of the 21 releases, a whopping 18 came in weaker than expected! Just 1 out of the 21 indicators came in stronger than expected. With US economic data completely collapsing this week, and the euro and gold rallying on Friday as US stocks tanked, have we just experienced a key pivot point in which the US starts to underperform the rest of the world again?
U.S. EMPLOYMENT & CONSUMER SPENDING
Payrolls added a meager 69,000 jobs, while April’s initially reported gain of 115,000 was revised down to 77,000, and March’s originally reported rise of 154,000 was reduced to 143,000.
Governments continue to cut, reducing payrolls by 13,000 jobs in May as states keep cutting expenses. Private employers added only 82,000 jobs. Construction employment fell by 28,000 jobs. Manufacturing added an average 10,500 jobs in each of the past two months, after averaging 41,000 new jobs in the first three months of the year.
In my April 2nd post FACTS & TRENDS: The U.S. Consumer About to Retrench, I assumed that employment growth would average 145k per month for the last 9 months of 2012 after the 245k monthly average in Q1. However, the March-May average was 96k and the April-May average dropped to 73k, making the 145k figure pretty elusive. If monthly employment growth is limited to 100k for the rest of the year, the YoY gain in employment will drop from the already low +1.3% to barely +1.1% by December and below 1% by March 2013.
Average hourly earnings continue to rise at a tepid 0.1% monthly rate. At that rate, the YoY growth rate will decline from the current +1.7% to about +1.2% by year-end and +1.0% by March 2013.
In total, income from employment will gradually ease off from the current +3.0% to the +2.3% range by December and barely +2.0% by March of next year, substantially less than my already conservative assumptions (+3.0-3.5%) in early April.
Consider that personal income increased 0.2%, +2.8% YoY in April based primarily on a a 0.2% rise (+3.2% y/y) in wages and salaries. The likely slowdown in income will drag the yearly growth rate in wages and salaries down below +2.5% by year-end and to +2.0% by March 2013.
The impact on consumer spending growth will be direct as consumers have already considerably reduced their savings rate to 3.4% in April, down from March’s 3.5%. A year ago, the saving rate was 4.8%. The savings rate got below 3% at the height of the housing bubble when everybody and his uncle was borrowing against their house. In any event, betting on a significant further decline in the savings rate is not fundamentally sound.
The opposite risk must also be considered. What if Americans decide to increase their savings? As shown in the accompanying chart, expenditures have far outpaced income in the past 12 months, a situation which generally has not lasted for long periods of time.
So, while personal consumption expenditures rose 0.3% MoM in April and again outpaced income, the 4.0% YoY gain is clearly unsustainable. Recent growth in spending was led by motor vehicles where pent-up demand is high but eminently volatile.
May’s auto sales in the U.S. were 1.33M, a 13.8M annualized pace, down from April’s 14.2M, the first month this year that annualized sales have fallen below 14M cars and light trucks (U.S. Auto Sales Keep Rising).
All this to say that the recent employment data for the U.S. are troubling and should be viewed with great concern by the Fed. Chairman Bernanke said in April that the Fed may provide more accommodation should unemployment fail to make “sufficient progress towards its longer-run normal level.” Since inflation is not a threat at this time, market hopes of an even more accommodating Fed could well be met pretty soon.
The PCE chain price index was flat in April after a 0.2% increase in March; it is up 1.8% from a year ago. The core PCE price index was also a bit slower in April, with a 0.1% increase following March’s 0.2%; it is 1.9% above a year ago.
The recent sharp decline in oil prices will not only help consumers, it will likely help monetary authorities across the world to become more stimulative. In the U.S. in particular where the price of gasoline should decline markedly in coming weeks.
Bernanke & friends cannot be oblivious to what’s happening abroad. The latest PMIs for Europe, China and many other countries, including many BRIC countries, continue to point to further weakness.
True, the U.S. is a relatively closed economy as the FT wrote last weekend (The protective walls of Fortress America):
Exports of $2.1tn last year were only 14 per cent of national output, according to the Commerce Department. The largest trading partners are its neighbours to the north and south, and all the countries that use the euro combined bought only $200bn worth of US goods and services last year, as much as Mexico.
But the neighbors are highly commodity-sensitive:
Canada’s economic growth slows to a crawl Consumer spending, total domestic demand increase at slowest pace since 2009
Figures Friday from Statistics Canada show the economy grew at a 1.9-per-cent annual pace from January through March, much less than the Bank of Canada was expecting, as consumer spending and total domestic demand both grew at the slowest pace since 2009.
Consumption slowed to a 0.9-per-cent annual rate, from a 2.8-per-cent pace in the last three months of 2011. Final domestic demand – which includes consumer spending but also areas like business investment and government expenditures – slowed to a 1.3-per-cent pace from 1.6 per cent. (Chart from ISI)
Brazil stimulus fails to boost growth First quarter GDP rise of 0.2% adds to gloom
China is also experiencing a serious slowdown, induced partly by the woes of its trading partners but also by its own domestic weaknesses. The deterioration is relatively modest, so far, but it is showing no signs of slacking off and is beginning to impact employment as Markit revealed:
Reduced intakes of new business contributed to another month of job shedding, with the rate of decline the sharpest in 38 months. Companies have now reduced their staff numbers in each of the past three months.
China’s official PMI had held better than Markit’s in recent months as larger companies seemed to be faring somewhat better than the SMEs. But May’s official PMI saw its new order index drop severely, hitting 49.8 in May, compared with 54.5 in April. Also, since the new export indicator decreased to 50.4 from 52.2, we can conclude that domestic new orders have declined precipitously in May.
While American manufacturers seem to be gaining market share, foreign demand is declining in absolute terms and the U.S. dollar is appreciating rapidly. The JP Morgan Global Manufacturing PMI fell to 50.6 in May:
Growth of total new orders meanwhile remained lacklustre, in part reflecting the first decline in new export business since last December. Manufacturers in Europe, China and Japan all reported reduced levels of new export business. Growth of new exports slowed sharply in the US.
The Fed’s next meeting is June 19-20.
If officials do decide to act, the Fed has different options. One would be to extend their program called Operation Twist, in which the Fed buys long-term securities and sells short-term securities. The current $400 billion program ends in June. It could also launch a new program in which it buys long-term bonds with money it creates, rather than with cash it receives from selling short-term securities. (WSJ)
And the ECB meets this week. On May 3rd, Draghi said
We saw stabilizing economic activity at low levels in the first three months” of the year, Draghi said. “The most recent survey indicators show uncertainty prevailing. We will be clearer in our assessment next month.
I still fail to see where he saw stabilization but he was right in expecting to see more clearly in early June. Just in case he reads me, here’s the rundown:
PMIs for Germany, France and Spain all fell to their lowest levels since mid-2009, while the downturn in the Netherlands accelerated to its fastest in five months. Rates of contraction eased slightly in Italy and Greece, but remained steeper than the euro area average. Greece moved off the bottom of the euro PMI league table for the first time since January 2010, replaced by Spain.
Manufacturing production dropped at the steepest rate since June 2009, following a similarly marked reduction in new orders. Companies reported weaker demand from both domestic and export markets. New export orders fell to the greatest extent since November last year, reflecting both slower global economic growth and lower levels of intra-Eurozone trade. Germany, Spain and Greece all reported especially marked reductions in new export orders.
Rates of job cutting accelerated in Germany, France, Spain and the Netherlands, with Greece posting the steepest overall cuts.
He is also witnessing what is obvious to everybody: the Eurozone politicians won’t do the job.
Draghi told a European Parliament committee in Brussels that without more aggressive action by policy makers the euro “is being shown now to be unsustainable unless further steps are being undertaken.”
He said it wasn’t his job to make up for the failures of policy makers. “It’s not our duty, it’s not in our mandate” to “fill the vacuum left by the lack of action by national governments on the fiscal front,” on “the structural front, and on the governance front,” he said.
Pretty tough words. Bernanke was more polite 6 weeks before when he said
The size of the Fiscal Cliff is such that there’s no chance the Fed could have any ability whatsoever to offset that effect on the economy.
In effect, he clearly told American policymakers that the hole they have created is such that the Fed can’t, alone, bridge it. So get along and do something!
So here we are: an untimely synchronized global slowdown/recession and poor political leadership just about everywhere. The only “doers” are the central bankers. Will they act? When? How?
I bet they will, because they have and they need to, again!
In the U.S., Bernanke understands the political scene, the coming fiscal cliff and the looming deflation risk. In Europe, Draghi is no Trichet and he knows the need to “tricher” rules and regulations when there’s no tomorrow.
Clearly, there’s no tomorrow in Europe. These are extraordinary times that require extraordinary actions which are most unlikely to come from the politicians.
The ECB’s tricky 3-year LTRO program is clearly not sufficient to stem the current crisis.
“The ECB’s special longer-term refinancing operations successfully reduced the perceived risk of a severe banking crisis in Europe,” the BIS said. “But by the middle of May, doubts had returned.”
These doubts covered nearly every conceivable aspect of the economy from growth in the euro area, to the stability of banks, the effects of fiscal consolidation on growth and finally, fears of political instability within the bloc. (FT)
The central bank needs to further boost its balance sheet to clamp down on bond market tensions. The markets, once again, are compelling the ECB into more aggressive action.
Extraordinarily low bund yields and declining inflation and commodity prices will help overcome German opposition to the needed bailout. Markets won’t have to wait for very long. The ECB meets this week.
Short-term measures include a rate cut by the European Central Bank, which holds its next rate-setting meeting next week, a resumption of government bond-buying under its securities market program and another round of ultra-cheap ECB loans for banks.
Some are looking for political progress on a pan-European deposit guarantee, bank recapitalisations, government investment to stimulate growth and, potentially, a banking licence for the European Stability Mechanism, Europe’s permanent bailout fund, to boost its firepower.
Hard decisions are unlikely before the Greek election on June 17, but this week’s volatility has sparked speculation the ECB could act sooner. (Traders look to ECB amid turmoil)