DRIVING BLIND (Cont’d)
American employers added a disappointing 74,000 jobs in December, a tally at odds with recent signs that the economy is gaining traction and moving beyond the supports put in place after the recession.
The downbeat readings were partly attributed to distortions caused by bad weather, and many economists warned that the report may prove to be a fluke. Employers, too, are reporting a mixed take on the economy and their labor needs.
Government payrolls declined by 13,000 in December, and health care—usually a steady source of job growth—declined by 1,000. Construction jobs, which are often weather-dependent, declined by 16,000. Manufacturing payrolls expanded just 9,000.
Meanwhile, last month’s most significant job gains were in sectors that traditionally aren’t high-paying, such as retail, which added 55,000 positions. The temporary-help sector increased by 40,000.
One piece of good news in Friday’s report was a substantially revised increase in November’s tally, to 241,000 new jobs from 203,000.
Weather or not? JP Morgan is rather cold about it (charts from WSJ):
The big question is how much of the disappointment was weather distortion. The 16,000 decline in construction payrolls is an obvious candidate as a casualty of cold weather in the survey week. Another clue comes from the 273,000 who reported themselves as employed but not at work due to bad weather, about 100,000 more than an average December. Caution should be taken in simply adding this 100,000 to the nonfarm payroll number, as the nonfarm number counts people as employed so long as they were paid, whether or not they were at work.
Our educated guess is weather may have taken 50,000 off payrolls. It’s hard to see how the weather — or anything else — was to blame for the 25,000 decrease in employment of accountants. Another outlier was health care employment, down 6,000 and the first monthly decline in over a decade, undoubtedly a data point that will enter the civic discussion on health care reform.
Weak personal income:
The weak payroll number was accompanied by a shorter work week and little change in hourly pay. The workweek fell by six minutes to 34.4 hours in December. Hourly pay for all employees increased only 2 cents, or 0.1%, to $24.17, less than the 0.2% gain forecasted.
The combination of weak net new jobs, fewer hours and very small pay raises suggests wages and salaries hardly grew last month. Since “wages and salaries” is the largest component of personal income, the household sector probably didn’t see much income growth in December. And the gain was even less when inflation is taken into account.
BloombergBriefs explains further:
A negative in the report was the underlying trend in average hourly wages, which slowed to a 0.1 percent month-over-month gain and 1.8 percent on a year-ago basis. Using data on hours worked and earnings, one can craft a labor income proxy that is up 1.8 percent, well below its
20-year average of 3 percent.
This is critical with respect to the growth outlook in the current quarter. During the past two quarters the growth picture has improved, due in part due to an increase in inventory accumulation. Given the increase in hourly wages and the labor income proxy, households may need to pull
back on spending in the first three months of the year, which increases the risk of a noticeable negative inventory adjustment in the first quarter.
Friday’s disappointing jobs report is likely to curb the Fed’s recent enthusiasm about the U.S. economic recovery, but it seems unlikely to convince officials they should alter the policy course Bernanke laid out.
That is even though the economy averaged monthly job gains of 182,000 positions last year. That is roughly the same as the 183,000-a-month pace of 2012 and 2011 average of 175,000. Is employment actually accelerating other than through the unemployment rate lens? The WSJ gets to the point:
(…) The report exacerbated another conundrum for officials.
The jobless rate, at 6.7% at year-end, is falling largely because people are leaving the labor force, reducing the numbers of people counted as unemployed.
Because the decline is being driven by unusual labor-force flows—aging workers retiring, the lure of government disability payments, discouraged workers and other factors—the jobless rate is a perplexing indicator of job-market slack and vigor.
Yet Fed officials have tied their fortunes to this mast, linking interest-rate decisions to unemployment-rate movements. Since late 2012, the Fed has said it wouldn’t raise short-term interest rates until after the jobless rate gets to 6.5% or lower. In December, officials softened the link, saying they would keep rates near zero “well past” the point when the jobless rate falls to 6.5%.
Most officials didn’t expect that threshold to be crossed until the second half of this year. At the current rate, it could be reached by February.
The jobless-rate movement and the Fed’s rhetoric create uncertainty about when rate increases will start. Short-term interest rates have been pinned near zero since December 2008, and officials have tried to assure the public they will stay low to encourage borrowing, investment, spending and growth.
Now, the public has more questions to consider: What does the Fed mean by “well past” the 6.5% threshold? Is that a year? A few months? How does it relate to the wind-down of the bond-buying program? What does it depend upon?
It will be Ms. Yellen’s job to answer the questions. Mr. Bernanke’s last day in office is Jan. 31.
Remember the To Tell The Truth game show?
- Supply/demand #1: Oversupply
The total number of jobs in the U.S. hit a peak of about 138 million in January 2008, one month after the start of the most recent recession.
In the ensuing downturn, nearly nine million jobs disappeared through early 2010, when the labor market started turning around.
Job gains accelerated in 2011 and have remained fairly steady since, edging up a bit each year.
To date, almost 8 million jobs have returned, leaving a gap just shy of 1 million, which is likely to be closed this year. But that doesn’t account for changes in the population.
If the population keeps growing at that same rate, and the U.S. continues to add jobs near 2013’s pace, then the total number of nonfarm jobs in the U.S. won’t get back to where they should be until 2019. If the pace picks up in 2014 and beyond — say to 250,000 a month — the gap will narrow sooner, in 2017.
That said, the U.S. economy hasn’t added an average 250,000 jobs or more a month since 1999.
- Supply/demand #2: Shortage
BlackRock fixed-income chief Rick Rieder says this morning’s disappointing December jobs report underscores the structural nature of an unemployment situation that’s beyond the control of the Federal Reserve.
“My view on unemployment is structural – you can’t fix it with quantitative easing,” Rieder tells Barron’s today. He said the disappointing number of jobs added can’t all be blamed on bad December weather, and that the labor force participation rate keeps dropping. “It means you have an economy that’s growing faster, and you don’t need people because of technology…. You’ve got all this economic data that’s strong but you don’t need people to do it.” (…)
- Supply/demand #3: Dunno!
(…) At least some of the decline in participation reflects demographic factors, including the Baby Boom generation moving into retirement age and younger people staying in school longer. But the participation rate for people age 25 to 54, which shouldn’t be affected much by such factors, has fallen to 80.7%, from 83.1% at the end of 2007.
Here’s the optimistic view…
This suggests the pool of people available for employment is substantially higher than the unemployment rate implies. So even if job growth does, as most economists expect, rev back up, it will be a while before companies need to pay up to attract workers. Indeed, average hourly earnings were up just 1.77% in December versus a year earlier, the slowest gain in more than a year. The net result is inflation may be even more subdued in the years to come than the Fed has forecast.
…but that optimism assumes that the drop-outs are simply waiting to drop back in, a view not shared by the Liscio Report (via Barron’s):
(…) But our friends at the Liscio Report, Doug Henwood and Philippa Dunne, find a rather different story, especially among younger groups: The vast majority of folks not in the labor force don’t want a job, even if one is available. That’s what they tell BLS survey takers anyway.
Data going back to 1994 show a steady uptrend in the percentage of young (16 to 24-year-old) and prime-age (25 to 54) Americans not in the labor force, with parallel rises in the number not wanting to work. Among younger ones, the percentage staying in school has remained around 1%, with no discernible trend, notwithstanding anecdotes of kids going to grad school while employment opportunities are scarce. Meanwhile, the overall share out of the labor force because they’re discouraged, have family responsibilities, transportation problems, illness, or a disability has stayed flat at around 1% since the BLS started asking this question in the current form in 1994, they add.
And, notwithstanding anecdotes of retiring boomers, the 55- to 64-year-olds were the only group in which the percentage not in the labor force and not wanting a job fell from 1994 to 2013. Perhaps they’ve got to keep working to support their kids, who aren’t?
While there was some improvement in December, the number of those not in the labor force is surprising, to put it mildly — up some 2.9 million in the past year and up 10.4 million, or 13%, since July 2009, when the recovery officially began. The number of these folks who want jobs is down 600,000 in the past year, despite a 332,000 rise last month.
“What is interesting,” Philippa observes, is that the number who wanted jobs “was climbing from late 2007 until the summer of 2012, when it hit 6.9 million. Since then, it’s been falling, and is down to 6.1 million, or minus 12%.”
For Yellen’s sake! Would the true supply/demand equation please stand up.
This is not trivial. We are all part of this extraordinary experiment by central bankers. History suggests that such massive liquefaction tends to fuel inflation but there are no sign of that in OECD countries. In fact, the JCB is fighting deflation while the ECB is pretty worried about it. In the U.S., the Fed has pegged its monetary policy on the unemployment rate but it is realizing that its peg is anchored in moving sands.
Actual employment growth is stable at a sluggish level but the unemployment rate is dropping like a rock. Could labour supply be much lower than generally thought? What is the U.S. real NAIRU (non-accelerating inflation rate of unemployment)? Truth is, nobody really knows.
But here’s what we know, first from David Rosenberg:
While it is true that employment is still lower today than it was at the 2007 peak, in some sense this is an unfair comparison. Many of those jobs created in the last cycle were artificial in the sense that they were created by an obvious unsustainable credit bubble. The good news is that non-financial employment has now recouped 95% of the recession job loss and is now literally two months away (390k) from attaining a new all-time high. (…) it is becoming increasingly apparent that this withdrawal from the jobs market is becoming increasingly structural. (…)
With the pool of available labour already shrinking to five-year lows and every measure of labour demand on the rise, one can reasonably expect wages to rise discernably in coming years, unless, that is, you believe that the laws of supply and demand apply to every market save for the labour market. Let’s get real. By hook or by crook, wages are going up in 2014 (minimum wages for sure and this trend is going global). (…)
With this in mind, the most fascinating statistic in the recent weeks was not ISM or nonfarm payrolls, but the number of times the Beige Book commented on wage pressures. Try 26. That’s not insignificant. (…)
As I sifted through the Beige Book to see which areas of the economy were posting upward wage pressures and growing skilled labour shortages I could see a large swath – Technology, Construction, Transportation Services, Restaurants, Durable Goods Manufacturing. (…)
Now this from yours truly:
Minimum wages are going up significantly in 2014 in states like California (+12.5%), Colorado (+12.5%), Connecticut (+5.5%), New Jersey (+13.8%), New York (+10.3%). These five states account for 25% of the U.S. population and 28% of its GDP. Obama intends to push for a 39% hike in the federal minimum wage to $10.10. In effect, many wages for low-skill jobs are tied to minimum wages.
The irony is that minimum wages affect non-skilled jobs which are clearly in excess supply currently. As we move up the skill spectrum, evidence of labour shortages is mounting in many industries and wages are rising.
Small businesses create the most jobs in the U.S. The November 2013 NFIB report stated that
Fifty-one percent of the owners hired or tried to hire in the last three months and 44 percent (86 percent of those trying to hire or hiring) reported few or no qualified applicants for open positions. This is the highest level of hiring activity since October, 2007.
Twenty-three percent of all owners reported job openings they could not fill in the current period (up 2 points), a positive signal for the unemployment rate and the highest reading since January, 2008.
- Unfilled job openings are almost back to historical peaks if we exclude the two recent bubbles.
- Employers have been more willing to hire full time employees:
- Quit rates have accelerated lately, indicating a greater willingness to change jobs. People generally decide to change employers because they are offered better salaries.
Hence, average hourly wages have been accelerating during the last 12 months.
Nothing terribly scary at this point but the present complacency about labour costs and inflation is dangerous. Wages were rising by 1.5% in 2012 and they finished 2013 at +2.2%. Meanwhile, inflation decelerated from 2.0% in 2012 to 1.2% at the end of 2013 as did real final sales from +2.8% at the end of 2012 to +1.8% in Q313. What’s going to happen if the U.S. economy accelerates like more and more economists are now predicting.
Certainly, the economy can accelerate without cost-push inflation if there is as much slack as most believe. But is there really as much slack? Recent evidence suggests that there is less than meets the eyes. If that is true, investors will soon start to worry about rising corporate costs and interest rates.
All this so late in the bull market!
Time to join the Fed and start tapering…your equity exposure.
(…) Originations of subprime loans have increased to their highest levels since the financial crisis, with quarterly volume reaching $40.3 billion in the second quarter of last year, up from a recent low of $14.9 billion in late 2009 and the most since the second quarter of 2007, according to Equifax. Subprime auto loan volume was $39.8 billion in the third quarter.
Cheaper financing for lenders increases the difference between their costs and the rates they charge to consumers. In the third quarter, those rates averaged 9.64% and 14.25% for new and used cars, respectively, Moody’s said. High rates give lenders “room” to make weaker loans because of the cushion that the thicker profits provide against losses, the firm said. (…)
Lenders may cut standards more to grab market share as the pace of auto sales slow and the number of subprime borrowers stops expanding, the rating firm said.
Examples of weaker lending include larger amounts and longer loan terms, Moody’s said. The average term for subprime loans rose to 60.9 months from 59.9 months in the third quarter from a year earlier, it said. (…)
Why This European Is Bullish on America The billionaire founder of Ineos says the shale revolution is making the U.S. a world-beater again. It would be ‘unbeatable’ with a lower corporate tax rate.
(…) Seven or eight years ago in his industry, “people were shutting things down” in America “because it wasn’t competitive. Now it’s become immensely competitive.” (…)
On the contrary, Europe has “the most expensive energy in the world.” The Continent has been very slow to move on shale gas, and the U.K. has only lately, and somewhat reluctantly, started to embrace fracking. (…)
“There’s lots of shale gas around” in the U.K. and elsewhere, Mr. Ratcliffe says. But “in Texas there are 280,000 active shale wells at the moment. . . . And I think a million wells in the United States” as a whole. By contrast, “I think we have one, at the most two, in the U.K., and I don’t think there are any in France.” The French made fracking illegal in 2011, and the country’s highest court upheld the ban in October. (…)
Social protections in Europe make it much more expensive to shut down underperforming plants. Many Europeans will say, “Yes, that’s the idea. To protect jobs.” (…)
But Mr. Ratcliffe argues that European-style social protections lead to under-investment that ultimately benefits no one. (…)
By contrast, he says, in America “you’d just shut it down.” Which is why, he adds, “in America all our assets are good assets, they all make money.” That may sound like a European social democrat’s nightmare, but Mr. Ratcliffe takes a longer view, explaining that if the lost money had instead been invested in new capacity, the company would be healthier, employees’ jobs more secure and better-paying because the plant would be profitable. This logic is unlikely to persuade Europe’s trade unions, but Mr. Ratcliffe says that the difficulty and expense of restructuring is one of the things holding back Europe—and its workers.
(…) Mr. Ratcliffe’s “only gripe” about the U.S.—”you have to have a gripe,” he says—is that America “has the highest corporate tax rates in the world: “They’re too high in my view, nearly 40%. And that’s a pity because in most other parts of the world corporate tax rates are about 25%.”
(…) If you weren’t paying all that tax, what you’d do is, you’d invest more. And we’d probably spend the money better than the government would.”
His suggestion for Washington on corporate taxes: “I think they should bring that down to about 30% or so. Then they’d be unbeatable. For investment, they’d be unbeatable, the United States.”
Oil group will be first major to explore British deposits
(…) The deal, to be announced on Monday, will be seen as a big vote of confidence in the UK’s fledgling shale industry. The coalition has made the exploitation of Britain’s unconventional gas reserves a top priority, offering tax breaks to shale developers and promising big benefits to communities that host shale drillers. (…)
George Osborne, chancellor, has argued that shale has “huge potential” to broaden Britain’s energy mix, create thousands of jobs and keep energy bills low. (…)
A boom in North American production from shale means natural gas in the US is now three to four times cheaper than in Europe. Cheap gas has driven down household energy costs for US consumers and sparked a manufacturing renaissance.
The coalition says Britain could potentially enjoy a similar bounty. It points to recent estimates that there could be as much as 1,300tn cubic feet of shale gas lying under just 11 English counties in the north and Midlands. Even if just one-10th of that is ultimately extracted, it would be the equivalent of 51 years’ gas supply for the UK. (…)
Italian industrial production rose for the third consecutive month in November, increasing by 0.3% compared with October in seasonally-adjusted terms, national statistics institute Istat said Monday.
Italy’s industrial production rose 0.7% in October compared with September, suggesting industry is on course to lift the country’s gross domestic product into expansionary territory in the fourth quarter.
Output rose 1.4% compared with November 2012 in workday-adjusted terms, the first annualized rise in two years, Istat said.
The Q4 earnings season gets serious this week with bank results starting on Tuesday. So far, 24 S&P 500 companies have reported Q4 earnings. The beat rate is 54% and the miss rate 37% (S&P).
Still early but not a great start. Early in Q3, the beat rate was closer to 60%. Thomson Reuters’ data shows that preseason beat rate is typically 67%.
Historically, when a higher-than-average percentage of companies beat their estimates in the preseason, more companies than average beat their estimates throughout the full earnings season 70% of the time, and vice versa.
Q4 estimates continue to trickle down. They are now seen by S&P at $28.14 ($107.19 for all of 2103), rising to $28.48 in Q1 which would bring the trailing 12m total to $109.90. Full year 2014 is now estimated at $121.45, +13.3%. This would beat the 2013 advance of 10.7%. Margins just keep on rising!
S&P 500 valuation is lofty by almost any measure, both for the aggregate market (15.9x) as well as the median stock (16.8x). We believe S&P 500 trades close to fair value and the forward path will depend on profit growth rather than P/E expansion. However, many clients argue that the P/E multiple will continue to rise in 2014 with 17x or 18x often cited, with some investors arguing for 20x. We explore valuation using various approaches. We conclude that further P/E expansion will be difficult to achieve. Of course, it is possible. It is just not probable based on history.
The current valuation of the S&P 500 is lofty by almost any measure, both for the aggregate market as well as the median stock: (1) The P/E ratio; (2) the current P/E expansion cycle; (3) EV/Sales; (4) EV/EBITDA; (5) Free Cash Flow yield; (6) Price/Book as well as the ROE and P/B relationship; and compared with the levels of (6) inflation; (7) nominal 10-year Treasury yields; and (8) real interest rates. Furthermore, the cyclically-adjusted P/E ratio suggests the S&P 500 is currently 30% overvalued in terms of (9) Operating EPS and (10) about 45% overvalued using As Reported earnings.
We downgrade the US equity market to underweight relative to other equity markets over 3 months following strong performance. Our broader asset allocation is unchanged and so are almost all our forecasts. Since our last GOAL report, we have rolled our oil forecast forward in time to lower levels along our longstanding profile of declining prices. We have also lowered the near-term forecast for equities in Asia ex-Japan slightly. Near-term risks have declined as the US fiscal and monetary outlook has become clearer.
Our allocation is still unchanged. We remain overweight equities over both 3 and 12 months and balance this with an underweight in cash over 3 months and an underweight in commodities and government bonds over 12 months. The longer-term outlook for equities remains strong in our view. We expect good performance over the next few years as economic growth improves, driving strong earnings growth and a decline in risk premia. We expect earnings growth to take over from multiple expansion as a driver of returns, and the decline in risk premia to largely be offset by a rise in underlying government bond yields.
Over 3 months our conviction in equities is now much lower as the run-up in prices leaves less room for unexpected events.Still, we remain overweight, as near-term risks have also declined and as we are in the middle of the period in which we expect growth in the US and Europe to shift higher.
Regionally, we downgrade the US to underweight over 3 months bringing it in line with our 12-month underweight. After last year’s strong performance the US market’s high valuations and margins leaves it with less room for performance than other markets, in our view. Our US strategists have also noted the risk of a 10% drawdown in 2014 following a large and low volatility rally in 2013 that may create a more attractive entry point later this year.
“Equity sentiment is, unsurprisingly, very bullish and Barron’s annual mid-December poll of buy- and sell-side strategists revealed near unanimity in terms of economically bullish sector views,” notes BCA Research in a note titled, “U.S. Equity Froth Watch.” Similarly, Citi strategists’ sentiment measure finds that “euphoria” has topped the 2008 highs and is back to 2001 levels. At the same time, the negativity toward bonds is nearly universal. (Barron’s)
(…) Lee notes that by simply dividing the S&P 500 into equal groups leaves 125 stocks that have an average P/E of 11.8 times forward earnings, with a range of 8x to 13x. Not only are these stocks cheaper than the market, they’re not lacking for growth either, Lee says. The average member of this group should grow by about 11%, far lower than the most expensive stocks’ 20% growth rate, but at less than half the valuation.
“In other words,” Lee writes, “there remains a substantial portion of the market offering double-digit growth for a mere 11.8x P/E.”
Lee screened for stocks with low P/Es, positive net income growth, that had Overweight ratings by JPMorgan analysts and upside to analyst target prices. He found 19 (…)
Barron’s Randall Forsyth:
But truth to tell, the governor’s staff might not actually have been to blame. They may only have been taking active steps to stem the exodus from the Garden State’s sky-high taxes and housing costs. According to surveys by both United Van Lines and Allied Van Lines, New Jersey was at or near the top of states of outbound movers in 2013. And U.S. census data for 2011 showed 216,000 leaving the Garden State and 146,000 moving in, with New York the No. 1 destination. So, blocking access to the GW Bridge may simply have been a misguided effort to stanch the outflow.
Or the whole episode could have been the result of a simple misunderstanding on the part of the staff. According to one market wag, the governor’s actual order was to “close the fridge.”
LAST, BUT CERTAINLY NOT LEAST, our third granddaughter, Pascale, will see the world today!