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The market is going great so no need to worry, right?

The market is going great so no need to worry, right?


There are weeks when sitting down to write this piece is tough because not much worthy of note has happened in the markets or the economy outside of the usual noise. This week, that was most definitely not the case. Thank God it is Friday – we all need a break.


New Market Highs and the Economy Gets Uglier

Thursday the S&P 500 closed at a new all-time high and is now above its 50-day, 100-day and 200-day moving averages. The post Federal Reserve Open Market Committee meeting debrief gave the market essentially what it wanted, a significantly more dovish stance with plenty of reasons to believe future rate cuts are imminent. Perhaps the Marty Zweig adage, “Don’t fight the Fed,” has been flipped on its head to “Fed, don’t fight the markets.” Unemployment is at multi-decade lows with more job openings than unemployed persons, rising hourly earnings, and improving retail sales while the market hits all-time highs and yet the Fed is preparing to stimulate. Yeah, something’s off here.

Stocks may be partying like it is 1999 (for those who remember that far back) but the yield on the 10-year closed at 2.01% Thursday. To put that in context, on June 9th when the 10-year was down to 2.09%, the Wall Street Journal ran an article asserting that, “Almost nobody saw the nosedive in bond yields coming, but a few players were positioned well enough to profit. Some think there is more room for yields to fall further,” along with this chart. To be clear, despite not one respondent predicting the yield on the 10-year would fall below 2.5% in 2019, none of these economists are idiots, but the thing is they all tend to read from the same playbook.

The stock market is giddy over its expectations for lower rates, yet the spread between the 3-month and the 10-year Treasury has been inverted for four weeks as of this writing, not exactly a ringing endorsement for economic growth prospects. Every time this curve has been inverted for 4 consecutive weeks, it has been followed by a recession (hat tip @Saxena_Puru) for this chart. Note that the chart uses 10-year versus 1-year until the 3-month became available in 1982. Much of the mainstream financial media and fin twit believe this time is different. Time will tell.

The red arrows denote 4 consecutive weeks of inversion and the blue arrows mark bear-market lows (20% declines).

Then there is this, with a hat tip to Sven Henrich whose tweet with a chart from Fed went viral – that in and of itself says a lot.

Both US imports and exports have declined from double-digit growth in 3Q 2018 to essentially flat today. The recent CFO Outlook by Duke’s Fuqua School of Business found that optimism about the US and about their own companies amongst CFO’s had fallen from the prior year.

The shipments of goods being moved around the country have plummeted since the beginning of 2018, as shown by the Cass Freight Index.

The Morgan Stanley Business Conditions Index fell 32 points in June, the largest one-month decline in its history.

If all that doesn’t have your attention, consider that the New York Fed’s recession probability model puts the probability that we are in a recession by May 2020 at 30%. Note that going back to 1961, whenever the probability has risen to this level we have either already been in a recession or shortly entered one with the exception of 1967 – 7 out of 8 times.

But hey, the market is going great so no need to worry right? If that’s what you are thinking, skip this next chart from @OddStats.


Geopolitics – From Bad to Oh No, No No

Brinksmanship with Iran continues as in the early hours of Friday we learned that the US planned a military strike against Iran in response to the shooting down of an American reconnaissance drone. The mission was called off at the last minute after the President learned that an estimated 150 people would likely have been killed. Frankly, the official story sounds a bit off, but what we do know is that we are in dangerous territory and one can only hope that some cooler heads prevail, and the situation gets dialed back a whole heck of a lot.

Given we weren’t enjoying enough nail-biting out of the Middle East news, an independent United Nations human rights expert investigating the killing of Saudi journalist Jamal Khashoggi is in a 101-page report recommending an investigation into the possible role of the Saudi Crown Prince Mohammed bin Salam citing “credible evidence,” and while not specifically assigning blame to bin Salam, did assign responsibility to the Saudi government. This week the US Senate voted to block arms sales to Saudi Arabia, rebuking the President’s decision to use an emergency declaration to move the deal forward. This matters when it comes to investing because there are some seriously high-stakes games being played out that have the potential to suddenly rock markets without any warning.

Over in Europe more and more data points pointing to a slowing economy, which led to European Central Bank President Mario Draghi to announce that more stimulus could be in the works if inflation fails to accelerate. At the ECB’s annual conference in Sintra, Portugal Draghi stated that, “In the absence of improvement, such that the sustained return of inflation to our aim is threatened, additional stimulus will be required.” It isn’t just inflation that is troubling the region. Euro Area Industrial Production (ex Construction) has only seen increases in 2 of the last 11 months.

Italy continues to struggle with its budget deficit outside the limits allowed by the European Union, leading to a battle between Rome and Brussels. Friday Deputy Prime Minister Matteo Salvini (head of the euro-skeptic Lega party) threatened to quit his position if he is not able to push through tax cuts for at least €10 billion. While the US has been laser-focused on the Fed (and the president’s tweets) the Italian situation is getting more tense and a time when UK leadership with respect to Brexit is also getting a lot more tense. To put the Italian problem in perspective and understand why this problem is not going away, look at the chart below.

Today, Italy’s per capita GDP is 2.8% BELOW where it was in 2000 while Germany is 24.8% higher. Even the beleaguered Greece has outperformed Italy. Italy’s debt level is material to the rest of the world, its economy is material to the European Union, its citizens are losing their patience and its leadership consists of a tenuous partnership between a far-right, fascist-leaning Lega and a far-left, communist(ish) 5 Star movement lead by folks that very few in the nation respect. So that’s going well.

As if the European Union didn’t have enough to worry about as its new parliament struggles to find any sort of direction or agreement on leadership, the parliamentary process for selecting the next Prime Minister of the UK is down to two finalists. Enthusiam is rampant.

A hard Brexit is looking more likely and that is not going to be smooth sailing for anyone.


The Bottom Line

All this is a lot to take in, but there is a bright light for the week. Anna Wintour, Vogue’s editor-in-chief and eternal trend-setter, has given flip-flops her seal of approval. So, we’ve got that going for us. If that didn’t put a little spring into your step, I suggest you check out this twitter feed from Paul Bronks. Your soon-to-be more swimsuit ready abs will thank me, but your neighbors will wonder what the hell is going on at your place.

Italy and California: A Sisyphean Nightmare?

Italy and California: A Sisyphean Nightmare?

I think most people are clear that in a robust, healthy economy entrepreneurs are able to quickly turn their ideas into reality, in the process creating jobs and occasionally having an enormous impact on the way we live, as in the case of Apple, Amazon, and for the ladies out there, Spanx.  My two homes, Italy and California both appear to be hell bent on becoming Sisyphean nightmares for not only the budding entrepreneur, but even for well-established, international corporations.

Yesterday the Wall Street Journal ran a piece entitled, “Can Italy Find it’s Way Back?”  The article opens with an example of just how difficult it is to get a business going in the country.  We are told of an entrepreneur who bought a tract of land when he was 45 with the intention of building a supermarket on it.  At 88 years old, he’s finally received the necessary permits!  Seriously!?  Colleagues of mine in Italy have shared similar insane tales of government bureaucracy, their frustration mounting and gesticulations increasingly animated as the bottles of vino empty.  It is Italy after all and intense conversation requires a good bottle of champagne or a rich bottle of red.

California is moving rapidly in the same direction, making it more and more difficult for entrepreneurs to translate a passion into reality, while for existing companies the regulator and tax burden is pushing them to locate elsewhere.  The headlines for years have told of one company after another deciding to leave the state.  Carl’s Junior announced that it would not open one more restaurant in the state because it takes too long and is too expensive to get through all the red tape.  Just this week Toyota announced it is moving a facility it has had in Torrance, California for over 30 years to Texas.

This is what I like to call, for obvious reasons, Elle’s Law of Unintended Consequences whereby bureaucrats’ attempts to protect invariably end up harming the very thing their legislation intended to protect.

Entrepreneurs, being adventurous types by definition, rationally choose to go where there are fewer barriers to success.  Large corporations may find that over time, the benefits of being in a specific locale are falling further and further below the associated costs.  When bureaucrats enact legislation that creates barriers, any reasonable businessperson will have to compare the associated costs with the potential benefits of operating under such conditions.

In Italy, labor laws have become so onerous that the economy is bizarrely bifurcated into two distinct types of businesses:  very small, family-run, mom-and-pop shops and large multi-national corporations that were already large by the time they entered the Italian market.  Why is this?  The labor laws that were enacted in Italy with the intention of protecting workers have made it inconceivably risky to hire anyone, because if it doesn’t work out, firing them is almost prohibitively costly.  If you have a small shop, with just you and your partner, it is insanely risky bring on additional help, so you simply don’t grow.  The economy is deprived of the potential success you could have had if the risks of expanding weren’t so great!  Think of how many jobs wouldn’t exist today if Google had never made it out of the basement.  Large multinationals that come into the country face a slightly easier mountain as for them, the likelihood of a high portion of hires not working out is fairly low.  Due to their size, they can survive having some level of deadweight, unlike the small firms.

Unfortunately, the damage doesn’t stop here.  The culture of protecting labor in this manner comes from a history of communism and socialism that emerged as a violent reaction to the hell experienced under fascism.  This mentality applies subtle negative attributes to those who attempt to be special, to do something unique and worthy of attention.  Thus there is a disincentive for putting in the extra effort, for taking the risks associated with overachieving and given this cultural climate, overachievers aren’t compensated much more than their colleagues who do the bare minimum.  Couple this with the reality that it is really difficult to fire someone, so imagine the incentives!  Shockingly enough, human beings, like all animals, respond strongly to incentives.  If I won’t get compensated much more for working my tail off, why would I put in the effort and take the risks to be outstanding?  If I can’t be fired, the floor for the level of performance I consider reasonable is going to be a lot lower than if I know there’s a line of people just waiting to take my place!  Now while we’ve all had days when this situation would sound awful comfortable, think about what it means for the performance level of the society as a whole.  How often have you heard envious tales of Italian efficiency and professionalism?

Is it any wonder that Italy’s economy is essentially stagnant?  How can it possibly grow when entrepreneurs are so heavily hamstrung and when workers have very little incentive to do more than the bare minimum where their is neither a carrot, nor a stick.

Sadly, every time I leave Italy and return to California I am struck more by the similarities than the differences.  The U.S. would be wise to look across the pond and understand what it is that is keeping so many countries in the eurozone economically stagnant and fight like hell to move in the opposite direction.

Obamacare and the Orwellian Oath

Obamacare and the Orwellian Oath

On February 18th, I spoke with Charles Payne and Julie Roginsky on Fox Business’ Cavuto show about the headlines claiming that Obamacare aka the Affordable Care Act (ACA) will harm jobs. We had a lively debate, which was surprising given that the three Sports Illustrated models gracing this year’s cover were waiting in the green room, an understandable distraction for many! Got me thinking that perhaps I ought to entertain the idea of becoming the first “bikini economist.” No sure that my supply curves would stimulate like claims around QE, but I digress…. For all the administration’s protestations that the ACA isn’t going to harm jobs, their own actions show they know it is. In a press briefing last week Treasury officials made it clear that firms will be required to certify to the IRS under penalty of perjury that ACA was not a motivating factor in their staffing decisions. So… to protect your company from the increase in costs from ACA you must swear that you are not trying to avoid the impact of ACA. But I thought this wasn’t a problem for jobs? If it has no impact, why the Orwellian oath? To be fair, the CBO doesn’t exactly say that jobs will be lost, but rather that ACA discourages work, particularly for those at the lower end of the income scale, in that you get bigger subsidies the less you make. Talk about a poverty trap! When did rewarding people for NOT trying to improve their circumstances become the American dream!? What kind of senseless drivel has the national conversation descended into when Jay Carney assures us that rather than “disincentivizing” these subsidies allow people to “pursue their dreams” without having the terrible burden of working. And just who is paying for these people to pursue their dreams? Oh right, those who STILL WORK! What about their dreams? Their desire to pursue other leisure activities? I guess it is OK to put those on hold so that they can involuntarily support the pursuit of dreams for those who choose to not work! Oh, and wait a minute! I thought this was all supposed to be good for the economy. Now how in hell does having fewer people working or having people work less grow the economy? So far the ACA gives us three little gems

  1. The employer mandate discourages hiring. No point in arguing that fact since firms now have to certify that it didn’t alter their staffing decisions!
  2. ACA delivers $1 trillion in tax increases . What does Congress do when it wants less of something, like smoking tobacco or using fossil fuels? Tax it! So again, can’t argue that this is a negative for growth.
  3. Now the CBO acknowledges that the $2 trillion in subsidies discourages work, but hey, how great is it to pursue leisure interests at the expense of your fellow taxpayer?

Well… at least you get to keep your insurance if you like it.

American Income Levels Stagnant for over 20 years!

American Income Levels Stagnant for over 20 years!

On February 13th, at I must add the ungodly hour of 6:30am PST, I spoke with Stuart Varney on Fox Business concerning the dismal state of income levels in the United States. According to the US Census bureau, median household income is just over $51k, which is about where it was 20 years ago! We also just learned that real disposable personal income has fallen by 2.7% from a year ago, the biggest collapse since the semi-depression in 1974!  American income levels have been stagnant for over 20 years.

On top of weak income levels, the employment situation continues to be of great concern. US unemployment rate is now at 6.6%, but this measure has become relatively meaningless as it no longer accurately describes what is happening in the work force. A more descriptive measure is the labor force participation rate, meaning the proportion of the population either employed or looking for employment as a percent of the population. That number is down at 63%, a level we have not seen since 1978! If the labor force participation rate were still at pre-crisis levels, the unemployment rate would be closer to 13%. Some argue that the decline in the labor force participation rate is primarily driven by the inevitable retirement waves of the baby boomers. However, the chart below illustrates that baby boomers are in fact participating in the work force at a higher rate than in decades, for women we are at all-time highs.


With income struggling, it should come as no surprise that savings levels are well below what they ought to be for a financially healthy country. The IRS’s most recent Quarterly Statistics of Income Bulletin is for the 2010 and 2011 tax filings, so it is a bit dated, but nonetheless, very insightful as to trends. According to the release 145.6 million taxpayers were eligible to contribute to an individual retirement account (IRA) in 2010, but only 3.5 million actually did so and of those that did, 62% were over 49 years old. Uh oh! Only 2.4% of those eligible to contribute to their IRAs did so. The average account value is only $92,000 and only 27.6% of all tax filers even have an IRA. Lastly, that wee bit of spending spree we experienced in December? With income struggling, that was funded by consumers dipping into their piggy banks to the tune of $46 billion causing the personal savings rate to fall from 4.3% to 3.9%, the lowest since January 2013.

Unemployment Problems Persist

Unemployment Problems Persist

Perhaps the reason so few are saving is because the job situation isn’t exactly rosy, nor are income levels. According to the most recent report from the Bureau of Labor Statistic, the unemployment rate has dropped to 6.7% which looks on the surface to be good news. However, if you look a bit deeper, the source of that improvement is troubling. The labor force participation rate, meaning the proportion of the population either employed or looking for employment has continued to drop, see chart at right, and is now at mid-1970s levels. Without the drop in the participation rate, the unemployment rate would be around 13%, rather than just under 7%. Additionally, according to data from the Minneapolis Federal Reserve (see chart at right), the American economy is experiencing the worst performance for labor markets since the Great Depression.

 

Some argue that the decline in the labor force participation rate is primarily driven by the inevitable retirement waves of the baby boomers. However, the chart below illustrates that baby boomers are in fact participating in the work force at a higher rate than in decades.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Along with the grim jobs recovery, household income levels continue to struggle, with income levels close to those 20 years ago, see chart above. Bottom Line: The fiscal and monetary stimulus has been unable to get employment or income levels back to anywhere near the levels enjoyed during the start of the 21st century. So far the impact appears to be more visible in rising prices in the stock markets and more recently rising home prices.

Changes in Unemployment

Changes in Unemployment

Unemployment continues to be a drain on the economy and the ranks of those even searching for a job declines.

Employment Chart

With such slow economic growth, it isn’t possible to get the unemployment situation to improve significantly, despite the attempts at upbeat headlines.  On April 5th we learned that March experienced the biggest monthly increase in people dropping out of the labor force since January 2012, with 663,000 no longer looking for work. This means that we now have 90 million working age Americans who are not in the labor force. Of those, 6.5 million want a job and want to be in the labor force, (Bureau of Labor Statistics). The labor force participation rate has now dropped to 63.3% of the population, a level not seen since October 1978. The number of Americans officially unemployed has almost doubled since the market hit these levels in 2007 while the number of Americans on food stamps has risen to levels never before seen, with an almost an 80% increase since 2007. It is no wonder that consumer confidence continues to sit in recessionary territory. What is most troubling is that a full 40% of those unemployed have been long-term, (see chart below). Remember that the growth of our economy is dependent on the quality and quantity of labor and capital in the economy. With so many leaving the workforce and so many others out of work for an extended period, both quality and quantity are being materially reduced, which is a detriment to future growth prospects.

Employment 02

Sequester Mania Ignores Other Warning Signs

On February 26th Lenore Hawkins joined Neil Cavuto to discuss the apoplectic fits of politicians and the media all over the country concerning the sequester, which represents a rather small decrease in the increase of government spending.  Yes you read that correctly, if the sequester actually occurs, government spending will still be higher in 2013 than in 2012, unless the powers that be do something.

Wall Street is still experiencing a great many layoffs and as a bellwether of the economy, this should get some attention.  With record high profit levels, how is this happening?  Profit margins are up, but gross revenues are well below their highs, thus the profits are coming from cost-cutting.

The U.S. financial sector expanded dramatically over the last hundred years in both relative and absolute terms.   During the mid-nineteenth century the sector fluctuated between around 1% and 2.5% of GDP, rising above the higher range twice in our history.  The first time the sector spiked as a percent of GDP was unsurprisingly in the early 1930s, reaching almost 6% of GDP, only to then drop to 2% of GDP in the early 1940s.  By 2006, the sector represented 8.5% of GDP, so a contraction in employment here is, while unsurprising, painful for the economy and particularly for those losing their jobs.

According to a report by the State of New York Comptroller, the state has added 8,500 jobs since the financial crisis, but lost 28,300, recovering only about 30% of the jobs lost.

The number of shares traded on major U.S. exchanges this year is down 7.2%, which is likely to fuel additional reductions in headcount.

Overall national employment is still dismal, according to the January employment report.

  • The number of unemployed rose from 12.2m to 12.3m.
  • Long-term unemployed represents 38.1% of those unemployed, a staggering percentage.
  • The average duration of unemployment is now 35.2 weeks.
  • The teenage jobless rate is even worse as 23.4%.

 

 

Employment Gains Disappoint

Employment Gains Disappoint

I’m starting to feel a bit like the grim reaper this week as the downward trends continue. This morning the ADP report showed that private sector jobs rose by only 38,000 last month, much less than the downwardly revised 183,000 gain that was expected.

  • Large businesses with 500 employees or more cut 19,000 new employees
  • Medium-size businesses added 30,000 workers
  • Small businesses that employ fewer than 50 workers added 27,000 new workers
  • Service-sector jobs increased by 48,000
  • Factory jobs fell by 9,000

Businesses drew down inventories, with the inventory index dropping to 48.7 in May from 53.6 in April.

On a positive note, price pressures eased with the prices index falling to 76.5 from 85.5 in April.

This data, coupled with the double-dip in housing reaffirms our belief that the Fed is unlikely to raise rates anytime soon. As one would expect, bond prices rose and yields dropped in response to this news, with the 10 year Treasury note dropping below 3%.

 

Unemployment drags on

Unemployment drags on

Roughly a million Americans have dropped out of the job market altogether over the past two months. That is the only reason why the headline unemployment rate is not exploding to a post-war high.  The share of the US working-age population with jobs in June actually fell from 58.7% to 58.5%. This is the real stress indicator. The ratio was 63% three years ago. Eight million jobs have been lost.

The unemployment rate dropped unexpectedly to 9.5%, but this was not received positively by markets as it was largely the result of a decline in the participation rate. As the unemployed grow frustrated and stop looking for work, they are removed from the unemployment rate calculation. Had the participation rate remained at April’s levels, the unemployment rate would be 9.9%.

The average time needed to find a job has risen to a record 35.2 weeks. Nothing like this has been seen before in the post-war era. Jeff Weniger, of Harris Private Bank, said this compares with a peak of 21.2 weeks in the Volcker recession of the early 1980s.

The number of workers that have been unemployed for more than 6 months is at 6.75%, a record 4.39% of the civilian work force.

Washington’s fiscal stimulus is draining away. It peaked in the first quarter, yet even then the economy eked out a growth rate of just 2.7%. This compares with 5.1%, 9.3%, 8.1% and 8.5% in the four quarters coming off recession in the early 1980s.

There is considerable controversy these days over what kind of GDP growth we will see in the second half of 2010.  It is going to be awfully tough to have a significant rebound in the economy with unemployment levels looking so grim.  We may very well have considerable volatility in the markets, but don’t mistake volatility for true growth!   For solid economic growth, people need jobs.  To have job growth, businesses need to want to hire.  For businesses to hire, they need to be confident and optimistic about the future.  So far, the theme is more about hunkering down and delveraging rather than preparing for growth.