FINANCIAL REVIEW

Columbo Fed

Sinclair Noe — January 7, 2015

Podcast: Play in new window | Download (Duration: 13:16 — 6.1MB)

DOW + 212 = 17,584
SPX + 23 = 2025
NAS + 57 = 4650
10 YR YLD – .01 = 1.95%
OIL + .59 = 48.52
GOLD – 8.20 = 1212.10
SILV – .02 = 16.63

After the holidays we are finally starting to get back to economic data. Let’s start with the ADP payroll report, which shows 241,000 net new private sector jobs for December. Breaking down that number, private-sector service providers added 194,000 jobs, while goods producers added 46,000 jobs. By company size, small businesses added 106,000 private-sector jobs, large businesses added 54,000 and medium businesses added 70,000. The Labor Department reports on jobs Friday morning and we tend to look to the ADP report as a precursor to the government’s monthly report, but it isn’t a real accurate predictor. Last month the government reported 321,000 new jobs and ADP initially showed 208,000 for November. Still, we are probably looking for around 220,000 to 240,000 new jobs on Friday and today’s report was in line with that estimate.

Meanwhile, Gallup has its own Job Creation Index which ended 2014 at plus 27 in December, eight points higher than where it started in January. The index has remained between plus 27 and plus 28 since May; essentially it has remained at the same level for the past eight months, suggesting the job market plateaued in the latter half of 2014.

In a separate report from Gallup, the number of Americans who are positive about the US economy outweighs those who negative about it; but just slightly, 49% to 45%. And everyone, it seems, is bullish about America’s job creation capabilities in 2015. From small businesses to CEOs to regular Americans, optimism is increasing for jobs growth in 2015. There is a good reason for that – for six straight months in 2014, growth exceeded 200,000 jobs a month. Last year, the unemployment rate dipped down to 5.8%, a rate not seen since July 2008. Yet those numbers don’t tell the full story. There is more to an economic recovery than optimism and a low unemployment rate. Americans are still struggling with low wages, with paychecks at roughly 1995 levels.

A large portion of those jobs are low-wage, part-time jobs that do little to help the families that struggle to make ends meet. In November, 6.7 million Americans worked part-time; 2.3 million of them wanted full-time work but couldn’t find it. Almost 4 million of them had only part-time work due to unfavorable business conditions and decline in seasonal demand.

The trend is likely to continue. According to a survey by Careerbuilder, one in four employers plan to hire more part-time workers in 2015, a 6% increase from 2014. But American workers don’t need part-time jobs – they need full-time ones. According to Gallup’s survey of over 600 small business owners, more than a quarter of them will be hiring someone in the next year. Just 8% say they will have to let people go. Additionally, 71% of business owners expect that 2015 will be kind to them and that their financial situation in 2015 will be “very good or somewhat good”. Yet pessimism persists in the top echelon of corporate America. American CEOs predict that 2015 will see weak economic growth, and according to the most recent Business Roundtable CEO outlook survey, gross domestic product will grow by 2.4% this year. Investments will drop by 5.8% and sales by 1.3%.

But Americans remain optimistic about jobs; according to Gallup, 36% think now is a good time to find a quality job. One of the ways to judge if the optimism about the job market is having a practical effect is to look at the number of people leaving their jobs in hopes of finding a better one. In November of this year, about 838,000 people left their jobs; a year ago that number was 890,000. More people are staying put at the jobs they have. And this means employers don’t have to offer big wage increases to get and keep the workers they need. And this remains true even as a jobs recovery has consistently forged ahead in recent years. The turning point in the labor market will be when we see wage growth of 3.5% to 4%. Until then we’re just taking baby steps.

The trade deficit shrank by 7.7% in November to $39 billion, which is the smallest deficit in 11 months. This goes directly to lower prices for imported oil, which more than offset a drop in exports of aircraft, heavy machinery, and computer related equipment.

The Eurozone has slipped into deflation. Consumer prices in Europe dropped 0.2% in December. ECB officials are working on a plan to purchase sovereign debt to prevent a deflationary spiral of falling prices. It is widely expected that ECB President Mario Draghi will announce some sort of quantitative easing scheme on January 25; the fly in the soup is Greece, which holds a snap election on January 22nd, and is likely to vote for an anti-austerity, anti-bailout political party that is calling to repudiate Greek debt. Draghi would like to talk down deflation, but today’s numbers make that argument moot. Come January 22nd the market will no longer hope or even expect a clear plan on QE, it will demand it.

In a separate report, Eurozone unemployment remained at 11.5% in November. Joblessness in Italy rose to a record 13.4%. German unemployment fell to 6.5% in December, the lowest in more than two decades. And, as we noted yesterday, Greece’s unemployment rate is still around 25%.

Bond investors are now hanging on European policy makers doing more; but even a big bond-buying program in Europe, and continued stimulus in Japan, might not be enough to make bond markets optimistic about global economic growth. Some bond investors say the stimulus from the central banks has a decreasing effect because, each time the stimulus occurs, it increases indebtedness and stokes speculation in financial markets that fails to translate into growth in the real economy.

So, Wall Street was moving higher today, a triple digit gain for the Dow despite news off a terrorist attack in Paris that left 12 people dead because apparently terrorists really hate French cartoonists. Also, barely making headlines, a suicide car bomber killed 37 people in Yemen today. The gain in stocks probably had less to do with any economic news or any reaction to geopolitical events and more to do with the simple idea that stocks had been on a 5 day losing streak and were due for a bounce. And then we got the minutes of the December FOMC meeting.

The Federal Open Market Committee consists of the Federal Reserve policymakers and they have previously indicated that there is a likelihood they will start to tighten monetary policy maybe in 2015. The key passage from December’s policy statement was: “Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy.” The Fed added that this guidance is “consistent” with its previous language that indicated the Fed would wait a “considerable time” before normalizing policy.

So, let’s try to translate the Fedspeak. The Fed says they will be patient, which means we probably won’t see any rate increases before April, at least. The Fed says there are downside risks from global weakness, which means we might not see any rate increase for quite a while longer. The policymakers think cheaper energy prices are a net positive for GDP growth and job gains, but they don’t see wages accelerating, and cheap oil and a strong dollar is pushing inflation lower; which sounds like they haven’t seen enough data to make a move. It all sounds a little like the old TV show Columbo. Remember how Peter Falk played the role of a befuddled detective with a wrinkled raincoat and he seemed to be completely lost and bumbling his way along, and then he solved the crime. The Fed is a lot like Columbo, they just haven’t solved the crime yet.

And a note on those lower oil prices; based on the Federal Reserve’s economic model, a $20-a-barrel drop in crude oil prices translates to a quarter percentage-point increase in GDP. That’s good but a lot of the benefits from higher consumer spending are front-loaded. Unless energy prices continue declining, there is only a one-time positive impact on the annualized growth of real incomes and real consumption. And it is uncertain if lower fuel prices will help the jobs picture, after all it’s just shifting spending from the gas station to some other retail outlet.

Still, lower gas prices are like a gift for transport-heavy companies like railroads, trucking companies, and the petrochemical industry. If they are smart they should be locking in as much of this downturn as possible. That is a huge benefit on this pullback. But the gift may be temporary. So says President Obama; he says consumers should use the savings wisely. The president also told The Detroit News that demand for oil from emerging markets like China and India would continue to grow “over the long term,” adding that the US needed to remain “smart” about its energy policy.

Right now, it is hard to see the floor for oil prices. Some things need to happen before we see a sustained rebound in prices. It’s an old story of supply and demand. On the supply side, oil prices need to fall below operating cash costs before companies start shutting down existing wells. Next, OPEC (and specifically Saudi Arabia) would need to impose some control over production, and the Saudis seem to be waiting for US oil companies to shut down some wells before they will shut down their own production. Right now, global oil producers are looking at a glut and responding by increasing drilling. Iraq, Russia, Latin America, West Africa, the United States, and Canada – all may increase production this year.

Next, demand would need to increase; lower prices will ultimately lead to a pickup in global oil demand, and cheap oil results in complacent conservation; but it won’t happen right away, you could reasonably expect a 6 month lag. Or we might see a longer lag because the global economy is fairly weak. One other way to put a floor under prices, is if we see traders get a little greedy and try to squeeze the shorts, and there are a lot of producers that have taken net short positions in the energy market as a hedge against lower prices. What could trigger a short squeeze? I’m thinking weakness, or even a couple of flashy defaults in the high yield debt markets.