Financial Review

Another Strong Jobs Report

Sinclair Noe — December 4, 2015

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DOW + 369 = 17,847
SPX + 42 = 2091
NAS + 104 = 5142
10 YR YLD – .05 = 2.28%
OIL – 1.01 = 40.07
GOLD + 25.30 = 1087.90

The economy added 211,000 jobs last month, beating estimates of about 200,000. The unemployment rate held steady at 5% as more workers entered the labor pool. The Labor Force Participation Rate increased in November to 62.5%, from 62.4% in October. The last two months’ jobs numbers were revised higher. The government said 298,000 new jobs were created in October instead of 271,000. September’s gain was raised to 145,000 from 137,000. Over the past 12 months, the economy has added 2.64 million jobs.

Let’s break down jobs by sector: Employment in construction rose by 46,000 in November, with much of the increase occurring in residential specialty trade contractors (+26,000). Over the past year, construction employment has grown by 259,000.

Professional and technical services added 28,000 jobs. Over the year, professional and technical services have added 298,000 jobs.

Health care employment increased by 24,000 over the month, following a large gain in October (+51,000). In November, hospitals added 13,000 jobs. Health care employment has grown by 470,000 over the year.

Employment in food services and drinking places continued to trend up in November (+32,000) and has risen by 374,000 over the year.

Retail trades added 31,000 and has increased by 284,000 over the year.

Mining lost 11,000 jobs; this area includes jobs in oil drilling and support services. Since a recent peak in December 2014, employment in mining has declined by 123,000.

Information lost 12,000 jobs over the month. Within the industry, employment in motion pictures and sound recording decreased by 13,000 in November but has shown little net change over the year.

State and local governments added 8,000 jobs in November, while the federal government added 6,000 jobs.

The past five years of job growth have been in the private sector. Government jobs are still 561,000 below the peak.

The number of persons working part time for economic reasons increased in November. These workers are included in an alternate measure of unemployment known as the U6, which increased to 9.9% from 9.8%.

In November, average hourly earnings for all employees on private non-farm payrolls rose by $.04 cents to $25.25, following a $.09 cent gain in October. Over the year, average hourly earnings have risen by 2.3 percent, falling from a 2.5% pace in October that raised hopes of rising wages in the months ahead. The average workweek for all employees on private non-farm payrolls edged down by 0.1 hour to 34.5 hours in November.

Prepare for liftoff. Unless there is some catastrophe in the next 12 days, the jobs report was strong enough to lock in a Federal Reserve rate increase at the upcoming December 16^th FOMC meeting. This was the last major economic report before the Fed policy meeting, and recent speeches from Fed Chair Janet Yellen and other policymakers leaves little doubt about their intentions.

In yesterday’s testimony to Congress’s Joint Economic Committee, Yellen stated her view that given existing demographics the United States needs to create about 100,000 jobs per month to absorb the natural growth of the labor force. Any job creation above that would be consistent with continued improvement in the labor market, either further cutting the unemployment rate or else drawing new people into the labor force out of the ranks of the discouraged; and that is exactly what we saw in this month’s jobs report – more people entered the work force.

Yellen has not quite come out and said explicitly that 100,000 new jobs is the green light for a December rate hike, but she’s dropped about as many hints as the Fed ever does about the future course of economic policy. When the Fed hikes rates on December 16^th, it will be one of the best communicated rate hikes ever.

There is no question that the labor market has shown improvement. The economy has added jobs for 69 consecutive months, gaining more than 13.7 million jobs. The unemployment rate dropped down to 5% in October and even as more people moved into the labor force in November, the unemployment rate held steady.

This is quite simply a historic time for job growth. And don’t give me the garbage about how you don’t’ believe the numbers. The statistics are imperfect, I grant, but they are the most accurate information available and there is no evidence they have been doctored – none. And this slow, steady, and strong job growth doesn’t fit into many political narratives but you should look at the numbers rather than narratives.

We are now at what the Fed would like to call full employment; that point where everybody who has some job skills and wants a job, can find a job; the point where there are just enough jobs to stimulate growth without pushing inflation above target. The problem is – we’re not there yet. Millions of working age people left the workforce in the downturn and they have not returned. The percentage of the population working was unchanged at 59.3, which is only a tenth of a percentage point higher than it was a year earlier.

The uptick in the participation rate, though small and based on historically low levels, is an encouraging indication of progress for those who had dropped out of the labor force. It suggests that labor-market slack still is greater than the 5% unemployment rate would strictly indicate.

And wages just have not been growing, which means no wage push inflation. For many people, a pay increase only comes with a second, or third job. So, we’re not yet at the point where demand pushes economic growth. The economy can probably add millions more jobs and the unemployment rate could drop to about 4% before we really see full employment.

Yesterday, Yellen said, “I think we’ve seen some welcome hints” of wage increases, but she cautioned, “it’s tentative evidence; we don’t know if it will last.”

Meanwhile the European Central Bank cut interest rates yesterday and extended their quantitative easing program. The Bank of Japan recently added more stimulus to prop up their economy. The divergence has resulted in a stronger dollar which hurts US exports, as seen in a separate report today showing the U.S. trade deficit widened in October as exports fell to a three-year low, suggesting that trade could again weigh on economic growth in the fourth quarter. The Commerce Department said the trade gap rose 3.4 percent to $43.9 billion, a sign that the worst of the drag from a stronger dollar was far from over. September’s trade deficit was revised up to $42.5 billion from the previously reported $40.8 billion.

The blowout year for mergers and acquisitions just keeps getting bigger. According to Dealogic, global M&A volume just soared to $4.3 trillion, pushing 2015 to date ahead of 2007’s total, when the previous record of $4.29 trillion of mergers was struck. U.S. targeted M&A volume hit a record high in September and currently stands above $2 trillion for the first time ever. What’s driving the deal making? Cheap debt, which might change if the Fed hikes rates.

Uber is raising more money, and the new valuation will make it larger than 80% of the S&P 500 stocks, including old, established names like Dow Chemical, BlackRock, and Netflix. Bloomberg reports the car-booking startup is looking to raise as much as $2.1 billion in a financing round that would give it a valuation of $62.5 billion. Uber has increased actual U.S. gross revenue about 200 percent this year and is profitable in more than 80 cities around the world, and the number of U.S. trips completed this year has increased 250 percent compared with the same period last year.

So, why is the Fed on a near-certain track to raise interest rates? Normally Wall Street reacts badly to the prospect of rate hikes, but today’s triple digit rally in the Dow Industrials and the NASDAQ Comp, are just an indication that a Fed rate hike has been baked into the cake and the strong jobs numbers really are an indication of a stronger economy, which should be reflected with higher valuations.

The Fed’s easy money policies have driven Wall Street for the past 7 years, and there has to be some concern that if the Fed takes the punchbowl away, the party might be over. But that might be part of the reason why the Fed is no longer willing to keep monetary policy at the emergency levels of 2008. The Fed has to be concerned that an overabundance of free money is spoiling corporate America, resulting in unicorn valuations. We know how that story ends and it is ugly. The thinking is that it is better to tap on the brakes now, even though the economy is growing slowly, rather than waiting for the economy to go much faster and slam on the brakes, only to swerve into the ditch, again.

Also, remember the exhortations of Former Fed chair Bernanke, repeated by current Fed chair Yellen, that there is only so much we should expect from monetary policy. Economic growth must be supported by fiscal policy. The House and Senate have taken a concrete step toward reviving the Export-Import Bank, by voting to renew the bank’s funding as part of a five-year highway and transportation construction measure. Obama signed the bill into law today, hours before current funding was scheduled to run out. The highway bill is a good example of fiscal policy adding to economic growth; spending on infrastructure is an investment that pays dividends in jobs and increased productivity, and taking on infrastructure projects while rates are still low just makes sense.

But today’s jobs report signals that rates won’t stay low for long. And that means higher mortgage rates, higher credit for auto loans and credit cards, and all manner of debt. And it is coming sooner rather than later.

Financial Review

April Jobs Report in Moderation

Sinclair Noe — May 8, 2015

 

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DOW + 267 = 18,191
SPX + 28 = 2116
NAS + 58 = 5003
10 YR YLD – .03 = 2.15%
OIL + .49 = 59.43
GOLD + 5.00 = 1187.20
SILV + .13 = 16.43

The economy added 223,000 new jobs in April. The unemployment rate dropped to 5.4% from 5.5% to mark the lowest level since mid-2008. The results were fairly close to estimates. Not too much, not too little. Wall Street actually liked the “Goldilocks” report and the Dow jumped to triple digit gains; the bond market, which is usually only happy when it rains saw strong initial selling, but then pushed bond yields slightly lower, and the dollar spiked briefly then held near lower levels. Once again we are reminded that the jobs report is probably the single most important economic report to follow because it affects almost everything else in the economy.

The number of jobs added in March was revised down to 85,000 from 126,000, reflecting the smallest increase in almost three years. The February jobs report was revised higher by 2,000 from 264,000 to 266,000. Payrolls for February and March were revised down by a combined 39,000. Typically, revisions add to prior months numbers. In 2014, for example, the government upgraded every monthly employment report except for one to show stronger job creation that originally estimated. The past three months have delivered average job gains of just over 191,000 jobs per month. That’s down from last year’s 260,000 average, but still decent. Another consideration: more people are hired in April than any other month of the year if seasonal adjustments are thrown out. And the number of jobs created in April with seasonal adjustments has exceeded the annual average in seven of the past 10 years.

By the way, revisions are to be expected. The Bureau of Labor Statistics’ monthly Employment Situation presents numbers compiled from two data sources: the payroll records of some 143,000 businesses and a telephone survey of about 60,000 households. The numbers are then seasonally adjusted. And over the next two months, the BLS revises the numbers “to incorporate additional sample reports and recalculated adjustment factors,” which can easily lead to big shifts in the data. It doesn’t mean the data is wrong, it just means that it is an almost impossible task to count all jobs every month with absolute accuracy, and this is a more or less accurate measure.

The average wage of American workers rose by 3 cents to $24.87 an hour in April, or a 0.1% increase. The increase means wages in the past 12 months have risen at a 2.2% rate. The amount of time people worked each week was unchanged at 34.5 hours. Workers are getting slightly higher wages on average, but the typical worker doesn’t feel any richer after taking inflation into account. Anemic wage growth has been one of the disappointing themes of the post-financial crisis recovery.

Last week we saw a report showing a big 0.7% Q1 jump in the employment cost index, and that had some people suggesting that the US economy has gone “beyond full employment.” Today’s numbers don’t show hardly any wage pressure. Despite the best year for hiring in more than a decade, the share of the nation’s income going to workers remains near an all-time low. You need strong wage increases to create a wage/price spiral, and the 0.1% increase in hourly wages wasn’t strong. One side note: the April report looks only at hourly wages, and not the wages of salaried workers.

Worker productivity slipped in the first quarter while labor costs surged, according to a Labor Department report Wednesday. The report marked only the third time in 25 years that productivity has suffered back-to-back quarterly declines. Lower productivity is usually a negative for the economy because it suggests that workers are becoming less efficient. It might also reflect weak capital expenditures by businesses.

Private sector jobs grew by 213,000, and the government sector added 10,000. Professional and business services added 62,000 jobs, health services added 61,000; mining and logging, which includes oil exploration and drilling, lost 15,000 jobs – reflecting ongoing weakness due to lower oil prices. Manufacturing employment was flat, reflecting the lingering effects of a stronger dollar that has curbed the sale of U.S. exports by making American goods and services more expensive.

Construction added 45,000 – construction jobs are a particularly positive sign of economic growth, but it might just be a sign of pent-up demand following a harsh winter. Home sales staged a big comeback in March, a possible sign that more Americans are eager to make expensive purchases. People bought existing homes at an annual pace of 5.19 million. The National Association of Realtors said those gains are expected to extend into April based on figures on signed contracts released by the Realtors. This could help spur additional growth in the construction sector as builders seek to meet demand. The combined employment in residential building construction and housing-related specialty trades posted the biggest advance since January 2006.

Among the major worker groups, the unemployment rate for Asians increased to 4.4 percent. The rates for adult men (5.0 percent), adult women (4.9 percent), teenagers (17.1 percent), whites (4.7 percent), blacks (9.6 percent), and Hispanics (6.9 percent) showed little or no change in April.

The rapid gains in employment over the past year, however, still have not made a huge dent in the number of people forced to work part time or those who have been unemployed for longer than six months. Some 6.6 million Americans can only find part-time jobs and while that is historically high, it is down from a peak of 9.2 million in 2010. Total employment is up 3 million from the peak and up 11.7 million from the employment recession low. Still, 2.5 million have been out of work for at last half a year. And there are about 15 million unemployed Americans who say they would like a job, even though they might not be actively looking.

The BLS has six measures of unemployment, numbered U-1 through U-6. U-3 sits in the middle and is the official rate. But U-3 leaves out a few sizable groups, “discouraged workers,” “marginally attached” and “part time for economic reasons.” Broadly speaking, this is a group that’s working either intermittently, or not at all and not even looking. The U-6 captures all those folks, and is the broadest measure of unemployment. It hit 10.8% in April, down from 10.9% a month ago and 12.3% a year ago. Think about how different our national conversation would be right now if we were talking about a 10% unemployment rate instead of a 5% rate.

The Labor Force Participation Rate increased 0.1% in April to 62.8%. This is the percentage of the working age population in the labor force. The higher number would indicate that more people are looking for work, or at least that employers are cutting fewer and fewer jobs. A large portion of the recent decline in the participation rate is due to demographics, as the boomer generation moves into retirement. The four-week average of the number of Americans applying for unemployment benefits fell to 279,500 last week, the lowest level in 15 years, according to the Labor Department. This figure tends to anticipate stronger hiring, though it’s possible that companies facing uncertainty are refraining from layoffs while delaying hiring until they get a better sense of the economy.

The unemployment rate and the Labor Force Participation Rate only tell part of the story, so we look to a subset, the participation rate and employment population ratio for people age 25-54, the prime working years. The 25 to 54 participation rate increased in April to 81.0%, and the 25 to 54 employment population ratio was unchanged at 77.2%; that’s still lower than it was at the lowest point of the previous two U.S. recessions.

All investment questions these days seem to revolve around when the Federal Reserve will raise interest rates, the April report didn’t provide any clear answers. The rebound in the April job report gives the Federal Reserve the green light to raise interest rates later this year, but no reason to rush. The data gives support to the consensus view at the Fed that weak first-quarter growth was an aberration, a blip in an otherwise decent economy. The unemployment rate at 5.4% is now closing in on the 5% rate, which many Fed officials consider consistent with full employment. Even without wages or inflation picking up, Fed policymakers will feel uncomfortable with rates sitting at zero as the unemployment rate closes in on 5 percent.

And what today’s report shows is that the economy is plodding along to recovery, slowly and consistently. It wasn’t a great report today, but it did not confirm the weakness of the March report, either. This slow improvement means the Fed can take their time before raising rates because the economy is not likely to get super-heated. So, forget about a rate increase in June, there is no need.

Many economist now think a September rate hike is possible. Fed policy makers have said some of the headwinds holding back the US will probably fade and give way to “moderate” growth; they have also said they will be data dependent; they have also indicated that it might be better to actually see the economy reach full employment before taking action – no need for a premature rate hike that might choke off growth.

Traders who use futures contracts to bet on the timing and pace of Fed rate hikes are wagering that the central bank will not move until December. Odds implied by Fed Fund futures show investors seeing a mere 7% chance the Fed raises rate in July, from 10% ahead of the jobs report. September odds slip to 22% from 27%. October odds down to 38% from 45%, and December odds to 55% from 62%. And a positive response from stock traders today says they don’t’ think today’s jobs report was strong enough to warrant quick response from the Fed. Of course, a lot can happen between now and then.

Wednesday, May 28, 2014 - Reflecting the Economy

Financial Review with Sinclair Noe

DOW – 42 = 16,633
SPX – 2 = 1909
NAS – 11 = 4225
10 YR YLD - .08 = 2.43%
OIL – 1.03 = 103.08
GOLD = 4.70 = 1259.60
SILV - .01 = 19.13

The major stock market indices were lower, but it wasn’t a big move, and we’ve been 4 up days, so today’s pullback was nothing but a pause. What was interesting today was the move in the bond market. The yield on the 10 year treasury dropped all the way to 2.43%; that’s the lowest rate in almost a year. The 10 year treasury has dropped 22 basis points this month, meaning treasuries are on track for the best month since January. Now, remember that the Federal Reserve is supposed to be tapering, cutting back on large scale purchases of treasury bonds.  

What’s fueling the move? It’s hard to pinpoint one thing. Europe is facing some sort of monetary stimulus package from the ECB next week; meanwhile, a report showed German unemployment rose and that pushed yields on the 10 year bund to 1.28%; that trade then spilled over to the US markets, toss in end of month window dressing and there was likely a short squeeze. There are some big short positions on treasuries right now; more shorts than longs.

At the end of the day, the bond market is supposed to reflect the economy; not an exact image but rather a mirror image. And the US economy is probably not as strong as expected. Tomorrow, we’ll get a revised look at first quarter GDP. The initial estimate on GDP showed just 0.1% growth; a pathetic rate blamed on bad weather; the revision is expected to show the economy contracted by 0.6%, maybe worse. Since the recession ended in June 2009, US GDP growth has dipped into the red only once: the first quarter of 2011, when economic output contracted at a 1.3% rate. It appears likely to happen again. The economy was repeatedly disrupted by cold and snowy weather in the first quarter and much of the activity that did not take place then is occurring now during the warmer spring months. Wall Street expects second-quarter growth to snap back with a 3.8% gain.

But where will the springtime burst of growth come from? Exports? Not to Europe and not to emerging markets. The initial GDP report said net exports subtracted 0.83 percentage point from the GDP growth rate in the first quarter. It may be a bigger drag on growth in Thursday’s update. Construction? A bit, yes, but we continue to see the housing market looking soft. Construction lending is seeing a slow, steady recovery, but it remains 66% below its boom-era peak of $631 billion in outstanding loans in early 2008. Companies restocking their shelves? Not likely. Inventories subtracted 0.57 percentage point from GDP growth, according to the first estimate, and that could grow with this week’s revision; inventories remain high and consumer spending sluggish. Corporate profits? Yes sir that is an area of strength but it’s also a two-edged sword.

The Commerce Department is starting to release a new report on corporate profits. Pretax profits adjusted for depreciation and the value of inventories climbed 1.9% in the fourth quarter to a record $2.13 trillion on a annualized basis. Corporate profits as a percentage of GDP stood at 10.2% in the fourth quarter, just a touch below a record high. Corporate profits are now higher than they’ve ever been before.

Here’s the problem; whenever profit margins reach a high, they tend to peak and then rollover, with the stock market and the economy dragging behind in like manner. It’s tough to keep pumping out record profits, in part because profit margins often depend on cost cutting, not just revenue; there are limits to how much fat a company can trim and there are limits to how much a company can increase sales while simultaneously cutting back on R&D and capital expenditures. Right now, stocks are priced to reflect very high corporate profits. Any disappointment would shake that pricing structure and translate into big stock market losses.

Like any individual indicator, this is not an absolute. Corporate profit margins can remain at elevated levels anywhere from a single quarter to multiple years and don’t typically present an imminent warning threat to the stock market or economy until forming a major peak and sudden decline. Profit margins peak on average before the stock market by more than a year and before recessions by more than two years. It doesn’t work out this way all the time; in the early 70’s profits peaked with the market, and in the early 80’s profits peaked after the stock market, and it is possible that the lag time stretches out so far as to make the indicator more or less worthless.

The point is that there are other factors that must be considered. Think of profits as one measurement of the business cycle. So, despite the Fed taper, there is increasing likelihood that interest rates will remain low and possibly decline a bit; if rates decline, stocks are likely to move up with bonds, as we’ve seen can happen; and if falling long-term yields flatten the yield curve, that would increase the risk of a market crash. In a low-yield, low inflation environment, there is a good opportunity to grow profits and so those crashes tend to be preceded by periods of very strong returns. So the current bull market is likely to remain in place until inflation picks up or low-flation/deflation drags down profits.

Falling yields tend to be somewhat more bullish than bearish, but it’s a poor indicator for how the stock market will react. Falling yields are good especially when we are in a bull market, but they can be dangerous if they should drive down the yield curve spread to an unusually low level and then there is the lag effect I mentioned earlier. When the long end of the yield curve comes down that is good for stocks for a while; it can even result in parabolic increases in the short term, but it also indicates bad news for the broader economy, and eventually the bill comes due.

Yesterday we talked about the proposed new EPA regulations on coal fired power plants. Today we’ll talk about the backlash to those proposals; which, by the way, have not been officially proposed yet. It’s anticipated that the new EPA guidelines will try to reduce the percentage of US electricity generated by coal to 14% by 2030 from about 37% right now. Coal is the single biggest source of electricity generation in the US and has been for more than 60 years. The amount of electricity generated by natural gas would rise to 46% by 2030 from about 30% now under the EPA plan. That would make it the biggest generator of the nation’s electricity.

Meanwhile, opponents of the plan say it will increase the cost of electricity and cost jobs. The US Chamber of Commerce released a study showing it would cost the economy $50 billion a year and destroy a quarter million jobs. Sometimes they just pull numbers out of the air; these reports tend to overlook the externalities associated with a dirty fuel like coal, and also overlook the positive impact of cleaner fuels. Anyway, the mudslinging has started.

And a follow-up on the Detroit bankruptcy story. A task force has issued the most detailed study yet of blight in Detroit and recommended that the city spend at least $850 million to quickly tear down about 40,000 dilapidated buildings, demolish or restore tens of thousands more, and clear thousands of trash-packed lots. It also said that the hulking remains of factories that dot Detroit, crumbling reminders of the city’s manufacturing prowess, must be salvaged or demolished, which could cost as much as $1 billion more.

If carried out, the recommendations by the Detroit Blight Removal Task Force would drastically alter the face of the nation’s largest bankrupt city. They would also cost significantly more than the approximately $450 million that the city already plans to spend on blight, raising questions about the feasibility of the vast cleanup effort, which is part of its larger campaign to emerge from bankruptcy by fall and begin remaking itself.

The blight study, which is perhaps the most elaborate survey of decay conducted in any large America city, found that 30% of buildings, or 78,506 of them, scattered across the city’s 139 square miles, are dilapidated or heading that way. It found that 114,000 parcels — about 30% of the city’s total — are vacant. And it found that more than 90% of publicly held parcels are blighted. The report also made several recommendations for preventing blight in the future, including changes to property tax and foreclosure laws, and heavy fines for scrap metal theft.

The basic plan is to clean up the city, but nobody really knows how to go about the task. Do you clean up by tearing down or do you clean up by building or rebuilding? For years, some have contemplated consolidating some of the city’s neighborhoods to allow the city to provide services to a smaller area, more suited to its shrunken population; Detroit has gone from 1.8 million to about 800,000. And if they don’t get this right this time, it will likely revert to farmland.