Financial Review

Carry On

Sinclair Noe — September 2, 2015

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DOW + 293 = 16351
SPX + 35 = 1948
NAS + 113 = 4749
10 YR YLD + .02 = 2.19%
OIL + .59 = 46.00
GOLD – 6.10 = 1134.70
SILV + .08 = 14.80

For the first 8 ½ months of the year, stocks traded in a very tight range, for the most part. We had an occasional triple digit move on the Dow, but that was the exception – now it looks like the norm. Investors have weathered over two weeks of unusually wide-swinging trade that has left the S&P 500 with its worst monthly drop in three years and a loss of 8.5 percent from an all-time high in May. There really isn’t anything that would tell you today marks some kind of recovery, rather it is just volatility and turbulence. Get used to it. Keep calm and carry on.

World markets were a bit more sanguine today; the Shanghai Composite stabilized, but still closed just slightly lower. Nine Chinese brokerages pledged additional funds to purchase shares, answering fresh government calls to support equities. Investors may see the trend continue. Shanghai’s stock market will be closed Thursday and Friday as China commemorates the 70th anniversary of the end of World War II.

U.S. index provider MSCI has declared the market gyrations in China, and a barrage of interventions by the authorities to stop the rout, not to be a factor in deciding whether to include China A-shares in its Emerging Markets Index. Just before the massive selloff began in mid-June, MSCI announced it would temporarily hold off on the move, but said it expected the shares to be incorporated once outstanding issues relating to Chinese market accessibility were resolved.

The Federal Reserve released its Beige Book this afternoon; this is a look at economic conditions around the country, not hard data but just observations and interviews. Manufacturers are starting to feel the effects of China’s economic slowdown and a strong dollar; the oil industry is starting to feel pressure from lower energy prices; housing and auto sales are strong. Economic activity has not slowed since July; keep in mind that the Beige Book runs through August 24, just before the recent volatility on Wall Street. The Fed uses the Beige Book as a guide heading into the FOMC meeting next week to determine monetary policy.

Now, here’s an interesting twist on whether the Fed might hike interest rates next week; it comes from Torsten Slok Deutsche Bank’s chief U.S. economist. The thinking is that if the Fed hikes rates, investors would see it as a policy error, in which case they would pressure yields at the long end of the US Treasury curve; in other words, long-term rates could drop and the dollar could get weaker. A flattening curve is generally considered an easing of financial conditions. He asserts that the central bank ought to “do the first hike exactly when there is a bearish narrative in markets” to ensure it doesn’t prompt yields further out along the curve to jump, as was the case in the infamous bond selloff sparked by 1994’s rate rise. So, if the Fed raises its interest rate target for Fed Funds Futures, don’t be surprised if interest rates and the dollar actually decline. At least that’s one theory.

Last week, as the stock market took a dive, interest rates dropped briefly; and mortgage applications increased dramatically. Jumbo loan borrowers were especially enticed by the potential savings. An index of application volume jumped 11.3 percent. Volume is now up 30 percent from a year ago. Refinance applications, which are most rate-sensitive, increased 17 percent from the previous week to the highest level since April, 2015. Loan applications to purchase a home, which have been less responsive to rates, rose 4 percent for the week and are now 25 percent higher than one year ago.  The average contract interest rate for 30-year fixed-rate mortgages remained unchanged at 4.08 percent.

Private-sector employment gains continued in August at a slightly faster pace than in the prior month. Payroll processing firm ADP reports employers added 190,000 jobs last month. The Labor Department’s employment report will be released Friday, and the consensus estimate calls for a gain of about 215,000 new jobs. A significantly more robust number might nudge the Fed to move, but global market volatility recently has prompted some analysts to predict a December rate increase. One wild card: In seven of the last 10 years, the August number for payrolls has come in 48,000 below the consensus, only to be revised upward later, according to RBS. In other words, the Friday Jobs Report is going to be a cliffhanger for nervous investors.

 The productivity of U.S. workers in the spring was stronger than initially reported, reflecting a pickup in economic growth after a poor start to the year. Productivity rose at a 3.3% annual pace in the second quarter, up from a preliminary 1.3% estimate.

Entrepreneurship in the United States is at its highest rate in at least 16 years. According to a study by Babson College and Baruch College, 14% of the United States working age population, about 24 million people, reported being entrepreneurs in 2014. The high entrepreneurship rate could be good news for non-entrepreneurs as well: 24% of entrepreneurs said they expect to hire 20 or more people in the next five years.

President Obama has 34 Senate votes in favor of an Iran Nuclear deal, and that means it is a done deal. With 34 senators favoring the accord between Iran and six world powers limiting the country’s nuclear program, opponents may still be able to pass a resolution disapproving the deal later this month, but they do not have the votes to override Obama’s promised veto. In most cases, support for the deal has not been enthusiastic, but enough Democrats have come to the conclusion that killing the accord would be far worse than approving it. The White House and Senate Democrats hope to find seven more votes next week to filibuster the Republican resolution of disapproval. That would ensure the resolution would never leave the Senate, and Obama would not be forced to use a veto.

ConocoPhillips is cutting about 10% of its global workforce, with the largest percentage of layoffs occurring in North America. News of the cuts came on the same day ConocoPhillips announced first oil at its new Surmont 2 thermal project in northern Alberta.

McDonald’s U.S. franchisees have voted to begin offering all-day breakfast on Oct. 6, a widely expected decision that the company and investors hope will help end a sales slump that began nearly three years ago. The move – the company’s biggest menu change in years – follows months of testing the idea at various locations. According to McDonald’s sales reports, breakfast currently accounts for about 25% of its U.S. sales.

A Federal Judge in San Francisco has granted class-action status to a lawsuit claiming that Uber misclassifies its drivers as independent contractors instead of employees. As many as 160,000 Uber drivers in California could now join the case as a group, seeking to require the company to pay payroll taxes, overtime pay, or possibly mileage. The case, filed in 2013, presents challenges to Uber’s business model. Classifying workers as contractors lets the company keep its labor costs low while recruiting scores of people who use their own cars to ferry passengers. The results of the high-profile legal battle may also reshape the sharing economy, setting a precedent for dozens of startups whose futures rely on independent contractors. Well, so much for those valuations.

Federal safety regulators have sharply lowered the number of vehicles likely affected by faulty Takata airbag inflators, cutting the figure by about 40% to 19 million from more than 30 million. New information shows that some of the vehicles were originally thought to be in the U.S. (instead of overseas) and that some cars were counted twice due to driver and passenger side air bags. The recall still remains the largest and most complex automotive recall in history – involving 11 different automakers.

CBS is planning a record amount of live-streaming NFL coverage this season, with all streams available to the public for free. The games will include two regular-season match-ups, four playoff events and Super Bowl 50. CBS’s streams will be available through its website for laptops, desktops, tablets, and on TV via some connected devices (Xbox One, Apple TV, Chromecast and Roku products).

Intel introduced its new generation of processors today – they call it Skylake.  The new chips will power the full range of PCs from entry-level laptops to Xeon workstations. Here’s what you need to know: the chips are really fast, the graphics are much better, and it uses less power which will extend battery life. The new graphics deliver a better picture than 4k ultra HD. The new chip was built to work with Windows 10 and the processors can wake up a computer in sleep mode in less than a half second; no more waiting around. Intel is also making a big deal about facial recognition; no more messing around with passwords; your computer will know who you are.

Notebooks and other devices equipped with Intel’s R200 RealSense camera will 3D-scan both your face and other objects, with lots of fun potential applications; including the ability to scan objects and send it to your 3D printer; finally we are getting to the Star Trek replicator. And finally, hassle-free wireless charging of laptops, tablets and notebooks. Using magnetic resonance coupling. Actually, they haven’t got that figured out just yet, but they are working on it and think they’ll have something ready to go in about a year.

And an extra note here. In the next 24 to 48 hours you will like see a very disturbing picture. It is a photo of a three year old child from the north Syrian town of Kobani near the Turkish border, scene of heavy fighting between Islamic State insurgents and Kurdish forces a few months ago. Like so many, his family tried to migrate to Europe; taking the treacherous path to sea, headed for the Greek island of Kos. Something went horribly wrong; the boat sank. Seven people were rescued and two reached the shore in life jackets.

The official said hopes were fading of saving the two people still missing. The confirmed dead included five children and one woman; the youngest child was 3 year old Aylan Kurdi. The picture you will see showed the little boy wearing a bright red t-shirt and shorts lying face-down in the surf on a beach near the resort town of Bodrum. It is all over the Twitterverse and will undoubtedly make the main stream media. Hashtag #humanity washed ashore. You should look at the picture. It will disturb you.

Financial Review

Good Jobs Report, Not Liftoff

Sinclair Noe — June 5, 2015

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DOW – 56 = 17,849
SPX – 3 = 2092
NAS + 9 = 5068
10 YR YLD + .10 = 2.40%
OIL + .96 = 58.96
GOLD – 4.10 = 1173.30
SILV + .05 = 16.23

The economy added 280,000 jobs in May. The unemployment rate increased to 5.5% as more people entered the labor force. Average hourly earnings rose by 8 cents to $24.96. Over the year, average hourly earnings have risen by 2.3 percent. March and April were revised up by a combined 32,000 jobs.

The headline of 280,000 jobs added in May is the strongest number since December. April’s numbers were revised down by 2,000 to 221,000, and March was revised up from 85,000 to 119,000 (so it went from very bad to just a little bad). The economy has added an average of 217,000 jobs a month so far this year. Still, job creation has also slowed from the second half of 2014, when the economy added an average of 281,000 jobs a month. The US economy has recorded 63 straight months of private sector jobs growth. Previous record was 51 months from 1996-2000. Total employment is now up 12 million from the employment recession low and up 3.3 million from the previous peak. Private employment is up 12.6 million from the employment recession low and up 3.8 million from the previous peak. Typically, government will increase jobs in a downturn but that did not happen over the past few years – just the opposite.

Perhaps the best news was in the survey of American households that determines the unemployment rate. The number of people in the labor force rose by almost 400,000, although not all of those people found a job. Still, it was enough to push the unemployment rate higher. The Labor Force Participation Rate increased in May to 62.9%. This is the percentage of the working age population in the labor force.   A large portion of the recent decline in the participation rate is due to demographics. And there are 2.5 million long-term unemployed workers who still want a job.

High-tech firms, health-care providers, hotels, home builders and retailers all added workers. Only the energy industry cut jobs. Here’s the breakdown: Mining and logging, which includes oil drilling and exploration lost 18,000 jobs; education and health services added 74,000; professional and business services added 63,000 jobs; leisure and hospitality added 57,000; retail trades added 31,000; government added 18,000; transportation and warehousing added 13,000; financial activities added 13,000; construction added 17,000; and manufacturing added 7,000. One discouraging stat is that about 20,000 jobs were temporary. That means employers are still reluctant to take on permanent positions or convert temps to permanent jobs. That is a continued sign of slack.

The alternate measure of labor underutilization, U-6, was unchanged at 10.8%. In May, some 17.3 million people were classified as unemployed, involuntary part-time workers or the marginally attached. When we talk about slack in the labor market, this is where we find it, in the difference between the headline unemployment rate of 5.5%, known as the U-3, and the 10.8% unemployment rate of U-6. For May, the difference is 5.3%, but it has been as high as a 7.5% spread. We will likely continue to see slack until the spread drops down to about 3%; meaning we probably won’t see higher wage pressure until these workers find meaningful employment. Wages can go up, but it is unlikely wages would go up fast.

Average pay rose 8 cents to $24.96 an hour, pushing the increase over the past 12 months up to 2.3%, so wages are just barely staying ahead of inflation. That’s the highest rate since mid-2013, suggesting the increase in hiring over the past few years is finally forcing companies to pay a little more to attract workers. The Labor Department estimated that average hourly earnings for production and nonsupervisory employees increased to $20.97, up 0.3 percent from April and 2 percent from a year earlier. That pace falls far short of the pre-recession average of 3.4 percent.

And workers are not really seeing income gains; median inflation-adjusted household income is down 5.3% in the past 8 years, slipping from $54,674 to $51,939. Education and skills are big factors; median inflation-adjusted household income for college educated workers $45,400, for workers with high school education it drops to just $25,900. There is even some pent-up demand for workers with skills, such as machinists, engineers, and information and technology workers.

The May Jobs Report looks solid but we should probably consider some seasonal factors at work; specifically, young people entering the workforce. People under the age of 25 accounted for 96% of the 397,000 increase in the labor force in May, which includes those looking for work as well as those working. They accounted for 76% of the actual net new jobs. So, most of the gain is not attributable to discouraged workers suddenly deciding to look for a job, but rather young workers just entering the labor pool.

May is a time for new grads to enter the workforce, and the Class of 2015 faces some challenges. Unemployment of young graduates is extremely high today, but not because of something unique about the Great Recession and its aftermath that has affected young people in particular. Rather, it is high because young workers always experience disproportionate increases in unemployment during periods of labor market weakness. Unemployment and underemployment rates among young graduates are improving but remain substantially higher than before the recession began. For young college graduates, the unemployment rate is currently 7.2 percent (compared with 5.5 percent in 2007), and the underemployment rate is 14.9 percent (compared with 9.6 percent in 2007). For young high school graduates, the unemployment rate is 19.5 percent (compared with 15.9 percent in 2007), and the underemployment rate is 37.0 percent (compared with 26.8 percent in 2007).

The current unemployment challenges for young workers did not arise because today’s young adults lack the right education or skills. Rather, it stems from weak demand for goods and services, which makes it unnecessary for employers to significantly ramp up hiring. And if recent grads don’t jump into a job, if they are idled for some period of time, they risk missing the two main paths – receiving further education or getting more work experience – that enable future career success. Wages of young college and high school graduates are performing poorly, and are substantially lower today than in 2000. The real (inflation-adjusted) wages of young high school graduates are 5.5 percent lower today than in 2000, and the wages of young college graduates are 2.5 percent lower.

Graduating in a weak economy has long-lasting economic consequences. Economic research suggests that for the next 10 to 15 years, those in the Class of 2015 will likely earn less than if they had graduated when job opportunities were plentiful.

Something else happened in May; the number of self-employed workers surged by 370,000 last month, according to the U.S. Labor Department’s survey of households. And nearly 1 million workers have gone to work for themselves since just February. Now, this is a volatile statistic because the Labor Department puts out two surveys: the establishment survey, which gets most of the attention including the headline number of jobs created, and the household survey, from which the unemployment rate is derived. Some of the strength could be attributed to a reversal from losses during a cold winter. And also self-employment can mean lots of things: someone who works as a consultant while looking for more stable employment, or maybe they saw their regular job cut to independent contractor status so the employer could avoid taxes or benefits; or maybe someone who struck out in a more typical job search and now they are freelancing; or it could be someone who starts a business in hopes of success on their own terms.

If we are truly seeing a return to entrepreneurship, that would be a very positive sign. It takes a lot of confidence to start your own business. It also requires a healthy dose of crazy, because most start-ups will fail or just muddle along. The next Facebook or Uber is the exception, not the norm. And for those hoping to have the next big thing in start-ups, keep in mind that much of the Silicon Valley start-up culture only exists because there’s so much QE fueled free money for rich people sloshing around. And that spigot could soon be closed.

Wall Street was paying particular attention to the jobs report because of its potential impact on the Fed’s decision about when to raise interest rates above their near-zero levels. A Fed rate hike later this year is still on. The payroll report might give the Fed justification to hike rates, even though the first quarter GDP contracted 0.7%. Yesterday, the International Monetary Fund asked the Fed to hold off raising rates until the first half of 2016 because of disappointing growth and a lack of inflation. So we have weak economic data offset by what looks like a stronger job market.

The Fed fund futures contract is now signaling the first rate hike occurring in October, two months ahead of what had been expected prior to the release of the jobs report. Traders see a 53-percent chance that the first Fed rate hike will come at the Fed’s second-to-last meeting of the year, and just a 34-percent chance of a September rate hike. The bond market responded with a spike in yields. The strength in the May jobs report puts upward pressure on the entire yield curve; the yield on the 10 year Treasury note spiked up to 2.4%; and the dollar hit a 13 year high against the Japanese yen, with the Dollar index moving above 96.

We still have large parts of the economy stuck in the mud, even as some argue that today’s jobs report shows that the economy has reached escape velocity. Today’s report was good but not conclusive.