Are we entering a longer growth, but lower return environment?
April employment numbers of 223,000 jobs added dropped the unemployment rate to 5.4%. March numbers were revised lower to 85,000 jobs vs. the 126,000 previously reported. Wages rose quite modestly month-over-month. This report provided a sigh of relief for the bulls on both the stock and the bond markets, reinforcing a view that the Federal Reserve will be in no hurry to raise rates. But, there are some nuances to the report, which we will discuss in the geek session below, that continue to suggest that the labor market is tight, wages will likely rise, and we will see the Funds rate rising this year. The pace will likely be slow. We still need more data.
What We are Watching—The Usual Plus China
As we have said before we are watching the employment numbers, wages and commodity prices with a further eye on China. As we indicated in our Perspectives “What to Expect…” pieces we believe the China numbers will prove disappointing as the country continues its transition to a more consumption-driven economy. We received some reinforcement on this view from Michael Pettis at our Altegris Mauldin Economics Strategic Investment Conference (SIC 2015) a week ago Michael believes that China will ultimately see its growth rate fall substantially—possibly to 4% or less as investment as a percent of GDP declines while consumption rises. Whether that number ultimately occurs, the direction and the mix of growth would indicate commodity prices could stay low as this important incremental buyer adds to industrial and infrastructure capacity at a slower rate. I spent some time at the Milken Conference before our SIC 2015 began, focusing on the China presentations to get some other views on the outlook. I heard little suggesting that China would take actions to maintain its growth at the reported 7% level. Instead, China is taking a very strategic long-term view both domestically and internationally. Infrastructure (e.g., Silk Road initiatives) is geared toward the strategic; internal policy initiatives (e.g., corruption, intellectual property, environment, technology, property) are geared toward the strategic. Currency is geared toward the strategic. China will take steps to avoid problems with the banking system—and those are significant–, but the message was China believes it can maintain political stability during a period of declining growth rates. I specifically asked someone (who will remain nameless) if there was any number from China that would change his view on what could happen next. The response: there was no number; low numbers are expected. News that could change his view would relate to political instability, not economic instability, suggesting disagreement between those currently in power pushing change and those who want the status quo. He dismissed that possibility but did bring it up, so it is worth watching. One has to watch through opaque lenses. In addition, to quote Gary Shilling at our SIC, “growth can cover a multitude of sins.” Gary was making that point with Lacy Hunt of Hoisington Investment Management, who was forecasting very slow global growth for decades to come stemming from the debt load the world’s economies are carrying. It certainly applies to China, as the slower growth may expose “sins” of which we are currently unaware.
Where Does that Leave Us?
In the short-term, the markets are reacting to every data point that indicates when the Fed may be tightening and at what pace. I believe that the data as we move through the quarter will support a view that the US economy is growing and the labor market is continuing to tighten. The Fed will wait for the data on the quarter, but the markets may not. We do need more data.
I agree with the general tone of the SIC that we are in for an extended period of low growth in the US and globally. The macro risks would appear to be more geopolitical than economic. The ultimate effect is on corporate profitability. With slower top-line growth, a more competitive battle for market share is likely. Specific company results will be more management dependent with a different mix of sectors performing well vs. the QE world we have been living in.
If the market comes to believe that the economic cycle will be slower but extended, multiples could rise above what are now some pretty full levels. If multiples do rise, discounting an apparently more certain future with lower rates, surprisingly, volatility could rise with it. Markets will react more violently in both directions to any news that pushes the longer-term view one way or the other. That volatility will most likely come from the interactions of the US economy with the rest of the world, the impact of that on currency and the ultimate rebalancing of supply and demand in the commodity sector. Although, Peter Diamandis at SIC presented a view of a world of “Abundance” (his book) that was hard to ignore, forecasting a world of oversupply in all factors of production. His presentation also reinforced a focus on technology as a driver of variable returns throughout many industries, including the technology and social media industries themselves. As Moore’s Law continues to march along, or even accelerate, we may see new disruptors disrupting the “old” disruptors. It is possible that includes some of the “old technology” companies surprisingly re-emerging as the “Internet of Things” and “Big Data” become even more important.
Rates will likely rise in the US, but the pace and magnitude may be consistent with a low growth environment with the real rate of interest being close to zero. In that environment one would have to look away from simply investing in the indexes to achieve returns. Active management, risk management, and a true look at the need for immediate liquidity versus long-term capital building should become a more significant part of the search for solutions in a low-return environment.
Specific Observations from the Strategic Investment Conference
Thoughts from the SIC that relate to employment and the Fed, included a view from Dave Rosenberg, echoed by others with some variations, that we were in for a very long but low growth cycle with a recession several years away.
Jim Bianco expressed the view that the Fed is most interested in financial market stability and is unlikely to raise rates until the Fed dots (the governors’ forecasts of the Funds rate) and the financial futures were closer together. The financial markets clearly are reflecting a slower pace for Funds rates rising than the dots from the Fed governors. On the other hand, former Fed governor Larry Meyer, who should know, said to Pay Attention to the governors’ forecasts of timing and degree. The markets will have to react. Chairperson Yellen’s recent comments about the markets would tend to support that observation. Jeff Gundlach said he would expect the Fed to allow the two key variables, employment and inflation, to run “hot,” above the targets for some time before raising rates. A view he has expressed in other fora subsequently.
The above comments specifically related to employment, the US economy and the Fed. There were many more observations from the various speakers at the SIC on a variety of global topics. You will be seeing those in videos we will be posting from many of the presenters as well as additional blog posts.
And Now for the Geek View on Employment
The actual employment rate fell from 5.4650% to 5.4427%. Rounding gets one from 5.5% to 5.4%. 14,000 more unemployed would have kept the number at 5.5%. One modest revision could get us there. To get to 5.3% from where we are would take a significantly larger change in the numbers. It might take us several months to see that. We may find ourselves “stuck” at 5.4% for some time even if the employment rolls increase by 200,000 or more for the next several months. The pundits will have a field day.
However, there are some strange things going on. I have commented previously that we are dealing with seasonally adjusted numbers. As the table below shows, we actually employed 1,178,000 more individuals in April. That ended up being 223,000 seasonally adjusted persons. Last year the actual employment increase of 1,152,000 people on the first go-round was seasonally adjusted to 288,000. The seasonal adjustment factors for 2015 have changed and could produce surprising numbers to the upside as we move through the year.
The unemployment rates (RU) broken down by demographics do say something about tightness in the labor markets. For example, the RU for those 25 and older is at 4.5%. Those with less than a high school education in that age group are at 8.6% while those with a college degree or more are at 2.7%. 16-19 yr. olds have a 17.1% RU. The black community is at 9.6% vs. whites at 4.7%. As I have said before, using Fed policy to deal with issues around education and training is not the most efficient and economically sensible approach to these structural and social problems.
I pay more attention to wages as an indication of the degree of tightness in the labor markets. The wage gains, while modest, are rising. Hourly earnings are up 1.85% from a year ago, and the index of weekly payrolls is up 4.7%. This is in spite of the declines related to the extraction (logging and mining) industries. For logging and mining, hourly earnings are down about 1% from a year ago to $26.26 per hour (third highest vs. utilities at $34.01 and Information Services at 28.69). Weekly earnings are down 2.9% to $1213/week vs. a $704 average overall. Logging and mining still has the highest weekly hours worked: 46.2/week vs. 33.7/week overall. These results do support our view that the labor markets, away from energy, are tightening enough to produce an increase in wage growth, which ultimately works its way into the profit picture—particularly in a slow growth environment.
The real message, though, is take all these numbers with several grains of salt. There is always more to dissect in the labor market. I can’t wait for the next JOLTS report…