Employment Numbers Surprise Almost No One; Alter No Fed Expectations, But…

Are we entering a longer growth, but lower return environment?

The Numbers

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.

TBL_Blog_OTM-Change_Jan14-Apr15_050814v2

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…

Employment Numbers Surprise Most and Change Fed Expectations (Again)

In contrast to February, March employment numbers surprised on the downside, with adjustments to January and February reducing employment for the first three months to a seasonally adjusted average rate of 197,000, down from 220,000 previously. As we said last month, we would have expected some payback as the true impact of the weather, the port strike, and what was happening in the oil patch worked its way into the revised numbers and the month of March. Still, this was a surprising number on the low side.

On the wage front, however, hourly earnings were up 0.3%. This is a little suspect given the layoffs and likely reduction of hours related to the oil patch where earnings are quite a bit higher than the average. If true, combined with average weekly payrolls, it pushes incomes up at more than a 5% annual rate for the first quarter. The anecdotal evidence, to some extent, continues to support that the labor markets are tight, and some companies are responding by raising hourly wages and adding more training for employees. The headline companies have been in retailing—Walmart and Target. McDonald’s has joined the crowd where it could, raising wages 10% in its company-owned outlets. These companies are seeing something in the difficulty of retaining employees with turnover hurting the quality of service. Given what we are seeing on the corporate revenue front, this likely reinforces the view that profits will be disappointing.

The Fed will continue to be data-driven. The employment numbers and the likely GDP print may keep the Fed on hold beyond mid-year, or it could simply change the rate at which fed funds will rise. We are watching the employment numbers, wages, and commodities. I hate to say that we need more data. Maybe April will provide that. The surprise could be a bottoming on the commodity front aided by growth in Europe and parts of Asia and some tempering of the rise of the dollar. The bearish technical trends of the hard commodities, particularly the industrials, would lead one to believe we are in a global recession. I don’t think so. This bears watching, but it most likely indicates that China, the big marginal buyer, is weaker than general expectations. In addition, energy is a major input into extraction and smelting in all of the metals. The lower energy prices reduce significantly the variable cost of production. Mines or smelting activities, which have been operating on the margin, have likely seen that margin improve thus pushing output higher than it might have been otherwise. If there is a variable contribution to overhead production continues. Please take a look at our recent Perspectives update on “What More to Expect in 2015…” for more on this topic and others. In the meantime, the activities in the commodities sector, combined with currency fluctuations, have been interesting for managed futures managers. The variations in performance among equity sectors have been a boon to active equity managers. And, fixed income managers more focused on absolute return have had choices to make. Worth paying attention to this changing environment.

Now, for the geeks who managed to make it through last month’s observations on employment, here’s an update:

The actual unemployment rate fell 0.08% in February—not quite enough to push the overall rate down another tenth, but close. As we pointed out last month, the unrounded February rate was 5.545%. March was 5.465%. Twenty-five thousand more employed would have taken the rounded number down to 5.4%. That brings us back to the seasonal adjustments, which we discussed last month. The table from last month has been updated below through March.

TBL_Blog_OTM Change_Jan14-Mar15_040614

As one can see, the seasonal adjustments are significant, and vary year-to-year and revision-to-revision reflecting new data; different birth/death numbers for small businesses; adjustments for unusual events (e.g., weather); and other factors. I will point out that, historically, the big unadjusted reduction in every January for the last several years is almost completely made up by the total of the subsequent three months. If that happened again this year and was precisely equal to 2,818,000, the unadjusted number in April would ultimately be 1,158,000. April is a big hiring month. How that translates into seasonally-adjusted numbers is not as clear. Our view is that the labor market is tight. We have some adjustments to live through out of the oil patch, but we will likely find ourselves back into economic numbers that indicate a growing economy here, but with different sectors providing the investment opportunities relative to what was experienced up until the end of US QE.

Employment numbers surprise most and change Fed expectations

Don’t expect equity-like returns in traditional fixed income.

I am just about to put out an update on our “What to Expect in 2015…” piece on Altegris Perspectives. However with a surprisingly good jobs report out this past Friday it is worth a specific comment on the report for those who care.

The conclusion from the employment numbers lends some support to an increase in Fed Funds rate at mid-year. The early reaction of the US yield curve – a 10bps upward movement in 2-year interest rates – indicates that market expectations are moving in that direction as well. I think the Fed will continue to be data driven, but this data point leans in that direction. It reinforces our view that fixed income portfolios, in particular, require a fresh look with a move toward a more absolute return approach. There also needs to be a realization that equity like returns experienced in fixed income are most likely a thing of the past without taking on equity-like risk or even greater. That is not the role of fixed income in a portfolio. With that said, let’s look at the employment numbers.

The seasonally adjusted employment number showed a 295,000 increase for February and a decline in the unemployment rate to 5.5%.  This compares to a consensus among economists of a 230,000 increase and a decline in the rate to 5.6%.  The only negative elements in the report were a small decline in the participation rate and a modest 0.1% increase in the hourly wage number. Although, with the average work week up, more additions to the employment rolls and a 0.5% increase in last month’s wage number, this is a positive for incomes. The latest Beige Book shows indications from most of the districts of rising difficulty finding the skill sets to match needs and a resulting pressure on wages. The impact of lower activity in the energy sector is expressed as a concern, but is not necessarily showing up fully in the numbers.

One has to be somewhat sensitive to these first numbers given the weather impact and the major seasonal adjustments in these early months of the year.

For the geeks out there, here are a few considerations:

The actual unemployment rate before rounding was 5.545%. This just barely rounds to 5.5%. A change in 10,000 more unemployed coming from a higher participation rate or maybe a better count on losses in the energy sector would have pushed that number higher. No doubt the Federal Reserve is aware of all this.

We are also dealing with seasonally adjusted numbers. The actual increase in employment in February, 2015 was 903,000 which was seasonally adjusted to 295,000. In January there are actually major declines in employment. The employment rolls were down in January this year at roughly the same number as last year, -2,821,000 vs.  -2,836,000 in January 2014.  Last year that decline translated, seasonally adjusted, to +129,000 additions to the employed work force. This year, with new seasonal adjustments the number translated to +239,000.  See the table below to get some sense of the monthly differences between seasonally adjusted and unadjusted numbers as well as the historical pattern of revisions.

Nonfarm Payroll Employment Table

There may be some payback in March. While the weather prevented folks from coming to work or visiting stores most of those employed but not working were still on the payroll. There may be more adjustments to employment levels once the impact of the weather requires a fresh look by employers at costs relative to lost income as well as some catchup on the energy sector.

The market focuses on every new number or headline that comes out and tries to discount that into values instantaneously. It isn’t just the Fed that tries to be data-driven. The employment report is one set of data. It, at the moment, supports the labor side of the Fed’s mandate and can be a lead indicator on the inflation front. It is another signal requiring one to Pay Attention. More to come.