Economy and equity markets: are they disconnected?

saSince July 2009 I have been ambivalent with equity markets after their strong recovery from March low and continued weak economic data. The magnificent 7 indicators are all favorable and therefore tell us that there is nothing to panic about equity markets. But is this disconnected from the economic reality? So, let’s review a number of economic indicators. More than the numbers themselves, I will be looking at trends. In this analysis, I will neither review the situation of the financial sector nor the housing sector.

1. GDP breakdown

The second estimate of the fourth-quarter increase in real GDP is 0.2% higher than the advance estimate at 5.9% annualized, primarily reflected upward revisions to private inventory investment, exports and nonresidential fixed investment that were partly offset by an upward revision to imports and downward revisions to personal consumption expenditures and to state and local government spending.

The trend is definitely improving. The next 2 quarters will tell us whether we may get into a second dip recession. Today, I tend to give the GDP the benefit of the doubt.

The Conference Board Leading Economic Index increased 0.1% in February (+0.3% in January and +1.2% in December) pointing to a slow recovery, but a recovery nonetheless.
Ken Goldstein, Economist at The Conference Board: "The indicators point to a slow recovery this summer. Going forward, the big question remains the strength of demand. Without increased consumer demand, job growth will likely be minimal over the next few months."

2. Consumption

Personal disposable income has grown for 5 month in a row until it decreased in January due to an increase in federal non-withheld income taxes according to the Bureau of Economic Analysis. At the same time, the personal consumption expenditures went up for the 9th consecutive month in January (+ $52.4 billion). The personal saving rate decreased to 3.3% from 4.2% in December, but is now in solid favorable territory, even if I would like to eventually see it in the 7-8% region.

The trend is positive. In my opinion, pay checks given by the Bush and Obama administrations were used to repair households’ balance sheets during H1 2009, and now we are witnessing a non-subsidized consumption growth.

Household debt service payments and household financial obligations as a percent of disposable personal income have also decreased from 13.92% and 18.87% in Q1 2008 to 12.60% and 17.51% in Q4 2009 respectively.

All this translated into an improving picture for retail sales.

3. Unemployment

Unemployment seems to have stabilized with an unemployment rate of 9.7% in February and 14.9 million unemployed; the number increases to 16.2% and 24.9 million unemployed if we add part-time workers for economic reasons and discouraged workers, but slightly off the high reached a coupe of months ago. However, the number of discouraged workers continues to increase unabated to 1.2 million people (+65% compared to February 2009 and + 13% compared to January 2010) .

The employment situation, according to the establishment data, confirms this stabilization. Total non-farm employment went down 36,000 in February vs. -26,000 in January, -726,000 in February 2009 and -109,000 in December. Weekly hours worked also point toward a stabilization.

The diffusion index for the total private sector dramatically improved to 48.0 in February vs. 44.2 in January, 39.6 in December and 17.1 in February 2009 (50 percent indicates an equal balance between industries with increasing and decreasing employment). The diffusion index for manufacturing jumped to 54.9 in February vs. 40.9 a month earlier.

4. Banks’ lending

In February, banks continued to shrink commercial loans for the 16th month in a row, shedding an additional $17 billion; total commercial loans outstanding are back to the summer 2007 and $345 billion below the peak reached in October 2008 ($1,645.6 billion).

Whilst this is negative for growth as a whole since less credit is available, I take it as a favorable element in what was an economy built on over-indebtedness steroids, particularly at the household level, and the system has to be purged.

In addition, the rate of decline seems to be arriving at or near a trough.

5. Net export of goods and services

The balance of net export of goods and services dramatically improved, whilst higher again for the last two quarters, to represent a $449 billion deficit. This suggests that the US trade deficit will have a long way to really get any closer to being balance.

As soon as the economy will improve on a sustainable basis, energy and commodities prices will forge ahead and will add more weigh on the US trade balance. Any oil alternative like gas or shale gas, will take some time to gap the national output/consumption imbalance, but worth watching since it could change the ball game.

Conclusion

Equity markets have anticipated the economic recovery which is in its infancy. The important indicators are at worse stabilizing. Markets paused in July and again in January/February to go back to their previous high and extend to new post crisis highs.

As of today, market patterns are justified by economic data. However, on a simple valuation based on Shiller’s cyclically adjusted PER, the S&P 500 is becoming expensive at 21.3 x earnings on March 18 vs. 13.3 x in April 2009 and an average of 16.4 x. On a simple PER basis, the S&P 500 is trading at the top of its mid 30s - mid 90s range but well below its mid 90s – 2008 exuberance.

I conclude that equity markets are not disconnected from the real economy and there no reason, under the current circumstances, to fear a market collapse. The S&P is however no longer cheap and, despite a good earning season, I would continue to selectively buy on weakness quality stocks having displayed their ability to pay dividends. I would favor energy (oil in particular), technology and consumer companies with worldwide brands (P&G, Nestlé, Unilever, J&J for example) as well as “progressing” markets (terminology that I prefer to emerging) and stay wary of bank’s stock at least in the "regressing" world (i.e. developed).

Monetary policy will remain accommodative until the real estate market has fully recovered and don't forget, “never fight the FED”. As my friend, Jacques-Henri Gaulard, Managing Partner of Autonomous Research – a top notch independent research firm specializing on the financial sector -, says about interest rates : "we have moved from L4L to L4E – Low for Longer to Low for Ever…"

Sources:

Bureau of Economic Analysis: National Economic Accounts

http://www.bea.gov/newsreleases/national/gdp/2010/txt/gdp4q09_2nd.txt

The Conference Board: Global Business Cycle Indicators

http://www.conference-board.org/pdf_free/economics/bci/birdairc2.pdf

Bureau of Labor Statistics: Employment Situation

http://www.bls.gov/news.release/empsit.toc.htm

Federal Reserve Bank of St Louis: Economic Research

http://www.research.stlouisfed.org/

Yale Department of Economics: Robert Shiller Online data

http://www.econ.yale.edu/~shiller/data.htm

FullerMoney: S&P 500 Graph

http://www.fullermoney.com

Markets & Beyond: The Magnificent 7 and Equity Markets

http://marketsandbeyond.blogspot.com/2010/03/magnificient-7-and-equity-markets.html

Autonomous Research

http://www.autonomous-research.com/x/default.html

First-time jobless claims rise and CDS spreads widen

More U.S. workers unexpectedly filed for jobless benefits last week. Initial claims for state unemployment benefits increased 8,000 (28,000 unadjusted) to a seasonally adjusted 480,000 in the week ended Jan. 30, the Labor Department said on Thursday. That was above market consensus of 460,000.

As for productivity, it kept surging during the fourth quarter at 6.2% annual rate and 7.2% in the third quarter (the biggest one-year gain since 2003) with labor cost dropping 4.4% (0.9% for all 2009). This is not surprising since companies continue to lay off workers and wage are still in a deflationary environment (high and rising unemployment and continued delocalizations). Whilst this bodes well for corporate earnings, it is not encouraging for consumption; this recovery will not be sustained without a brisk improvement in the labor market or a new stimulus package which, I hope, will never come since it would be disastrous beyond the short term effect, adding debt and leading to the eventual collapse of the economies concerned. It is not possible to postpone needed adjustments by buying growth via successive stimulus packages without seeding even more difficult circumstances.

This is combining with widening spreads in the debt markets. We have not finished with PIIGS countries in Europe (Portugal, Italy, Ireland, Greece and Spain). Greece is in a very bad shape and the main labor union today called for a strike: this does not bode well for the success of needed reforms to be implemented there. My next main worry is Spain, the fourth largest economy in the Euro-zone.

The EU's endorsement of Greece's budget plan is not going to calm investors’ fears, if one refers to the poor track record of the EU with its own rules (look at France for example or past Greece trafficking of central Bank numbers to join the Euro): politics will always come ahead of reality, even if short term expedients are long term detrimental to what federalist European politicians want. By the way, the Greek Prime Minister points the finger at speculators, the usual scapegoats… (note that when they are going along they are investors, otherwise speculators), and not reassuring.

It would be quite an irony if a new crisis was to originate in Europe without Governments being able to blame the US for their own sins: a much too rapid integration pushed forward by federalist politicians.

What is happening in Greece (and wait for Portugal and Spain) is just exemplifying that without deep reforms undertaken, lax fiscal policies, large public sector and unbearable social benefits coupled with an aging population lead to run away budget deficits and commensurate debts. Also, by not acting when they could (some still can, but time is running short rapidly), it is a certainty that markets will call the shots.

The risk is that the deterioration of sovereign debt spreads to the corporate sector which seems starting to happen.

Markets, already fragile, have reacted negatively to the numbers and the deteriorating Euro-zone sentiment, deepened losses as I am writing (-2.3% for the S&P 500 and the DAX); banks are being hit very hard (-5.5% DJ STOXX 600 banks). Precious metals are also taking a hit (gold -4%, platinum -3.9% and silver -5.3%) like Q3 2008. It looks like a repeat of Q3 2008 when all asset classes collapsed (but Treasuries playing their safe  - not so safe - haven status). I do not know whether we will have a repeat of last year meltdown (I rate it a 10% possibility even to a lesser extent), but it will largely depend on Europe's seriousness and speed of response to the Club Med imbalances crisis (by comparison, this helps the US hence the dollar rally). Markets are also saying that Western countries cannot carry on printing money, contemplate budget deficits running away and ballooning public indebtedness: it is a warning shot.

The Chinese market was a leading indicator in 2008 as were banks, both down and up. Watch bank indices and the Shanghai index together with the S&P 500 and the NASDAQ: 200 days moving average have been reached and in the case of the DJ Euro Banks breached with conviction.

One of my recommendations of the year was to stay away (or be short) of financials in 2010: no change!

I will be away travelling to India for a couple of days, which should be most interesting, and therefore will not post any comment during this period.

Sources:

BCA Research - U.S. Q4 GDP Growth: Less Than Meets The Eye

http://www.bcaresearch.com/public/story.asp?pre=PRE-20100201.GIF

Fullermoney

http://www.fullermoney.com

Bloomberg: Greece’s Biggest Union Sets Strike, Threatens Cuts (Update1)

http://www.bloomberg.com/apps/news?pid=20601087&sid=aN2G_2S_aP2M&pos=9

Bloomberg: Corporate Credit Risk Jumps as Sovereign Debt Woes Accelerate

http://www.bloomberg.com/apps/news?pid=20601087&sid=a9ugUulle9A4&pos=5

United States Department of Labor: Unemployment insurance weekly claims report

http://www.dol.gov/opa/media/press/eta/ui/current.htm

US unemployment: a few must see charts

Friday, I commented on non-farm payrolls weak numbers. Today, I am providing several charts from various sources that put these in perspective together with additional comments.


1. Employment and the 2000s: the lost decade

the number of jobs at the end of a decade has been anywhere from 20% to 38% greater than 10 years prior. This sub-par job growth is particularly noteworthy due to the fact that the US population has increased by 10% in addition to a significant increase in global wealth during the same time frame.

2. The unemployment situation in the current economic recession compares very badly with past one since WW II

This recession is the worst recession since WWII in percentage terms, and 2nd worst in terms of the unemployment rate (only early '80s recession with a peak of 10.8 percent was worse). We are lower as the 1948 recession but will recover like the 2001 recession i.e. very lengthy recovery.



3. Monthly Changes in Non Farm Payroll, 2004-09

This graph jut shows the gross figures. It is evident that the pace of job shedding is abating, but does not point towards a fast recovery in the employment situation.




4. The percent of those employed 27 weeks and over 27 weeks and over is at record high since WW II at 40%, almost twice the previous peak
Unemployed are having more difficulties to find a job. It is important for this number to decrease since then next step is for unemployed to no longer looking for a job.



5. The employment rate is now at the lowest since August 1983 at 58.2%

The decline has been particularly sharp.The US finished the decade at 130.9 million, practically unchanged from the start of the decade. Meanwhile, the total pool of available labour rose from 146 million to 159 million. Therefore we have 13 million more people competing for the same number of job than in 2000.


6. Temp help is improving

This is a positive signal since temporary jobs is a leading indicator on the unemployment situation. December was the 5th positive number in a row.



No doubt that we are seeing modestly positive growth in the economy and that the pace of job declines is moderating. This however has been the result of an unprecedented public sector intervention. The private sector is still idle despite the magnitude of a fiscal and monetary stimulus of of historical proportion.

The leaves me worried about the macro-economic outlook since the extraordinary measures taken in 2008-2009 cannot be repeated if the private sector does not roll again.

Source:

Chart of the Day
http://www.chartoftheday.com/20100108.htm?T

The New York Times: The Labor Picture in December
http://www.nytimes.com/interactive/2010/01/08/business/economy/0108-jobs-graphic.html

Calculated Risk: Unemployment Report
http://www.calculatedriskblog.com/2010/01/employment-report-85k-jobs-lost-10.html

Bruce Steinberg: Employment Report
http://www.brucesteinberg.net/Monthly_Employment_Situation.htm

Gluskin Sheff
https://ems.gluskinsheff.net/Articles/Snack_with_Dave_010810.pdf

Poor US unemployment numbers

Change in nonfarm payroll came in worse than expected at -85,000 jobs vs. a consensus of a flat number (range +40.000/-50.000). Revisions showed payrolls increased the prior month for the first time in almost two years at +4.000 and decrease 127,000 in October. Both the number of unemployed persons, at 15.3 million, and the unemployment rate, at 10%, remained unchanged.

Looking at in more details, the numbers are rather bad:

• Long term unemployed (those jobless for 27 weeks and over) continues to trend up at 6.1 million
• Involuntary part-time workers were about unchanged at 9.2 million
• Workers marginally attached to the labor force (want to work and are available for work but did not seek a job for at least 4 weeks) dramatically rose to 2.5 million (+578,000 over December last year)
• Among these 2.5 million people, workers discouraged to seek a job increased by 642,000 compared to last year, for a total of 929,000
• The civilian labor force participation rate fell to 64.6 percent in December. The employment-population ratio declined to 58.2 percent

If we add unemployed persons to workers marginally attached to the labor force, we reach an unemployment number close to 12% I we add the involuntary part-time workers, we are at 17.5% (100% ratio) or 14.5% (50% ratio).

This is on the back of December retail sales that look better than anticipated (+2.8% compared to a year ago according to ISCS sales index). With no improvement in the jobless numbers during the 3-6 coming months, having a negative effect on 1) would be consumers sentiment and 2) disposable income, there is a real risk that annualized growth recedes in 2010.

Source:

Bureau of Labor Statistics: Employment Situation Summary
http://www.bls.gov/news.release/empsit.nr0.htm

Bloomberg: Payrolls in U.S. Drop 85,000; Unemployment at 10
http://www.bloomberg.com/apps/news?pid=20601087&sid=aet6GtG2Ip_I&pos=1

Yahoo!: December retail sales show signs of life
http://news.yahoo.com/s/ap/20100107/ap_on_bi_go_ec_fi/us_retail_sales

Chart of the Day -US Unemployment

Last week, the Labor Department reported that non-farm payrolls (jobs) decreased by 11,000 in November - the smallest decline since the recession began at the close of 2007. Temp-agency employment surged 52.4 k in November, the largest surge for 5 years; this metric is a quite reliable forward-looking indicator. These number are definitely positive but let's wait their confirmation in December and if they are not just part-time employees hired for the season's shopping.

Today's chart puts that decline into perspective by comparing job losses during the current economic recession (solid red line) to that of the last recession (dashed gold line) and the average recession from 1950-2006 (dashed blue line). As today's chart illustrates, the current job market has suffered losses that are more than triple as much as what occurs at the lows of the average recession/job loss cycle.


Sources:

Chart of the Day
http://www.chartoftheday.com/20091204.htm?T

Bureau of Labor Statistics
http://www.bls.gov/news.release/pdf/empsit.pdf

Can green shoots be sustainable?

For a couple of months, media ahs been full of greenshoots: the economy is back on track, we are going to see a V shape recovery, GDP upgrades are multiplying, corporate earnings are much better etc.

However without the consumer going back to shops to buy, these greenshots with end up like leaves on trees during the Autumn: brown.

Whilst a lagging indicator, unemployment will be key in this current recession due to its psychological effect on consumers combined with the depth of this recession. Let's review 3 graphs.

Graph 1 shows that the unemployment in the US will be the deepest since WWII. True the pace of employment destruction eased to 216,000 in August vs. 276,000 in July (revised up) and 463,000 in June (revised up). This is however not surprising being nearly 2 years in recession: the pace of 400,000/500,000+ new unemployed a month was not sustainable for very much longer with the stimulus package and money injected. Unemployment rate increased to 9.7%; however including part-time workers who would like to work fulltime and other unemployed that are discouraged to seeking a job, the rate is above 16%!



This recession is however by far the deepest since the early 70s, and will affect the way the baby boomers will consume and reflect on their pensions having lived on debt steroids for 20 years: fear is new; fear of losing their job, fear of losing their home, fear of losing their savings, fear about the social and health coverage, fear about their pension, concern about their children higher education and job, etc.

This results in reconstituting their savings (up to 6.9%) after having been sub zero 3 years ago. However, this steep increase is mainly in the form of debt repayment (and not in liquid savings accounts) and is helped by deflationary pressures. it does not bold well for consumption in the coming months.

The third chart illustrates that the current job market has suffered losses that are more than six times as much as average (20 months after the beginning of a recession). In fact, if this were an average recession/job loss cycle, the number of jobs would have begun to increase five months ago...

Whilst at odd with many commentators, I am still convinced that we are due for not so nice surprises on the economic front by year-end, Q1 2010 at the latest, hence my view of an equity market correction.


Sources:

Bureau of Labor Statistics
http://www.bls.gov/news.release/empsit.nr0.htm

U.S. Department of Commerce
http://www.bea.gov/national/nipaweb/Nipa-Frb.asp?Freq=Qtr

Prof. Michael Hudson
Debt Deflation Arrives:What the Jump in the U.S. Savings Rate Means
http://www.michael-hudson.com/articles/financial/090630ODebtDeflation_SavingsRate.html#_ftn2

The New York Times
http://economix.blogs.nytimes.com/2009/05/08/comparing-this-recession-to-previous-ones-job-losses/

Chart of the Day

Yesterday, US nonfarm payrolls (jobs) decreased by 467,000 in June. The headline came in at -467k compared with -350k consensus and the back revisions were negligible(+8k). The diffusion index fell to 28.6 from 31, which means that nearly three-quarters of the corporate sector is still in the process of shedding jobs. The 4 weeks average is continues it downward slope however. The stock market as well as commodities and energy declined sharply on the news.

Today's chart puts that decline into perspective by comparing job losses during the current economic recession (solid red line) to that of the last recession (dashed gold line) and the average recession from 1954-2006 (dashed blue line). The US have lost a record 9 million full-time jobs this cycle, more than triple the average in the context of a post-WWII recession, with over 2 million pushed onto part-time work. In fact, if this were an average recession/job loss cycle, the number of jobs would have begun to increase three months ago. This confirms the severity of the recession, but do not forget that employment data is a lagging indicator.
Source:

Bloomberg: July 03, 2009
http://www.bloomberg.com/apps/news?pid=20601110&sid=aNWsvYFLUCjA

Gluskin Sheff: July 02, 2009
Market and data musings - David A. Rosenberg
http://www.gluskinsheff.com/us-intl/musings/