Sunday, October 6, 2019

The Myth of Income Stagnation, Again

The key to a happy economic outlook and a continuation of the bull market in stocks is productivity growth. I think productivity growth is starting to make a comeback as the labor market gets tighter. If so, then wages—which have been rising faster than prices since the mid-1990s—would rise at a faster clip. Faster growth of real wages likely would more than offset the supply-side slowdown in payroll employment growth. A quicker pace of productivity growth would keep a lid on inflation. Profit margins would remain at recent historical highs or even go higher. The bull market in stocks would continue as earnings moved higher.

At a meeting recently in San Francisco with one of our accounts, I was asked to explain why an 8/7/18 Pew Research Center study disputed my claim that real wages have been rising for many years. The fellow came prepared with a copy of the piece, titled “For most U.S. workers, real wages have barely budged in decades.”

Right at the top is a chart showing that the purchasing power of average hourly earnings has been flat for 40 years! Can that possibly be right? Nope, it cannot be right. It makes absolutely no sense. In fact, it’s total nonsense. Consider the following:

(1) Agreeing on wage measure. The author of the study and I both focus on the average hourly earnings (AHE) of production and nonsupervisory workers. The series starts in January 1964, while the series for all workers is available only since March 2006. But the less comprehensive series has covered around 80%-84% of all workers and isn’t as skewed by the wages of top earners.

(2) Disagreeing on price measure. The Pew study divided AHE by the CPI indexed to 2018 dollars. It is well known that the CPI is upwardly biased, especially compared to the personal consumption expenditures deflator (PCED) (Fig. 1). Since January 1964 through August of this year, the CPI is up 728% while the PCED is up 539%, both indexed to 2018.

Over this same period, AHE is up 844%. Adjusted by the CPI, AHE was $22.90 during August, no higher than it was during late 1973, confirming Pew’s alarming and depressing headline (Fig. 2). Adjusted by the PCED, the AHE was the same, but up 48% over the same period!

(3) Making sense. The PCED-adjusted measure of the real wage makes much more sense. It rose during the second half of the 1960s before stagnating during the 1970s as a result of two oil price shocks and during the 1980s as a result of deindustrialization. It rebounded, along with productivity growth, during the second half of the 1990s in an uptrend into record-high territory since the late 1990s that persists to this very day.

Thursday, October 3, 2019

No Recession In Purchasing Managers Report

One of my favorite songs is “We Didn’t Start the Fire” (1989), by Billy Joel, who is one year older than I am. The lyrics are simply a long list of major personalities and issues that have pleased, pained, and plagued my generation—the Baby Boomers—since our parents started to have children during the late 1940s. The lyrics include brief, rapid-fire allusions to more than 100 domestic and global headlines during the Cold War, from 1949 through 1989. Many of them refer to troublesome events during that period.

Today, Billy Joel would have no trouble updating his list of troublesome events: Red China, North Korea, South Korea, vaccine, Ayatollah’s in Iran, foreign debts, homeless vets, China’s under martial law, impeachment, MMT, negative rates, deflation, inverted yield curve, M-PMI, and many more. Actually, the first eight items were in Joel’s original lyrics.

Yesterday’s cause for concern was the release of September’s M-PMI report. It wasn’t pretty. It was weak across the board (Fig. 1). Consider the following:

(1) Weak, but still no recession. The overall index fell to 47.8 from 49.1 during August. These are the first readings below 50.0 since 2016. There was no recession back then. The latest readings don’t signal a recession now according to the Institute for Supply Management (ISM), which conducts the PMI survey:

“A PMI® above 42.9 percent, over a period of time, generally indicates an expansion of the overall economy. Therefore, the September PMI® indicates growth for the 125th consecutive month in the overall economy, and the second month of contraction following 35 straight months of growth in the manufacturing sector. The past relationship between the PMI® and the overall economy indicates that the PMI® for September (47.8 percent) corresponds to a 1.5-percent increase in real gross domestic product (GDP) on an annualized basis.”

(2) Regional surveys also mostly down and out. The three major components of the M-PMI were all below 50.0 during September: new orders (47.3), production (47.3), and employment (46.3), as Debbie reviews below. The weakness in the M-PMI was confirmed by the composite and orders averages for the regional business surveys conducted by five Federal Reserve district banks (Fig. 2). However, the regional average employment index rebounded during September, while the employment component of the M-PMI fell to the lowest reading since January 2016 (Fig. 3).

(3) Trade war hits exports index. Also standing out on the weak side was the M-PMI’s new exports component, which plunged from last year’s peak of 62.8 during February to 41.0 during September (Fig. 4). That was the lowest reading since March 2009. Trump’s escalating trade war has depressed US exports, according to the latest ISM survey. The imports index, however, edged up from 46.0 during August to 48.1 last month.

(4) Bad news for S&P 500 revenues. The growth rate in S&P 500 aggregate revenues, on a y/y basis, is highly correlated with the M-PMI (Fig. 5). September’s reading for the latter suggests that the former could turn negative. That would imply negative earnings growth too. Aggregate revenues were up 3.0% during Q2.

The good news is that aggregate revenues growth is also highly correlated with the NM-PMI, which remained above 50.0 in September for the 122nd month, though is showing a slowdown in service-sector growth. September’s reading fell to a three-year low of 52.6 from 56.4 in August and a recent peak of 60.8 a year ago. However, ISM notes that an NM-PMI above 48.6, over time, generally indicates an expansion in the overall economy (Fig. 6).

Wednesday, September 25, 2019

As Germany Sinks, Draghi Promotes MMT

Germany's Homegrown Problems. IHS Markit has released its flash estimates for September’s Purchasing Managers’ Indexes (PMIs) in the Eurozone along with those for France and Germany. The German data were downright ugly. There’s no oomph or oompah in Germany. Instead, manufacturing has fallen into a recession and is dragging down the rest of the economy. Real GDP edged down 0.3% (saar) during Q2 and is up just 0.4% y/y (Fig. 1). Another q/q decline is likely during Q3.

In the Eurozone, Markit estimates that the Composite PMI (C-PMI) fell from 51.9 during August to 50.4 this month (Fig. 2). The drop was led by the Manufacturing PMI (M-PMI), which is down from a recent peak of 60.6 during December 2017 to 45.6 this month. However, the Nonmanufacturing (NM-PMI) also contributed to the month’s decline, falling from 53.5 to 52.0. Germany stands out with an M-PMI that is now down to 41.4 compared to 50.3 in France (Fig. 3). Also weakening in Germany is the NM-PMI, which is down from this year’s high of 55.8 during June to 52.5 in September (Fig. 4).

I’ve previously observed that there is something wrong with Germany’s economy. Trump’s trade wars may be part of the problem, but Germany—along with most of the rest of the world—has a serious homegrown problem: not enough babies and too many seniors. Babies tend to stimulate consumption as they grow older, while old people don’t stimulate much of anything. It’s hard to stimulate people who are already old to do much of anything.

That may explain the weakness in global auto sales in recent years (Fig. 5). Germany’s manufacturing economy is particularly dependent on the auto industry. Let’s have a closer look at Germany’s economy:

(1) Tougher emission standards. In the Eurozone, regulators made things worse for the industry with new emission standards imposed a year ago. The new EU-wide test procedure was the authorities’ reaction to VW’s 2015 admission to widescale cheating on diesel vehicles, with suspicions since spreading to other manufacturers.

(2) Losing cache. Germany’s high-performance and high-priced Bimmers and Benzes may not be as popular with Millennials around the world as they were with the Baby Boomers. Millennials tend to be minimalists. They are more concerned about fuel economy and are likely to favor electric vehicles once EVs become cheaper and have more range.

(3) Competing with Chinese EVs. A 9/20 Bloomberg article titled “China Is Winning the Race to Dominate Electric Cars” hits on several of the issues plaguing Germany’s automakers. For starters: “The global auto market is not only not growing, but it is also shrinking. Sales peaked in 2017 at nearly 86 million on a trailing-12-months basis; right now in 2019, sales are closer to 76 million.”

The future for the auto industry is EVs, which are mostly made in China: “There is only one company in the top 10 by percent of electric passenger vehicle revenue that isn’t Chinese: Japan’s Mitsubishi Corp. Two Chinese automakers get more than 40% of revenue from electric vehicle sales; a third gets nearly a quarter of its revenue from EVs.”

(4) Fiscal stimulus coming? In August, German Chancellor Angela Merkel said she sees no need for a stimulus package “so far” but added that “we will react according to the situation.” She pointed to plans to remove the so-called solidarity tax, an added income tax aimed at covering costs associated with rebuilding the former East Germany, for most taxpayers.

(5) Green new deal. The problem is that the government plans to spend $60 billion through 2030 on green new deals, which are more likely to weigh on the economy than to stimulate it. According to the 9/20 WSJ article on this subject:

“The measures, including subsidies for green power generation, will be financed by revenues from higher taxes on polluting activities, such as air travel and car fuel, as well as a new carbon emission certificate trading scheme to be launched in 2021. The package won’t affect Germany’s balanced budget. Despite international pressure on Berlin to loosen the purse strings and revive a slowing economy, the country’s budget surplus is projected to stand at over €40 billion in 2019.”

The government will help to finance more than a million charging stations for EVs by 2030. Owners and buyers of EV cars will get government subsidies, which might further depress gasoline-powered auto sales.

Draghi Saying Give MMT a Chance. Outgoing ECB President Mario Draghi told European lawmakers that Modern Monetary Theory (MMT) should be considered to stimulate the slowing economy of the Eurozone. “It’s a government decision, not [that of] the central bank,” he said. During his tenure, Draghi’s monetary policy commitment to “do whatever it takes” to save the Eurozone economy hasn’t been enough, so I am not surprised that before his 10/31 departure he is calling on fiscal policy to save the day.

The basic tenet of MMT is that a government may borrow and spend to infinity and beyond because it controls the creation of money. Under MMT, governments can never run out of money to pay their debts, say MMT advocates. They would only cease MMT if inflation heated up.

On his way out the door, Draghi set the stage for MMT in the Eurozone by lowering the ECB's official deposit rate from -0.40% to -0.50% and restarting the asset-purchase program. The ECB is set to buy €20 billion per month in Eurozone securities, including government bonds.

It is unlikely that German leaders will readily take the advice of the ECB, let alone its outgoing president, to consider an idea like MMT. Officials of the EU’s largest economy deeply value fiscal discipline. They undoubtedly will protest that MMT violates the principles of the Maastricht Treaty, the official treaty on the European Union signed in 1992, which emphasizes sound fiscal policies and limits on debt.

Thursday, September 12, 2019

US Bond Yields Made in Germany

Another round of central bank easing is underway. So why are bond yields rising?

The 10-year US Treasury bond yield rose from a recent low of 1.47% on 9/4 to 1.72% on Tuesday (Fig. 1). The record low was 1.37%, hit on 7/8/16 just after the Brits voted to leave the European Union (EU). The risks of a no-deal Brexit have eased in recent days, though it still could happen next month. A hard Brexit could cause the bond yield to retest its recent low.

In any event, the main reason that the US bond yield has moved higher in recent days has more to do with Germany than the UK. The 10-year German government bond yield has risen from a recent record low of -0.71% on 8/30 to -0.54% Tuesday. Reuter’s reported: “Germany’s 30-year government bond yield briefly rose into positive territory on Tuesday for the first time in over a month, lifted by expectations for fiscal stimulus and caution over the scale of stimulus the European Central Bank might deliver this week.”

During a parliamentary budget debate on Tuesday, Germany’s Finance Minister Olaf Scholz said that Germany can counter a possible recession with a big stimulus package. On Monday, Reuters reported that Germany was considering creating a “shadow budget” to boost public investment above and beyond limits set by its national debt rules, sparking a bond sell-off.

European Central Bank (ECB) President Mario Draghi has been lobbying for fiscal policy to turn more stimulative to support the ECB’s ultra-easy monetary policies. Germany has resisted doing so and even questioned whether the ECB’s asset purchase program could legally buy sovereign bonds. Germany’s fiscal and monetary conservatives might be starting to waver as a result of Germany’s intensifying manufacturing recession, with factory orders and production down 5.6% and 4.8% y/y through July (Fig. 2).

Last year, when there was widespread bearishness in the bond market, with some predicting that the US yield would rise from 3% to 4%-5%, I observed that the US bond yield might be “tethered” to the comparable German and Japanese yields, which were barely above zero. This year, both have dropped solidly below zero.

During the Q&A portion of his 7/25 press conference, Draghi pleaded for more fiscal stimulus, especially from Germany:

“What’s hitting the manufacturing sector in Germany and [elsewhere in Europe is] an idiosyncratic shock. Here what becomes really very important is fiscal policy. [T]he mildly expansionary fiscal policy is supporting activity in the euro area. But if there were to be a significant worsening in the Eurozone economy, it’s unquestionable that fiscal policy … becomes of the essence. … I started making this point way back in 2014 in a Jackson Hole speech: monetary policy has done a lot to support the euro area … but if we continue with this deteriorating outlook, fiscal policy will become of the essence.”

Thursday, September 5, 2019

From FOMO to FONIR

I visited with our accounts in Atlanta and Chattanooga recently. They seemed relatively calm. Most of them believe that the US economy can continue to grow for the foreseeable future. So they aren’t freaking out about the recent inversion of the yield curve. However, they are somewhat anxious about the prospect of negative interest rates in the US, though they think it is a remote possibility. Consider the following:

(1) US bond yields stand out. We discussed in our meetings the expectation that the Bank of Japan (BOJ) is likely to keep its official policy interest rate at -0.10% for the foreseeable future, as it has since 1/29/16, while the Governing Council of the European Central Bank (ECB) is likely to lower its official deposit rate, currently -0.40%, deeper into negative territory at its 9/12 meeting (Fig. 1). The ECB is widely expected to resume quantitative easing at that meeting as well (Fig. 2).

Such expectations have driven the 10-year German government bond yield down to -0.70% on Monday from 0.24% at the start of this year. At 1.50% on Friday, the 10-year US Treasury bond yield is literally outstanding compared to the comparable yields available overseas: UK (0.34%), Japan (-0.27), Sweden (-0.34), France (-0.40), Germany (-0.70) (Fig. 3). The negative-interest-rate policies (NIRPs) of the ECB and BOJ are increasing the amount of negative-interest-rate bonds (NIRBs) around the world.

(2) Dividend & earnings yields stand out. The rationale for remaining bullish on US stocks seems to be shifting from TINA (there is no alternative) and FOMO (fear of missing out) to FONIR (fear of negative interest rates). These fears are inherently bullish for stocks and continue to overcome the bearish fear that an inverted yield curve is predicting an impending recession, i.e., FOIYC (fear of inverted yield curve).

A few of the accounts with whom I met recently noted that the 10-year US Treasury bond yield at 1.50% is below the S&P 500 dividend yield, at 1.90% during Q2-2019 (Fig. 4). That is one very good reason why they remain mostly fully invested in the stock market. I observed that the forward earnings yield of the S&P 500, at 6.06% during August, is even more outstanding compared to the bond yield (Fig. 5).

(3) Performance derby. The 119bps drop in the US bond yield since the beginning of the year certainly has benefited dividend-yielding stocks. The S&P 500 sectors that tend to have lots of dividend-paying companies have outperformed those that tend to have fewer of them: Information Technology (28.0% ytd), Real Estate (26.0), Consumer Discretionary (20.3), Communication Services (20.0), Consumer Staples (19.0), Utilities (17.6), Industrials (17.4), S&P 500 (16.7), Financials (12.6), Materials (11.9), Health Care (4.6), and Energy (-0.5) (Fig. 6).

FONIR should continue to benefit dividend-yielding stocks. Their high valuation multiples reflect investors’ willingness to pay up for these stocks, as evidenced by the relatively high forward P/Es of the S&P 500 sectors with lots of dividend payers: Real Estate (44.0), Consumer Discretionary (21.2), Information Technology (19.6), Consumer Staples (19.6), Utilities (19.4), Communication Services (17.4), Materials (16.9), S&P 500 (16.8), Industrials (15.4), Health Care (14.8), Energy (14.7), and Financials (11.4) (Fig. 7).

(4) Real yields. During July, the US bond yield averaged 2.05%, while the CPI inflation rate was 1.80%. So the inflation-adjusted bond yield was close to zero, at 0.25% (Fig. 8). During August, the bond yield fell below the inflation rate. In other words, in real terms, bond yields are entering negative territory. Meanwhile, the real earnings yield of the S&P 500, using reported earnings, remained solidly in positive territory during Q2-2019, at 3.02% (Fig. 9). The real forward earnings yield of the S&P 500 was 4.03% during July (Fig. 10).