CNBC Appearance

Crude Oil Price and S&P 500 Energy



The macroeconomic case for owning Energy stocks is weakening along with the price of oil. As global economic growth slows, so does the demand for oil. The price of oil is the key determinant of the performance of energy stocks relative to the S&P 500. The price of a barrel of Brent crude oil has been trending down in a volatile fashion since it hit a cyclical peak of $126.47 on April 8 of this year. This morning, it is down to $103.86. The S&P 500 Energy sector has been underperforming the S&P 500 since April 11.

Contributing to last week’s 4.7% drop in the price of Brent was news that US petroleum usage fell sharply in early December. I track the four-week moving average, which fell to 18.3 million barrels per day as of the week of December 9. That’s below the comparable readings for 2007 through 2010. The latest gasoline usage was 3.4% below the comparable year-ago pace, and gasoline inventories are the highest ever at this time of the year. (See our US Petroleum Weekly.)

Nevertheless, there is a case to be made for owning Energy stocks as a hedge against turmoil in the Middle East. On Friday, Bloomberg reported: “The US is concerned Iran is on the edge of enriching uranium at a facility deep underground near the Muslim holy city of Qom, a move that may strengthen those advocating tougher action to stop Iran’s suspected nuclear weapons program. Iranian nuclear scientists at the Fordo facility appear to be within weeks of producing 20 percent enriched uranium, according to Iran analysts and nuclear specialists in close communication with US officials and atomic inspectors. US officials, speaking on condition of anonymity, worry Iran’s actions may bolster calls for a military response and ratchet up pressure to limit Iran’s oil exports, which might send oil prices soaring.”

Friday Essay: “We are the 64%”

Be afraid, be very afraid. I’m not warning you about the stock market, though it has been performing poorly in recent days. I am warning you about big government. Actually, the warning has been issued by a recent Gallup poll of the polis. Let’s have a look:

(1) The overwhelming silent majority think that big government is the biggest problem. On Monday, the polling organization reported: “Americans’ concerns about the threat of big government continue to dwarf those about big business and big labor, and by an even larger margin now than in March 2009. The 64% of Americans who say big government will be the biggest threat to the country is just one percentage point shy of the record high, while the 26% who say big business [will be] is down from the 32% recorded during the recession. Relatively few name big labor as the greatest threat.”

(2) Big business and big labor aren’t as worrisome. Gallup adds: “Historically, Americans have always been more concerned about big government than big business or big labor in response to this trend question dating back to 1965. Concerns about big business surged to a high of 38% in 2002, after the large-scale accounting scandals at Enron and WorldCom. An all-time-high 65% of Americans named big government as the greatest threat in 1999 and 2000. Worries about big labor have declined significantly over the years, from a high of 29% in 1965 to the 8% to 11% range over the past decade and a half.”

(3) Even Democrats are disillusioned. Now get this: “Almost half of Democrats now say big government is the biggest threat to the nation, more than say so about big business, and far more than were concerned about big government in March 2009…. By contrast, 82% of Republicans and 64% of independents today view big government as the biggest threat, slightly higher percentages than Gallup found in 2009.”

President Barack Obama seems to be completely out of touch with the popular sentiments expressed in this important poll. Neither he nor the Occupy Wall Street (and the Ports) crowd have convinced the citizenry that the number one threat to our national prosperity is big business, in general, and big banks, in particular. Rather, the vast (silent) majority of the people see big government as the number one threat.

In his latest campaign speech on this subject on December 6 in Osawatomie, Kansas, the President was on the wrong side of this debate. To be fair and more accurate, he was on the wrong side of the latest Gallup poll on this matter. It’s certainly true, however, that as hard as he has tried, he hasn’t convinced the majority of Americans that their problems should be blamed on the collective villainy of big business, Wall Street, and the rich. There is a huge gap between the “we-are-the-99%” crowd, who chant the anti-business mantra every day, and the “we-are-the-64%” crowd, who fear big government.

The 99 crowd actually represents no more than 26% of Americans who believe that big business is the biggest threat to the country according to the latest poll. If they want to represent the majority, they should occupy Washington.

So why did our President schlep to a very small town in Kansas to give a speech at the Osawatomie High School? He was channeling Theodore Roosevelt, who gave his famous “New Nationalism” speech in that town on August 31, 1910. Like Teddy Roosevelt, Mr. Obama argued that the government needs to have more power to direct business. He said, “Yes, business, and not government, will always be the primary generator of good jobs with incomes that lift people into the middle class and keep them there. But as a nation, we’ve always come together, through our government, to help create the conditions where both workers and businesses can succeed.” He added: “And it will require American business leaders to understand that their obligations don’t just end with their shareholders.”

In his speech, Roosevelt also advocated a greater role for government: “The National Government belongs to the whole American people, and where the whole American people are interested, that interest can be guarded effectively only by the National Government. The betterment which we seek must be accomplished, I believe, mainly through the National Government.”

In conclusion, President Obama’s version of the New Nationalism isn’t resonating with the voters. In fact, I’ll bet you $10,000 that the next President of the United States is Newt Gingrich. I’m just kidding--about the $10,000! Too bad that Mitt Romney wasn’t just kidding when he challenged Rick Perry to a $10,000 bet on a disputed comment Perry made about Romney in their latest debate on December 10. If Romney does prevail over Gingrich, you can bet that the Democrats will run that video in their attack ads.

By the way, the scary phrase that starts this post originated in the 1986 horror film The Fly, starring Jeff Goldblum (as Seth Brundle) and Geena Davis (as Veronica Quaife). Quaife is a reporter working on the teleportation story, which is the subject of the movie. When it becomes clear that Brundle is starting to turn into an insect, he reassures one of the characters, “Don’t be afraid.” Quaife’s response is: “No. Be afraid. Be very afraid.”

Professors Copper & Gold

What are Professors Copper and Gold saying about the outlook for 2012? Copper is the metal that is renowned for having a PhD in economics. Yesterday’s 4.7% plunge to $3.27 per pound was a bad break, though it remains above the most recent low of $3.05 on October 20. It suggests that global economic growth is weakening. That’s confirmed by the decline in the CRB raw industrials spot price index, which includes copper along with 12 other commodity prices. This index fell to a new low for the year at 514.6 yesterday, but remains above the 2010 low of 463.5 on February 8, 2010.

Gold is the metal that is renowned as a great inflation hedge. I’ve always viewed it more broadly as a hedge against out-of-control governments with reckless fiscal and monetary policies. Yesterday, the price of gold plunged 4.2% to $1,603 an ounce. It found support at its 200-day moving average. Could it be that governments are embracing fiscal and monetary discipline? That’s a stretch.

Another interpretation of the weakness in the price of gold is that governments have reached the limits of their recklessness. They have run out of effective policy options to either clean up or cover up their fiscal messes. They can’t even reflate their way out of their excessive debt burdens, though they’ve tried. European governments have formulated four Grand Plans that haven’t worked to end their financial crisis. So here comes the dreaded Endgame, including failed government bond auctions, sovereign debt defaults, the collapse of the euro and European banks, deflation, and depression. Sorry, I think that’s a stretch too.

More likely is that governments around the world won’t let the global economy roll over into a recession--which could quickly turn into a depression. They may be much more limited in using fiscal policy to boost economic growth than they were three years ago. But there is always another round of massive quantitative easing of their monetary policies. If so, then gold may very well rebound off its 200-day moving average.

If it fails to do so, it will be because the only safe asset will be deemed to be the US dollar and US Treasury bonds. Last week in Kansas City, one of our long-only accounts was especially concerned that the Endgame scenario is upon us. We discussed the best way to preserve capital in such a calamitous environment. The conclusion was to load up on the US dollar and US Treasury bonds, the scenario that seems to be working so far this week.

US Treasury Outlays & Receipts

Is Gridlock bullish or bearish? In the past, it’s probably been bullish more than it has been bearish. After all, our constitutional system was designed by our Founders to disperse power among the Executive, Legislative, and Judicial branches of our government. Congress was designed so that special interest groups more often than not would be stymied from achieving their legislative agendas by resistance from “factions” with opposing interests. In Civics, Gridlock is called by the less pejorative name of “Checks and Balances.”

So the system seems to have worked exactly as it was designed (i.e., not to work) this year. According to the Congressional Record, this year through November, the House approved 326 bills, the fewest in at least 10 non-election years; the Senate passed 368 measures, the fewest since 1995. Conversely, the House passed 970 measures in 2009 and 1,127 in 2007, and the Senate for those years approved 478 and 621, respectively.

So far, that hasn’t been very bullish for the stock market. That’s because the legacy of all the lawmaking over the past few years has been to saddle the US economy with huge federal deficits and rapidly mounting federal debt. Various attempts to narrow these deficits have failed miserably. From this perspective, Gridlock is bearish. The outlook is for more of the same next year, and beyond depending on the election results on November 6, 2012.

How did we get to this sorry state? The special interest groups learned that they could achieve their goals through cooperation rather than conflict with one another. Most importantly, they figured out that the government’s budget isn’t a zero sum game if the resulting spending binge is deficit financed. The Constitution needs a Balanced Budget Amendment. European governments seem to be moving in exactly that direction as a result of their fiscal crises.

We monitor the latest developments and trends in the US federal government’s budget in our US Government Finance briefing book. Let’s have a look:

(1) A trillion here, a trillion there. Over the past 12 months through November, the federal deficit was $1.01 trillion. On this basis, it has exceeded $1 trillion since June 2009 (Figure 1). Federal government outlays totaled $3.6 over the past 12 months through November. That’s up 50% since March 2005. Over this period, receipts totaled $2.3 trillion, up 14.8% from the most recent cyclical low during January 2010, but still 11.1% below the previous record high during April 2008 (Figure 2).

(2) Lots more IOUs. Total US government debt outstanding rose to a record $15.1 trillion during November. It is up 50% since September 2008 and 100% since December 2004 (Figure 17). The per capita comparisons are shocking. The government’s debt divided by the labor force, which represents actual and potential taxpayers, rose to a record $9,819 in November, a 100% jump since the spring of 2004 (Figure 23). In October, the government’s debt was 1.6 times greater than a year’s worth of disposable income excluding government transfer payments. That’s a record high, and up from 1.0 during May 2008 (Figure 24).

(3) Tax revenues are up and down. Total federal tax receipts tend to be a lagging indicator of the economy (Figure 12). They rose to a cyclical high of $2.3 trillion over the past 12 months through November, led entirely by individual income tax receipts, which rose to $1.1 trillion (Figure 2 and 9). Corporate tax receipts have flattened at around $200 billion. That’s really puzzling given that corporate profits are at a record high; yet these receipts are about 50% below the record high of $382.3 billion during June 2007. It may be that US corporations are earning more of their profits overseas and aren’t repatriating them because of the high corporate tax rate in the US.

In the past, payroll tax receipts (so-called “social insurance and retirement receipts”) rose during economic expansions, and even during recessions. They’ve been falling since November 2008, when they peaked at $905 billion. They were down to $806 billion over the past 12 months through November (Figure 9). That’s because Washington has been cutting payroll tax rates in an effort to stimulate economic growth.

(4) No more PayGo. The problem with cutting payroll tax rates is that the result is a rapidly widening social welfare deficit in America. Our Social Security and Medicare entitlement systems were designed to be fully financed by payroll taxes, which was the case until the middle of the previous decade. But then the social welfare deficit ballooned to a record high of $402.3 billion over the 12 months through November of this year (Figures 13 and 14).

By the way, a “do-nothing” congressional session, which passes relatively few bills, does not necessarily mean that the power and scale of our government in Washington has been diminished. When Congress cannot approve multiple separate pieces of legislation in a timely fashion, it will often bundle the bills together into the scheme known as an “omnibus” spending bill--which often leads to billions of dollars in pork being wasted on congressional cronyism in one piece of legislation.

S&P 500 Sectors’ Performance & Earnings

In my meetings with our accounts in Kansas City last week, everyone said that they are very tired of the volatility in stock prices this year. Don’t stare too long at the chart above of the year-to-date performance of the S&P 500's 10 sectors. It can make you very dizzy. The volatility has been especially intense since late July. That’s when the 10 sectors’ respective volatilities became increasingly correlated while at the same time Stable sectors began outperforming Cyclical ones, in a significant reversal of their relative fortunes so far this year. Here are the latest derby results ytd as of yesterday’s close: Utilities (9.7%), Consumer Staples (7.3), Health Care (5.6), Consumer Discretionary (4.5), Information Technology (2.6), Energy (0.8), Telecom Services (-3.1), Industrials (-5.0), Materials (-12.8), and Financials (-20.2).

Since the last week of July through the start of December, there has been a noticeable drop in consensus expected earnings growth for the 10 sectors in 2012. The most pronounced declines have been for Energy (from 11.9% down to 2.8%), Materials (14.2% to 10.6%), Industrials (18.0% to 13.4%), Telecom Services (13.5% to 7.6%), and Financials (35.9% to 23.5%). The other sectors’ earnings growth expectations have been relatively more stable. Earnings growth for the overall S&P 500 for next year has declined from a peak of 15.2% during the week of July 22 to 10.1% in the latest week.

These earnings revisions help to explain some of the reversals of fortune in the sectors’ performances since the summer. The extreme volatility reflects a number of other factors too. Investors’ sentiment has been buffeted by the ongoing crisis in Europe. The Cyclical sectors all tend to rise in lock step when Europe’s leaders are scrambling to formulate yet another plan to clean up their mess. Then when the latest plan is announced and found to be lacking, the Cyclical sectors all go down together--while the Stable ones outperform, but head in the same direction. Financials tend to be among the worst performers during these letdowns. The widespread and highly correlated volatility on a short-term basis can also be attributed to high frequency trading and the impact of ETFs, especially leveraged ones. Needless to say, all these factors are likely to continue to buffet stock prices in the coming year.

Meanwhile, one source of underlying stability has been industry analysts’ expectations for total S&P 500 earnings this year and next year. This year’s estimate has ranged between $95.97 and $100.09 per share since the beginning of the year. The 2012 estimate has ranged between $107.95 and $113.83 over this same period. Next year’s estimate mostly fell from the top of this range to the bottom of this range since the beginning of the year, but it has stabilized around $108 over the past couple of weeks. That’s noteworthy given the bad news coming out of Europe.

Then again, there was some bad news coming out of some big companies in recent days that may push the 2012 consensus estimate lower again. That wouldn’t surprise Joe and me since we are forecasting that earnings will be $100 next year. Executives at DuPont, 3M, and Texas Instruments warned that they are seeing signs that their customers are trimming their inventories in anticipation of weaker sales. One of the concerns is a slowdown in the European auto industry. Another problem is that the shortage of disk drives following flooding in Thailand is depressing the demand for semiconductors. Intel announced yesterday that its revenue this quarter would be lower than previously expected--at $13.7 billion versus the earlier projected $14.7 billion.

CNBC Appearance

US & Chinese Economic Indicators

Last week’s batch of better-than-expected US economic indicators helped to offset the ongoing jitters about the Euro Mess. On Thursday, the Bureau of Labor Statistics reported that initial unemployment claims dropped by 23,000 during the week of December 3 to 381,000, the lowest reading since the last week of February. The four-week average declined to 393,250, the lowest since the first week of April. It is not unusual for jobless claims to plunge during the first few months of an economic recovery, then stall for a while at levels still well above previous cyclical lows, and then move lower again.

The same pattern seems to be happening again. I think it was starting to do so a year ago. However, it was aborted by the Fed’s misguided QE-2.0 policy, which boosted food and fuel prices. Those higher prices flattened consumers’ purchasing power and spending, and also depressed their confidence. So it is encouraging to see that the Consumer Sentiment Index rebounded in mid-December to 67.7 from a recent low of 55.7, which tends to confirm that labor market conditions are improving.

China’s monetary policy is turning stimulative again. That’s the good news, and so is the recent drop in China’s measures of inflation. The bad news is that the People’s Bank of China (PBoC) is easing in response to some weakening in economic activity. On December 5, bank reserve requirements were lowered by 50bps. The CPI inflation rate has plunged from a recent peak of 6.5% y/y during July to 4.2% during November, just about matching the PBoC’s target of 4.0% for the year. The PPI inflation rate plunged from 7.5% during July to 2.7% last month.

Europe accounted for 17.7% of China’s exports during November. Over the past 12 months through November, those exports are up only 5.2% compared to 34.4% last November. On a seasonally adjusted basis, China’s exports to Europe dropped sharply by 7.1% m/m during September and 5.5% during October, but moved up 5.1% during November. China’s total exports edged up to a record high of $2.0 trillion (saar) during November. Industrial production was also at a new high in November. However, it was up “only” 12.4% y/y, the lowest growth rate since August 2009.

S&P 500 Revenues and Margins

Do you recall what the bears were saying about the earnings-led bull market during 2009 and 2010? They fought it all the way up as the S&P 500 increased 101.6% from a closing low of 676.53 on March 9, 2009 to a high, so far, of 1363.61 on April 29. The Naysayers dismissed the dramatic rebound in earnings as unsustainable. They claimed that it was all based on cost cutting, which couldn’t continue for very long. They predicted that revenue growth would be subpar, at best. So let’s see what actually happened using data we compiled on forward revenues, earnings, and profit margins for the S&P 500 and its 10 sectors in our new publication titled S&P 500 Sector Squiggles: Revenues, Earnings, and Margins. 

S&P 500 forward revenues did decline by 6.1% during 2009, while forward earnings rose 0.3% as the forward profit margin rose from 7.7% at the start of the year to 8.4% by the end of the year. But in 2010, forward revenues rose 7.1%, which along with an increase in the profit margin to 9.6% at the end of last year, boosted forward earnings by 23.8%. Data available through early December show that revenues and earnings are up 7.8% and 11.7% so far this year, while the profit margin has stalled since the spring around 10%.

Looking into 2012, it’s hard to see much upside for these three variables. I expect that they will be flat. More specifically, revenues could average $1,050 a share, about the same as this year. The profit margin might edge down to 9.5%. The result would be earnings around $100, up slightly from about $97 this year.

The scenario behind these numbers is slower global growth, with Europe in a mild recession while the US economy continues to muddle along with real GDP growing around 2%.

S&P 500 and Industrial Commodity Prices

One of the best ways to assess whether the global economy is progressing and regressing on a real-time basis is to track the CRB raw industrials spot price index. It includes the prices of 13 industrial commodities. I like it because it excludes petroleum and lumber products, which have their own unique supply and demand fundamentals. The index is highly correlated with global industrial production and global exports. (See Figures 1 and 2 in our High Frequency Economic Indicators.)

The CRB index is also highly correlated with the overall S&P 500, especially with its Transportation index. Indeed, this commodity price index is one of the three components of our Fundamental Stock Market Indicator (FSMI), which has an especially tight fit with the S&P 500 (Figure 55). The message from these sensitive indicators is that the global economy remains relatively weak:

(1) As of yesterday, the CRB raw industrials spot price index (1967 = 100) was 527.4, down 17.3% from its record high of 638.1 on April 12. However, it remains just above its previous cyclical peak of 525.7 on May 13, 2008, and 66.7% above its previous cyclical low of 316.3 on December 5, 2008.

(2) Our Boom Bust Barometer (BBB)--which is the ratio of the CRB index to the four-week moving average of initial unemployment claims--was 133.9 at the end of November, which is 16.1% below the most recent cyclical peak of 159.6 on March 12, 2011 and 14.4% below the prior cyclical peak on August 11, 2007 (Figure 54).

(3) Our FSMI--which averages our BBB and Bloomberg’s weekly Consumer Comfort Index--edged down at the end of November to 91.9. It is 15.5% below its most recent cyclical peak on February 26, 2011. It suggests that the S&P 500 should be trading between 1150 and 1200 (Figure 55).

S&P 500/400/600 Forward Earnings & Factory Orders

Industry analysts who cover the S&P 1500 either didn’t receive or didn’t read the European recession memo. European economies are heading down, according to November’s purchasing managers indexes (PMIs) for the euro zone and the UK. Emerging economies--including Brazil and China--are showing some signs of stress too, which most likely reflect their weakening exports to Europe, as well as the depressing impact of previous tightening of their monetary policies.

Yet, in the US, forward earnings managed to rise to new record highs for the S&P 400 MidCaps and the S&P 600 SmallCaps during the week of December 2. The forward earnings of the S&P 500 remains in a record high flat trend, which started earlier this year. It is up for the fifth straight week to $107.18, the highest reading in eight weeks.

The V-shaped recovery that started in early 2009 for the forward earnings of all three market cap indexes may be over for the LargeCaps, but it seems to be resuming now after stalling earlier this year. This may be happening because LargeCaps tend to be more exposed to sales within Europe and exports to the region than smaller US companies, which are more highly leveraged to growth in the US.

Industry analysts are clearly giving more weight to signs of resilience in the US economy despite the weakening outlook for the global economy, particularly in Europe. The US purchasing managers’ surveys for both manufacturing and nonmanufacturing stood out during November with readings above 50. Most other PMI readings around the world were below this make-or-break level for economic growth. While it’s hard to imagine that the US can decouple from the weakening global trend, industry analysts are relatively sanguine about this prospect, for now. That could all change quickly if Europe’s recession gets much worst and if Europe’s credit crunch depresses economic activity beyond the region as European banks cut back on their global lending.

So while the resilience of the three measures of forward earnings is impressive, I should warn you that they also took last gasps in mid-2008. Then they keeled over during the second half of that year through early 2009 as the US financial crisis intensified, causing a severe global recession.

The flattening of the S&P 500’s forward earnings poses a risk to Industrials. There is a very tight relationship between S&P 500 forward earnings and new factory orders. Profitable companies expand, while unprofitable ones do not. So it isn’t surprising that total orders have stalled over the past three months through October around $5.4 trillion, at a seasonally adjusted annual rate, along with the forward earnings of the S&P 500.

On the other hand, nondefense capital goods orders, which are volatile on a m/m basis, remain on an uptrend, though they dropped in October, led by a sharp decline in civilian aircraft orders. Shipments of nondefense capital goods rose to a new cyclical high of $862.4 billion (saar) over the three months through October, with new orders for construction equipment jumping to a new record high during the month.

US Employment Indicators



The Birthers were quiet on Friday following the release of November’s payroll employment report. They usually get all hot and bothered about the so-called birth/death adjustment (BDA) to total payrolls. Whenever it is up, they claim that it is bogus and immediately subtract it from the total to demonstrate that the labor market is weaker than suggested by the headline employment number. They did that last month when the BDA added 102,000 to October’s payrolls, which showed a gain of 80,000 on a preliminary basis. November’s report showed that this adjustment reduced payrolls by 29,000. Yet the Birthers didn’t bray that the increase in payrolls must have been greater than the first-reported official estimate of 120,000.

The Birthers will be back as soon as the BDA is positive again, which won’t be long. The statistical model used by the Bureau of Labor Statistics (BLS) is “designed to reduce a primary source of non-sampling error which is the inability of the sample to capture, on a timely basis, employment growth generated by new business formations.” Even during 2008, 2009, and 2010 the BDA added 724,000, 477,000, and 288,000 to payrolls. By the way, that adjustment is added to the data before the total is seasonally adjusted. Yet the Birthers always make the serious mistake of comparing the seasonally unadjusted BDA to the seasonally adjusted total.

Friday’s employment report was mostly chock full of good news. However, there was some bad news too. Let’s review:

(1) All employment measures showed solid gains in November. Total nonfarm payrolls rose 120,000 and household employment jumped 278,000 during the month. Private-sector employment rose 140,000 according to the official release, while ADP reported a solid gain of 206,000. The irrelevance of the BDA issue is confirmed on a regular basis by the close correlation of the trend and magnitude of changes in the comparable BLS and ADP statistics. So for example, the private payrolls over the past 12 months have increased 1.88 million according to BLS and 1.86 million according to ADP. Household employment (which includes government workers) is up 1.67 million over this same period.

(2) The revisions in the previous two months tend to be more important employment indicators than the preliminary estimate. I have long argued that more weight should be placed on those revisions than on the first reported estimate. The revisions tend to be upward during economic expansions and downward during recessions. September’s preliminary gain for total payroll employment has now been revised up twice by a total of 107,000 (from 103,000 to 158,000 to 210,000). October’s estimate has been revised up once by 20,000 (from 80,000 to 100,000), and will likely be revised upward again when December payroll data are released on January 6. Over the past 12 months through October, revisions have boosted payrolls by 326,000 (231,000 the past three months).  

(3) Total hours worked rose to a new cyclical high during November. The index of aggregate weekly hours in private industries edged up 0.1% during the month, despite a 0.5% downtick in manufacturing, which seems a bit odd, given the strength in industrial production.

(4) The evidence on part-time vs. full-time jobs is mixed. The household survey shows that full-time employment increased by 323,000 during November to a new cyclical high of 113.1 million. That’s still 8.7 million below the record high of 121.8 million during November 2007. Part-time employment fell 91,000 during the month, and remains near recent record highs. During November, nearly 20% of household employment was part time.

The payroll data show that the temporary help services industry increased headcount by 22,300 during November. Other industries that tend to rely on part-time workers also expanded during November, with retail and leisure & hospitality jobs up 49,800 and 22,000, respectively, during the month. Over the past 24 months, the temporary help service industry added 484,000 employees, accounting for 21.4% of the gain in total payroll employment.

(5) The pace of hiring is improving, but the pace of firing remains elevated. The latest available JOLTS data through September show that the pace of hiring rose during the month to the highest in 16 months. On a 12-month basis, total hiring started to exceed total separations during September 2010 for the first time since the spring of 2008. Over the past 12 months through September, total hires were 48.0 million and total separations were 46.7 million, yielding an employment gain of 1.3 million.

This improvement in hiring activity is consistent with the Monster Employment Index, a measure of online job ads. This index has been trending higher all year. However, it did dip slightly during November, but remained at the third highest reading of this year. All of the major industries included in the index were flat to down during November with the exception of Transportation and Warehouses, which climbed to a new high for the series going back to 2003. While initial unemployment claims rose back above 400,000 during the week of November 26 (402,000), the four-week average was 395,750 during that week.

(6) The bad news is that wage gains aren’t keeping up with inflation. The good news is that the falling real cost of labor should continue to boost employment. Average hourly earnings for all workers rose 1.8% y/y through November. Over the same period, we estimate that the CPI rose 3.6%. So there has been an erosion of purchasing power for workers. In the past, real pay per worker tended to be highly correlated with productivity. Recently, there has been a divergence as productivity continues to grow rapidly. That’s certainly boosted corporate profits, which in turn may be starting to boost employment. My mantra: “Jobs are created by profitable companies, not by government programs.”

US Employment & Confidence Indicators

Yesterday’s ADP report on private-sector payroll employment during November was magnificent. No wonder that consumer confidence rebounded during the month. Chicago’s purchasing managers also had good things to say about business activity in their neighborhood. The evidence continues to demonstrate the resilience of the US economy. It’s doing remarkably well despite all the loco commotion in Europe and Washington. Let’s review the latest batch of happy data:

(1) This may be the third “new normal” jobless recovery in a row that’s starting to morph into an old normal recovery. Sure enough, November’s gain of 206,000 payroll jobs in the private sector, as reported by ADP, is the kind of gain that could start lowering the unemployment rate if it continues. The ADP report was chock full of good news, including an upward revision in October’s gain from 110,000 to 130,000. Especially impressive is that 53% of November’s new jobs were created by small businesses with under 50 employees. Note to Washington: Government doesn’t create jobs; small businesses do as they grow into bigger businesses. Just don’t get in their way.

(2) November’s bounce in consumer confidence confirms that the labor market is improving. The Consumer Confidence Index rebounded 15.1 points during November to 56.0 from 40.9 during October. It was the biggest m/m rebound since April 2003. This index tends to give more weight to consumers’ assessment of the labor markets than the Consumer Sentiment Index, which increased 3.2 points during November.

(3) Chicago’s purchasing managers are showing thumbs up. Chicago’s Institute for Supply Management yesterday reported that its business barometer increased to 62.6 in November from 58.4 the prior month as orders and production strengthened. The group's production gauge increased to a seven-month high of 67.3 from 63.4. Their new orders index rose to 70.2, the highest since March, from 61.3. Manufacturing in the Midwest is benefiting from rising auto sales and the strength in demand for capital goods at home and abroad.

US Home Sales & Prices

The housing industry remains in a depression. The sum of existing and new single-family home sales bottomed last year at 4.1 million units (saar). This year, it has been fluctuating around 5.3 million units. That’s down from a record high of 8.5 million units during July 2005. It matches the pace of sales during the mid-1990s, just before the housing bubble.

Housing activity is likely to remain depressed next year. Despite record low mortgage interest rates, the mortgage applications index for purchasing homes remains around the lowest readings since the mid-1990s. High unemployment and tougher lending standards are offsetting record low mortgage rates.

In addition, home prices are still falling, which must be another reason why home sales remain weak. There’s no rush to buy if home prices are either moving sideways or down. There are four major measures of home prices. The most current one is the median existing home price compiled by the National Association of Realtors. It is available through October. It is very volatile on a m/m basis, so Debbie and I track the 12-month moving average, which dropped to a new cyclical low of $166,108 during October. That’s 25.9% below the record high of $224,283 during July 2006, and the lowest since November 2002.

US National Income Shares

(1) National Income (NI) is growing slowly. During Q3, NI totaled a record $13.4 trillion (saar), up only 3.8% y/y. That’s down from a recent peak of 6.7% during Q3-2010, and the slowest since Q4-2009. Over the past four quarters, compensation rose just 2.8% while profits rose 7.9%. This divergence suggests that profits have been gaining share of NI at the expense of labor. However, it also reflects the fact that compensation is tied to domestic growth, which has been subpar in the US, while profits have been getting a boost from faster global economic growth.

(2) The rebound in profits’ share of National Income has been spectacular. It jumped from a recession low of 7.9% during Q4-2008 to 14.7% during the third quarter of this year. That surpasses all previous cyclical peaks.

(3) After-tax comparisons show even more remarkable results for profits. NI share comparisons only make sense on a strictly pre-tax basis. But let’s do them on an after-tax basis to glean some insights on how our taxation and social welfare systems redistribute income. After-tax corporate profits rose to a record high 11.6% of NI during Q3, far surpassing any previous peak.

(4) Compensation of employees continued to lose share of National Income during Q3. It fell to 61.4%, the lowest since Q3-1965, and down from a record high of 68.5% during Q2-1980. It may be returning to the 58%-60% “norm” of the late 1940s. This round trip coincides with the rise and fall of the membership and power of private sector unions in the United States. The picture looks much worse for compensation from wages and salaries (excluding benefits). This share fell to a record low of 49.4% of NI during Q3. It has been on a downtrend since the late 1960s, when the norm had been around 57% following the end of World War II.

(5) Workers have opted for a larger share of their compensation in benefits. These benefits tend to be dominated by health care benefits, which are provided on a tax-free basis. As a result, the share of compensation paid as “supplements to wages and salaries” rose from about 3% in the late 1940s to about 12% in the early 1980s. This NI share has continued to fluctuate around this level since then. It was 12.0% during Q3.

(6) Personal income both before and after taxes remains very high relative to National Income. Notwithstanding the dismal downward trends of the NI shares of pre-tax compensation measures, personal income was 96.6% of NI during Q3, which is where it has been since the mid-1980s. Disposable personal income was 86.1% of NI during Q3, which is down only slightly from the recent record high of 89.9% during Q2-2009.

How can this be? What’s propping up pre-tax and after-tax personal income to offset the downward pressure on compensation measures relative to National Income? Government social benefits paid to individuals have soared from less than 4% of NI during the early 1950s to over 17% recently. Such benefits were mostly covered by payroll taxes collected from employers and employees until 2001.

This pay-as-you-go system has been derailed since then as the deficit between entitlements and payroll tax revenues ballooned from zero at the beginning of the previous decade to nearly $900 billion over the past 12 months through October. In other words, pre-tax and after-tax personal incomes have been propped up by deficit-financed government transfers to individuals.

European Monetary & Business Indicators

Europe is starting to fall into a recession, and it is starting to depress global economic activity. While I still believe that the global economy can grow if Europe falls into a recession, growth certainly would be slowed.

A possible fatal flaw with this decoupling thesis may be that Europe’s recession isn’t attributable just to the implementation of austerity measures to restore fiscal discipline. Increasingly, it’s looking like an old-fashioned credit crunch, as Europe’s banks are retrenching on their lending activities so that they aren’t forced to raise more capital, which is either very expensive or very scarce right now.

Europe’s Monetary Financial Institutions (MFIs) had a combined loan portfolio of €12.4 trillion during September, a record high. That’s $16.5 trillion, which well exceeds the $6.9 trillion in bank loans in the US. Facing higher capital requirements and fearing more losses on their sovereign bonds, the banks are likely to respond by reducing their lending, not only in Europe but around the world.

Of course, banks elsewhere might pick up the slack and the capital markets remain wide open to most corporate borrowers. Nevertheless, a severe credit crunch coming out of Europe could trigger a global recession. Hopefully, the latest Grand Plan to clean up the Euro Mess, which is discussed in today’s Morning Briefing (for our subscribers), is actually coming and will be effective at averting a European credit crunch. For now, the latest batch of global indicators shows that Europe is falling into a recession, while the global economy continues to grow, albeit at a slower pace. Let’s review some of these most relevant indicators:

(1) New orders dropped sharply during September in Europe. The euro area (EA17) industrial new orders index plunged by 6.4% following an increase of 1.4% during August. In the European Union (EU27), new orders decreased by 2.3% in September, after falling 0.3% in August. Excluding ships, railway & aerospace equipment orders, which tend to be more volatile, industrial new orders dropped by 4.3% in the EA17 and by 2.1% in the EU27.

(2) Capital goods orders led the drop in European orders. In September, new orders for capital goods fell by 6.8% in the euro area and by 2.1% in the EU27. Intermediate goods dropped by 3.2% and 2.1%, respectively. Nondurable consumer goods declined by 2.0% in both zones. Durable consumer goods decreased by 0.6% in the euro area, but increased by 1.1% in the EU27.

(3) The biggest losers among Europe’s manufacturers are those in the biggest economies. Among the member states of the EU for which data are available, total manufacturing orders fell in 10 and rose in 12 during September. The largest decreases were registered in Italy (-9.2%), Estonia (-9.1), France (-6.2), Spain (-5.3), and Germany (-4.4). The largest increases occurred in Denmark (14.0), Latvia (13.1), Poland (5.1), and the Czech Republic (4.8).

S&P 500 Net Earnings Revisions Index

I don’t like what I am seeing in the S&P 500’s Net Earnings Revisions Indexes (NERIs). They are calculated as the number of estimates revised up less the number that have been revised down, expressed as a percentage of the total estimates for the month. To smooth out the high degree of m/m volatility, I track three-month rolling averages. A NERI reading of 100% indicates that all of the estimates are rising, -100% means all estimates are falling, and zero means that an equal percentage of estimates are rising and falling. Here’s what’s worrisome:

(1) The S&P 500’s NERI dropped to -10.5% in November, down from -6.0% in October. It is now the lowest since May 2009. This is another indicator showing that despite the very strong Q3 earnings results reported during October, industry analysts are lowering their expectations. They may be getting guidance from company managements that Europe is a problem. Or, they may be simply reading the financial press and plugging the bad news coming out of Europe into their spreadsheets.

(2) The S&P 500’s NERI is highly correlated with both the manufacturing PMI and the non-manufacturing PMI. The M-PMI has been hovering just north of 50 from July through October, having peaked this year at 61.4 during February. In the past, whenever NERI turned negative, the M-PMI had a tendency to fall below 50. The good news is that the correlation between NERI and the NM-PMI isn’t as tight, or as alarming.

(3) NERI was negative for all 10 sectors during November versus 8/10 sectors during October. The worst was Telecom (-24.2%) followed by Financials (-23.2), Materials (-17.7), Energy (-15.1), Industrials (-13.3), Information Technology (-8.8), Consumer Staples (-5.8), Consumer Discretionary (-2.9), Utilities (-2.7), and Health Care (-1.6).

Credit Insurance Fraud Industry

Who is to blame for this mess? I’ve accused the Credit Insurance Fraud Industry (CIFI) of causing the financial crisis that started in the US subprime mortgage market during 2007 and has now spread to the European sovereign debt market. This industry expanded dramatically during the previous two decades by selling credit insurance derivative products that magically transformed subprime mortgages, junk bonds, liars’ loans, and other trashy debts into AAA-rated credits. This financial engineering was a great business while it lasted. But it was all mostly a huge fraud.

In the June 9, 2009 Morning Briefing, I wrote: “Before the crisis started in 2007, the fastest growing business was the Credit Insurance Fraud Industry. This industry emerged following the Basel Accords of 1988. The banking regulators of the major industrial nations agreed to impose uniform capital requirements on banks. Risky assets required more capital. The credit insurance fraud industry employed an army of financial engineers whose innovations magically transformed the most dodgy loans and bonds into AAA securities. Many of these products were defective. Fraud was rampant in the industry. The worst offenders were the credit rating agencies that had awarded triple-A ratings to thousands of CDOs.”

Lloyd Blankfein, the chief executive of Goldman Sachs, wrote an article in the February 8, 2009 FT titled, "Do not destroy the essential catalyst of risk." He observed that it should have been obvious that there was something not right about CDOs: “In January 2008, there were 12 triple A-rated companies in the world. At the same time, there were 64,000 structured finance instruments, such as collateralised debt obligations, rated triple A. It is easy and appropriate to blame the rating agencies for lapses in their credit judgments. But the blame for the result is not theirs alone. Every financial institution that participated in the process has to accept its share of the responsibility.” Mr. Blankfein, who is still the CIFI’s capo di tutti capi, should be asked the following three questions under oath: “When did you know this? Why didn’t you alert us sooner? How much money did your firm make selling these bogus instruments to your customers while shorting them at the same time?”

The CIFI’s financial alchemy can create the illusion that trash has been turned into gold, but it’s all hocus pocus; it’s not real. We all know how the CIFI messed up the US mortgage market. Let’s consider its major contributions to the Euro Mess:

(1) The euro transformed Greek debt into German debt. Prior to the introduction of the euro on January 1, 1999, bond buyers required higher yields on European bonds issued by “weak” credits such as the government bonds of Greece, Italy, and Spain versus the much lower yields on German bonds. Indeed, during 1992-1994, the Greek yield was over 20%. It plunged below 4% in June 2003, matching the German yield. The government bond yields of all the other members of the euro zone also converged to equal the German yield.

The euro had converted the junk debt of some of the members into AAA credits. But not for long, given that now the Greek yield is 25%. That yield soared after a new Greek government revealed in late 2009 that the previous one had fraudulently understated the size of its fiscal deficit. In other words, governments can be involved in the CIFI.

The Bond Vigilantes became much less vigilant and stopped doing their due diligence on the credit quality of what are now called the “peripheral” countries of the euro zone. So, the buyers of the bonds willingly bought into the fraud and enabled the CIFI to expand like mad. Besides, is it really necessary to do any credit research at all on any bond if you can protect against its default by purchasing the CIFI’s insurance policies against such “credit events?” The answer to this question should have been, “Yes, it is!”--especially after AIG blew up. Instead, European banks loaded up on euro-denominated sovereign debt as though it was all issued by Germany.

(2) The Euro Mess may be morphing into AIG-2.0. The October 16, 2008 issue of BusinessWeek had a very good analysis of how AIG brought down the European banks: "How AIG'S Credit Loophole Squeezed Europe's Banks." Before the financial crisis hit, AIG did a booming business in credit default swaps. The biggest buyers were European banks, whose deals during 2007 with AIG totaled a staggering $426 billion. “But the banks didn’t always buy the swaps as insurance against defaults--they often used them to skirt capital requirements… By owning credit default swaps, banks could make it appear as if they had off-loaded most of the risk of a loan to AIG or another firm, thereby reducing their capital needs. The perfectly legal ploy allowed banks across the Continent to free up money to make more loans. It was part of the game taking place across the global financial system. During the boom, firms seemingly created money out of nothing, propelling the markets to unsustainable heights. Such excessive risk-taking has brought down several European lenders.” The European banks had set aside only 1.6% of a loan's value, rather than 8%. When AIG imploded on September 15, 2008, European banks suddenly found themselves up the creek without a paddle. That’s where they are again now.

European leaders have fashioned three Grand Plans (GP) so far. All three seem to have turned their sovereign debt problem into a full-blown banking crisis. The first Greek rescue plan (GP-1.0) was approved on May 9, 2010 and established the EFSF. By July 21 of this year, a second rescue plan (GP-2.0) was needed. It included voluntary haircuts of 20% and increased the size of the EFSF. In the third plan (GP-3.0) on October 27, lenders were forced to accept a voluntary 50% haircut on their Greek debt. The latest plan is shaping up to be AIG-2.0 because banks holding European sovereign debt can no longer be sure that the CDS contracts they purchased to insure against defaults will be honored. So, they’ve been selling their bonds. In principle, the EFSF was expanded again under GP-3.0 to buy these bonds, but the details remain in limbo.

(3) The EFSF is a CDO-Squared. On Friday, ECB President Mario Draghi hit back at the European leaders who have recently called on the ECB to clean up the Euro Mess for them. Instead, he insisted that they implement their bailout fund: “We are more than one and a half years after the summit that launched the EFSF as part of a financial support package amounting to 750 billion euros or one trillion dollars; we are four months after the summit that decided to make the full EFSF guarantee volume available; and we are four weeks after the summit that agreed on leveraging of the resources by a factor of up to four or five and that declared the EFSF would be fully operational and that all its tools will be used in an effective way to ensure financial stability in the euro area. Where is the implementation of these long-standing decisions?,” he demanded to know in a speech at the European Banking Congress, "Continuity, consistency and credibility," European Central Bank (November 18, 2011).

The EFSF has slammed into a brick wall because it is based on the faulty premise that Europe’s non-AAA debtors can join together with the AAA-rated ones to form a triple-A-rated rescue fund that can borrow on behalf of the debtors who need to be rescued. That sure sounds like the super-senior tranche of a CDO. The assumption is that the fund will remain AAA-rated even if it is expanded. That assumption held up after the EFSF was increased to €440 billion on July 21, but the non-AAA guarantors of the fund (i.e., Italy and Spain) were downgraded because they thus became exposed to more liability. When the EFSF was expanded in principle again on October 27 to over €1 trillion--in effect, a CDO-Squared--the details of how this would be done were omitted to avoid a downgrade of France’s AAA rating, which would have forced the rating agencies to lower the credit rating of the EFSF.

Note: This is an excerpt from today’s Morning Briefing for our subscribers.