Thursday, May 18, 2017

Death by Amazon

An anchor store is one of the larger stores in a shopping mall, usually a department store or a major retail chain. Shopping malls were first developed in the 1950s. Their developers signed up large department stores to draw retail traffic that would result in visits to the smaller stores in the mall as well. The anchors usually paid heavily discounted rents.

Amazon is a river in South America. It is the largest one in the world by discharge of water and the longest in length. A piranha is a freshwater fish with sharp teeth and a powerful jaw that inhabits South American rivers, including the Amazon. If you happen to fall off a riverboat steaming down the Amazon, the piranhas will pick your bones clean.

Amazon is also a piranha-like corporation that eats up retailers, particularly the anchor stores, and doesn’t even leave the bones. I have been picking apart this story for a while. For example, see our 3/30 Morning Briefing titled “Jeff Bezos, The Terminator.” I was quoted in a 5/12 IBD article on the subject as follows:
"Amazon is killing lots of businesses. In the process, it may also be killing inflation," Ed Yardeni, noted economist and president of Yardeni Research, said in a recent report. Using Chief Executive Jeff Bezos’ playbook, Amazon has pummeled rivals with price cuts enabled by its smart logistics and relentless drive toward efficiency. Labor-displacing warehouse robotics give Amazon a cost advantage, and it aims to one day deploy delivery drones to extend its edge all the way to the customer’s doorstep. Amazon’s casualty list already is formidable. Over the years, Amazon has left consumer-facing retailers such as Borders, Circuit City and Sports Authority in the dust. Department chains have been closing stores, unable to answer the e-commerce challenge.
The IBD article reported that Amazon’s piranhas are about to chew up other businesses. Consider the following:

(1) Big-box retailers & grocers. Amazon is going after big-box retailers like Wal-Mart and Costco by leaning on their consumer staples vendors to sell their products, which are packaged in big boxes, to consumers directly through Amazon’s distribution system. The $1.3 trillion US grocery market could be Amazon’s biggest potential source of revenue upside. IBD noted, “Amazon hopes to eliminate store cashiers at Amazon Go convenience stores now being tested. Amazon Go stores use sensors to track items as shoppers put them into baskets. The shopper’s Amazon account gets automatically charged.”

(2) B2B. Yardeni Research already has received mailings inviting us to set up an Amazon Business account for our office needs. IBD observed: “The online sales channel for business customers is sending prices down for industrial products, pressuring companies like W.W. Grainger.”

(3) Entertainment. Amazon is also going head-to-head with Netflix and all of Hollywood, by producing and distributing movies. The CEO of the entertainment provider Liberty Media, Greg Maffei, called Amazon a “ridiculously scary” rival at a financial conference on May 9. He presciently explained that Amazon’s competitive advantage is that it “has an ability, because of its scale, to invest at incredibly low or negative rates of return—because they can cross-subsidize, and the market is willing to suspend disbelief in future profitability.”

(4) On-demand & logistics. IBD reported: “Amazon recently was granted a patent for automated, ‘on-demand apparel manufacturing.’ The patent highlights plans to go beyond clothing into other fabric-based products, such as footwear, bedding and home goods. … Amazon is also bringing more of its logistics and delivery operations in-house.” This means that it is aiming to compete with, and eventually chew up, the airfreight, trucking, and home delivery industries.

(5) Cloud. In March 2006, Amazon officially launched Amazon Web Services (AWS). We signed up in 2008 for this fantastic cloud service, which has been remarkably reliable and very cost effective for us. IBD reported:
As corporate America outsources more computing work to AWS and other highly automated cloud services, companies buy less hardware and software for internal data centers and cut back on IT staffing. In the March quarter, IBM’s (IBM) hardware business fell nearly 17% to $2.5 billion year-over-year, reflecting the impact of cloud adoption. How do the likes of IBM, Cisco Systems (CSCO) and Hewlett Packard Enterprises (HPE) fight back? By cutting prices. ‘Cloud is deflationary and collapses markets,’ said a Citigroup report in April. "Labor, with 85% deflation in the cloud, has the most significant disruption from cloud economics," says the Citi report. It says 15 IT staffers in a public, shared cloud service can replace 100 in a private data center.
According to Citigroup, AWS will rake in some $37.5 billion in revenue by 2020, up from $17 billion this year. IBD quoted me as follows:
“Perhaps most importantly, AWS’ juicy operating profit margin of more than 25% gives Amazon a way to fund its new ventures and a retail business that has notoriously skinny margins. The cash and financial flexibility AWS provides ensure that Amazon will be a lethal competitor in the retailing industry for many years to come.”
In other words, “Death by Amazon” is a plague that will continue to afflict more and more businesses and industries. We can keep track of the mounting body count with a few economic indicators and by reading the business obituary page.

In March, online shopping rose to a record 29.7% of all online and in-store sales of GAFO, i.e., general merchandise, apparel and accessories, furniture, and other sales. That’s up from just above 5.0% in 1994, when Jeff Bezos founded Amazon on July 5 that year. Over this same period, department stores’ share of GAFO plummeted from 34.3% to 12.5% currently. The box retailers saw their share rise from about 7.0% in 1992 to peak at 27.2% during January 2014, and ease back down to 25.3% currently.

In a 5/4 CNBC interview, Warren Buffett said he sold off about a third of his company’s 81 million shares of IBM since the start of the year. “I would say what they’ve run into is some pretty tough competitors,” Buffett said. “IBM is a big strong company, but they’ve got big strong competitors too.” In a 5/8 CNBC interview, Buffett was asked why he didn’t own any Amazon shares. He had a simple one-word answer: “Stupidity.”

Buffett explained, “I was impressed with Jeff [Bezos] early. I never expected he could pull off what he did ... on the scale that it happened.” He added, “At the same time he’s shaking up the whole retail world, he’s also shaking up the IT world simultaneously.”

In the nominal GDP data, I see that capital spending on software and on information processing equipment both rose to record highs during Q1-2017 of $346.2 billion (saar) and $334.3 billion. Computers and peripheral equipment, which is included in the latter category, has been virtually flat in both current and inflation-adjusted dollars since Q4-2010 at around $82 billion (saar). This flattening out after rapidly increasing since the early 1980s coincides with Amazon leading the expansion of the cloud business since 2006. Companies don’t need to buy computers when they can sign up for the computing power and storage they need on the cloud, which uses the available hardware much more efficiently.

Wednesday, May 10, 2017

Earnings: Small Is Beautiful

The money keeps pouring into equity ETFs. The latest data from the Investment Company Institute shows that they attracted $38.1 billion during March, $98.6 billion during Q1, and $198.7 billion since November, when Donald Trump was elected president. Over the past 12 months through March, equity ETFs attracted a record $295 billion. No wonder the S&P 500 is up 7.1% ytd through Tuesday’s close and is just 0.1% below Monday’s record high. It is up 12.0% since Election Day.

Just as impressive, the S&P 400 MidCaps and S&P 600 SmallCaps stock price indexes are up 14.2% and 16.7% since Election Day. The stock market rally since then has been attributable to a combination of higher forward P/Es and increases to record highs in the forward earnings of the S&P 500/400/600. The current bull market has been especially good for MidCap and SmallCap investors. Consider the following:

(1) Performance & earnings derby. The S&P 500/400/600 price indexes are up 254.7%, 329.7%, and 368.3% since March 9, 2009. That’s because the forward earnings of the three composites are up 107.2%, 132.8%, and 161.4% over that same period.

(2) Valuation derbies. All three started the bull market with forward P/Es just above 10.0, specifically at 10.3, 10.1, and 11.1, respectively. These valuation multiples for the S&P 500/400/600 are currently 17.5, 18.3, and 19.4.

(3) Earnings in 2017 & 2018. Analysts’ consensus expectations in early May showed earnings growth for the S&P 500/400/600 of 11.4%, 10.5%, and 9.8% this year. Next year, they expect estimate growth rates will be 11.9%, 13.6%, and 19.8%. Interestingly, their expectations for 2018 have been remarkably stable since late last year for the LargeCaps and SmallCaps, while their MidCap consensus forecast has been rising.

(4) Q1 upside hooks. Now that the Q1 earnings season is almost complete, we see upside hooks in the results relative to expectations at the start of the season for all three composites. The S&P 500/400/600 Q1 actual/blended numbers now show y/y gains of 13.9%, 10.5%, and 6.3%. In other words, LargeCap investors have something to brag about for now. (By the way, at the beginning of the current earnings season, the estimates were 9.2%, 6.7%, and 2.1%.)

(5) Alpha & beta. The reason that small companies grow faster than large companies is that if they survive, they tend to grow into bigger companies, while the large ones may have hit their critical mass many years ago. There is more alpha in small companies, and more beta in large companies. “Alpha” refers to company-specific developments, while “beta” refers to economy-wide ones that impact all companies. Of course, this can be a curse during recessions when both alpha and beta fall apart for many small companies, while large companies mostly take a beta hit.

Currently, the big problem for all companies is a shortage of workers. This hits smaller companies harder because they need to increase their payrolls to grow more so than large ones. The NFIB survey of small business owners released yesterday for April showed that 31.7% are not able to fill open positions, using the three-month average to reduce m/m volatility in this series. That’s the highest since February 2001. On the other hand, 17.5% of them are saying that government regulation is their number-one problem, down from a recent peak of 22.2% during May 2015. SmallCaps and MidCaps are likely to benefit more than LargeCaps from President Trump’s economic agenda to reduce regulations and cut corporate taxes.

Wednesday, May 3, 2017

Seinfeld Market: Nothing Bad Happening

"The Pitch” is the 43rd episode of the TV sitcom Seinfeld. It is the third episode of the fourth season. It aired on September 16, 1992. In it, NBC executives ask Jerry Seinfeld to pitch them an idea for a TV series. His friend George Costanza decides he can be a sitcom writer and comes up with the idea of “a show about nothing.”

The bull market in stocks since March 2009 has had a fairly simple script too. As a result of the Trauma of 2008, investors have been prone to recurring panic attacks. They feared that something bad was about to happen again, so they sold stocks. When their fears weren’t realized, the selloffs were followed by relief rallies to new cyclical highs and to new record highs since March 28, 2013. Their jitters are understandable given that the S&P 500 plunged 56.8% from October 9, 2007 through March 9, 2009.

From 2009 through 2016, there were four major corrections and several significant scares. I kept track of them and the main events that seemed to cause them. By my count, there were 57 panic attacks from 2009 through 2016, with 2012 being especially anxiety-prone with 12 attacks. (See our S&P 500 Panic Attacks Since 2009.)

From 2010 through 2012, there were recurring fears that the Eurozone might disintegrate. There were Greek debt crises and concerns about bad loans in the Italian banking sector. Investors were greatly relieved when ECB President Mario Draghi pledged during the summer of 2012 to do whatever it takes to defend the Eurozone. China also popped up from time to time as concerns mounted about real estate bubbles, slowing growth, and capital outflows over there. At the end of 2012, fear of a “fiscal cliff” in the US evaporated when a budget deal was struck at the start of 2013 between Democrats and Republicans. I expected it, though I certainly had no idea that it would be worked out between Vice President Joe Biden and Senate Minority Leader Mitch McConnell. In a November 9, 2013 Barron’s interview titled “Lifting the Odds for a Market Melt-Up,” I observed:
I have met a lot of institutional investors I call "fully invested bears" who all agree this is going to end badly. Now, they are a bit more relaxed, thinking it won’t end badly anytime soon. Investors have anxiety fatigue. I think it’s because we didn’t go over the fiscal cliff. We haven’t had a significant correction since June of last year. We had the fiscal cliff; they raised taxes; then there was the sequester, and then the latest fiscal impasse. And yet the market is at a record high. Investors have learned that any time you get a sell-off, you want to be a buyer. The trick to this bull market has been to avoid getting thrown off.
There was another nasty selloff at the start of 2016 as two Fed officials warned that the FOMC was likely to follow 2015’s one rate hike at the end of that year with four hikes in 2016. I had predicted “one-and-done” for 2015 and again for 2016. Contributing to the selloff in early 2016 was the plunge in the price of oil, which had started on June 20, 2014. That triggered a significant widening in the yield spread between high-yield corporate bonds and the US Treasury 10-year bond yield from 2014’s low of 253 basis points on June 23 to a high of 844 basis points on February 11, 2016. The widening was led by soaring yields of junk bonds issued by oil companies. There were widespread fears that all this could lead to a recession. In addition, the Chinese currency was depreciating amid signs of accelerating capital outflows from China.

I remained bullish. In a February 6, 2016 Barron’s interview titled “Yardeni: No U.S. Recession in Sight,” I reiterated my opinions that the Fed was unlikely to hike the federal funds rate more than once and that the secular bull market remained intact. I argued on Monday, January 25 that “it may be too late to panic” and that the previous “Wednesday’s action might have made capitulation lows in both the stock and oil markets.” Sure enough, the price of a barrel of Brent crude oil did bottom on Wednesday, January 20. The S&P 500 bottomed on February 11, the same day that the high-yield spread peaked. The S&P 500 Energy sector dropped 47.3% from its high on June 23, 2014 to bottom on January 20, 2016. During the summer of 2016, I perceived the end of the energy-led earnings recession and projected that the bull would resume his charge.

Following the surprising Brexit vote that summer, the stock market declined for just two days despite lots of gloomy predictions. Just prior to the presidential election, I argued that the rebound in earnings, following the recession in the energy industry, would likely push stock prices higher no matter who won. After Donald Trump did so, I raised my outlook for the S&P 500, expecting that a combination of deregulation and tax cuts would boost earnings. The latest bull market was still going strong in early 2017.

I was interviewed again in the February 4, 2017 issue of Barron’s saying:
It would be a mistake to bet against what President Trump might accomplish on the policy side. I’m giving him the benefit of the doubt, hoping good policies get implemented and bad ones forgotten. We could get substantial tax cuts. All his proposals don’t need to be implemented for the Trump rally to be validated. If you get $1 trillion to $2 trillion coming back from overseas because of a lower tax on repatriated corporate earnings, that would be very powerful in terms of keeping the market up.
So far, investors are relieved that the bad outcomes predicted by the naysayers about Trump in the White House haven’t happened. The anticipated bullish outcomes are also still mostly on-the-come. Nothing really terrible or wonderful is happening other than that earnings are rising in record-high territory again.

By the way, in case you missed it, you might be relieved to know that Greece and its international creditors on Tuesday reached a preliminary deal allowing the country to receive yet another round of bailout payments in exchange for promises to raise taxes and to further cut pensions and social spending. Chinese stocks seem to be stabilizing this week, having dropped sharply during the second half of April after officials slammed what they called short-term speculators. This past Sunday evening, congressional leaders reached an agreement on a spending deal that would fund the government through the end of September and avoid a looming shutdown. This weekend, the French are likely to elect a President who is all for the EU and euro. These developments should all be a relief, though no one really worried much about any of them this time. Nothing bad is happening, which is good news for stocks.

Thursday, April 27, 2017

A Happier Global Economy

Since late last year, I’ve liked what I’ve been seeing abroad, especially in emerging economies. The latest batch of data out of China was certainly surprisingly strong, though that isn’t surprising given that the country’s central planners still command the economy over there as they see fit. The EU’s economy also has impressed me. Like everyone else, I’ve been concerned about the region’s political drift toward anti-EU populism that could lead to the destabilizing disintegration of the EU and/or the Eurozone. However, that risk seems to have dissipated significantly given the recent successes of the establishment parties that remain in power in Spain and the Netherlands. Italy continues to be ungovernable—so what else is new?—but still committed to the EU.

What about France? Following last weekend’s first-round presidential election, I expect that pro-EU centrist Emmanuel Macron, who was a member of the Socialist Party from 2006-2009, will beat National Front leader Marine Le Pen during the second-round contest scheduled for May 7. As they say in French, “Plus les choses changent, plus elles restent les mêmes.”

Let’s take a tour of the latest developments around the world, shall we?

(1) Commodity prices. The CRB raw industrials spot price index dropped last week to the lowest level since January 9. However, it’s down only 2.4% from its recent high on March 17. It is still up 26.2% from its most recent low near the end of 2015. In the big picture, this index remains on a solid uptrend. However, it is a bit odd to see this recent weakness coinciding with all the better-than-expected data coming out of China last week.

(2) PMIs & production. There shouldn’t be much more downside in commodity prices given the strength in April’s flash M-PMIs for Germany and France. The composite PMI (C-PMI) for Germany edged down to 56.3 from 57.1 last month. That’s still a relatively high level, with Germany’s M-PMI remaining very elevated at 58.2 versus 58.3 during March. France’s C-PMI jumped to 57.4 from 56.8, with lots of strength in the M-PMI (55.1) and NM-PMI (57.7). Japan’s M-PMI also remained solid at 52.8 this month.

On the other hand, the flash M-PMI for the US continued to edge down from a recent high of 55.0 during January to 52.8 this month. The NM-PMI has also come down from a recent high of 55.6 during January to 52.5 this month. Nevertheless, these are all solid readings for the US. The average of the business conditions indexes from the NY and Philly Fed district surveys declined to 13.6 this month from a recent high of 31.0 during February, as Debbie discusses below. Looks like some of the “animal spirits” unleashed by Trump’s election may be going back into their cages!

On yet another hand, industrial production indexes remain on uptrends in the US, Canada, the Eurozone, and Japan. Even Brazil’s output seems to have bottomed, while Mexico’s remains stalled at a record high despite Trumps tough talk on US trade with our southern neighbor. Most impressive is that industrial production among the 34 members of the OECD rose 1.2% y/y during January after having stalled during 2015 and the first half of 2016. It is now almost at the previous record high during January 2008.

(3) Retail and auto sales. In the Eurozone, the volume of retail sales (excluding motor vehicles) rose 0.7% m/m and 1.8% y/y during February to a new record high. Both French and German shoppers are doing lots of shopping, with their volume indexes up 2.8% and 1.6% y/y, respectively, at record highs. The Italians and Spaniards are lagging far behind. New passenger car registrations in the EU jumped 1.2% m/m and 6.0% y/y during March, using the 12-month sum.

(4) Inflation. Both actual and expected inflation rates have edged down recently, suggesting that the global economy isn’t overheating. Expected inflation implied by the yield spread between the US Treasury 10-year bond and TIPS fell from a recent high of 2.08% on January 27 to 1.84% at the end of last week.

The headline CPI inflation rates, on a y/y basis, moved down in March in the US (from 2.7% to 2.4%) and the Eurozone (from 2.0% to 1.5%), and was little changed in China (from 0.8% to 0.9%). The core CPI inflation rates also have ticked down in the US (from 2.2% to 2.0%) and the Eurozone (from 0.9% to 0.7%), and edged up in China (from 1.8% to 2.0%).

(5) Forward revenues and earnings growth. Interestingly, there has been a significant increase since early last year in analysts’ consensus expectations for short-term revenues growth over the year ahead, from 2.3% to 6.3% in mid-April. Even more impressive is the rebound in year-ahead short-term earnings growth from the most recent low of 6.2% early last year to 13.7% now. Long-term earnings growth, over the next five years at an annual rate, is up to 12.5%, the highest since September 2011.

(6) Global trade. Global trade indicators are looking more buoyant. The Baltic Dry Index is up 86% y/y through mid-April. Over the past 12 months through March, US West Coast ports’ outbound container traffic is up 6.0% y/y to the highest level of activity since January 2015. Actual exports data coming out of Asia are especially strong. March data are available in dollars for India (up 28.3% y/y), Indonesia (23.2), China (17.4), Singapore (15.8), Taiwan (14.0) South Korea (13.5), and Japan (10.3). Altogether, they are up 16.4% y/y, and 15.4% excluding China.

No wonder that the Emerging Markets Asia MSCI stock price index (in local currency) is up 29.0% from its low early last year. The index’s forward earnings (in local currency) is up 8.6% over this period. Analysts’ consensus expected short-term earnings growth over the year ahead for this index was back up to 16.0% in early April compared to the most recent low of 4.5% early last year. The index remains relatively cheap with a forward P/E of 12.2.

(7) IMF forecast. The IMF’s economists are raising their expectations for global economic growth. Since nearly the start of the latest global economic expansion, they were too optimistic and have had to lower their forecasts. Last week, they nudged up the IMF’s forecast for world growth this year a tenth of a percentage point to 3.5%, which will be the fastest rate in five years if they are right. Next year’s growth rate is expected to be 3.6%, according to the IMF’s latest World Economic Outlook. Global growth was 3.1% last year.

The so-called advanced economies, which grew 1.7% last year, are expected to expand by 2.0% during both 2017 and 2018. The emerging and developing economies, which grew 4.1% last year, are predicted to grow by 4.5% this year and 4.8% next year. The top concern among the IMF’s economists is trade protectionism, specifically an “inward shift in policies, including toward protectionism, with lower global growth caused by reduced trade and cross-border investment flows.”

Wednesday, April 19, 2017

Driving in the Slow Lane

Following the latest reports on housing starts (down 6.8% m/m during March) and manufacturing output (down 0.4% last month), the Atlanta Fed’s GDPNow model showed an increase of just 0.5% (saar) in Q1’s real GDP. As I noted recently, the auto industry is a major soft patch in the economy. Sure enough, auto output fell 3.6% during March. Auto assemblies are down 7.3% over the past five months to 11.1 million units (saar) from last year’s peak of 12.0mu. The weather can be blamed for the drop in housing starts, but not for the weakness in auto sales and production.

There are other soft patches in the economy. For example, the ATA Truck Tonnage Index dipped 1.0% m/m in March, and is up by only 0.7% y/y. In other words, it has stalled at a record high over the past year. Sales of medium-weight and heavy trucks dropped 8.0% m/m in March and 19.0% y/y.

So it comes as no surprise that the Citigroup Economic Surprise Index (CESI) has plunged from a recent high of 57.9 on March 15 to 6.6 on Tuesday. These developments are likely to put pressure on the Fed to hold off on another rate hike for now, and on the Trump administration to move forward with its fiscal stimulus agenda. Treasury Security Steve Mnuchin said on Monday that tax reform might not happen until after the summer. I think the weakness in the economy will prompt a faster response by Washington.

By the way, there is a reasonably good fit between the CESI and the 13-week change in the US Treasury 10-year bond yield. The actual yield has dropped from a recent peak of 2.62% on March 13 to 2.17% yesterday. It seems to be heading toward the bottom end of my predicted trading range of 2.00%-2.50% for the first half of this year.

Wednesday, April 12, 2017

Back to Slower, Longer Economic Growth?

In my meetings with some of our accounts recently, many were skeptical that the strength in the soft data in the US will trickle down to the hard data until the Trump administration actually succeeds in cutting taxes and in boosting infrastructure spending. The soft data consist mostly of surveys of consumers, CEOs, purchasing managers, small business owners, industry analysts, and investors. They all turned remarkably upbeat after Election Day, as I have been monitoring in our new Animal Spirits chart publication.

On the other hand, a few hard-data indicators are downright downbeat. Auto sales totaled 16.6 million units (saar) during March, down from a recent high of 18.4 million units at the end of last year. Payrolls in general merchandise stores have dropped 89,300 over the past five months through March as a result of widespread store closings due to competition from Amazon. Then again, employment in construction, manufacturing, and natural resources rose 175,000 during the first three months of this year. The sum of commercial and industrial bank loans and nonfinancial commercial paper has been flat since the start of the year.

A bigger question is whether there has been a structural decline in the potential growth of the economy that may defy both the animal spirits that seem to have been unleashed by Trump’s election as well as his “Make America Great Again” (MAGA) fiscal policies, assuming they get fully implemented. If so, then the long-term trend of growth for both the real economy and corporate earnings may be lower than in the past. The good news in this scenario is that it might mean that a boom is less likely, which obviously would reduce the risk of a bust.

While much has changed since Election Day, some things have not. Demography hasn’t changed. Neither has technology. Globalization might change, but for now the world remains very competitive as a result of relatively free (though not necessarily fair) trade. Productivity growth remains abysmal, and might improve as a result of MAGA policies, or might not. Consider the following:

(1) Potential output. The Congressional Budget Office (CBO) calculates a quarterly series for potential real GDP growth that starts in 1952 and is available through 2027. The outlook for this year and beyond is based on demographic projections used to estimate labor force growth and assumptions about productivity. From 1952 through 2001, potential real GDP grew in a range mostly between 2.5% and 4.0%, averaging 3.5%. Since then, growth has consistently been below 3.0%, and actually below 2.0% since Q1-2007.

(2) Real GDP. I constructed a series for the underlying growth in real GDP simply as the 40-quarter percent change in real GDP annualized. It tells more or less the same story as the CBO’s estimate for potential output. From 1960 through 1975, growth averaged 4.7%. From 1975 through 2007, it averaged 3.7%. It plunged during the Great Recession, and has remained consistently below 2.0% since Q3-2009.

(3) Labor force. Trump may or may not succeed with his MAGA plans. However, he certainly can’t Make America Young Again (MAYA). He can’t bring back the Baby Boom. There has been a dramatic slowing in the growth of the working-age population and the labor force, particularly of the 16- to 64-year-olds. The actual growth rates of this age segment of the working-age population and the labor force are down to only 0.5% and 0.3% over the past 10 years at annual rates.

(4) Productivity. The big unknown is whether Trump’s MAGA policies can revive productivity growth. That’s the only way that real GDP growth might finally exceed 2.0%. Getting it up to Trump’s 4.0% goal seems very unlikely. Nonfarm productivity growth has been below 1.0% since Q4-2014, based on the five-year percent change at an annual rate. Surprisingly, manufacturing has contributed greatly to this weakness, also rising less than 1.0% since Q4-2015.

Wednesday, April 5, 2017

Bull by the Tail

Stock market valuation measures are elevated across the board, for sure. The forward P/E of the S&P 500 is currently 17.7. It is highly correlated with the forward price-to-sales ratio (P/S) of the same stock market index. This valuation metric closely tracks the Buffett Ratio, which is equal to the market capitalization of the entire US equity market (excluding foreign issues) divided by nominal GNP. During Q4-2016, the Buffett Ratio was 1.67, not far below the record high of 1.80 during Q3-2000. The forward P/S rose from 1.58 in early 2016 to a record high of 1.93 in March.

These all are nose-bleed levels. However, they may be justified if Trump proceeds with deregulation and succeeds in implementing tax cuts. His policies may or may not do much to boost GDP growth and S&P 500 sales (a.k.a. revenues). Nevertheless, they could certainly boost earnings.

The risk is that Trump’s victory activated a melt-up mechanism that has nothing to do with sensible assessments of the fundamentals or valuation. Instead, structural market flows may be driving the market’s animal spirits. Consider the following:

(1) Lots of corporate cash is still buying equites. At the end of last week, we updated our chart publications with Q4-2016 data for S&P 500 buybacks. They remained very high at a $541 billion annualized rate. For all of last year, buybacks totaled $536 billion, a slight decline from the previous year’s cyclical high of $572 billion. S&P 500 dividends rose to a record high of $396 billion last year. Since the start of the bull market during Q1-2009 through the end of last year, buybacks totaled $3.4 trillion, while dividends added up to $2.4 trillion. Combined, they pumped $5.7 trillion into the bull market, driving stock prices higher without much, if any, help from households, mutual funds, institutional investors, or foreign investors.

(2) Passive is the new active. On the other hand, equity ETFs have been increasingly consistent net buyers of equities during the current bull market. Their net inflows totaled a record $281 billion over the past 12 months through February. Since the start of the bull market during March 2009, their cumulative net inflows equaled $1,167 billion, well exceeding the $179 billion trickle into equity mutual funds.

So there you have it: The bull may be chasing its own tail. I know that image doesn’t quite jibe with the bull charging ahead, but work with me here. The bull has been on steroids from share buybacks by corporate managers, who have been motivated by somewhat different and more bullish valuation parameters than those that motivate institutional investors, as we have discussed many times before. Most individual investors seemingly swore that they would never return to the stock market after it crashed in 2008 and early 2009. But time heals all wounds, and suddenly some of them may have turned belatedly bullish on stocks after Election Day. Add a buying panic of equity ETFs by individual investors to corporations’ consistent buying of their own shares, and the result may very well be a melt-up.

Wednesday, March 29, 2017

Many Happy S&P 500 Revenues

The global economy fell into a growth recession from mid-2014 through early 2016. It was caused by a severe recession in the global commodities sector, led by a collapse in oil prices. It was widely expected that the negative consequences of lower oil prices for producers would be more than offset by the positive ones for consumers. That was not the case. The former outweighed the latter because the commodity-related cuts in capital spending overshadowed the boost to consumer spending from lower oil prices. In addition, there was a brief credit crunch in the high-yield market on fears that commodity producers would default on their bonds and trigger a widespread financial contagion.

Now the worst is over for commodity producers, as their prices have rebounded. That’s because they scrambled to reduce output and restructure their operations to be more profitable at lower prices. More importantly, global demand for commodities remained solid. Now with commodity prices, especially oil prices, well below their 2014 highs, consumers are benefitting more than producers are suffering.

Voila! The global economy is showing more signs of improving in recent months. That’s already boosting revenues growth for the S&P 500, and should be increasingly obvious as corporations report their top-line growth rates for the Q1 earnings season during April. Let’s have a closer look:

(1) Commodity prices. The CRB raw industrials spot price index fell 27% from April 24, 2014 through November 23, 2015. The index is up 28% from the low. The price of a barrel of Brent crude oil plunged 76% from its 2014 high of $115.06 on June 19 to its 2016 low of $27.88 on January 20. It is up 84% from its low to $51.28 yesterday.

(2) Business sales. US manufacturers’ shipments of petroleum products plunged 58% from the end of 2013 through February 2016. That drop weighed heavily on US manufacturing and trade sales, which declined on a y/y basis each month from January 2015 through July 2016. Excluding petroleum shipments, this broad measure of business sales of goods barely grew during this energy recession.

(3) S&P 500 revenues. I am not surprised to see S&P 500 revenues tracing out the same pattern as business sales since I have been tracking the close relationship of the two for some time. The y/y growth rates of business sales and S&P 500 revenues (either on an aggregate or per-share basis) continue to be very close. The same goes for the relationship excluding Energy revenues from the S&P 500 aggregate and business sales excluding petroleum shipments.

I continue to monitor analysts’ expectations for the short-term (year-ahead) growth rates of S&P 500 revenues and earnings (STRG and STEG), as well as long-term (five-year-ahead) earnings growth (LTEG) on a weekly basis. STRG has rebounded from close to zero in early 2015 to about 5.5% currently. Since the start of last year, STEG has jumped from about 5% to over 10%. LTEG is around 12.3%, near the best reading of the current economic expansion.

I doubt that any of these improvements have much to do with Trump’s election victory. I have no doubts that the end of the global Energy sector’s recession accounts for much of the improvement.

(4) Business surveys. Another upbeat indicator for S&P 500 revenues is the M-PMI, which has a good correlation with the y/y growth rate in S&P 500 revenues (both in aggregate and per-share). The former jumped from a recent low of 49.4 during August 2016 to 57.7 during February, the best level since August 2014. That too is consistent with a manufacturing recovery following the end of the energy recession, and augurs well for revenues growth.

By the way, there is a similarly good correlation between revenues growth and the composite business indicators from the regional surveys conducted by five Fed districts. All five are available through March, with their average index jumping from last year’s low of -12.8 to 21.6 this month. The energy recession is clearly over.

Wednesday, March 22, 2017

Age-Old Adages for the Bull Market

There are plenty of age-old adages about the stock market that focus on the Fed’s impact on the market. They tend to be cautionary and are recited by old timers who’ve lived through some wicked bear markets and fearsome corrections. The basic message is that the Fed is your friend until it isn’t. Consider the following:

(1) Zweig. Martin Zweig was a highly respected analyst and investor who passed away in 2013. He famously often said “Don’t fight the Fed.” He started his newsletter in 1971 and his hedge fund in 1984. On Friday, October 16, 1987, in a memorable appearance on Wall Street Week with Louis Rukeyser, he warned of an imminent stock market crash. It happened the following Monday, and Zweig became an investment rock star. His newsletter, The Zweig Forecast, had a stellar track record, according to Mark Hulbert, who tracks such things.

In his 1986 book Winning on Wall Street, Zweig elaborated on his famous saying: “Monetary conditions exert an enormous influence on stock prices. Indeed, the monetary climate—primarily the trend in interest rates and Federal Reserve policy—is the dominant factor in determining the stock market’s major direction. … Generally, a rising trend in rates is bearish for stocks; a falling trend is bullish.” There are two reasons for this, he wrote: “First, falling interest rates reduce the competition on stocks from other investments, especially short-term instruments such as Treasury bills, certificates of deposit, or money market funds. … Second, when interest rates fall, it costs corporations less to borrow. … As expenses fall, profits rise. … So, as interest rates drop, investors tend to bid prices higher, partly on the expectation of better earnings. The opposite effect occurs when interest rates rise.”

(2) Martin. In 1949, President Harry Truman appointed Scott Paper CEO Thomas McCabe to run the Fed. McCabe pushed to regain the Fed’s power over monetary policy and did so with the Fed-Treasury Accord of 1951. He negotiated the deal with Assistant Treasury Secretary William McChesney Martin. McCabe returned to Scott Paper and Martin took over as chairman of a re-empowered Federal Reserve on April 2, 1951, serving in that position until January 31, 1970 under five presidents. The March 1951 Accord freed the Fed and marked the start of the modern Federal Reserve System. Under Martin, the Fed’s overriding goals became price and macroeconomic stability. He believed that the Fed’s job was to be a party pooper. His famous “punch bowl” metaphor seems to trace back to a speech given on October 19, 1955 in which he said:

“In the field of monetary and credit policy, precautionary action to prevent inflationary excesses is bound to have some onerous effects—if it did not it would be ineffective and futile. Those who have the task of making such policy don’t expect you to applaud. The Federal Reserve, as one writer put it, after the recent increase in the discount rate, is in the position of the chaperone who has ordered the punch bowl removed just when the party was really warming up.”

(3) Gould. According to the Market Technicians Association, the late technical analysis pioneer Edson Gould, who was active from the 1930s through the 1970s, observed that “whenever the Federal Reserve raises either the federal funds target rate, margin requirements, or reserve requirements three times without a decline, the stock market is likely to suffer a substantial, perhaps serious, setback.” This adage is widely known as “three steps and a stumble.” So far, investors are betting against it since stocks actually rose sharply last Wednesday after the Fed hiked the federal funds rate for the third time since the Great Recession.

What do the data show about the relationship between the Fed’s monetary policy cycle and the S&P 500? Monthly data for the index show that it tends to bottom during the beginning of easing phases of monetary policy, when the Fed is lowering the federal funds rate. It tends to continue rising through the end of the easing phases and even when the Fed starts raising interest rates. Three rate hikes may cause occasional stumbles, but it’s hard to see them in the data.

What does stand out is that the tightening phase of monetary policy often ends in tears because it tends to trigger financial crises. Forward P/Es have a tendency to peak before the crises hit as investors begin to fret that higher interest rates may be starting to stress the economy.

Wednesday, March 15, 2017

US Flow of Funds: ETFs Driving Stocks Higher

The Fed released its Financial Accounts of the United States with data for Q4-2016 last week. It provides amazingly comprehensive insights into the flow of funds, balance sheets, and integrated macroeconomic accounts of the US financial system. It’s really almost too much information to wrap one’s head around.

To help process it all, we have created a bunch of chart publications over the years that visualize quite a bit of it on our website. The saying that a picture is “worth a thousand words” is attributed to newspaper editor Tess Flanders discussing journalism and publicity in 1911. We have always believed that a chart is worth a thousand data points in a time series. Given our chosen profession, we tend to focus on the data for the equity and debt markets in the Fed’s quarterly statistical extravaganza. Let’s focus on equities:

(1) Supply-side totals. Net issuance of equities last year totaled minus $229.7 billion, with nonfinancial corporate (NFC) issues at -$565.7 billion and financial issues at $269.7 billion. The increase in financials was led by a $283.9 billion increase in equity ETFs, the biggest annual increase on record. The decline in NFC issues reflected the impact of stock buybacks and M&A activity more than offsetting IPOs and secondary issues.

(2) Demand-side total. To get a closer view of the demand for equities, let’s focus now on the quarterly data at an annual rate rather than at the four-quarter sum. This shows that equity mutual funds have been net sellers for the past five quarters, reducing their holdings by $151.3 billion over this period. Over the same period, equity ETFs purchased $266.4 billion, with their Q4-2016 purchases a record $485.4 billion, at a seasonally adjusted annual rate. Other institutional investors have been selling equities for the past 24 consecutive quarters, i.e., during most of the bull market! Foreign investors have also been net sellers over this same period.

The bottom line is that the current bull market has been driven largely by corporations buying back their shares, as I have been observing for many years. More recently, we have been seeing individual investors increasingly moving out of equity mutual funds and into equity ETFs. Both kinds of buyers tend to be much less concerned about historically high valuation multiples than more traditional buyers are.

We may be witnessing the beginning of an ETF-led melt-up, which may simply reflect individual investors pouring money into passive stock index funds. Lots of them seem to be more interested in seeking out low-cost funds rather than cheap stocks. In this case, valuation multiples would lead the melt-up, until something happens to scare investors out of those passive funds, which could trigger either a correction or a nasty meltdown. It is obviously a bit late in the game to start only now to be a long-term investor given that stocks aren’t cheap no matter how valuation is sliced and diced.

Wednesday, March 8, 2017

Happy Anniversary: Dancing With the Bulls

Anniversaries are usually joyous events. This week marked the eighth anniversary of the bull market. On March 3, 2009, President Barack Obama told us to buy stocks: “What you’re now seeing is profit-and-earning ratios are starting to get to the point where buying stocks is a potentially good deal if you’ve got a long-term perspective on it.” On March 6, 2009, the S&P 500 fell to an intra-day low of 666, and never looked back. You might recall (because I’ve reminded you a few times since then) that soon after, I declared that this devilish number was THE low. March 9, 2009 marked the closing low of 676.53. Let’s review some of the accomplishments of the charging bull:

(1) Performance, earnings, and valuation. The S&P 500 is up 249% since March 9, 2009 through yesterday’s close. The forward earnings of the S&P 500 is up 103%. The forward P/E is up 75% (from 10.2 to 17.9).

(2) Blue Angels. Putting all these trends together in our Blue Angels charts shows that the market is certainly flying high. Valuations suggest that stock prices are too high. However, forward earnings for the S&P 500 continues to climb in record-high territory. Furthermore, valuation isn’t too high if President Donald Trump delivers the goodies that he promised, including tax cuts, deregulation, and infrastructure spending. The market clearly liked Trump’s speech before Congress last week, along with his kinder and gentler tone. It was his first truly presidential-sounding performance since he first landed on the political stage.

(3) Fundamentals. Last week’s rally was impressive, and certainly provided a vote of confidence in the President’s economic agenda. That vote was also merited by last Wednesday’s M-PMI, which jumped to 57.7 during February, up from 56.0 during January and 52.0 during October, before the presidential election. Yesterday’s ADP report showing a gain of nearly 300,000 in February payrolls is yet another number suggesting that Trump’s victory unleashed the economy’s animal spirits.

(4) Sentiment. The Bull-Bear Ratio compiled by Investors Intelligence rose to 3.82 last week. That’s the highest since April 2015. Of course, if we all start celebrating the stock market melt-up, the contrarian killjoys will say that such events are usually followed by a meltdown. They’ll observe that the hard work is still ahead, i.e., getting the bullish part of the Trump agenda passed by Congress while blocking the bearish parts that have to do with protectionism.

For now, I continue to dance with the bulls. On a note of caution, let’s recall the infamous last words of former Citi CEO Charles (“Chuck”) Prince. In July 2007, Prince told the FT that global liquidity was enormous and only a significant disruptive event could create difficulty in the leveraged buyout market. “As long as the music is playing, you’ve got to get up and dance. We’re still dancing,” he said. On November 4, 2007, he retired from both his chairman and chief executive positions due to unexpectedly poor Q3 results, mainly attributed to CDO- and MBS-related losses.

Wednesday, March 1, 2017

Buffett’s Rules & Ratios

In a CNBC interview on Monday, Warren Buffett, the Oracle of Omaha, declared that stocks are “on the cheap side.” He has played the Trump rally by putting another $20 billion into the stock market since Election Day. Stocks are cheap, he said, because interest rates remain very low. This suggests that Buffett is betting both on and against Trump. He obviously made a very good decision not to let his personal politics get in the way of joining the animal spirits rally since Election Day. Warren Buffett is a long-time Democrat who supported Hillary Clinton, but he says he agrees with President Donald Trump on some issues—including homeland security as a top priority, boosting economic growth, and increasing the incomes of more Americans who have been hurt by globalization.

Yet, Buffett seems to be betting that interest rates won’t go up much anytime soon. In other words, he isn’t convinced that Trump will succeed in stimulating the economy very much with fiscal policy. He said that Republican leaders will probably have to scale back their tax reform ambitions because their current plan is too complicated to pass Congress, especially if they intend to do something on this by August: “I think complexity will give way to speed.” He expressed skepticism that the Republican tax plan will be revenue-neutral “without the craziest dynamic scoring in the world.” He also said that he doubts that the border adjustment tax (BAT) will see the light of day.

I agree with Buffett on the revenue-neutrality issue. The plan that the administration is outlining suggests a guns-and-butter fiscal approach with more defense spending, no cuts in entitlements, and lower tax rates. It’s hard to see how this won’t lead to higher bond yields, especially if the Fed starts increasing the federal funds rate at a pace closer to normal. (I am still forecasting that the US Treasury 10-year bond yield will range between 2.00%-2.50% during the first half of this year and 2.50%-3.00% during the second half of this year.)

In his interview, Buffett told CNBC on Monday that mixing politics and investment strategies would be a “big mistake.” He added, “Probably half the time [in] my adult life, I’ve had a president other than the one I voted for, but that’s never taken me out of stocks.” That’s been my pitch for a while: Investors should focus on whether the political environment is on balance bullish or bearish, not on whether the policies are right or wrong.

The Oracle of Omaha is credited with having devised the Buffett Ratio to measure stock market valuation. This indicator takes the market capitalization of all stocks traded in the US and divides it by GDP. In an interview he did with Fortune in December 2001, Buffett said, “For me, the message of that chart is this: If the percentage relationship falls to the 70% or 80% area, buying stocks is likely to work very well for you. If the ratio approaches 200%—as it did in 1999 and a part of 2000—you are playing with fire.”

Yet, Buffett thinks that stocks are cheap even though his ratio has risen from a cyclical low of 1.51 during Q3-2015 to 1.59 during Q3-2016. So it is approaching the cyclical high of 1.69 during Q1-2015 and the record high of 1.80 during Q1-2000. That’s using the Fed’s quarterly data on the total market capitalization of US equities excluding foreign issues. Now consider the following related indicators:

(1) S&P 500 Buffett Ratio. A similar ratio using the market cap of the S&P 500 to the revenues of this composite is highly correlated with the Buffett Ratio. It was 1.82 during Q4-2016, nearing the record high of 2.01 during Q4-1999.

(2) Forward ratios. It turns out that the S&P 500 version of the Buffett Ratio is highly correlated with the S&P 500’s price-to-sales (P/S) ratio using forward revenues as the denominator. On a monthly basis, it rose to 1.91 during February, suggesting that the Buffett Ratio is already back to its previous record high, just before the tech bubble burst.

I also monitor the forward P/S ratio on a weekly basis. It rose to a record high of 1.91 during the week of February 16. It is highly correlated with the S&P 500’s forward P/E, which rose to 17.8 during the same week.

There are two alternative economic scenarios that follow from the above discussion. The economy continues to grow in both, though running hotter in one than the other. Of course, there is a third scenario in which the economy falls into a recession. That’s possible if Trump’s protectionist leanings trump his pro-growth agenda. However, I believe that Trump is intent on maintaining free trade, but on a more bilateral basis than a multilateral basis. So here are the two growth scenarios in brief:

Very hot. If Trump delivers a guns-and-butter fiscal program—including most of the tax cuts he has promised along with more defense spending and public/private-financed infrastructure spending—economic growth could accelerate. But so might inflation, given that the economy is at full employment. Government deficits would probably remain large or widen, causing public debt to increase. In this scenario, the Fed would be emboldened to increase interest rates in a more normal fashion rather than gradually. Bond yields would rise. This should be a bullish scenario, on balance, if the boost to earnings from lower corporate tax rates and regulatory costs is as big as promised.

Not so hot. Alternatively, if Buffett is right, and interest rates stay at current low levels, that would imply that Trump’s grand plans for the economy won’t be so grand after all in their implementation. Animal spirits would evaporate. Interest rates would stay low, but valuations would be hard to justify if earnings don’t get the boost that was widely discounted after Election Day.

I am rooting for animal spirits.

Wednesday, February 22, 2017

The Recession Is Over

It’s easy to believe that the strength in the US economy since Election Day has a great deal to do with Trump’s surprising and stunning victory, including Republican majorities in both houses of Congress. His promises to cut taxes and reduce regulations seem to have revived animal spirits across the board among US consumers, small business owners, manufacturers, purchasing managers, and investors. I have been reporting on the incredible vertical ascents since the election in the Consumer Optimism Index, the Small Business Optimism Index, the average of the Fed districts’ composite business indicators, the M-PMI and NM-PMI, and the stock market. Also going vertical have been my Boom-Bust Barometer and my Weekly Leading Index.

It’s harder to imagine that Trump’s victory can explain the recent strength in global economic indicators. It’s possible that he revived animal spirits overseas on expectations that his fiscal policies might boost US economic growth, which should benefit the global economy. But his protectionist “America First” rhetoric, championing bringing jobs and manufacturing capacity back to the US, should squelch any optimism that better growth in the US will be shared with the rest of the world through the US trade deficit. Despite the media’s 24/7 focus on everything Trump, there may be a couple of other reasons why the global economy is showing signs of better growth:

(1) The energy recession is over. For starters, the 76% plunge in the price of a barrel of Brent crude oil from June 19, 2014 through January 20, 2016 triggered a global recession in the oil industry, which depressed other industrial commodity prices as well. The CRB raw industrials spot price index dropped 27% from April 24, 2014 through November 23, 2015. The price of oil and the CRB index have rebounded 102% and nearly 30% from their recent lows.

So the global energy industry’s recession is over, and it is no longer weighing on global economic growth. A good way to see this is to compare the y/y growth rates in S&P 500 revenues—which is a good indicator of global economic activity, since about half of those sales occur overseas—with and without the revenues of the Energy sector. With Energy, the growth rate turned negative from Q1-2015 through Q2-2016. It turned positive during Q3-2016. Excluding Energy, the growth rate remained positive over this same period, though it did weaken to a low of 0.2% during Q4-2015.

(2) China is back to its old tricks. China is also boosting economic growth by continuing to stimulate it with plenty of credit. During January, total “social financing” rose by a record $542.3 billion. That’s not on a y/y basis, but rather on a m/m basis! On a y/y basis, social financing totaled $2.7 trillion over the past 12 months through January. Bank loans, which are included in social financing, rose $335.7 billion during January m/m and $1.8 trillion over the past 12 months.

Wednesday, February 15, 2017

Running Hotter

There is only one obvious explanation for the remarkable vertical ascent in the Small Business Optimism Index over the past three months through January: Donald J. Trump. The index, which is compiled by the National Federation of Independent Business (NFIB), jumped from 94.9 during October to 105.9 during January, the highest since December 2004. That 11.0-point increase is reminiscent of a comparable leap higher during 1980 when business owners started to anticipate that Ronald Reagan might beat Jimmy Carter in that year’s November presidential election. There was another similar outsized increase during 1982 and 1983 when Fed Chairman Paul Volcker lowered interest rates to revive the economy from a severe recession.

Small businesses add up to a big portion of our economy. They currently employ 49.9 million workers, accounting for 40.5% of private-sector payrolls, according to data compiled by ADP. Since the start of the data during January 2005, small business payrolls have increased by 5.9 million, surpassing the gains by medium-sized (5.0 million) and large (1.2 million) companies over the same period. Here are a few of the key highlights from the latest NFIB survey:

(1) Problem solver? Each month, the NFIB survey includes a question on the most important problem faced by small businesses. Since early 2013, taxes and government regulation have been alternating between first and second places. Trump has pledged to lower both for small businesses. Apparently, small business owners expect that’s what he will do. Now all he has to do is deliver.

(2) A new problem. The NFIB survey also lists “poor sales” as a problem. That was the number-one complaint from October 2008 to July 2012. The survey doesn’t ask about the availability of labor. Nevertheless, that is actually becoming a big concern among small business owners according to another question in the survey. During January, roughly 30% of them said they have job openings that they aren’t able to fill right now. That’s the highest such reading since February 2001 based on a three-month average. It confirms that the economy is at full employment, as also evidenced by the unemployment rate, which is inversely correlated with this series and has been below 5.0% for the past nine months through January.

(3) Wages, prices, and profits. The NFIB’s jobs-hard-to-fill series is also highly correlated with the jobs-plentiful series included in the Conference Board’s survey of consumer confidence. All these labor market indicators suggest that wage inflation should be running hotter.

So far, there isn’t much evidence that wage inflation is picking up in the average hourly earnings data that are released by the Bureau of Labor Statistics in the monthly employment report. Previously, I have shown that there is more wage pressure showing up in the Atlanta Fed’s Median Wage Tracker.

In any event, so far over the past six months on average, only 3.3% of small business owners said they were actually raising their selling prices. So far, I am not seeing any pressure on the forward earnings of the S&P 600 SmallCap’s stock composite, which is rising in record-high territory. However, the composite’s forward profit margin is currently down to 5.2% from a cyclical peak of 6.1% during October 2013.

Wednesday, February 8, 2017

Are There Enough Shovel-Ready Workers?

Is promising to create 25 million jobs an unrealistic whopper by a fellow who tends to tell whoppers? Or is President Donald Trump simply thinking big, as he is wont to do? In a 9/15 campaign speech at the New York Economic Club, he predicted that his plan would increase employment by 25 million new jobs over the next 10 years. I looked at the 10-year change in payroll employment since the start of the data during 1939. The most this series has ever increased was 24.2 million jobs from May 1991 through May 2001. That period spanned the presidencies of George H. Bush and Bill Clinton. Looking at the eight-year changes, the biggest increase for any two-term president was 23.5 million under Bill Clinton. So the economy has added nearly 25 million jobs before, but it may be harder to do so again over the next 10 years.

Trump’s goal would be much more realistic if the economy were in a severe recession right now, since that would provide more upside during the initial recovery. Payroll employment has increased 15.8 million since it bottomed during February 2010, but only 8.0 million over the past 10 years. While Trump’s policies might stimulate more economic growth, there are still natural demographic limits to the number of employable people. Consider the following:

(1) Population. To create 2.5 million jobs per year, on average, over the next 10 years requires the availability of that many able-bodied workers. Over the past 10 years through January, the civilian working-age population (16 years old or older) rose 2.3 million per year on average. However, the population that is 16-64 years old increased 1.1 million, on average. It’s hard to imagine that this group will increase much, if at all, over the next 10 years as the large Baby Boom cohort retires and is replaced by a smaller cohort of first-time young adult workers.

(2) Labor force. Over the past 10 years through January, the civilian labor force increased by only 657,000 per year, on average, the lowest since November 1959. The 16-64 component of the labor force rose just 291,000 per year over this same period. Again, the Baby Boom demographics don’t bode well for any pickup in coming years. Even if Trump’s policies were implemented eight years ago rather than Obama’s policies, the Great Recession might still have been followed by a weak recovery in the economy and jobs. As I’ve noted before, the unemployment rate during the Obama years lines up remarkably well with the unemployment rate during the Reagan years. Really bad recessions might have a tendency to be followed by weak recoveries.

(3) NILFs. Over the past 10 years through January, the number of people who are not in the labor force (NILFs) rose 1.7 million per year, on average. The number of NILFs who are 65 years old or older rose close to 1.0 million per year, on average, the fastest on record. In January, there were a near-record 94.4 million NILFs. However, only 6.1% of them wanted a job, though they weren’t actively seeking one. That’s still 5.8 million employable people who could make Trump’s employment record greater if many of them get jobs. But that’s a pretty big “if.”

(4) Trump. Trump’s website supports his job-creating claim as follows: “For each 1 percent in added GDP growth, the economy adds 1.2 million jobs. Increasing growth by 1.5 percent would result in 18 million jobs (1.5 million times 1.2 million, multiplied by 10 years) above the projected current law job figures of 7 million, producing a total of 25 million new jobs for the American economy.”

A 9/15 Fact Sheet on Trump’s website states on this same topic: “Lifting unnecessary restrictions on all sources of American energy (such as coal and onshore and offshore oil and gas) will (a) increase GDP by more than $100 billion annually, add over 500,000 new jobs annually, and increase annual wages by more than $30 billion over the next 7 years; (b) increase federal, state, and local tax revenues by almost $6 trillion over 4 decades; and (c) increase total economic activity by more than $20 trillion over the next 40 years.”

Economic theory may run into the brick wall of demographic reality.

Thursday, February 2, 2017

Washington’s Mud Pit

President Donald Trump has certainly hit the ground running. He is moving fast to implement his agenda and to deliver on his campaign promises. However, it isn’t only Democrats who are setting up lots of obstacles and even landmines to slow, if not stop, his momentum. Even the Republicans in Congress may be starting to rain on his parade so that his agenda will get bogged down in the mud that is a key feature of Washington’s treacherous terrain. This might explain why the stock market rally since Election Day through last Wednesday is showing signs of bogging down too.

A 1/27 Reuters article observed: “When President Donald Trump was elected last November, Republican lawmakers enthusiastically joined his call to rewrite the tax code and dismantle Obamacare in the first 100 days of his presidency. But as congressional Republicans gathered for an annual policy retreat in Philadelphia on Wednesday, the 100-day goal morphed into 200 days. As the week wore on, leaders were saying it could take until the end of 2017--or possibly longer--for passage of final legislation. Trump had a different idea when he spoke to lawmakers in Philadelphia, telling them: Enough talk. Time to deliver. The divergent views on the timetable were among many indications of tensions that simmered just below the surface at the three-day Republican retreat.”

Trump’s popularity rating was the lowest of any incoming president in the history of such polling. If it doesn’t improve quickly, Republicans may continue to drag their feet on implementing his controversial agenda. Already, some of them are questioning the need for and the cost of a wall on the border with Mexico, the impact of any new “border tax” that might raise prices to consumers and spark trade retaliation, and the advisability of completely repealing Obamacare.

No wonder the post-election rally has run out of momentum, as investors may be starting to worry that Trump is already running on increasingly muddy ground. Then again, it might be refreshing to focus on other issues that might also be important to the stock market. For example, how about:

(1) Earnings. Forward earnings rose to record highs for the S&P 500/400/600 last week. Among the S&P 500 sectors, forward earnings are at record highs for Health Care, Information Technology, and Utilities. They’ve stalled recently at record highs for Consumer Discretionary, Consumer Staples, Industrials, Materials, and Telecom Services. They are in cyclical recoveries for Energy and Financials.

(2) Commodity prices. The CRB raw industrials stock price index continues its V-shaped recovery since bottoming on November 23, 2015 after falling 27% from April 14, 2014’s high. It is back to the highest readings since October 2014 and only 7% below 2014’s high.

(3) European economy. In the Eurozone, real GDP rose 2.0% (q/q, saar) during Q4-2016, faster than the revised 1.6% expansion seen in the previous quarter, a flash estimate from Eurostat showed yesterday. The Eurozone Economic Sentiment Indicator (ESSI) rose to the highest since April 2011 last month. That’s a good sign for the growth in real GDP on a y/y basis, which is highly correlated with the ESSI.

In Europe, new passenger car registrations in the European Union plus the European Free Trade Association (Iceland, Norway, and Switzerland) rose to a record high of 15.1 million units last year. In the Eurozone, the volume of retail sales excluding motor vehicles edged down in November from October’s record high. This measure of sales volume is up 2.2% y/y, a solid increase.

(4) Consumer confidence. I average the monthly Consumer Sentiment Index and the Consumer Confidence Index to derive the Consumer Optimism Index (COI). In January, it held onto its big gain following Election Day. The COI current conditions index actually edged up to the highest since July 2007, while the COI expectations index moved ever so slightly lower.

Wednesday, January 25, 2017

DJIA 20,000: Counting on Earnings

Today was another happy day for the bull market that started on March 9, 2009, when the DJIA was 6547.05. Today, it crossed 20,000. It closed above 1000 on November 14, 1972, 5000 on November 21, 1995, 10,000 on March 29, 1999, and 15,000 on May 7, 2013. I first joined Wall Street during January 1978 when EF Hutton hired me as an economist. The DJIA is up 2,314% since the start of my career on the Street. It is up 206.5% so far since March 9, 2009. It is up 9.5% since Election Day.

For a change, let’s ignore Washington. Let’s ignore the Republicans and the Democrats. Let’s ignore the White House, Congress, and K Street. That’s what the financial markets were doing for the past eight years. Investors were focusing most of the time on the Fed and the other central banks. Now we are all being forced to participate (in one way or the other, though mostly as observers) in the greatest circus of all times. I guess that is only fitting now that Ringling Brothers is going out of business. Instead it will be Cirque du Trump 24x7 for the next four years.

Of course, over the past eight years, stock market investors also have been focused on earnings, as they always are. While the 7.4% rally in the S&P 500 after Election Day through Wednesday’s record high might have had a lot to do with the results of that day, it helps that the earnings outlook has been improving. In our 8/22 Morning Briefing, I declared that the earnings recession was over, and that it was mostly attributable to the S&P 500 Energy sector as a result of the plunge in oil prices from mid-2014 through early 2016.

Let’s analyze the latest earnings data:

(1) Earnings. On a year-over-year basis, S&P 500 operating earnings, based on Thomson Reuters (TR) data, showed declines from Q3-2015 through Q2-2016. It rose 4.1% during Q3-2016, and probably rose around 6.0% during Q4-2016. Arguably, the earnings recession ended earlier than suggested by the growth rate based on the actual level of operating earnings (TR basis), which bottomed during Q1-2016, declining 11.7% from the previous record high during Q4-2014. It is up 15.8% from that recent bottom through Q3-2016 to a new record high.

(2) Revenues. On a year-over-year basis, S&P 500 revenues declined from Q1-2015 through Q4-2015. It edged up during the first half of 2016, and was up 2.5% y/y during Q3-2016. This too suggests that the earnings recession actually ended in early 2016.

(3) Q4 reporting season. So far this earnings-reporting season, i.e., through the 1/19 week, the blended earnings number (including both reported and estimated figures) shows a gain of 4.7%, up from 4.1% the previous quarter. Joe and I are expecting the traditional upward “hook” in actual earnings relative to expected earnings for the current earnings season, which is why we predict that the actual growth rate will be close to 6.0%.

(4) Forward ho! S&P 500 forward operating earnings per share, which is the time-weighted average of consensus expected earnings for the current and next year, rose to $133.65 during the 1/19 week. That’s a fresh record high and a good leading indicator for actual earnings as long as there is no recession coming over the next 12 months.

The consensus estimate for 2018 has been moving higher in recent weeks, which doesn’t usually happen, as optimistically biased analysts typically lower their distant forecasts as reality approaches. Analysts may be starting to incorporate tax cuts and less regulation into their 2018 estimates. They now expect that 2018 earnings will rise 12.0%, following this year’s gain of 12.3%.

The analysts may also be raising their economic growth expectations, as evidenced by the firming in their 2017 and 2018 estimates for S&P 500 revenues, which are showing gains of 5.8% this year and 4.9% next year. Forward revenues is also rising in record-high territory.

Wednesday, January 18, 2017

Earnings: Yes They Can Grow

A week after his election victory, I concluded that incoming President Donald Trump could succeed in stimulating economic growth, so I raised my real GDP forecast for 2017 from 2.5% to 3.0%. Since then, I’ve been keeping track of all the signs showing a revival of “animal spirits” in surveys of consumer and business confidence.

On Monday, the IMF raised its economic growth forecasts for the US, saying output could grow nearly a half-percentage-point faster than previously thought over this year and next, thanks to Trump’s plans to cut taxes and boost infrastructure spending. That would put US real GDP growth at 2.3% this year and 2.5% next year. The IMF’s move follows similar revisions by the World Bank last week.

If so, then the outlooks for the growth rates of S&P 500 revenues and earnings are improving. Both have recovered from the energy-led recession that started during the summer of 2014 and ended early last year, when the price of oil rebounded. Consider the following:

(1) Forward revenues and forward earnings of the S&P 500 have been rising rapidly since last spring into record-high territory. They are both good harbingers of actual revenues and earnings.

(2) Business sales are recovering from the energy recession. Manufacturing and trade sales rose 2.3% y/y during November, the best growth rate since October 2014. This series is highly correlated with the growth in S&P 500 aggregate revenues, which was 0.6% y/y during Q3-2016. It probably rose to about 2.0% during Q4-2016. Joe and I think the growth rate for revenues this year could be around 4%-5%.

Interestingly, the US M-PMI tends to be a leading indicator for the growth rate in S&P 500 aggregate revenues. During December of last year, the M-PMI rose to 54.7, the highest reading since December 2014.

(3) Retail sales rose 0.6% m/m during December. Chronic pessimists noted that it was essentially unchanged excluding gasoline and autos. Apparently, they weren’t impressed with December’s auto sales of 18.4 million units (saar), a cyclical high. Excluding gasoline but including autos, retail sales rose 0.2% to a new record high, and remain highly correlated with our Earned Income Proxy for private industry wages and salaries in personal income, which also rose to a fresh record high last month.

(4) Short-term leading economic indicators are upbeat. The Citigroup Economic Surprise Index rose to 40.7 on January 17. That’s near last year’s highest reading. The CRB raw industrials spot price index continues to recover from its cyclical low early last year. It was up 23.8% y/y on January 13.

My Boom-Bust Barometer continues to rise vertically in record high territory. The same can be said for the two Weekly Leading Indexes compiled by YRI and ECRI.

Wednesday, January 11, 2017

Animal Spirits

Just for fun, I compared the lyrics in the song “Physical” by Olivia Newton-John with Janet Yellen’s “Fiscal” lyrics during her press conference performance at the end of last year following the December 13-14 meeting of the FOMC. The word “physical” appears 20 times in Olivia’s song, and “fiscal” was mentioned 20 times during Janet’s press conference. In the minutes of the December meeting, the word “fiscal” appears 15 times, compared to just once during the previous meeting on November 1-2, which was before Election Day on November 8.

Prior to Election Day, a few Fed officials had called on Congress to step in to revive US economic growth with fiscal stimulus. They want to proceed with “normalizing” monetary policy so that they will have room to ease in the event of a future shock. They were looking for a way to continue to gradually raise rates without hampering economic growth, which has been slow. President-elect Donald Trump might just solve their problem with fiscal policy, included cuts in tax rates and more spending on infrastructure.

“Physical” starts with “Let’s get physical” and ends with “Let’s get animal, animal / I wanna get animal / Let’s get into animal.” That’s not appropriate or relevant language in a discussion about the Fed chair. However, President-elect Donald Trump is fair game.

After all, a Google search of “Trump and animal spirits” yields over 2 million links. They include lots of prim and proper ones such as a 1/5 FT article by Gillian Tett titled “Donald Trump unleashes business’s animal spirits.” She reported that Trump’s top eight officials (president, vice-president, chief of staff, attorney-general, and secretaries of State, Commerce, Defense, and Treasury) had only 55 years of government experience but 83 years in business. Obama’s comparable team had 117 years in government, but ONLY five years in business IN TOTAL.

As I’ve observed before, this is a radical change in governing regimes. As one of our accounts observed, government by dealmakers is about to replace government by community organizers. So far, this has all revived lots of animal spirits in the stock market. While the country may be split on Trump, his election has boosted overall consumer confidence. Purchasing managers were also more upbeat after the election, and so were small business owners.

December’s survey of small business owners by the National Federation of Independent Business (NFIB) was released on Tuesday. It was full of animal spirits. This group tends to be conservative. They generally don’t like government. When they are asked about the “most important problems small businesses face,” taxes and government regulation tend to be at the top of their list. They were still the top concerns in December, but Trump’s victory was clearly reflected in the extraordinary ascent in the Small Business Optimism Index from 98.4 during November to 105.8 in December, the highest since the end of 2004.

There’s more: The net percentage of firms expecting the economy to improve soared from 12% during November to 50% last month, the highest since March 2002. The percentage saying now is a good time to expand jumped from 11% to 23%, the highest since June 2005. The net percentage expecting to increase employment rose to 16%, the highest since January 2007.

So who cares? Aren’t these just a bunch of anti-government conservatives who are running minor little businesses and are looking forward to paying less than their fair share of taxes under the new Trump administration? Not so fast: Small businesses account for a very significant portion of jobs and hiring. Consider the following:

(1) Small business is big employer. ADP, the payroll processing company, compiles data series on employment in the private sector of the U.S. labor market by company size. At the end of 2016, the shares of employment attributable to small, medium-sized, and large firms were 40.5%, 37.7%, and 21.8%.

(2) Small business drives jobless rate. There has been a very high correlation between “poor sales” reported by small business owners and the national unemployment rate. If Trump succeeds in boosting their sales by cutting personal income tax rates, the jobless rate should remain low.

There is also a high correlation between the earnings of small businesses and the inverse of the poor sales. Trump’s proposed tax cuts would boost their earnings, which are inversely correlated with the national unemployment rate.

(3) A new problem for small business. Before I put any more twists in this pretzel, I expect that the biggest problem facing small business owners in 2017 is likely to be finding workers. Indeed, during December, 29.0% said that they have openings for jobs that they aren’t able to fill.

By the way, the term “animal spirits” was popularized by none other than John Maynard Keynes in The General Theory of Employment, Interest, and Money (1936) in the following passage:
Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than mathematical expectations, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits—a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.
This passage has been widely discussed and interpreted. Cutting through the jargon, I think Keynes was saying that the business cycle is driven by the instability of human nature. He seemed to agree that booms might reflect “spontaneous optimism,” which cause instability in a similar fashion as speculation, setting the stage for a bust. Keynes added: “Thus if the animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die;—though fears of loss may have a basis no more reasonable than hopes of profit had before.” Of course, his book heralded the idea that government spending could stabilize the business cycle by at least minimizing the downside of the cycle. How is that working out so far?