Wednesday, January 30, 2019

Stocks: Something for Worriers

The S&P 500 is one of the 10 components of the Index of Leading Economic Indicators (LEI). The LEI stalled during the last three months of 2018—falling 0.3% in October, rising 0.2% in November, then falling again by 0.1% in December. The drop in stock prices accounted for much of that weakness. The rebound in the S&P 500 so far in January is a relief.

However, the selloff late last year and the partial government shutdown early this year depressed the expectations sub-index of the Consumer Optimism Index (COI) during January (Fig. 1). This is the average of the expectations components of the Consumer Sentiment Index (CSI) and the Consumer Confidence Index (CCI). That average is also one of the LEI indicators, and it has fully reversed the jump it took after Trump was elected president.

The good news is that the current conditions component of the COI remains at a cyclical high, edging down only slightly during January. That reflects the continued strength in the labor market. So does the 213,000 increase in ADP payrolls during January.

However, if you are a worrier, then you can certainly worry about the ratio of the current conditions and expectations components of the CCI, which tends to spike higher at the start of recessions, as it did this month (Fig. 2). It also tends to spike after a bear market has started (Fig. 3).

I expect that expectations will rebound along with stock prices, assuming that there isn’t another government shutdown in the offing. I also expect that an amicable resolution in the US-China trade talks will boost stock prices and consumer confidence.

Helping to boost sentiment for both stock investors and consumers is today’s decision by the FOMC to pause rate-hiking. Today’s FOMC statement didn’t include the 12/19 statement’s language that “further gradual increases” in interest rates were warranted. Instead, a more cautious approach was signaled: “In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate to support these outcomes.”

In a separate statement released yesterday too, the FOMC also signaled a more flexible approach to QT, i.e., the paring of the Fed’s balance sheet: “The Committee is prepared to adjust any of the details for completing balance sheet normalization in light of economic and financial developments.”

At 2681, the S&P 500 is now up 14.0% from the 12/26 low of last year, and is only another 9.3% gain away from its 9/20 record high of 2930. My year-end target of 3100 is looking more achievable.

Wednesday, January 9, 2019

On the Demographic Path to Human Self-Extinction

In Chapter 16 of my book Predicting the Markets, I observe that fertility rates have dropped below replacement rates around the world as a result of urbanization. Only in India and Africa are couples having enough babies to replace themselves. Humans are on a demographic path of self-extinction.

Leading the way has been Japan. I have often described the country as the world’s largest nursing home. That distinction undoubtedly will soon belong to China. All around the world, nursing homes will be bulging with more occupants, while the maternity wards will have lots of vacant cribs.

The economic consequences of these demographic trends will be slower growth and subdued inflation, if not outright deflation. That means that interest rates most likely will remain historically low for a very long time. That could be positive for the valuation multiples that investors are willing to pay for the stocks of companies that are able to grow their earnings at an above-average rate. It should also be very positive for the stocks of companies that are able to grow their dividends in this demographically challenged environment.

A global shortage of workers should stimulate more labor-saving and labor-replacing technological innovations. The result should be faster productivity growth. That should give a lift to real wages that should offset some of the slowdown in employment growth attributable to labor shortages.

The scenario I just sketched isn’t a forecast. It is a description of exactly what has been happening in Japan. The forecast is that most of the rest of the world will follow suit. Japan is the poster child for the rest of us who aren’t having enough babies to replace ourselves. Consider the following:

(1) Japan. On a 12-month basis, the number of deaths in Japan exceeded the number of live births for the first time during July 2007 (Fig. 1). On this basis, during July of this year, deaths exceeded live births by a record 351,000 (Fig. 2). The situation has been exacerbated by a record low of only 586,700 marriages over the past 12 months through July (Fig. 3).

So Japan’s population has been falling in recent years and rapidly aging. The percentage of the population that is 65 or older has increased from 25.2% at the start of 2014 to 28.2% at the end of last year (Fig. 4). Yet the total labor force has actually been rising gradually over the past few years (Fig. 5). That’s because the labor force participation rate has been moving higher (Fig. 6). The problem is that more Japanese women have been entering the labor force and not getting married, which depresses the number of births. If that continues, the number of births will remain depressed.

These demographic trends go a long way toward explaining why Japan’s inflation rate remains near zero, despite the ultra-easy monetary policies of the Bank of Japan, which has been targeting a 2.0% inflation rate since January 22, 2013 (Fig. 7). Older people and fewer children aren’t conducive to home-building, car-buying, or the consumption of other durable goods.

(2) China. The demographic profile of China isn’t as geriatric as Japan’s, but it is heading in the same direction, accelerated by the government’s one-child policy that was in force from 1979 through 2015 (Fig. 8). For the first time ever, the percentage of seniors in the population, at 6.6%, matched the percentage of children under five years old during 1998 (Fig. 9). By the middle of this century, the former is projected by the UN to rise to 26.3%, while the latter falls to 4.6%.

Young married adults who have no siblings must accept the burden of taking care of four aging parents. Now that the government has declared that couples can have more than one child, many are likely to be overburdened having even one child.

As I’ve noted in recent months, all this is weighing on Chinese real retail sales growth, which has been on a downtrend for the past several years (Fig. 10).

(3) United States. The good news in the US is that the fertility rate is in line with the replacement rate. However, the demographic trends are heading in the wrong direction. Young people are staying single longer. Newly married older couples are likely to have fewer children than younger couples. The cost of college education is also a downer for many couples, forcing them to consider how many children they can afford.

The proof is in the maternity wards. Over the past 12 months through March, live births in the US totaled 3.84 million, the lowest since November 1997 (Fig. 11). Over the same period, the number of deaths totaled a record 2.36 million. So births exceeded deaths by 1.48 million, the lowest reading on record, dating back to December 1972 (Fig. 12).

Meanwhile, as the Baby Boomers age, they are turning into minimalists. They don’t need their big houses anymore. They don’t need minivans to take the kids to soccer practice. The Millennials are natural-born minimalists, for reasons I have reviewed in the past on many occasions.

I don’t view this as necessarily bad news for the US economy. Rather, I see these demographic trends as reducing the likelihood of an economic boom, which reduces the likelihood of a bust. The business-cycle expansion should continue, and inflation should remain subdued.

Tuesday, January 1, 2019

Video Podcast: Is the Fed Done?

Today is January 1, 2019. I wish you all a healthy, happy, and prosperous New Year! In this video, I discuss why the new year is likely to start with some downbeat economic data that should cause the Fed to pause hiking interest rates. Regional business surveys conducted by five of the Fed district banks were very weak during December. That explains the recent drop in the 10-year Treasury bond yield below 2.70%. The 2-year Treasury yield tends to be a good one-year leading indicator of the federal funds rate, and is currently predicting no change this year. Are the implications bearish or bullish for the stock market?