The Productivity Puzzle (excerpt)

There is widespread concern about the slow growth in nonfarm business productivity. Over the past 20 quarters (five years) since Q1-2010, it is up only 0.5% on average during each of the Q1-to-Q1 periods spanning this period: 0.4% through Q1-2011, 0.9% through Q1-2012, 0.5% through Q1-2013, 0.6% through Q1-2014, and 0.3% through Q1-2015. That’s awfully weak growth.

There are lots of different reasons to be concerned. Fed Chair Janet Yellen is worried that wage gains are being held down by weak productivity. Bond investors are worried that inflation might rebound if tightening labor markets push up labor costs, with wages rising faster than productivity. In this scenario, stock investors would fret that profit margins would be squeezed if labor costs rise faster than prices. Progressives are saying that companies are using their cash and borrowings to buy back their shares rather than invest in productivity-enhancing capital equipment. They claim that’s worsening income inequality.

In other words, everyone wants to see productivity growing at a faster pace. The key reason is that productivity is the key determinant of consumers’ purchasing power (i.e., real income) and the standard of living (i.e., consumption). However, there are measures of these two variables suggesting that the productivity problem may not be as serious as widely believed. Consider the following:

(1) Long term. First, let’s keep in mind that technological innovations--which are the key drivers of productivity--tend to be lumpy. They don’t happen continuously over time, and they take time to be adopted once they are ready for prime time. We can see this by looking at the growth in productivity over 24-quarter periods. Since the early 1950s, productivity grew especially fast during the 1960s and the late 1990s and the first few years of the next decade. Before and after these bursts, the pace of productivity growth was relatively subpar.

(2) Short term. On a shorter-term basis, productivity jumped 5.2% from Q1-2009 through Q1-2010 before the slowdown since then. That boosts the average productivity growth rate a full percentage point to 1.3% per Q1-to-Q1 period over this six-year time span. I constructed a good proxy for productivity by dividing real GDP by the average weekly hours index in the private sector. I did so because there are no official productivity measures for goods and services industries in real GDP.

I constructed proxy measures of productivity in goods and services industries by dividing their contributions to real GDP by their average weekly hours indexes. Both proxies jumped during 2009. Goods productivity has continued to trend higher at a slower pace, but services productivity has dropped 5.7% from Q4-2009 through Q1-2015! That seems very odd and suggests that the government’s bean counters may be having an especially tough time counting the beans in services.

(3) Freebies. “[T]he U.S. doesn’t have a productivity problem, it has a measurement problem.” That’s according to a 7/16 WSJ article titled “Silicon Valley Doesn’t Believe U.S. Productivity Is Down.” It reviews the contrarian views of Hal Varian, Google’s chief economist. The article notes, “[T]he only way goods and services move the official U.S. productivity needle is when consumers and businesses pay for them. Anything free, no matter how much it improves everyday life, isn’t included.” Many of today’s time-saving technologies are free, like some location-based apps, cloud computing, and robust search engines.

On the other hand, the first posted comment about the article observes: “I suspect that all the productivity gains provided by Google and the like are more than offset by the ridiculous amount of time people spend on FaceBook, Twitter, Instagram etc writing about the cute thing their dog did today, or posting a picture of what they had for lunch...”

Today's Morning Briefing: Opie Kicks the Can. (1) The best can kickers on the road. (2) Going fishing on a summer’s day down a country road. (3) Mario and Opie. (4) Between “aw, shucks” and “shock and awe.” (5) Another panic sell-off followed by another relief rally. (6) Marty Zweig’s famous mantra on steroids. (7) Another better-than-expected earnings season, especially ex-Energy. (8) Putting together the pieces of the productivity puzzle. (9) Productivity has a long boom-bust cycle because innovation is lumpy. (10) Our productivity proxies suggest bean counters aren’t counting all the beans in services. (11) The freebie problem. (12) “Mr. Holmes” (+ +). (More for subscribers.)

Yellen Still Sees Slack in Labor Market (excerpt)

Was it a coincidence? The S&P 500 rose 1.2% on Friday to 2076. Fed Chair Janet Yellen spoke about the economy and monetary policy the same day. Previously, I’ve observed that whenever she does so, stock prices tend to be up that day. Of course, investors were also relieved to see that China’s stock market rallied and Greece might still get a bailout. In any event, Yellen will be speaking again on July 15 and July 16 in her semiannual testimony to Congress on monetary policy.

In her speech on Friday, she made headlines saying, “Based on my outlook, I expect that it will be appropriate at some point later this year to take the first step to raise the federal funds rate and thus begin normalizing monetary policy.” So one-and-done is still the most likely scenario for Fed policy this year. If so, then the next hot topic will be when might the second rate hike occur next year and how many more rate hikes might there be. Yellen’s comments suggested that rate hikes are likely to be small, few, and far between in 2016.

Yellen is a labor economist by background, and it shows. She just isn’t convinced that the labor market has improved as much as suggested by numerous upbeat indicators, including the official unemployment rate, payroll employment, and job openings. She said: “But it is my judgment that the lower level of the unemployment rate today probably does not fully capture the extent of slack remaining in the labor market--in other words, how far away we are from a full-employment economy.”

Today's Morning Briefing: Bull in a China Shop. (1) Best-laid plans of mice and men, and central planners. (2) Central bankers are central planners too. (3) Pain in China’s master plans. (4) Government cheerleaders held pep rallies to rally stocks. (5) The biggest winner and loser in China. (6) “Silk Road” has a slippery slope. (7) Falling PPI and auto sales. (8) Command economies don’t do markets very well. (9) Xi’s dream turning into a nightmare. (10) Obamacare is a nightmare. (11) Yellen does it again and says it again. (12) Record job openings. (13) Taylor Swift gets + + + for best capitalist of the year. (More for subscribers.)

China’s Bubble Pops (excerpt)

The Chinese may have set a record for inflating a huge stock market bubble in the shortest period of time. It started last year on November 21, when the PBOC cut interest rates for the first time in two years. It did so to revive economic growth. Instead, investors and speculators piled into the stock market. At the beginning of February, the PBOC lowered bank reserve requirements. Effective March 2, the PBOC cut interest rates for the second time in three months. On March 5, the PBOC lowered the rates it charges commercial lenders on a special short-term lending tool.

The Shanghai-Shenzhen 300 stock price index soared 107% from November 21 through this year’s peak on June 8. It has plunged 32% since then. Even the less volatile China MSCI stock price index (in yuan) jumped 35% from November 21 through April 27. It has plunged 21% since then, retracing most of the rally. In the past, this index was highly correlated with the price of copper, which failed to confirm the recent ascent in Chinese stock prices. Instead, the nearby futures price of copper remained near its lowest reading since July 2009.

The latest moves by Chinese officials to prop up stock prices certainly won’t revive confidence in China’s stock market. Why would anyone want to invest in a market where the government can ban selling?

Yesterday, Bloomberg reported: “China’s securities regulator banned major shareholders, corporate executives and directors from selling stakes in listed companies for six months, its latest effort to stop the nation’s $3.5 trillion stock-market rout. Investors with stakes exceeding 5 percent must maintain their positions, the China Securities Regulatory Commission said in a statement. The rule is intended to guard capital-market stability amid an ‘unreasonable plunge’ in share prices, the CSRC said.”

Regulators have introduced market-boosting measures almost every night over the past several days, as the following selected timeline shows:

6/25: PBOC injects cash into the financial markets.
6/27: PBOC cuts interest rates and lets banks lend more money.
7/1: Investors allowed to put up real assets as collateral to buy stocks.
7/2: Stock manipulation will be investigated.
7/4: IPOs suspended.
7/4: People’s Daily urged investors to stay calm.
7/4: Twenty-one brokerage firms will invest $19 billion in a stock market fund.
7/7: Trading suspended in more than 1,300 companies.
7/8: State-run companies ordered to maintain holdings in listed units.

The stock market meltdown and the inept official attempts to stop the rout could weaken confidence in the government’s ability to manage the economy, which has been slowing significantly. A slew of June data will be released in the next few days. May’s indicators were uniformly weak. For example, electricity output over the past 12 months through May was up just 3.5% y/y, the slowest pace since October 2009.

Today's Morning Briefing: The Confidence Game. (1) The first and second mandates. (2) The third mandate. (3) The credibility challenge. (4) Chinese set a record in the history of bubbles. (5) Roundtrip. (6) Banning selling is a dumb desperate measure. (7) Market-boosting measures failing to boost market. (8) Draghi running out of W-I-T. (9) Japanese exports are weak. (10) Fed needs to reload its gun. (11) “Stay Home” outperforming “Go Global.” (More for subscribers.)

US Economy Is Still the Promised Land (excerpt)

June’s employment report was released on Thursday rather than Friday, when US markets and government offices were closed for the long Fourth of July weekend. Overall, there weren’t any fireworks in the report. Our Earned Income Proxy rose to a new record high in June, edging up only 0.2% m/m. Last month’s 223,000 payroll gain was fine, but the previous two months were revised downwards by 60,000. The labor force fell 432,000, while the household measure of employment declined 56,000.

Wages rose, but by only 2.0% y/y, which remains remarkably low given that the JOLTS measure of the jobs openings rate rose during April to the highest since January 2001. The unemployment rate is down to 5.3%, the lowest since April 2008. It is just 4.8% for adults, a new cyclical low. Yet despite the tightness in the labor markets, wage inflation remains remarkably subdued. On the other hand, Q1’s Employment Cost Index for private industry rose to 2.8% y/y, the highest since Q3-2008.

Like Moses, Fed Chair Janet Yellen has pledged to bring us to the Promised Land of milk and honey, i.e., good jobs and good wages. Are we there yet? There certainly are plenty of job openings that can’t easily be filled by the available supply of labor. Apparently, employers aren’t convinced that raising wages will attract the workers they need. Workers who have the right skills to match the available jobs are in the Promised Land. The ones who don’t qualify are still wandering around in the desert, or they’ve dropped out of the labor force and stopped searching for the Promised Land.

There are plenty of other economic indicators suggesting that the US is still the Promised Land for most Americans. Here’s a brief review of the latest:

(1) Construction spending, especially on factory capacity. Construction spending rose to a cyclical high of $1.04 trillion (saar) during May. Leading the way was a 1.5% m/m jump in nonresidential private construction, with manufacturing soaring 6.2% during the month. The latter has been climbing almost vertically this year, posting a 70% y/y gain. This is certainly consistent with the view that despite the strong dollar, the US may be enjoying an industrial renaissance based on cheap energy and technological innovation.

(2) Business equipment spending, especially on heavy trucks. Another category of capital spending that’s showing strength is sales of medium and heavy trucks. It rose to 450,000 units (saar) during June, a new cyclical high and the best pace since February 2007. That’s impressive given that the oil patch has been hard hit by the plunge in oil prices since last summer.

(3) Consumer spending, especially on autos. Retail auto sales averaged 17.1 million units (saar) during Q2, the best such pace since Q3-2005. Overall retail sales have rebounded smartly this spring following the winter’s ice patch. There seemed to be a spring soft patch in retail sales, but it was revised away. While June’s employment report had some soft spots, there was enough strength to provide consumers with more purchasing power.

(4) Purchasing managers, especially the ISM survey. There was also a soft patch in the M-PMI earlier this year. The index fell from 55.1 last December to a recent low of 51.5 during March and April. But it rose during the past two months to 53.5 in June.

Today's Morning Briefing: Ye Shall Merge & Acquire. (1) Greece: This too shall pass? (2) Greeks invented mythology and mathematics. (3) Be fruitful and multiply. (4) M&A and buybacks are shrinking supply of stocks. (5) The Wilshire 3,666. (6) Jump-starting growth with M&A. (7) America is still the Promised Land for most Americans. (8) Janet and Moses. (9) Wages: Are we there yet? (10) More evidence of US industrial renaissance. (11) Pedal to the metal. (12) “Terminator Genisys” (+). (More for subscribers.)

Braking and Accelerating in China (excerpt)

The Chinese have a very high savings rate, widely estimated to be 40%-50% of their income. A rough proxy for the amount of saving is M2, which rose to a record $21 trillion during May. It is up $2 trillion y/y and $12 trillion over the past five years.

The PBOC’s monetary policies have channeled most of those deposits into loans that expanded industrial capacity and funded property development. Now there is a glut of these, which is weighing on economic growth. Yet as I discussed yesterday, China’s banking regulators are set to scrap the country's longstanding loan-to-deposit ratio requirement, which is currently 75%. That move could inject another $1.1 trillion into the economy.

Over the past seven months, Chinese investors have poured money into the stock market seeking better returns, thus inflating a speculative bubble, which may be starting to burst already. Helping to burst the bubble are regulators intent on keeping a lid on margin lending by shadow banks. The 6/25 FT reported that official margin lending totaled $354 billion as of Wednesday’s close, up nearly 5.5-fold from a year earlier. However, this officially sanctioned margin lending, which is tightly regulated and relatively transparent, is only the tip of the iceberg for Chinese leveraged stock investing.

Unregulated margin leverage can reach 5:1 or higher, with no limits on which shares investors can buy. The funds come mainly from wealth management products (WMPs) sold by banks and trust companies. These are structured deposits that banks market to customers as a higher-yielding alternative to traditional savings deposits. Regulators moved to limit the availability of shadow margin debt on Saturday, June 13, triggering panic selling on Monday, June 15.

This past Saturday, China’s central bank cut its benchmark lending rate to a record low and lowered reserve-requirement ratios for some lenders. In the fourth reduction since November, the one-year lending rate was reduced by 25 basis points to 4.85%. The one-year deposit rate will fall by 25 basis points to 2%, while reserve ratios for some lenders, including city commercial and rural commercial banks, will be cut by 50 basis points. The PBOC was clearly worried about a meltdown in the stock market.

Today's Morning Briefing: Central Bank Credit & Credibility. (1) Are central banks losing control? (2) Given global turmoil, US stocks may be more attractive again. (3) BOJ pumps up liquidity, but fails to ramp up production. (4) Japan’s forward earnings still rising to record highs. (5) Chinese savings glut. (6) As China’s margin debt regulators step on brakes, PBOC steps on monetary accelerator. (7) Wealth management products may be China’s weapons of mass financial destruction. (8) ECB stimulates bank lending a little bit. (9) How much does Greece owe ECB? (10) Not cool: Dudley compares Greece to Lehman. (11) Liftoff or back off? (12) Fist fight between IMF and BIS. (More for subscribers.)

Eurozone Stocks Hit Air Pocket (excerpt)

This may very well be the week for a deal, or for no deal. The question is who will blink first in this dangerous game of chicken between Greece and its creditors. Global stock investors started to blink on April 13, when the EMU MSCI (in euros) hit the year’s high with a gain of 22.9% ytd. On Monday, it was down 9.4% from that peak and still up 11.3% ytd. So it continues to outperform the US, UK, and EM MSCIs. Interestingly, the latest selloff in the EMU MSCI has been remarkably widespread among the 10 sectors comprising the index.

The good news is that the forward earnings of the EMU MSCI has been recovering nicely over the 14 weeks through June 4. In addition, the region’s Net Earnings Revisions Index jumped to 4.0% during May, the highest since September 2010. Obviously, industry analysts either aren’t counting on a Grexit, or don’t expect it will matter much to their companies. The index remains relatively cheap, with the forward P/E at 15.1.

While numerous economic indicators show that the Eurozone’s economy is on an upswing, it’s a very anemic one based on the region’s measures of industrial production. Here is the y/y performance derby for the region and its four biggest economies: Spain (2.2%), Germany (1.3), Italy (0.1), and France (-0.1). That’s not much to get excited about. It’s not much better in some of the other European economies: Sweden (1.5), UK (1.2), and the Netherlands (-4.2).

Yesterday, one of our accounts asked me if Europe’s economy is strong enough to absorb the shock of a Grexit. I think so, but I wouldn’t bet the ranch on it. Keep in mind that the Eurozone’s recovery is weak despite the fact that the following six cylinders have all been firing: near-zero interest rates, QE, a weak euro, rising bank lending, soaring stock prices, and lower oil prices.

Today's Morning Briefing: Dead Reckoning.(1) Deduced reckoning. (2) Are investors in the same boat with Nicole Kidman? (3) Is the Greek play a tragedy or comedy? (4) In praise of kicking the can down the road. (5) Angela vs. Wolfgang. (6) Earnings finally recovering in Eurozone. (7) No wind in the sails of commodity, currency, and S&P 500 traders. (8) Eurozone’s economic recovery remains uninspiring. (9) China’s economy continues to struggle with excess capacity and PPI deflation. (10) Focus on market-weight-rated S&P 500 IT industries. (More for subscribers.)

Abrupt Normalization in Bond Market (excerpt)

One simple model of the 10-year bond yield compares it to the growth rate of US nominal GDP on a y/y basis. While real GDP fell 0.7% (saar) during Q1 on a q/q basis, it was up 2.7% y/y, confirming that the quarterly result might have been distorted by faulty seasonal adjustments. Recent economic indicators confirm that the US economy continues to grow at a moderate pace. In any event, nominal GDP rose 3.6% y/y during Q1. That’s well above even the latest yield. In the Eurozone, real GDP rose 1.5% (saar) q/q during Q1. It was up 1.0% y/y, with nominal GDP rising 2.0%.

This suggests that the rebound in yields is an abrupt normalization relative to nominal economic activity. This happened in reaction to the ebbing of deflationary fears. Expected inflation in US 10-year TIPS is up from this year’s low of 1.54% on January 13 to 1.86% on Tuesday. In addition, growth prospects seem to be improving in the US and Eurozone. While the ECB is committed to its QE program through most of next year, the Fed is likely to respond by raising the federal funds rate later this year. Expectations that the Fed will soon start normalizing monetary policy is another explanation for the abrupt normalization of bond yields.

Today's Morning Briefing: Bond Bath. (1) Blondes vs. bonds. (2) Bonds vs. bunds. (3) Where do we go from here? (4) From abnormal to less abnormal. (5) Deflation fears ebbing. (6) A simple bond model. (7) Draghi deserves credit and blame. (8) Dudley says Fed policy is market dependent. (9) Tranquility in the commodity pits. (10) Riding the Age Wave. (More for subscribers.)

No Soft Patch for Small Business (excerpt)

The NFIB survey of small firms reports a series reflecting the net percentage of business owners saying that their earnings were higher over the past three months versus lower. It has been negative since the start of the data in January 1986. It jumped last month to -7%, the highest reading since October 2005. It’s up from the series’ record low of -47% during January 2009.

Not surprisingly, the 12-month average of the earnings series is highly correlated with the NFIB small business optimism index. When small business owners are optimistic because their earnings are improving, they tend to hire workers. Sure enough, the percentage of small companies expecting to increase employment is up to 11.6%, the highest since February 2008. The percentage of small firms with job openings is up to 25.4%, the highest since December 2001.

The latest NFIB survey noted: “Owners report that the labor market is, from an historical perspective, getting very tight. Owner complaints about ‘finding qualified workers’ are rising, job openings are near 42 year record high levels, and job creation plans remain solid. Over 80 percent of those hiring or trying to hire in May reported few nor no qualified applicants.” In an obvious dig, the report added that there’s not much the Fed can do to increase the supply of qualified workers.

Today's Morning Briefing: Small Business Is Big. (1) Jury is out on soft-patch verdict. (2) No soft patch for small business owners. (3) Businesses create jobs, not governments. (4) Small businesses lead the way. (5) Corporate profits lead employment and capital spending. (6) Hard to find qualified workers. (7) Capital spending improving, but lagging. (8) A real jolt in JOLTS. (9) SMidCaps vs. LargeCaps. (10) Falling oil prices have had bigger impact on earnings than rising dollar. (11) Margins getting squeezed among SMidCaps as they ramp up hirng. (More for subscribers.)

China Remains Epicenter of Global Deflation (excerpt)

Monday’s WSJ included an article titled “Glut of Chinese Goods Pinches Global Economy.” The main point is that “China’s excess manufacturing capacity and slowing growth rate are … putting renewed downward pressure on prices.” I have been expounding on this theme for quite some time, so I obviously think the article is worth reading.

When China’s economy was booming, so did its demand for commodities. The result was the commodity super-cycle, which started in late 2001 after China joined the World Trade Organization on December 11 of that year. The super-cycle was briefly interrupted by the financial crisis of 2008. However, the Chinese government responded to it with a major fiscal stimulus program while the PBOC pumped lots of credit into the economy. Other governments and central banks did the same, but the Chinese led the way.

As a result, commodity prices soared again in 2009 through 2010. However, China’s factories turned expensive commodities into lots of cheap manufactured goods thanks to the availability of cheap labor. In other words, the trend in the so-called “China Price” was disinflationary, if not deflationary for the world economy. For the seven countries that report their CPIs by goods and services, durable goods prices have been falling steadily since the start of 2001: Eurozone (-1.7%), US (-12.5), UK (-13.7), Sweden (-21.6), Taiwan (-22.3), Switzerland (-23.9), and Japan (-43.7).

But China’s economic growth peaked during 2010, and labor costs started rising. The commodity super-cycle wasn’t so super, lasting just 10 years rather than 25-50 years. The subsequent drop in commodity prices since 2010 depressed commodity producers. Nevertheless, the China Price continues to fall as Chinese factories replace labor with automation. The 5/5 South China Morning Post included an article titled, “Building work starts on first all-robot manufacturing plant in China’s Dongguan.” A total of 1,000 robots will be installed at the factory, run by Shenzhen Everwin Precision Technology Co, with the aim of reducing the current workforce of 1,800 by 90% to only about 200.

To avert large-scale unemployment, the government continues to provide fiscal and monetary stimulus, which only worsens the excess capacity problem in manufacturing.

The WSJ article cited above reports, “Prices of all goods imported to the U.S. directly from China have fallen in 20 of the past 38 months, by 2.2% in all. For U.S. consumers, that is good news. But for policy makers and corporate executives, declining prices present a real challenge. The declines can sap profitability, deter investment and block wage growth, all of which are needed to help the world break out of its years of underwhelming growth.”

The article notes, as I have on a regular basis, that China’s PPI has declined on a y/y basis for 38 consecutive months. The PBOC has responded by easing credit conditions, which is likely to boost excess capacity by keeping “zombie” companies in business and by spurring even more capacity expansion.

Today's Morning Briefing: Blaming China. (1) No shortage of gluts thanks to China. (2) The epicenter of deflation. (3) Not so super super-cycle. (4) “China Price” remains deflationary as robots replace humans. (5) Deal or no deal? (6) Lots of big deals in healthcare, IT, and telecom. (7) Fed financing M&A mega-boom. (8) The fastest and easiest way to grow. (9) Challenging time for active managers. (10) Dividend-yielding stocks underperforming. (11) Focus on market-weight-rated S&P 500 auto-related industries. (More for subscribers.)

Central Banks Restore Wealth, Working on Growth (excerpt)

The major central banks of the world have been easing their monetary policies significantly since the financial crisis of 2008. They’ve succeeded in averting another financial crisis so far. They’ve also succeeded in recovering most of the fortunes that were lost during the crisis. For example, the total market value of all stocks traded in the US rose $22.7 trillion since Q1-2009 through the end of last year to $36.5 trillion. The S&P 500’s capitalization has increased $12.9 trillion during the bull market so far through last week. Both are at record highs, with the S&P 500 exceeding its 2007 peak by $5.0 trillion. All equity investors have benefited from the stock market rally.

Bond investors also enjoyed big gains as yields fell and prices rose. For example, US bond mutual funds had capital gains totaling $522 billion since the start of 2009. As we noted yesterday, the 12-month average of the median existing home price is up 29% since February 2012, while real estate held by households has increased by $4.2 trillion since then through the end of last year. Gold has also been golden, with a 118% rise in the price since the start of 2009 to its record high on September 6, 2011. It’s down 36% since then, but that’s hardly a sunken treasure for anyone who bought gold a few years ago.

Nevertheless, the central banks have been frustrated by the slow pace of the recoveries in their economies since the crisis of 2008. Reviving self-sustaining economic growth hasn’t been as easy as easing has been. Previously, I’ve argued that the ultra-easy monetary policies of the central banks might perversely have contributed to the slow pace of economic growth.

Today's Morning Briefing: Easy Come, Easy Go. (1) Elvis Presley and Janet Yellen. (2) Sunken treasures recovered. (3) Why easing hasn’t worked as expected. (4) Stock gains aren’t trickling down. (5) Savers earning less so saving more. (6) Fed has enabled fiscal excesses at cut-rate rates. (7) Near-zero interest rates contributing to income inequality. (8) Fed policies causing capital misallocation. (9) Enabling financial engineering. (10) The blame game. (11) Demography is also a downer. (12) Focus on market-weight-rated S&P 500 Industrials. (More for subscribers.)

How the Fed Depressed the Recovery (excerpt)

In my opinion, the Fed has significantly contributed to the weakness of the current economic expansion as follows:

(1) By keeping interest rates near zero for so long, risk-averse savers have had to accept bupkis for returns on their liquid assets, which rose to a record $10.7 trillion during the week of May 11. Many of them have been saving more, thus spending less. The 12-month sum of personal saving has been running around $700 billion since the end of the financial crisis in 2008, double the pace during the 1990s and the first half of the previous decade.

(2) Ultra-easy money attracted investors rather than nesters into the housing market following the 2008 crisis. They bought up all the cheap homes and drove home prices back up to levels that may be unaffordable for many first-time homebuyers.

(3) As I’ve discussed many times over the past year, thanks to the Fed, corporate bond yields have been trading below the S&P 500’s forward earnings yield since 2004, providing companies with an incentive to buy back their shares and engage in M&A rather than invest in plant and equipment.

Cheap money did stimulate some business investment, but the increased capacity wasn’t matched by more demand, resulting in some deflationary pressures. Stock prices have soared, but this has exacerbated the perception of widespread income and wealth inequality.

Today's Morning Briefing: Tiptoe Through the Soft Patch. (1) Tiny Tim and Janet Yellen. (2) Is the Great Recession over yet? (3) ECI wages get a footnote. (4) Yellen still worrying about underwater homes. (5) Three abating headwinds. (6) Fed sees 2.5% real GDP growth ahead. (7) Yellen is in one-and-done camp. (8) What’s the matter with Kansas? (9) Are the headwinds abating? (10) Here is how the Fed’s policies have depressed consumer and business spending, and housing activity. (11) What’s the matter with the dollar, bonds, and stocks? (More for subscribers.)

Signs of a Recovery in Eurozone Profits (excerpt)

The ECB isn’t buying stocks (just yet), but the bank’s officials are certainly doing their best to boost stock prices by depressing the euro and keeping a lid on interest rates. Last Thursday, ECB President Mario Draghi countered any notion that the bank’s QE might be tapered ahead of schedule. He was clearly concerned about the recent backup in bond yields, strength in the euro, and weakness in stock prices. To make sure everyone got the message, another member of the ECB’s executive board said on Monday evening that the bank will front-load some of its purchases of sovereign debt in May and June.

The forward earnings of the EMU MSCI seems finally to be turning up as both 2015 and 2016 earnings estimates have stopped falling recently. NERI turned positive during April (1.3) and rose to a five-year high in May (4.0) following 48 consecutive months of negative readings. The upturn is widespread including Germany, France, and Spain, though not Italy so far.

The weaker euro finally might be starting to boost profits in the Eurozone. There is probably more upside for the region over the rest of the year barring a Grexit.

Today's Morning Briefing: Central Planners. (1) Does kicking the can beat the alternative? (2) Why can’t a series of short-term fixes be a long-term fix? (3) The Greek example. (4) Central bankers have turned into central planners. (5) The latest plan is to do more of the same to drive up stock prices. (6) China’s new plan is to pump up stock prices. (7) BOJ buying ETFs. (8) Profits finally showing signs of life in Eurozone. (9) US lags while FOMC plays Hamlet. (10) What do Fed economists do all day? (11) Fed staff attacks Piketty and other Progressives. Read all about it! (12) Fed debates seasonal distortions. (More for subscribers.)

Valuation & the Fed Model (excerpt)

Valuation like beauty is in the eye of the beholder. With bond yields at historical lows, why shouldn’t valuation multiples be at historical highs? At 2%, the 10-year Treasury bond yield has an effective forward P/E of 50, implying that stocks trading at a forward earnings yield of 5.9% and a multiple of 17 are grossly undervalued by as much as 62%. Of course, this “Fed Model,” as I first named it back in July 1997, has been showing that stocks are undervalued since the Tech bubble burst. Furthermore, historically low interest rates may be a sign of secular stagnation, which isn’t particularly bullish.

Previously I’ve argued that valuations are being driven by equity purchasers who don’t pay much attention to valuations. They are corporate managers buying back their shares because the forward earnings yields on their shares exceed their borrowing cost of capital in the bond market. As far as they are concerned, beauty is measured by the appreciation of their stock price as they buy back their shares. In this scenario, the source of irrational exuberance is the ultra-cheap money available in the bond market for share buy backs and M&A thanks to the ultra-easy monetary policies of the Fed.

Today's Morning Briefing: Beauty Contest. (1) Episode 42 in The Twilight Zone. (2) Different strokes: Dear Leader vs. King Kong. (3) Some pushback on valuation. (4) Irrational Exuberance Zone. (5) The 3 scenarios again. (6) Channeling the Tech bubble. (7) Record PEG for S&P 500. (8) Smithers & Co. on Tobin’s Q. (9) Does valuation matter? (10) Do interest rates matter? (11) Draghi renews his vows. (12) Front-end loaded QE. (13) Lackluster recovery in Eurozone. (More for subscribers.)

Bond Market: Sprechen Sie Deutsch? (excerpt)

Yesterday’s much weaker than expected US retail sales report initially caused the 10-year US Treasury bond yield to fall in the morning. Then it spent the rest of the day moving higher. The comparable pesky German bond yield continued to move higher to 0.73% from its record low of 0.03% on April 17. The US bond yield has been joined at the hip with the German one all year.

While April’s payroll employment report put a Fed rate hike back on the table yet again for June, the retail sales report arguably took it off the table--yet again. That should have been bullish for bonds. Instead, the dollar took a dive on the soft-patch sales report. The weaker dollar lifted the prices of precious metals and oil (before crude oil inventory data depressed them), which also unnerved bonds.

A 2% bond yield looks attractive for the US 10-year Treasury given the subdued outlook for the Fed’s rate hiking. The problem is that if the German yield gets there, the US yield will be closer to 3%. That would make it even more attractive as long as you didn’t buy the bond at 2%.

Today's Morning Briefing: Consumers Not Registering. (1) Less “ka-ching” around the world. (2) A demographic theory of secular stagnation. (3) Older workers can’t depend on broke social welfare states. (4) May you live a long life and have lots of savings. (5) How governments depressed fertility. (6) US retail sales join the soft-patch batch. (7) China’s senior moment? (8) Japan, Italy, and Germany are at the top of median-age ranking. (9) Spotting some shoppers in Europe. (10) Bonds learning to speak Deutsche. (11) Focus on market-weight-rated S&P 500 Retail industry. (More for subscribers.)

What’s Driving Yields Higher (except)

Only a few weeks ago, we all figured out why bond yields had dropped close to zero in the Eurozone. It was mostly because the ECB implemented QE on March 9, and pledged to buy bonds yielding at least the same as the central bank’s deposit rate, which was lowered to minus 0.20% on September 4.

That hasn’t changed. So why the backup in bond yields? Maybe the markets have concluded that the ECB’s QE will avert deflation and boost the Eurozone’s economic growth. The rebound in oil prices certainly helped to allay some of the deflation concerns in the bond market.

Oil prices stopped falling on January 13. The price of copper stopped falling on January 29, and is up 18% since then. Both have been highly correlated with the US bond yield over the past year. The rebound in the price of oil may be a correction of a severely oversold condition. The supply/demand balance remains bearish, but turmoil in the Middle East is recurring and tends to add a risk premium to the price of oil.

The price of copper may reflect an improving global economy in general and a strengthening Chinese economy in particular. More likely, it reflects expectations that the Chinese government will provide lots of stimulus to revive China’s growth rate, which isn’t likely to happen.

Today's Morning Briefing: Major Tom & the Fed. (1) Ground Control has lost control of the bond market. (2) Bond yields should maintain current altitude for a while. (3) Stocks ready to go into outer space? (4) A simple theory for the backup in yields. (5) Close correlation between bond yield and oil and copper prices over past year. (6) US bond market no longer for isolationists. (7) Four Fed heads speak. (8) No big surprise in Q1 earnings season’s positive surprise. (9) Financials and Health Care sectors save the quarter. (10) Energy earnings crash and burn, but S&P 500 earnings up impressive 11.5% y/y ex-Energy. (More for subscribers.)

Yellen on the Wage Question (excerpt)

Fed Chair Janet Yellen has stressed the importance of wage inflation in influencing the FOMC’s decision to start raising interest rates. April’s average hourly earnings (AHE) for all workers rose just 0.1% m/m and 2.2% y/y. She has said that she would like to see 3%-4% wage gains, or be reasonably confident that they are heading in that direction. The three-month change in this measure of wages settled down to 1.8% (saar) during April from 3.6% during March. Nothing to get Yellen too excited, which seemed to get the stock market very excited on Friday.

However, Q1’s Employment Cost Index (ECI) for wages and salaries in the private sector--a more comprehensive measure of wages than the AHE rose 2.7% y/y, the highest since Q3-2008. The Phillips Curve, which posits an inverse relationship between wage inflation and the unemployment rate, is actually working much better with the ECI than the AHE measure of wages, especially compared to the short-term unemployment rate. (See Phillips Curve.)

Yellen is a big believer in the Phillips Curve. She said so in an important 3/27 speech: “A substantial body of theory, informed by considerable historical evidence, suggests that inflation will eventually begin to rise as resource utilization continues to tighten. It is largely for this reason that a significant pickup in incoming readings on core inflation will not [her emphasis] be a precondition for me to judge that an initial increase in the federal funds rate would be warranted. With respect to wages, I anticipate that real wage gains for American workers are likely to pick up to a rate more in line with trend labor productivity growth as employment settles in at its maximum sustainable level. We could see nominal wage growth eventually running notably higher than the current roughly 2 percent pace.” In a footnote, she cited four studies for “recent evidence on the relationship between labor market slack and wages.”

Today's Morning Briefing: Goldilocks' Godmother. (1) Janet & Hamlet: To lift or not to lift? That is the question. (2) Janet & Christine: High and mighty say stocks are mighty high. (3) Yellen’s dashboard shows labor market is cruising. (4) Phillips Curve may be starting to work, pointing to bigger wage gains. (5) April retail sales may settle soft-patch question. (6) Yellen’s latest assessment of stock valuation: It’s high. (7) Addictive fairy dust. (8) Another relief rally after latest feared outcomes turn out to be nonevents. (9) On the verge of a melt-up? (10) Energy, Materials, and Financials join the rally parade. (11) ECI vs. AHE. (More for subscribers.)

Why Are Bonds Taking a Dive? (excerpt)

US bond yields have jumped recently. The 10-year Treasury is up from a recent low of 1.87% on April 17 to 2.26% yesterday. Everyone is blaming that development on the spike in Eurozone bond yields, particularly the surge in the 10-year German government yield from its all-time low of 0.033% on April 17 to 0.58% yesterday. That’s despite the implementation of QE by the ECB starting on March 9.

With the benefit of hindsight, the backup in yields isn’t a surprise. Yields simply fell too low at the start of the year on fears that plunging oil prices might trigger widespread deflation, especially in the Eurozone, and maybe cause another financial crisis if oil companies started to default on their debts. Now that oil prices have rebounded, those concerns are evaporating and yields are normalizing. I think it’s that simple.

In any event, the backup in bond yields is doing the same to mortgage rates in the US. That could stall the already lackluster recovery in the housing industry, which might explain why lumber prices are falling. So maybe the Fed should postpone its lift-off given the lift-off in bond yields?

Today's Morning Briefing: Bonds Away? (1) Confused Fed heads. (2) More on the dark side than the light side. (3) Our collective conundrum. (4) A simple explanation why bond yields have surged. (5) Are bond traders expecting Fed lift-off, while forex players aren’t? (6) Wages might finally be rising faster, but gasoline prices are rising rapidly too. (7) Stocks, bonds, and currencies could be choppy through the summer. (8) FOMC members expecting much better growth may be disappointed. (9) ADP payrolls especially weak for large goods-producing companies. (10) Oil and dollar hitting capital spending on construction and industrial machinery. (11) Focus on overweight-rated S&P 500 Financials. (More for subscribers.)

Industrial Commodities Still Sinking (excerpt)

There’s no party in the commodity pits. While the price of a barrel of crude oil has rebounded smartly from a low of $46.59 on January 13 to $62.84 yesterday, the CRB raw industrials spot price index continues to slip and slide. In the past, the weakness in the CRB index would have been a bearish omen for stock prices. It still might be, but the monetary liquidity that isn’t boosting global economic growth and commodity prices is fueling bull markets in stocks and bonds. Consider the following:

(1) From 2005 through mid-2011, there was a reasonably good correlation between the S&P 500 and the CRB index. The two have diverged since then, with the S&P 500 heading higher to new record highs, while the commodity index has been trending lower and is now at the lowest since February 8, 2010.

(2) Since late 2001, there has been a very good correlation between the Emerging Markets MSCI stock price index (in local currencies) and the CRB index. The two have diverged significantly over the past year, with the former only 2.6% below its 2007 record high. Leading the way since early 2014 has been India in anticipation of a new reform-minded government headed by Prime Minister Narendra Modi, whose party won election last May.

Since mid-November of last year, when the PBOC started to ease monetary policy, the China MSCI stock price index has also joined the global melt-up parade. It had been very highly correlated with the price of copper since 2009. They too have diverged over the past year. This is yet another sign that ultra-easy monetary policy is boosting asset inflation rather than real growth and price inflation.

Today's Morning Briefing: Go Away or Go Global? (1) Nice melt-up overseas. (2) Days of Infamy: May Day to Halloween. (3) Two wicked corrections. (4) Three choices: Stay Home, Go Global, or Go Away. (5) Sunrise in Japan? (6) Can central banks overcome secular stagnation? (7) Not much fun in the commodity pits. (8) Unusual divergence between stock prices and commodity prices. (9) Lumber trading like lead. (10) China’s international reserves depressed by depreciations of euro and yen. (11) China’s capital outflows story still rings true. (More for subscribers.)

Churning (excerpt)

So far so good. In the 2/2 Morning Briefing, I wrote: “[T]he stock market may continue to trade in a volatile range during the first half of this year. The main negative for stocks is that valuation multiples are historically high, while earnings growth estimates are declining in the face of a strong dollar, weakening commodity prices, a flattening yield curve, and slowing global economic growth. The big positives are that bond yields are at historical lows and the plunge in oil prices is boosting consumer confidence and spending. Joe and I are still targeting 2150 for the S&P 500 by the end of this year and 2300 by the middle of next year.”

Yesterday, Kristen Scholer posted a story on the WSJ website titled “Why Record Highs May be Harder to Come By This Year.” She observed: “The Dow Jones Industrial Average and S&P 500 set 188 fresh all-time highs, or the equivalent of roughly one every five trading sessions, during 2013 and 2014. This year, though, the major indexes have booked only nine historic highs as stocks have moved sideways for much of 2015. … It has been 34 sessions since the S&P 500 last finished at a historic high. That’s the index’s longest streak without an all-time high since the first record of the current bull market in 2013, according to Bespoke Investment Group.”

Why has this been happening? According to the article: “Corporate buybacks, deals and low interest rates have kept equities afloat, while stalled earnings growth, high valuations and slowing economic activity have put a lid on gains.” If that sounds like the same story I’ve been telling, then I should disclose that I was interviewed for the WSJ story and mentioned as follows: “He thinks the tug of war between the bulls and the bears will continue through the summer and into the fall. ‘While some institutional investors might be inclined to sell due to overvaluation, the most significant buyers continue to be corporate managers buying back their shares, and they aren’t nearly as sensitive to valuations,’ he said.”

At the beginning of 2013, in the 1/29 Morning Briefing, which was titled “Nothing to Fear but Nothing to Fear.” I noted: “In recent discussions, some of my professional friends told me they are now worrying that there is nothing to worry about. They note that there may be too many bulls for the good of the bull market.” I also noticed that many of them had “anxiety fatigue.” After the widely feared Fiscal Cliff was averted, investors seemed to be less prone to anxiety attacks. In other words, they were less prone to sell on bearish news, and more likely to hold their stocks and add to their positions on any weakness.

Now they seem to have “bull market fatigue” because valuations are stretched. Nevertheless, they are mostly staying fully invested. Consider the following:

(1) Anxiety fatigue. Since the start of the year, the S&P 500 has been trading between a record high of 2117 on March 2 and a low of 1992 on January 15. There have been lots of panic attacks since 2013, but none that turned into significant corrections. Recent worries that the plunge in the oil price might trigger a rout in the junk bond market haven’t panned out. China’s latest batch of weak economic indicators has been mitigated by the PBOC’s easier monetary policy. The winter/spring economic slowdown in the US increases the odds of a “one-and-done” or “none-and-done” rate hike by the Fed this year.

(2) Moving averages. The S&P 500 has remained above its still-rising 200-day moving average after briefly retesting it in early October last year. The S&P 500 Transportation index is currently back to its 200-dma. That’s a bit of a concern from a Dow Theory perspective, especially since the index’s 50-day moving average has turned down since it peaked on January 22.

(3) Melt-up worries. Interestingly, in recent conversations with our accounts, I am finding that more of them are worrying about missing a melt-up in stock prices than about dodging a correction or a meltdown. What might trigger a melt-up? The obvious answer is a significant postponement of monetary normalization by the Fed. A more likely scenario is that the initial lift-off in interest rates might cause corporations to stampede into the bond market to raise funds for more buy backs and M&A.

Today's Morning Briefing: Paths of Least Resistance. (1) Going nowhere fast. (2) Tug of war. (3) From “anxiety fatigue” to “bull market fatigue.” (4) Still too many bulls. (5) Home on the range. (6) Sector-neutral strategy beating many active managers. (7) Melt-up anxiety. (8) Hard to find anything bullish in crude oil’s demand/supply balance. (9) Maybe it’s geopolitical. (10) Saudis playing for keeps. (11) Focus on market-weight-rated S&P 500 Energy. (More for subscribers.)

Dollar's Turn? (excerpt)

On balance, there still looks to be more stagnation around the world than either a boom or a bust. So how can we explain the remarkable rebound in oil prices in recent weeks? The nearby futures price of a barrel of Brent crude has risen from its recent low of $45.59 on January 13 to $63.45 on Friday.

That’s despite record production by Saudi Arabia, all-time highs in crude oil inventories, gushing US oil production, and the possible end of sanctions against Iran. Could it be that the global economy is improving more than widely recognized? I doubt it. There’s certainly no confirmation of this possibility in the CRB raw industrials spot price index, which continued to edge lower last week, and now is the lowest since February 2010. This index does not include any petroleum or lumber commodities.

The apparent bottoming of oil prices is coinciding with the apparent peaking in the trade-weighted dollar. Previously, I’ve often observed that the two are highly inversely correlated. The dollar may be peaking on expectations that the Fed’s policy stance over the rest of the year is more likely to be “one-and-done” or even “none-and-done” than normalization, notwithstanding the recent upbeat views of two Fed officials (Stanley Fischer and Bill Dudley) about the US economic outlook. I am in the one-and-done camp for now.

The strong correlation may occur because rising (falling) oil prices increase (decrease) the dollar revenues of oil exporting countries. Many of them prefer to diversify their currency holdings so when they get lots of dollars, they tend to convert them to other currencies, which weakens the dollar. The reverse happens when they earn fewer dollars on their oil exports.

The currency markets are turning bullish not only for oil but also for other commodities, suggesting that there may be mounting expectations of better global economic activity. A few of the commodity currencies--i.e., the Canadian dollar, Brazilian real, and Russian ruble (thanks to the oil price rebound)--have been rallying in recent days. However, that’s after significant selloffs over the past year or so. On the other hand, the Australian dollar and the South African rand have simply stopped falling in recent days.

Today's Morning Briefing: Uneven Growth.(1) Ups and downs in IMFs latest forecast. (2) Redistributing the same growth. (3) Draghi’s push. (4) Rising in the EZ: production, exports, and car sales. (5) Fischer and Dudley expect more. (6) Weakening in the US: production, orders, and starts. (7) Stepping on the gas and the brakes in China. (8) Data suggest massive capital outflows from China. (9) India is looking up, while Brazil is looking down. (10) Industrial commodities yet to confirm oil’s rebound. (11) Has the dollar peaked because oil has bottomed, or vice versa? (More for subscribers.)