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.)

US Economy: Small Is Beautiful (excerpt)

Notwithstanding politicians’ claims, businesses create jobs, not Washington. To be more exact, it is small businesses started and run by entrepreneurs that create most of the jobs in our economy.

ADP, the payroll processing company, compiles data series on employment in the private sector of the US labor market by company size. The series start during January 2005. Since then through June 2015, small companies with 1-49 employees added 5.1 million workers and had payrolls totaling 50.2 million. Medium-sized companies with 50-499 employees added 3.8 million workers and had payrolls totaling 43.0 million. Large companies with 500 workers or more cut 234,000 from their payrolls, which totaled 26.5 million.

Small and medium-sized companies currently account for 42% and 36% of private payrolls, according to ADP. Large companies account for just 22% of total private payrolls, down from 24% at the start of 2005.

This is really remarkable data. It suggests that if Washington’s policymakers really and truly want to create jobs they should provide a favorable business climate for small and medium-sized companies. The best way for Washington to do that is to cut their taxes and reduce their regulations. That’s what small business owners tell the folks at the National Federation of Independent Business (NFIB) who poll them monthly about business conditions. When asked about their biggest problems, the average responses over the past six months through June showed 22.0% and 21.8% complaining about taxes and government regulation. Only 11.3% said that sales are poor, while merely 2.2% said that credit conditions are tight.

Today's Morning Briefing: Entrepreneurial Capitalism at Work. (1) Who actually creates jobs? (2) ADP data show that small and medium-sized companies do most of the hiring. (3) Be nice to small business owners. (4) NFIB survey data show profits drive employment and capacity cycles. (5) National unemployment rate closely correlated with NFIB indicators. (6) Wage inflation should be higher given all the job openings. (7) Barack, Elizabeth, and Hillary spout the party line. (8) Entrepreneurial vs. crony capitalism. (9) SMidCaps have led the bullish charge. (10) Morgan Stanley warns that China could cause next global recession. (11) Still muddling along. (12) Focus on market-weight-rated S&P 500 Information Technology. (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.)

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.)

Happy Fourth of July! (excerpt)

In addition to barbeques and fireworks, the Fourth of July weekend is also a big one for big discount sales. Consumers are certainly in a happy mood. The Consumer Confidence Index rose from 94.6 during May to 101.4 during June, remaining near recent cyclical highs. The labor market continues to improve, with the percentage of consumers saying that jobs are plentiful at 21.4% last month, a new cyclical high and the best reading since February 2008.

An index of pending existing home sales rose in May to the highest since April 2006. That’s yet another sign of improving consumer confidence. The puzzle, though, is that Census data on household formation show that they continue to be all renters. This suggests that most of the housing transactions are between younger current owners who are trading up and older current owners who are trading down. First-time homebuyers seem to be missing in action. That may be because the Millennials are saddled with student debt, postponing getting married, and renting apartments in cities, as we discussed last week.

Finally, I should note that the five available regional business surveys for June are showing an upturn from their winter/spring soft patch. The average of the composite business indexes for the Fed Districts of New York, Philadelphia, Richmond, Kansas, and Dallas rose to 0.7 last month, the first reading above zero since February. That’s still relatively weak, suggesting that there may still be some soft spots in the economy. The Dallas survey is especially weak because the oil industry in Texas has been hard hit by lower oil prices.

Today's Morning Briefing: Land of the Free, Home of the Brave. (1) Fireworks on July 4 in US, July 5 in Greece, and July 6 in the markets. (2) Another panic attack followed by another relief rally? (3) Greece will either be kicked out or kicked down the road. (4) US fundamentals improving relative to rest of world, but valuation is a problem. (5) S&P 1500 forward earnings bottoming and turning up. (6) Consumers are in a spending mood as labor market continues to improve. (7) Housing sales looking up, although all new households are renting. (8) Trading up and down. (9) Regional business surveys still show a few soft spots. (10) Focus on market-weight-rated S&P 500 housing-related industries. (More for subscribers.)

The Productivity Puzzle (excerpt)

There is something very odd about the productivity numbers. They don’t make much sense. Productivity growth seems awfully weak given all the news articles about robots, automation, drones, the Internet of Things, and all the apps that are enabling everyone to work more efficiently.

The real output of the nonfinancial business (NFB) sector recovered from the last recession during Q4-2011, when it first exceeded the previous cyclical peak. Since then through Q1-2015, it is up 10.3%. Over this same period, NFB productivity is up only 2.3%. In other words, an 8.0% increase in hours worked accounted for most of the increase in output. On a y/y basis, real NFB output has been hovering around 3% since mid-2010. Over the same period, hours worked has been growing around 2%, while productivity has been rising around just 1%.

My hunch is that the output of the services-producing industries may be undercounted. Alternatively, productivity may be particularly weak in these industries. The easiest and best productivity gains in services-producing industries may have been gotten, and extracting more out of them is getting harder to do. Here are the relevant data points:

(1) The ratio of real GDP for goods to goods-producing payroll employment was at a near-record high of $267,810 per worker during Q1 (saar), up 1.7% y/y. The similar ratio for services rose to $81,372 per worker, down 0.1% y/y.

(2) Since the start of the data in 1947, the goods-producing “productivity” ratio is up a whopping 908%, while the comparable rate for services is up only 77%.

Today's Morning Briefing: Everyday Low Price. (1) EDLP. (2) Walmart stuffing labor costs down supply chain. (3) Is the Phillips Curve right about wage inflation, but wrong about price inflation? (4) S&P 500 Hypermarkets & Super Centers are getting squeezed. (5) Other retailers still showing upbeat metrics. (6) Is there something wrong with the productivity stats? (7) Productivity ratio falling recently in services. (8) Global economy muddling along in the mud. (9) US economy still has some soft spots. (10) Eurozone’s M-PMIs more upbeat than actual production. (11) Submerging economies. (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.)

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.)

US Housing: Breaking Ground? (excerpt)

Many years ago, before China emerged, the price of copper was driven mostly by demand from the US housing industry. Could it be that US housing starts are taking off, which is why copper is firming? Let’s review some of the related indicators:

(1) Employment. Residential construction payrolls rose 23,600 during April. That was the best monthly increase since the start of the current housing expansion. However, that followed a decline of 1,800 during March, the first decrease since May 2012. Then again, total residential construction employment rose to 2.45 million, the highest since January 2009.

(2) Railcar loadings. On the other hand, railcar loadings of lumber and wood products are consistent with the current subdued pace of housing starts.

(3) Lumber prices. While both are volatile, there is a decent correlation between the nearby futures price of lumber and the S&P 500 Homebuilding stock price index. I have found that an average of the two is highly correlated with housing starts. The average is down 14.4% ytd.

Today's Morning Briefing: Breaking Bad? (1) China’s stock market turns volatile as P/Es surge. (2) The “insanity” trade in China. (3) PBOC warns about too much debt as it cuts interest rates. (4) China suffering from too much capacity, too much debt, too much deflation, too much pollution, and too many seniors. (5) Professor Copper is bullish on China and bearish on bonds. (6) Is housing turning up or down? (7) Payrolls say “up,” while lumber futures say “down.” (8) Brexit and Grexit? (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.)

S&P 500 Forward Earnings Driving Economic Slowdown (excerpt)

There are lots of correlations between S&P 500 forward earnings and several key economic indicators. The former dropped sharply late last year and early this year as Energy industry analysts slashed their earnings estimates for this year and next year.

While the plunge in oil prices accounts for much of the weakness in forward earnings since last fall, the soaring dollar has also weighed on earnings. Corporate profits tend to be the key driver of employment and capital spending. Profitable companies tend to expand their payrolls and capacity. Unprofitable companies don’t do so.

This explains why there is such a good correlation between the y/y growth rates of forward earnings and aggregate weekly hours. Forward earnings is also highly correlated with total factory orders as well as nondefense capital goods orders excluding aircraft. The weakness in forward earnings confirms that the slowdown in US economic growth so far this year wasn’t attributable just to the icy winter. Spring’s economic indicators remain disappointing so far.

The profits picture should brighten a bit if the dollar has peaked and oil prices have bottomed. The US economic outlook should also brighten in this scenario. However, don’t expect a boom.

Today's Morning Briefing: Forward Thinking. (1) Six degrees of separation. (2) LinkedIn and the kindness of strangers. (3) Correlations and divergences. (4) Industrial commodity prices aren’t confirming oil rally. (5) The oil price might have bottomed and peaked. (6) The dollar might have peaked. (7) Don’t buy into A$, C$, and gold rallies. (8) Expected inflation rebounding. (9) Forward earnings flagging, and so is economy. (10) Profitable companies expand. Unprofitable ones don’t. (11) Neither boom nor bust. (12) Focus on now underweight-rated S&P 500 housing-related industries. (More for subscribers.)

Will Robots Bend the Phillips Curve? (excerpt)

There’s an important debate about wage inflation. The inverse relationship between wage inflation and the unemployment rate is known as the "Phillips Curve." It makes sense that wage inflation would rise or fall depending on whether the unemployment rate was relatively low or high. However, I have been arguing that the Phillips Curve might not work as well given increasing globalization, innovation, and competition.

In his Barron’s column this week, Gene Epstein argues that wage growth is about to take off. He bases this forecast on a version of the Phillips Curve model devised by Jason Benderly of Applied Global Macro Research. In addition to the level of the unemployment rate, this model includes the change in the jobless rate, labor productivity, and the after-tax profit margin.

I note that the unemployment rate remained at 5.5% during March, the lowest since May 2008, yet wage inflation remained subdued for all workers at 2.1%, while falling recently to 1.8% for production and nonsupervisory workers. On the other hand, as we noted last week, wage inflation over the past three months through March for all workers jumped to 3.9% (saar), the highest since December 2008. That might have reflected the one-shot impact of the widespread hike in the minimum wage at the start of the year. Or else, the Phillips Curve is starting to work, finally.

If it’s different this time, then robots might be one of the reasons. The 4/23 WSJ reported that in Oxnard, California, “A 14-arm, automated harvester recently wheeled through rows of strawberry plants here, illustrating an emerging solution to one of the produce industry’s most pressing problems: a shortfall of farmhands.” The 4/24 NYT reported, “Faced with an acute and worsening shortage of blue-collar workers, China is rushing to develop and deploy a wide variety of robots for use in thousands of factories.”

Today's Morning Briefing: Great Debates. (1) The link between easy money and secular stagnation. (2) Summers vs Rogoff. (3) Debt super-cycle. (4) Time heals all wounds. (5) Asia’s debt binge. (6) Glut of gluts. (7) Will China solve its debt problem with a stock bubble? (8) Lots of burdensome debt burdens in Japan, Eurozone, and China. (9) US corporations borrowing for financial engineering. (10) A cold spring following an icy winter. (11) Dallas slipping on oil. (12) Are robots bending the Phillips Curve? (13) Lots of debatable subjects including Fed, oil, dollar, Grexit, MENA, and the meaning of life. (More for subscribers.)

From Ice Patch to Soft Patch (excerpt)

The performance of the US stock market is quite impressive considering that there isn’t much of a spring in the latest batch of economic indicators. The winter’s ice patch is looking more and more like the spring’s soft patch--all the more reason to expect either one-and-done or none-and-done from the Fed. Consider the following:

(1) Business surveys. Three of the six regional business surveys that I track are available through April. The averages of their composite indexes tend to be highly correlated with the national M-PMI. The average for the FRB districts of Kansas City, New York, and Philadelphia fell to -0.2 this month from 2.6 last month and a recent peak of 18.8 during November of last year. It’s the lowest since May 2013.

The average of the three new orders indexes was -5.8 this month, about the same as last month’s -6.2, which was the lowest since October 2012. The employment index fell to 1.0, the lowest since November 2013.

(2) Flash M-PMI. The national flash M-PMI compiled by Markit fell from 55.7 in March to 54.2 this month. The ISM’s M-PMI was much weaker than Markit’s reading in March. The same is likely this month given the weakness of the available regional surveys so far.

(3) Durable goods orders. The weakness in the regional orders indexes was confirmed by Friday’s release of March durable goods orders. While the overall number rose 4.0% m/m, boosted by a surge in aircraft orders, nondefense capital goods orders excluding aircraft fell for the seventh consecutive month through March, by a total of 6.7%. Orders have been especially weak for primary metals, fabricated metal products, machinery, and electrical equipment, appliances, and components. That probably reflects the combined depressing impact of lower oil prices on the energy industry and the higher dollar on exports.

(4) Lumber prices. In recent days, I’ve noted the plunge in lumber prices since the beginning of the year through Wednesday. That’s not a good omen for housing starts or the S&P 500 Homebuilding Index. Neither is the flat trend in railcar loadings of lumber and wood products over the past year. New home sales fell 11.4% m/m during March.

Today's Morning Briefing: Conspiracy Theories. (1) Compelling narratives without any proof. (2) The central bankers are doing it in broad daylight. (3) Bonds and stocks achieve “escape velocity,” while economies don’t. (4) Connecting the dots in Chicago. (5) Fed’s bunker in Chicago. (6) Bernanke’s new job in Chicago. (7) Spoofing the CME in Chicago. (8) Crash Boys: Michael Lewis has some questions for CME & CFTC. (9) Meet Sarao and Aleyniko. (10) Goldman’s sinister algorithm. (11) The stock market is high on life. (12) More soft-patch indicators in the US. (13) Flash-fried PMIs. (14) “House of Clinton” (+ + +). (More for subscribers.)

Inflation Warning (excerpt)

Last week, the 4/16 WSJ reported: “U.S. wages may be starting to pick up, a development that could help policy makers at the Federal Reserve feel more confident that sluggish U.S. inflation also will gain traction, Fed Vice Chairman Stanley Fischer said Thursday.” He said so on a panel discussion in Washington. That same morning, in a CNBC interview, he said the Fed knows the markets “look ahead somewhat, so I think--I hope--that they are taking into account that the Fed, at some point, is likely to raise the interest rate.” On timing, he said markets “can’t depend on the current situation continuing forever--or even probably--beyond the end of this year.”

He reiterated that “there are more signs every day” of mild wage increases. What is he looking at? Let’s have a look:

(1) Minimum wage. Anecdotally, the minimum wage was raised in 21 states at the start of the year. However, during March, average hourly earnings rose only 2.1% and 1.8% for all workers and for production and nonsupervisory workers.

(2) McDonald’s. On 4/15, fast-food cooks and cashiers demanding a $15 minimum wage walked off the job in 236 cities in what organizers called the largest mobilization of low-wage workers ever. On April 1, McDonald’s announced plans to give employees a 10% pay bump and some extra benefits. The raise will affect about 90,000 workers at a small fraction of McDonald’s stores. Employees at franchises, which make up the majority of the burger chain's locations, won't be affected.

(3) Walmart. At the start of April, Walmart raised its minimum starting wage to $9 an hour, 24% higher than the federal minimum. A 4/10 story on PBS NewsHour noted, “The company says that its wage increases will impact 500,000 workers, but the number who will see their wages rise from the federal minimum of $7.25 to $9 is much smaller. Only 5,000 of its 1.4 million workers actually make the minimum wage. And the minimum in most of the country, 29 states, is already considerably higher than the federal minimum. Seven states and the District of Columbia have minimums of $9 or higher. So the average pay raise for the affected Walmart workers will be far less than the 24% raise for the very small number currently earning the federal minimum.”

(4) Quit rate. The quit rate in retailing tends to be relatively high, especially among low-paid workers. Retailers are raising their wages to reduce their labor turnover costs.

(5) Q1 wages and prices. Average hourly earnings for all workers rose 3.9% (saar) during the first three months of the year, the highest since December 2008. That’s the kind of y/y increase that Fed officials have said would allow them to normalize monetary policy sooner and at a faster clip.

In addition, the core CPI inflation rate edged back up to 1.8% during March, closer to the Fed’s 2% target--which is really for the core PCED, which was 1.4% during February. The three-month annualized change in the core CPI through March was 2.3%, suggesting that the core PCED, which was 0.9% through February, might show a higher increase when March data are released on Thursday, April 30.

Today's Morning Briefing: The Twilight Zone. (1) Valuations on the border of the Irrational Zone. (2) Three fears hit market: Greek exit, China bubble, and inflation uptick. (3) Recapping stretched valuations. (4) Institutional investors remain skeptical. (5) Outperforming SMidCaps less exposed to dollar. (6) Shortage of bargains. (7) Buybacks = Corporate QE. (8) Corporate execs comparing earnings yield to borrowing rate when buying back shares. (9) Warning: Inflation may be warming. (More for subscribers.)

US Consumers: Chill in the Air (excerpt)

Yesterday’s March retail sales report was certainly disappointing. It suggests that the winter’s big chill has turned into the spring’s sloppy soft patch. Bond yields fell on the news, which might force the Fed to postpone liftoff from mid-year to later this year.

The weakness in retail sales from December through February didn’t jibe with the strength in employment and consumer confidence. Another surprise was that the windfall from falling gasoline prices didn’t show up in better spending in other retail categories. Then March employment data turned weak, and the month’s 1.0% gain in retail sales excluding gasoline (to a new record high) wasn’t much of a spring rebound following the 0.8% decline from December through February. Even worse, on an inflation-adjusted basis, core retail sales (excluding autos, gasoline, and building materials) fell 1.3% saar during Q1.

What’s the problem? It might be our health. American consumers now spend a record $8,066 per capita annually on health care. Thanks to Obamacare, we are all paying more to the piper. The out-of-pocket costs of health care have increased significantly, with higher premiums and co-pays and bigger deductibles. Unfortunately, it’s hard to quantify this because statistics are not available. The government’s data show total spending on health care without showing payments made by the government, insurance companies, and consumers.

Today's Morning Briefing: Paying the Piper. (1) T-Day! (2) Road crews filling potholes on a hit-or-miss basis. (3) It’s good to be king. (4) Who pays taxes? (5) From winter’s ice patch to spring’s soft patch. (6) Postponing liftoff? (7) Not much spring in March retail sales. (8) Health care out-of-pocket outlays infecting retail sales? (9) Excluding energy, revenues growth holding up. (10) Lots of geopolitical hot spots. (11) Talking points vs. wish lists. (12) Focus on market-weight-rated S&P 500 Retail. (More for subscribers.)

Have Profit Margins Peaked? (excerpt)

Both the S&P and the US Bureau of Economic Analysis reported that profit margins dipped during Q4-2014. The former was at 10.2%, while the latter was at 10.4%. But both remained near their record highs of the previous quarter. One of our accounts observed that data that I compile are showing a possible peak in the forward profit margins of the S&P 500/400/600. That’s not so clear for the S&P 500, where the margin peaked at a record high of 10.8% during the week of December 4, 2014. It did dip recently, but edged up over the past few weeks back to 10.6% in early April.

The dips are more noticeable and remain underway for the SMidCaps. For the S&P 400, the forward profit margin is down from last year’s peak of 6.7% during the week of June 19 to 6.2% currently. For the S&P 600, it is down from the 2013 peak of 6.1% during the week of October 3 to 5.5% currently.

The perceptive fellow who brought this to our attention wondered why margins seem to be coming down more for smaller than for larger firms. That’s a good question, assuming that the forward profit margins accurately reflect the situation. We think so. We calculate the data by dividing forward earnings by forward revenues.

The pace of employment has picked up over the past year. ADP data through March show that payrolls are up 2.9 million y/y, with large companies adding 546,000, medium-sized companies adding 1.0 million, and small companies adding 1.3 million. The additional payrolls may squeeze margins more for small firms than for large firms simply because add-to-staffs are more significant to the budgets of the former than the latter.

In any event, profit margins may be peaking across the board, though they aren’t likely to tumble until the next recession. If they have peaked, then profits growth will be determined mostly by revenues growth, which is likely to be below 5% this year and next year.

Today's Morning Briefing: On the Margin. (1) More stagnation than boom or bust. (2) Commodity prices stabilizing. (3) Six cylinders firing in Eurozone, but recovery remains lackluster. (4) Waiting for US consumers to spend gasoline windfall. (5) Japanese output remains disappointing. (6) Chinese exports and imports are shockingly weak. (7) Bad news for Brazil. (8) Signs of profit margin peak, especially for SMidCaps. (9) Hillary’s challenge: Six out of 10 say junk Obama policies. (10) Focus on underweight-rated S&P 500 Materials. (More for subscribers.)

April Employment Report Will Be Key to Fed (excerpt)

Until the March report, the past few monthly employment reports indicated that the economy was performing better than suggested by other economic indicators. Turns out that not only was March weak with a nonfarm payroll gain of only 126,000 but January’s advance was revised down by 38,000 to 201,000 and February’s was lowered by 31,000 to 264,000.

Those are the first back-to-back downward revisions since February/March 2011 (based on first-reported data). Downward revisions tend to occur when the economy is contracting. They are rare during expansions. Since 2011, there have been only 9 downward revisions but 41 upwards revisions. If the weather is to blame for the latest reductions, that’s not a problem.

It’s hard to find much positive news in the March report. The household employment survey found that full-time jobs rose 190,000 to a new cyclical high, while part-time positions fell 170,000. That’s good, but total household employment rose just 34,000 during March. The labor force fell 96,000.

Bad weather seems to have had some impact on depressing employment during the first three months of the year. But so did the strong dollar, weak oil prices, and slow economic activity abroad. The dollar may be starting to stabilize, and the price of oil may be bottoming. Economic activity seems to be improving in the Eurozone.

In any event, I expect that April’s employment report should show a spring rebound. If so, then the Fed would remain on course for one-and-done for this year, if not in June then in September.

Today's Morning Briefing: Forecasting Jobs & the Weather. (1) March employment changes outlook for Fed’s liftoff again. (2) Both “one-and-done” and “none-and-done” more likely again. (3) Earned Income Proxy froze in March. (4) Was it a worse winter than normal? (5) Green shoots. (6) Unusual downward revisions in payrolls. (7) Globalization reduces reliability of Phillips Curve. (8) Not much wage inflation in US or Japan. (9) Deal or no deal with Iran? (10) English vs. Farsi. (11) Saudis raising their price. (12) Oil still gushing in US. (13) “Effie Gray” (+). (More for subscribers.)

Is US Economy Coming Out of Ice Patch? (excerpt)

On March 18, I observed that spring is coming. Just as I predicted, it started two days later on March 20. On the other hand, the latest batch of economic indicators for March suggests that I may have been too optimistic when I wrote: “I agree with Chauncey Gardiner’s prediction: ‘In the spring, there will be growth.'”

I argued that the economy’s weakness during the first two months of the year reflected an ice patch rather than a soft patch. There are still grounds for optimism as the ground thaws. However, the latest data suggest that it could be a cold spring:

(1) Business surveys. Yesterday we learned that the latest survey of manufacturing purchasing managers showed a decline in the M-PMI to 51.5 during March from 52.9 during February. I wasn’t surprised since the overall index is highly correlated with the average of the composite indexes for the six available regional business surveys. This average fell to -0.1 during March, the lowest since April 2013.

The same can be said for the orders and employment components of the national and average regional surveys. The average regional orders index was especially weak in March, falling to -9.6, the lowest since May 2009. The national orders index (51.8) wasn’t as weak, but it was down from February (52.5). The national employment index (50.0) was weaker than suggested by the regional average, which edged higher during March.

It’s getting harder to blame the weather. Of course, other factors are working to slow the economy. The strong dollar’s negative impact is visible in the M-PMI’s new exports component, which dropped to 47.5 in March, the lowest reading since November 2012. The plunge in oil prices may be depressing energy-related new orders as well as production.

(2) Employment. Yesterday, we also learned that the ADP measure of private payroll employment rose 189,000, the weakest since January 2014. It may be that energy-related employment is taking a hit from the drop in oil prices. The four-week average of jobless claims in North Dakota, Ohio, Pennsylvania, and Texas has spiked up recently from 41,210 near the end of last year to 54,408 in mid-March.

Today's Morning Briefing: Ice & Soft Patches. (1) Full steam ahead on ECB’s QE. (2) ECB facing self-inflicted bond shortage. (3) Negative yields at the short end of the yield curve. (4) Questioning the necessity of ECB’s QE. (5) Taper talk already. (6) Central bankers co-opt the bond market that was once ruled by Bond Vigilantes. (7) Will there be growth in the spring? (8) March business surveys mostly downbeat. (9) Energy-related job losses weighing on ADP payroll gains. (10) Personal income strong, while spending is weak. (11) March data will be key, with auto sales auguring well for spring spending. (12) Focus on market-weight-rated S&P 500 auto-related industries. (More for subscribers.)

Inflation Remains Below Target (excerpt)

So what is inflation doing? February’s inflation data released in yesterday’s personal income report show that the core PCED remains stuck about half a point below the Fed’s 2% target for this variable. It was up 1.4% y/y during February, and has been hovering around 1.5% for the past 10 months. However, over the past three months through February, the core PCED increased 0.9% (saar), the third consecutive reading below 1.0%. It may be hard for Fed officials to be reasonably confident that inflation is heading higher given the trend of the recent three-month inflation rates.

The persistence of the core inflation rate below 2% despite ultra-easy monetary policy in the US and elsewhere over the past six years is certainly puzzling Fed officials. Nevertheless, rather than reassessing their models of inflation, they continue to expect that a tightening labor market will boost wage inflation soon, which then will boost price inflation. In other words, they continue to bet on the Phillips Curve model.

I have argued on many occasions over the past couple of years that there may be structural forces at work (such as globalization, competition, and innovation) keeping a lid on inflation. If so, then maintaining ultra-easy monetary policy to boost wage and price inflation may instead boost asset inflation. Indeed, easy money actually may be deflationary by boosting supplies of goods and services more than the demand for them, as I’ve discussed before. Let’s have a closer look at the latest price inflation data:

(1) Inflating, disinflation, & deflating. The PCED is based on prices in the CPI, but with different weights that are more reflective of actual consumer spending. The core CPI inflation rate tends to exceed the core PCED inflation rate. The former was 1.7% y/y during February, while the latter was 1.4%.

The services components of the CPI and PCED rose 2.4% and 2.1% during February. Both have disinflated by about 50bps since early 2014. Nondurable goods prices including energy are deflating--down by about 4% y/y. Durable goods prices are also deflating--down 1.6% in the CPI and down 2.6% in the PCED.

(2) Devil in the details. One of the main reasons why services inflation is lower in the PCED than in the CPI is because medical care services inflation is lower in the former (currently 0.8%) than in the latter (currently 1.8%). Both have been disinflating in recent years. It’s not obvious to us why the Fed would want to see this component of inflation rise to achieve its 2% target.

On the other hand, rents have been rapidly inflating in recent years based on the CPI (3.5%) and PCED (3.4%), with both at the highest readings since November 2008. Again, would Fed officials cheer if they achieved their 2% inflation target by driving rent inflation still higher?

It’s not obvious how ultra-easy monetary policy is supposed to stop consumer durables prices from deflating. They’ve been doing so mostly as a result of globalization, which has lowered labor costs in manufacturing. Now automation and robotics is increasingly replacing labor in durable goods manufacturing. If the Fed’s policies succeed in boosting wage costs, manufacturers may simply replace labor with technology. This all begs the question: Why are higher durable goods prices a good thing anyway?

Today's Morning Briefing: Days of Wine & Rosés. (1) Les Misérables. (2) Rosé a day. (3) Setback for Socialists in France. (4) Six cylinders firing in Eurozone. (5) Slicing and dicing Yellen’s latest speech. (6) FOMC lowers new normal unemployment rate. (7) Waiting for Godot and Phillips? (8) From ZIRP to LIRP. (9) Liftoff coming, though it might be postponed, but will be gradual until further notice. (10) Fed puzzled by persistence of low inflation. (11) Slicing and dicing the inflation data. (12) Three-month annualized core PCED inflation rate falling below 1.0% rather than rising to 2.0%! (More for subscribers.)