“Cult of Equity”

In his August Investment Outlook posted on PIMCO’s website on July 31, Bill Gross declared that the "cult of equity is dying.” That’s a late call since the cult has been mostly dying after flourishing during the 1990s, as evidenced by the secular downtrend in valuation multiples since 2000. The bull markets of 2003-2007 and since 2009 have been widely disparaged by perma-bears, including Mr. Gross, as cyclical rallies (“sugar highs”) in a secular bear market. In any event, high-profile predictions such as this one by Mr. Gross have often been great contrary indicators. So far so good.

However, it will be some time before we know for sure whether Mr. Gross will be proven right or wrong. The question for now is whether the logic of his argument makes sense. I don’t think so. He bases his pessimistic outlook for stocks on his view that “GDP growth itself is slowing significantly due to deleveraging in a New Normal economy.” He may be right about that, but US corporations are finding more of their growth overseas. What matters is the outlook for overall world GDP and for business opportunities on a global basis.

Mr. Gross believes that because “conditions…have never been more favorable for corporate profits,” they can only get worse. The growth trend line for both after-tax corporate profits in the National Income and Product Accounts and nominal GDP in the US has been about 7% since 1960. In recent years, profits have been growing above this line, while nominal GDP has fallen below it. In my opinion, this is a sustainable divergence, assuming that overseas profit opportunities continue to outpace domestic ones. The growth trend in S&P 500 forward earnings remains around 7%.

Oddly, in his concluding paragraph, Mr. Gross contradicts his central thesis: “Unfair though it may be, an investor should continue to expect an attempted inflationary solution in almost all developed economies over the next few years and even decades. Financial repression, QEs of all sorts and sizes, and even negative nominal interest rates now experienced in Switzerland and five other Euroland countries may dominate the timescape. The cult of equity may be dying, but the cult of inflation may only have just begun.” In an inflationary scenario, I would think that stocks might significantly outperform bonds.

To be fair to Mr. Gross, I think his sensationalist writing style detracts from his basic message, which is that equity returns may be subpar for a while and almost certainly less than the actuarial assumptions of most pension plans. That’s a reasonable assessment, though it could be wrong too if corporations continue to find plenty of global opportunities to boost their profits, as I expect.

Today's Morning Briefing: The Draghi Code. (1) Lost in translation. (2) Shooting from his hip or good on his feet? (3) Taking Lehman off the table? (4) The ECB’s mandate is to stay in business. (5) Rescue funds to the rescue first, but ECB can help too. (6) The “conditionality” requirement. (7) Lots of skeptics, but Draghi is ready to act. (8) Industry analysts cutting H2 earnings estimates. (9) Energy and Materials are weakest. (10) Global economic indicators remain weak, led by recessionary ones in Europe. (More for subscribers.)

Employment

Friday’s payroll employment report wasn’t weak enough to justify another round of quantitative easing by the Fed. Nor was it strong enough to take QE3 off the table. So the FOMC made the right decision last Wednesday, i.e., to talk about doing WIT (Whatever It Takes), rather than doing it. What will they decide to do at the September 12-13 meeting of the FOMC? Probably more of them same, i.e., keep talking about doing something.

Over the past 12 months, payroll employment gains have averaged 153,170 per month. That pace is likely to continue over the next 12 months. There are few reasons to expect otherwise, with the exception of the dreaded fiscal cliff. In this scenario, the Fed might feel compelled to implement QE3 as the only policy response available since fiscal policy would be gridlocked. This, then, is a good reason for the members of the FOMC to hold off on QE--even if employment remains lackluster over the rest of this year--until they see how Congress deals with the fiscal cliff between now and yearend!

While July’s payroll gain was better than expected, the overall report confirmed that the labor market remains challenging. The one bright spot is that the YRI Earned Income Proxy rose 0.2% during July to another record high, following a gain of 0.7% during June. It is simply aggregate weekly hours times average hourly earnings in total private industries. It is highly correlated with private industry wages and salaries in personal income. That could be a good omen for retail sales and overall consumer spending in coming months.

Other employment indicators confirmed the slow pace of improvement in the labor market. Most heartening is that initial unemployment claims rose just 8,000 to 365,000 during the last week of July after falling 31,000 the previous week. However, the weekly data have been especially volatile in recent weeks. On the other hand, the Monster Employment Index of online job ads fell 6 points during July to 147. However, it remains on a slow, but not so steady upward trend.

Today's Morning Briefing: Thanks, Guys! (1) Mario, Ben, Mariano, Alan, Bill, and Richard. (2) The equity cult is dying again. (3) Earnings driven by global GDP. (4) ECB’s mandate is to avert euro collapse. (5) Draghi sets stage for QE in 2-year notes. (6) Spain needs more Sangria. (7) Bernanke talks the talk. (8) Krueger adds two decimal points to jobless rate. (9) Still targeting 1450 on S&P 500. (10) Sector neutrality still makes sense. (11) Fiscal cliff might delay QE3. (12) Wages and salaries at new record high. (13) “Trishna” (+ +) and “To Rome With Love” (+). (More for subscribers.)

QE3 and the Drought

One very good reason for the Fed to hold off on QE3 is that QE2 seemed to have the unintended consequence of boosting food and fuel prices, which depressed consumers’ purchasing power and spending. The terrible drought in the US is pushing grain prices up to record highs, while gasoline prices are rebounding as tensions mount between Israel and Iran. In other words, real incomes are about to get hit again. There is nothing the Fed can do about it other than to make it worse.

The drought in the US is quickly turning into a major disaster. I may have to lower my forecast for GDP for the second half of the year if it doesn’t abate soon. Yesterday, the US Agriculture Department added 218 counties in a dozen states as disaster areas. That brings this year's total to 1,584 in 32 states, more than 90% of them because of the drought. More than half of US counties now are classified by the federal government as natural disaster areas mostly because of the drought.

The 7/31 WSJ reported that farm incomes won’t be battered by the drought “as widespread use of crop insurance and record corn and soybean prices cushion the blow to growers.” That may be so, but the drought is likely to depress spending on farm equipment, including light trucks.

The economies of the Midwest and the South have been particularly strong thanks to their booming agriculture and manufacturing industries. Now even manufacturing is showing signs of slowing, as evidenced by the latest survey of purchasing managers.

Today's Morning Briefing: Talking About Doing More. (1) FOMC will closely monitor. (2) Dueling mandates. (3) Half-lives of new monetary policies getting shorter. (4) Time to assess dim WITs. (5) Ronald Reagan vs. Mario Draghi. (6) ADP is underappreciated. (7) Birth/Death Adjustment doesn’t track ADP small business employment. (8) Will auto sales wilt with corn crop? (More for subscribers.)

CNBC Appearance

Wages & Salaries

There was some very good news in June’s personal income report. Total wages and salaries rose 0.6% to another record high during the month. I am not surprised since it tracks the YRI Earned Income Proxy very closely, as I noted following the release of June’s employment report at the beginning of the month.

This augurs well for consumer spending in coming months, though such spending was unchanged during June. It was also encouraging to see that the Consumer Confidence Index rose during July to 65.9 from 62.7 in June. However, it was odd that the present situation component of this index ticked down given the strength of wages and salaries. Perhaps June’s headline news was unsettling and may have offset the improvement in paychecks. I still expect to see better retail sales figures over the next few months.

Today's Morning Briefing: From WIN to WIT. (1) Gerald, Mario, and Ben. (2) Words speak louder than actions. (3) Markets may be set up for let downs. (4) ECB and Fed committees polarized. (5) LTRO-3? (6) A ton of bricks weighing on BRICs. (7) An unsettling fortune cookie. (8) Profits swinging downwards in China. (9) India’s blackout and drought. (10) Wages and salaries are shining in US. (More for subscribers.)