8 million new jobs and counting

The private sector of the U.S. economy has created about 8 million jobs since early 2010, for an average gain of almost 180K per month. Last month it created almost 200K jobs, and in the past year private sector job gains averaged 180K per month. Jobs growth has been relatively steady at about 2% per year for almost four years now. At the current pace, private sector employment will reach a new all-time high within the next 4-5 months. We'd all like to see even more new jobs, but it's time to stop bemoaning the sorry state of the economy. It's probably growing slower than it otherwise could, but it is definitely growing.

I prefer to focus on jobs created in the private sector, because those are the ones that really count. After all, in the last government shutdown, our own government estimated that over 20% of the federal workforce was non-essential (in some departments the number was as high as 80-90%). The first chart above compares the private sector workforce as measured by two different surveys. The magnitude of job creation in the current recovery is very similar to that of the previous recovery. The second chart above shows the monthly gain in private sector jobs; again, the record of the current recovery is very similar to that of the prior recovery.

The problem that is real and unique with this recovery is the lack of growth of the labor force (defined as those who are working and those who are looking for a job). In fact, since 2008 there has been zero growth in the labor force. Ordinarily, we would have expected to see annual growth of about 1%. From a longer term perspective, we also have the problem of the decline in the labor force  participation rate, which has declined from 67% in 2000 to 63% today—about 4% of the working age population has simply "dropped out." If past trends had continued, there could have been at least 10 million more jobs created by now.

Is this the fault of the Fed? Can more Quantitative Easing entice millions more to go out and look for a job? Can more QE convince businesses to expand? I seriously doubt it.

The economy could be a lot stronger and more prosperous, but that very likely has nothing to do with monetary policy. It's time for the Fed to taper QE now and plan on reversing it as soon as possible before something goes wrong (e.g., inflation). We won't see any dramatic improvement in the economy until fiscal policy becomes more growth-oriented and less redistribution-oriented.

Despite what you might have heard repeated many times in the media, jobs growth in the current recovery has not been dominated by part-time jobs. As the chart above shows, there actually has been zero growth in part-time jobs since the last recession, and the ratio of part-time to total jobs has been falling steadily, much as it has in every recession in the past.

Corporate profits just keep on increasing

Today's revision to Q3/13 GDP gives us our first look at corporate profits for the quarter, and they just keep on growing. Nominal after-tax profits are at a new all-time high, and have risen almost 9% in the past year. This is very impressive no matter how you look at it.

The two charts above show after-tax corporate profits and nominal GDP; the first chart takes the long view, while the second chart zooms in on the past quarter century. The y-axes of both graphs have similar ranges, so it should be apparent that corporate profits have risen at a much faster pace than nominal GDP both in the current recovery and over the past two decades. 

The chart above shows after-tax corporate profits as a % of nominal GDP. Profits are very close to an all-time high on this basis, and significantly above where they have been over the past 55 years. It's been my view for the past several years that the market looks at this chart and sees a mean-reverting phenomenon, and thus expects profits to revert to 6-7% of GDP over the foreseeable future. This implies that the market has very little confidence that profits will continue to increase, and is very worried that profits could suffer a significant decline, both nominally and relative to GDP, in coming years. That's why PE multiples are only average despite the fact that profits are at record levels. (Last August I explained this in more detail.)

In effect, the market is priced to a significant deterioration in the profits outlook. Yet profits continue to defy their presumed mean-reversion tendency and continue to increase. Profits will undoubtedly decline when we suffer the next recession, but that might be years away. Worrying about an imminent recession is characteristic of this entire recovery, as I explained yesterday ("The most risk-averse recovery ever"). But so far, the pessimists have been missing out on a fabulous equity rally.

The chart above shows the PE ratio of the S&P 500 index using NIPA profits (the BLS's calculation of total economic after-tax corporate profits). I've normalized the S&P 500 index so that the average PE ratio using this method is similar to the long-term average PE ratio of the index using reported corporate profits. Here we see that PE multiples are significantly below their long-term average, whereas the reported PE of the S&P 500 is about average (see chart below). I explained the reason for the differences in these two PE ratios, and their rationales, here.

In short, this market continues to be very skeptical of the future. Very risk averse.

GDP revised upwards calls for tapering soon

Today's revision to third quarter GDP was meaningful, since it boosted both real growth and inflation by meaningful increments. As a result, nominal GDP growth (annualized) for the quarter was 5.6%, up from the previously reported 4.7%. As the chart above shows, nominal GDP growth in the third quarter now looks to be among the strongest in the current business cycle expansion.

If the Fed has been trying hard to boost real and nominal GDP growth and avoid deflation, they are certainly not failing at the task. Since the recovery started (mid-2009), nominal GDP growth has been an annualized 3.9%. Last quarter's growth rate of 4.7% is meaningfully higher, and the trend in the past three quarters has been definitely higher. Real growth since the recovery started has been an annualized 2.3%, and last quarter's growth of 3.5% was substantially better; real growth has also been picking up in recent quarters. Inflation, as measured by the broadest measure available—the GDP deflator—was 1.9% last quarter and has averaged 1.6% since the recovery began.

Yes, the current expansion has been weaker across the board than prior expansions. But not egregiously so. An as I noted in yesterday's post, one of the key factors working to depress growth in recent years has been an unprecedented amount of risk aversion. The Fed can only do so much to counteract that problem. Real GDP growth has been weak because the growth in the number of people working has been weak. Quantitative Easing can't convince businesses to hire more if they are concerned about the future and burdened by onerous new regulations and the highest corporate income tax rate in the developed world.

Tapering doesn't mean that monetary policy will become tighter, since QE was never about printing money. Tapering is of course the first step towards an eventual tightening of policy, but even if the Fed were to start tapering tomorrow, monetary policy would remain extraordinarily accommodative (as measured by the level of real short-term interest rates, which remain decidedly negative) for a long time. Markets are overly concerned about tapering because markets have consistently misunderstood the function of QE, which was not to print money but to satisfy a risk-averse world's demand for risk-free, safe assets.

Now that nominal and real GDP are clearly out of the danger zone, confidence is slowly returning, risk aversion is beginning to decline, and the need for QE is therefore declining. Tapering makes sense, and in the long run it should boost confidence and reinforce the outlook for non-inflationary growth.

If tapering doesn't happen at the FOMC meeting this month, then surely it will by the end of January, which will be Bernanke's last as Fed Chairman.

The most risk-averse recovery ever

The recovery from the recent Great Recession has been the weakest ever, and that may have a lot to do with the fact that this has also been the most risk-averse recovery ever. Households have deleveraged like never before; the world has stocked up on cash and cash equivalents like never before; banks have accumulated massive amounts of excess reserves; and business investment has been weak despite record-setting profits. Contrary to popular perception, these facts suggest that the real function and purpose of the Fed's Quantitative Easing program was to satisfy the world's voracious appetite for risk-free, safe assets. QE has not boosted the economy, because QE only serves to treat the symptoms of risk aversion that have held the economy back. 

The chart above shows the leverage of the household sector, which is calculated based on the Fed's Flow of Funds data through Q2/13. Total liabilities as a % of assets have fallen by almost 25% in just over four years, taking household leverage back to levels last seen in the mid-1990s. In the past 70 years there has never been such a dramatic deleveraging of household balance sheets.

The chart above shows another way of looking at households' leverage. It compares monthly debt service and financial obligation payments to disposable income. By this measure, households currently have the lowest financial burdens in the past 30 years. We've never before seen such a significant decline in financial burdens. Households have seriously hunkered down, which is not surprising given the unprecedented financial and economic turmoil unleashed in the Great Recession. Once burned, twice shy, as they say. 

The chart above shows the average delinquency rate on credit cards and all consumer loans as of Q3/13. Both of these measures of the health of household finances have fallen dramatically since the Great Recession, to the lowest level in over 20 years. Moreover, as of last October, the average 30+ day delinquency rate on credit cards issued by the top six issuers (Amex, B of A, Capital One, Chase, Citibank, and Discover) was a mere 1.9%. It's never been this low, and that is very good news for banks as well as households. Banks' profit margins are up, and households' financial health is greatly improved, thanks to deleveraging and more responsible risk-taking. But we've only seen this improvement thanks to lots of risk aversion.

Since late 2008, the Fed has pumped up the supply of bank reserves by $2.4 trillion through its purchases of Treasuries and MBS. More than 97% of those additional reserves currently are held by banks in the form of "excess reserves." Those reserves are not needed to back up deposits and are available to support an almost unlimited expansion of new loans. Bank lending should be soaring.

But it isn't, as the chart above documents. Bank credit has expanded at a very slow rate since late 2008, even as banks' ability to make new loans has become virtually unlimited. This can only mean that a) banks have tightened their lending standards, and/or b) businesses and households have been reluctant to take on more debt, preferring instead to deleverage. No matter how you look at it, this is powerful evidence of risk aversion across the entire economy.

Instead of using their ballooning reserves to support a huge increase in new lending, banks have been content to hold onto them, even though they pay only 0.25%. (Prior to late 2008 they paid nothing, so banks always sought to minimize their holdings of reserves since they were nonproductive assets.) In effect, banks since late 2008 have preferred to lend money to the Fed at 0.25% rather than lend money to consumers and businesses at higher rates, which is yet another example of risk aversion.

As the chart above shows, savings deposits at U.S. banks have soared by over $3 trillion since late 2008. Banks have been the recipients of a virtual flood of new savings deposits from consumers and businesses even though the interest rate on those deposits has been the lowest in modern banking history. Banks have apparently been quite content to hand over all of that additional deposit inflow to the Fed in exchange for risk-free bank reserves. (Here's what has happened behind the scenes: The Fed bought about $2.7 trillion of Treasuries and MBS from the public, and after all was said and done, the public decided to put all the proceeds into bank savings deposits. Banks then used the new deposits to acquire bank reserves.)

In a sense, banks have simply become intermediaries, funneling cash from households and businesses to the Fed, which has purchased notes and bonds with the proceeds. At the end of the day, the Fed has been effectively "transmogrifying" Treasury notes and bonds and MBS into T-bill equivalents (aka bank reserves). The Fed hasn't been printing money, it's been exchanging bank reserves for notes and bonds. The public and the banking system have been quite happy holding on to deposits and reserves paying almost nothing, rather than riskier notes and bonds yielding more. Why? Because risk aversion has been intense.

The two charts above illustrate just how risk-averse the corporate sector has been in this recovery. The bottom chart shows that after-tax corporate profits are at all-time record highs, having more than doubled since the end of 2008 and having more than tripled since the end of 2000. Yet as the top chart shows, capital goods orders—a good proxy for business investment—are just barely higher today than they were prior to the 2001 recession. The same goes for private sector jobs, which today are about 1 million less than they were in early 2008, and only 3% higher than they were in 2000. Businesses have been VERY reluctant to invest their profits and expand their operations. For their part, investors are only willing to pay modest multiples to own equities today, despite record levels of profitability and record-low interest rates. This is risk aversion on a grand scale.

Why so much risk aversion? There are undoubtedly lots of reasons, but the obvious ones are 1) the profound shock that accompanied the Great Recession, as the global economy and financial markets teetered on the brink of disaster; 2) the great uncertainty that has accompanied the Fed's unprecedented foray into Quantitative Easing (you can see that uncertainty reflected in the surge in the price of gold to $1900/oz.); 3) the increased regulatory burdens imposed by Dodd-Frank and Obamacare; and 4) the trillion-dollar deficits that arose from a massive increase in government spending in 2008 and 2009.

Many of these problems are still with us, but arguably they are fading. The federal deficit has plunged by more than half, to "only" $650 billion. The Fed is getting ready to taper QE, and a reversal of QE is on the horizon. Obamacare is slowly but surely imploding. Global equity market capitalization has recovered to pre-recession highs—surely this reflects at least a decline in pessimism if not the return of some optimism. Swap spreads in most major markets are at very low levels, suggesting an almost complete absence of systemic risk. At this rate, risk aversion will sooner or later be replaced by an budding appetite for more risk.

If policymakers want to accelerate the process, they should direct their efforts towards reducing the sources of risk aversion (e.g., less monetary uncertainty, reduced regulatory burdens) and increasing consumers' and businesses' willingness to take on risk (e.g., lower marginal tax rates which increase the rewards to work and risk taking).

The bad news is that there are a lot of problems out there and not much confidence in the future. The good news is that it shouldn't be too hard for things to get better.

The economy continues to grow, so bring on the taper

Recent statistics clearly reflect an economy that continues to grow. The economy has been growing and improving slowly, but it has been making upward progress for almost four and a half years now. It's hard to see what's keeping the Fed from tapering its QE purchases, and it's easy to see how there is room for short-term interest rates to rise in the not-too-distant future. The health of the economy is just not that bad.

Auto sales in November jumped to a very respectable 16.3 million annualized rate. They've almost fully recovered to pre-recession levels, having risen 13% a year on average since their early 2009 low. That's almost five years of double-digit growth!

People have stopped paying much attention to the ADP estimate of private sector jobs growth, but as the chart above shows, while the ADP number doesn't exactly track the BLS number every month, it's not too far off over time. Between the two surveys, it looks like we are seeing private sector jobs growth of roughly 200K per month on average, with no sign of weakness. Sure, things could be a lot better, but adding 200K jobs every month eventually adds up to something meaningful.  At this rate, private sector jobs will reach a new all-time high by next May.

 

The November ISM service sector surveys were lackluster, but they don't suggest either deterioration or stronger growth. Just more of the same. Nevertheless, that's still progress.

The above chart shows the yield on 10-yr Treasuries. Since the Fed began its third QE program over a year ago, buying some $45 billion of longer maturity Treasuries every month, yields have risen by almost 150 bps. That's not exactly what the Fed was hoping for. Rather, it's a testament to the Fed's inability to manipulate interest rates. Bond yields are up because the bond market is figuring out that the economy is not exactly at risk, the Fed will not be able to keep short-term rates near zero for much longer, and it's probably past time to begin tapering its QE purchases. The stock market periodically worries about the end of QE purchases, but the truth is that higher interest rates go hand in hand with a healthier economy, so concerns about "tapering" are misplaced. Bring on the taper! Let's show some confidence in the future—there is no reason not to.