Wednesday, June 1, 2016

Growth persists

We're still in the weakest recovery ever, and despite widespread fears that it is running out of gas, the US economy continues to expand. Here are some charts that document the ongoing, modest business cycle expansion:

The ISM May manufacturing index was a bit stronger than expected (51.3 vs. 50.3), but it suggests that the economy is growing at a pace (2% or so) that is the same as we have seen, on average, over the past seven years. It's likely, therefore, that Q2/16 growth will be substantially higher than the 0.8% registered in Q1/16. This won't imply any meaningful acceleration of growth, however, since quarterly growth rates are typically much more volatile than the underlying growth trend.

The export orders subindex of the ISM manufacturing report was mildly positive, since it points to some modest improvement in overseas economies.

With oil prices having risen 50% in the past 4-5 months, it's not surprising to see the prices paid subindex jump to levels not seen for almost 5 years. Deflation is yesterday's news.

The employment subindex of the ISM report is symptomatic of what continues to ail the economy: a lack of investment. Companies are not confident enough about the future to commit to serious expansion and hiring plans.

Manufacturing activity in the Eurozone is about as un-robust as it is in the US.

The chart above suggests that changes in the ISM manufacturing index tend to lead (though not always) changes in 12-mo. trailing revenues per share of the S&P 500 companies. If this relationship holds, we should see a return to rising revenues per share by year end. As it is, revenues per share have only dropped. 1.2% over the past year—a relatively modest slowdown.

I wish it were more pronounced, but the decline in the prices of TIPS and gold over the past month or two suggests that the market has become a bit less worried and pessimistic.

Less worry translates into a modest rise in equity prices, as the chart above shows.

As the chart above shows, the rise in oil prices has coincided with a firming in non-energy commodity prices. Over time, the correlation of the two is strong, but oil prices are far more volatile (note the difference in the scales of the two y-axes).

The chart above shows that commodity prices have risen vis a vis most currencies in recent months. So it's not just a currency phenomenon, it's more likely that global economies have strengthened on the margin. It's worth highlighting here the fact that the Swiss franc has been the most stable—in commodity terms—of the major currencies over the years.

The housing market continues its recovery, with prices approaching their highs of just over 10 years ago. I note the apparent trend for inflation-adjusted (real) housing prices to average just over 1% per year (shown in the second chart), a rate that would be consistent with ongoing improvements in quality, size and amenities. UPDATE: This is bolstered by recent Census Bureau data, as summarized in  Mark Perry's post showing how square footage has increased over the years.

This chart has been one of the most reliable guides to upcoming recessions that I'm aware of. It suggests that recessions typically follow sharp increases in real short-term interest rates and a flattening or inversion of the Treasury yield curve (both conditions being symptomatic of very tight monetary policy). Today we are not even close to those conditions. Real interest rates are still very low, and the slope of the yield curve is a bit above average. In the absence of tight money and in the presence of relatively cheap energy prices, it's likely that the economy will continue to grow.

It's been a sluggish recovery and many millions are still without jobs. But in aggregate, real disposable incomes have been rising and continue to do so. Gains in the past year (3.2%) are in line with historical experience, but the level of disposable income remains significantly less than it might have been had this been a typical recovery. Jobs and income have gone missing, but it is a recovery nonetheless.

All of this makes a strong case for avoiding the very low yields on cash and cash equivalents.


Frozen in the North said...

Dear Scott

One chart and comment was especially interesting, the lack of jobs and the lack of investments. That observation says little as to the lack of investment. In my opinion, the lack of interest in investing is driven by the low cost of borrowing; for the CEO and his team (that have a very finite lifespan) there are better ways to improve stock performance and hence their "rewards: keeping their jobs and fat bonus" that require little investment efforts: Massive stock buy back that reduces the float of shares, increases the stock price as the owners are fewer in numbers.

If memory serves its something like $400 billion that was largely used for share buyback -- the other idea that's been a real winner is M&A activity -- don't improve anything or build anything, buy something and show an increase in turnover of 20%... Honestly, the CEO and CFO have the right idea. Like a hooker its a "sure thing" of course there could be complications later on, but then the management knows they will not be around when the solids hit the fan.

Scott Grannis said...

Frozen, re the lack of jobs and investment: Bear in mind, first, that after-tax corporate profits have been on the order of $1.6-1.8 trillion per year for the past four years, and have averaged $1.6 trillion per year since the recovery began 7 years ago. So $400 billion in buybacks is a drop in the bucket.

In any event, another thing you ignore is the increased cost of expanding a business: regulatory burdens, taxes, healthcare, etc. Moreover, there is the uncertainty concerning future regulatory burdens and taxes, and the uncertainty of a monetary policy that is in uncharted waters. These factors enter into the equation when deciding whether to use profits to increase hiring, plant and equipment, vs. buybacks (which, because of our tax code, are advantaged by the capital gains tax).

We shouldn't be surprised to see weak investment at a time when the costs and uncertainties of starting and running a business are higher than ever before. As you say, management probably figures that buybacks are more advantageous to shareholders than expanding their business, and that is a rational decision.

How to change this for the better? Cut regulatory burdens and reduce taxes on capital, in order to boost the after-tax return on new investment.

marcusbalbus said...


Benjamin Cole said...

Nice post.
Fascinating side note: non-oil commodity prices appear not much different today than in 1975 (albeit after a bit of a disco-era spike).

This fits in with the idea that commodities and manufactured goods will become cheaper continuously, as long as we have free markets.

I suspect housing would become cheaper continuously also, but of course we do not have free markets in property development in the United States. We have regulated socialized property zoning.

Benjamin Cole said...

Weak jobs report. Only one month, but not encouraging. 38K?

Johnny Bee Dawg said...

Market is worried that the Fed cannot raise rates to address expanding M2 while the rest of the world has negative rates.
Bonds are outperforming stocks, and Long Treasuries are the best performing part of the entire bond market this year. Think about that! The curve is flattening.
Now that the jobs numbers have bombed this morning, the Gold Miners index is up over 8%...just this morning.

Long Treasuries and Gold are the leadership in this market. That does not make for a pleasant financial picture.
PUBs have abandoned their role of protecting us from socialism, and now we are paying the price.

William McKibbin said...

The reality is that the Fed is more than willing to trade away growth in real working wages, real home values, and the employment to population ratio in order to ensure the lending value of dollar -- I would go so far as to say that the Fed would even turn a blind eye to a cross-country ride by the four horsemen of the apocalypse in order to ensure the lending value of the dollar -- debtor nations rarely do the right thing...

Matthew Grech said...

The more one looks at the jobs report the worse it gets.

Revisions totaled -59K. So, in reality, the +38K is -21K.

The labor force declined by over 450K. This should not be happening at this point in the cycle.

The labor force participation rate declined. So the 4.7% unemployment figure is a BS number.

Of the sectors that make up the jobs report, Food and Healthcare (read: low-paying) were two of the strongest. Decliners: Construction, Manufacturing, among others.

I too know that this is just one report. But it was a disaster. And I think it was a disaster for very fundamental reasons.

Scott Grannis said...

Quick comments before a post to come later today: The yield curve is actually a bit steeper today (by 2 bps) than it was yesterday; 2-yr yields are down 12 bps, 10-yr yields are down 10 bps. Gold hasn't made any progress for 3+ months. The dollar is trading right around its long-term historical average (inflation-adjusted). Inflation expectations have dropped, but only marginally.

Year over year jobs growth is 2%, about the same as it has been for years. The Verizon strike subtracted about 40K jobs last month, but they will be added back in this month. A weak report, to be sure, but we have seen weak reports like this 5 times in the past six years; it's likely an outlier, just like the other ones. Nevertheless, this likely postpones any Fed rate hikes for at least several months, and the market is fully aware of that.

The Fed may be boxed in, unable to raise rates for the foreseeable future, but the market is not terribly concerned about the economy's future prospects. It's going to be slow and steady as she goes until fiscal policy takes a turn for the better.

Johnny Bee Dawg said...

Excellent points and good perspective.
Will still be watching Gold Miners, though, to see if this 9% pop today continues and puts the index up another leg.

Hans said...

I guess you are correct, Mr Grannis, as bank default loan
rates have been in an free fall ever since 1987.

Even with the recent increases, they are barely above 1%.

Another rather interesting thing, banks are now only making
15% of all loans!