Thursday, May 21, 2015

Claims keep falling, but risk aversion is still the problem

This continues to be the weakest recovery in modern times, but it has set a record for the lowest rate of layoffs.

Using a 4-week moving average, initial claims for unemployment last week fell to their lowest level in 15 years. 

Relative to the number of people working, claims are now at their lowest point in recorded history. The average worker has never been so little at risk of losing his or her job.

Meanwhile, after-tax corporate profits have never been so strong.

Nevertheless, despite record-setting profits, business investment has been quite weak. In real terms, capital goods orders, a good proxy for business investment, are at the same level today as they were 20 years ago, even though the economy has grown by over 60% in that time! 

The problem today is not layoffs and unemployment, it's a lack of investment. Animal spirits are lacking, and risk aversion is still high.

Sovereign yields in developed countries are very near their all-time lows. That is the best proof that animal spirits are lacking and risk aversion is still high. The world is willing to pay extraordinarily high prices for the safety and security of sovereign debt. Why? Because the world is very afraid of the alternatives, even though they yield substantially more.

As the chart above shows, the earnings yield on the S&P 500 has rarely been so high relative to the yield on 10-yr Treasuries.

Weak investment and tepid jobs growth have created a $2 trillion annual shortfall in GDP (by my calculations, the so-called output gap is about 10% of GDP).

Even a massive increase in government spending and transfer payments couldn't boost the economy. Indeed, it's quite likely that it was the big increase in government spending and transfer payments that weakened the economy.

The solution to this dilemma is straightforward. We don't need more attempts at government stimulus. What we desperately need is more incentives for private investment. We need lower marginal tax rates and we need reduced regulatory burdens.


Benjamin Cole said...

I propose FICA tax cuts offset by QE.

William said...

Scott, does the "business investment" which you commented upon include US corporate foreign investments - or is it only their US investments?

I thought perhaps US corporations might be seeing greater financial opportunities overseas and investing there rather than in the USA.

Scott Grannis said...

Capital goods orders are only domestic investment. But I think business investment is weak in many parts of the world, as evidenced by very low sovereign yields and relatively slow growth.

steve said...

as $15/hour min wage becomes more popular, investment will DROP as business people access many opportunities as unworthy. if you own a business in seattle with 10 people making $10/hour and have to pay them $15/hour, that's $50K. of course the proponents say "just raise prices!". the BUYERS of these goods may have another say on that matter. without question, workers will be replaced with technology.

also, I wonder if part of the lack of investment over the past 10 years or so is a result of technology reducing the need AND significantly increasing efficiency. would certainly explain record profits.

steve said...

um, that would be $100K difference, not $50K. sorry about that!

Unknown said...

Lately REITs have been receding at a stead pace down nearly 13.5% ytd. Is this due to the uncertainty interest rates or are there other underlying factors?

Scott Grannis said...

I suspect the main problem with REITs is worries about rising rates. REITs have suffered as real yields have risen, and higher real yields reflect the market's belief that the economy is stronger than expected and the Fed is more likely to raise rates. REIT investors worry that higher rates will harm the economy and harm real estate in general. I think these concerns are over-rated, since higher rates will only happen in an environment of stronger economic growth and decreased risk aversion, and both in turn should be good for real estate.