Good economic news overshadowed by Kung Flu and Sanders risks

January private sector jobs growth solidly beat expectations (206K vs 155K), but benchmark revisions going back many years reduced the number of people currently working in the private sector by 440K. Jobs growth in earlier periods was revised downwards, but growth in the past six months was increased. A mixed bag, to be sure, but in the end neither worrisome nor cause for celebration. At worst, the economy appears to be on a slightly slower growth track now than it was in the first two years of Trump's administration. At best, the economy appears to have picked up a bit in the past six months, and this reinforces news from the service and manufacturing sectors that the worst of the negative impact of Trump's tariff wars has passed—capped, of course, by the recent signing of Phase 1 of the U.S.-China trade agreement.

In any event, the signs of improvement in recent data is for the time being eclipsed by the global spread of the Coronavirus (which one wag suggested should be called the Kung Flu). The U.S. actually faces two significant risks, neither of which seems likely, but either of which would have devastating consequences: a viral pandemic and a Bernie Sanders presidency (socialism always results in tears). In prediction markets, Sanders leads the Democratic pack by a wide margin, but Trump leads overall with (currently) a 55% chance of being re-elected. Needless to say, both risks bear watching, but it's premature to run for the exits at this time.

Chart #1 

Chart #1 shows the monthly change in private sector payrolls—the private sector being the only sector that truly counts. The green dashed line is meant to highlight the fact that jobs growth in the past few years has been slower than it was in earlier years. However, there does appear to be a pickup in the past six months or so.

Chart #2

One of the most salutary—yet widely overlooked—trends in the current business cycle expansion has been the absence of growth in public sector jobs (see Chart #2). There were 22.7 million public sector jobs at the recession-era peak in April '09 (not counting the temporary boost from the census), and there are just as many public sector jobs today. Never before in recorded history have we seen such a dramatic relative shrinkage in the number of public sectors jobs. The ratio of private to public sector jobs hasn't been this high since 1957! This dramatic relative shrinkage of the public sector is akin to turning an economic headwind into a tailwind, because private sector jobs are inherently more productive, on average, than public sector jobs.

Chart #3

Chart #3 shows the 12- and 6-month rates of growth of private sector jobs. Here again we see the decline in jobs growth in recent years, and the noticeable pickup in the past six months.

Chart #4

A pickup in the labor force participation rate, shown in Chart #4, is another piece of good news to be found in today's January jobs report. This confirms that workers who were sidelined (of working age but unwilling to work or look for a job) are now being enticed to get back in the game. The economy has plenty of room to expand if this recent trend continues, and I see no reason it won't. Unless, of course, a viral pandemic emerges and/or a socialist takes control of the U.S. government.

Chart #5

Chart #5 compares the ISM manufacturing index to the quarterly annualized growth rate of the U.S. economy. The two have become less correlated in the past decade than in previous decades, but it is definitely encouraging to see the recent surge in the ISM index. At the very least this rules out the prospect of a significant near-term weakening in the economy. At best, it confirms that we've seen the worst of Trump's trade war, which has almost certainly been a significant headwind for the past year. The price we've paid to force a change in China's behavior has been steep, but it may yet prove a worthwhile gamble on Trump's part.

Chart #6

Chart #6 focuses on the export orders component of the ISM manufacturing index. Here we see solid evidence that the negative impact of Trump's tariffs and China's retaliations—which began in early 2018—has not only faded but substantially reversed.

Chart #7

Chart #7 shows the ISM service sector business activity index, which also provides evidence that things have improved significantly of late.

Chart #8 

Unfortunately, despite all the signs of improvement in Charts #1-7, the economy's animal spirits, which were perking up in the latter half of 2019, have since reversed. This can be seen in Chart #8, which shows a remarkable correlation between 10-yr Treasury yields (red line) and the ratio of copper to gold prices (blue line). The 10-yr Treasury yield tends to rise as confidence in the economy improves, and it tends to fall as growth expectations fade and risk-aversion rises. Similarly, copper tends to rise relative to gold as growth expectations improve, and copper tends to fall relative to growth as growth expectations fade (less growth means less demand for copper) and risk aversion rises (which increases the demand for the safety of gold).

The current low level of yields and the low level of the copper/gold ratio are two important signs that the market is quite cautious about the future (i.e., few have ignored the threats of a global pandemic and the new enthusiasm for socialist polices). Needless to say, all eyes should be glued to the prices of copper, gold, and Treasuries.

In the meantime, there is still much encouragement to be found in the fact that 1) swap spreads are very low, which means liquidity is still abundant and systemic risk is low, 2) credit spreads are quite low, which means the outlook for corporate profits is healthy, 3) real yields are very low, which means the Fed is not a threat to growth, 4) inflation is relatively low and stable, which means the Fed has no need to tighten policy, 5) the dollar is relatively strong and stable, which means the Fed has not been "printing money," and 6) the market still displays lots of signs of caution (e.g., gold is up, money demand is strong, and interest rates are extremely low).