U.S. EMPLOYMENT: “Graceful Slowing”
Employers added a seasonally adjusted 287,000 jobs in June for the strongest job growth in eight months, the Labor Department said. Nearly every sector of the economy added workers to power a dramatic swing from May’s dismal payroll gain of 11,000, which was the weakest reading since the U.S. stopped shedding jobs in 2010.
The pace of job creation has slowed since the winter. But unlike a sharp drop-off that might signal a possible recession, “this looks more like a graceful slowing into a lower channel of job growth, which is normal at this late stage of the business expansion,” Morgan Stanley chief U.S. economist Ellen Zentner said. (…)
Average hourly earnings for private-sector workers rose just 0.1% in June from the prior month. But wages were up 2.6% from a year earlier, matching the fastest annual growth rate since the summer of 2009. (…)
In sum, the employment report increases the chances of a Fed rate increase in September, but officials are likely to remain in a wait-and-see mode until then, and will likely pass on moving in July. They want to see follow-through and to be sure the economy is really on its feet after a volatile first half, and they also want to be sure markets are stable in the wake of Britain’s vote to leave the European Union.
Averaging the monthly volatility into quarterly data, we have 3 consecutive slowdowns with the latest quarter at 147k. Keep in mind that the monthly data has a 100k margin of error so this will need to be revisited next month. Also keep in mind that employment is not a leading indicator as the chart clearly shows. Coincident at best.
And now the not so graceful stuff, just to keep the FOMC guessing:
Worst semester since 2010 for labour market despite June surge
(…) private non-farm payrolls rose by less than one million since the start of the year, the worst half-year tally since the second semester of 2010. (NBF)
It may be the worst semester since 2010 but employment was trending up in 2010. Today, it is trending down, like in 2000 and 2007…
Amid the enthusiasm generated by the payroll report, few people discussed the not so graceful data from the household employment report released simultaneously by the BLS. Household employment rose 67k in June after +26k in May and –316k in April. Since February: +23k, a huge step down from +1,877k during the 4 months previous.
In its July 8 note detailing the differences between the two surveys, the BLS advises to look at both surveys:
Both the payroll and household surveys are needed for a complete picture of the labor market. The payroll survey provides a highly reliable gauge of monthly change in nonfarm payroll employment. The household survey provides a broader picture of employment including agriculture and the self-employed.
The BLS also publishes a third series, the “Adjusted household survey employment” that is more similar in concept and definition to the payroll survey employment and that “tracks much more closely with the payroll survey measure”. On that measure, employment fell 119k in June and is down 231k since February after +1,150k during the 4 months previous.
Lance Roberts has the best chart on that:
The chart below enhances David’s work by comparing the 6-month annual percentage change of the adjusted employment index as compared to the official payroll measure, the civilian household measure, and the Fed’s Labor Market Conditions Index. Importantly, on a trend basis, all measures have turned lower.
In all, Mrs Yellen and friends will have plenty of reasons to remain hopefully uncertain given the volatile stats. I don’t know how much weight the FOMC staff puts on independent surveys such as Markit’s and the NFIB. Markit’s PMI employment Index has a pretty good fit with the payroll numbers and it did not spike in June, even though it stabilized at the low end of its 2011-2016 range:
Finally, hours worked are not showing any signs that employers need a lot more bodies, however graceful they may be:
Consumer Credit Increased at 6.18% Pace in May The pace of U.S. consumer borrowing picked up in May as Americans took out more student and auto loans, a sign households are growing increasingly comfortable with more debt.
Outstanding consumer credit, a measure of nonmortgage debt, rose by a seasonally adjusted $18.56 billion in May from the prior month, the Federal Reserve said Friday. The 6.18% seasonally adjusted annual growth rate is an acceleration from April’s 4.48% pace, though it was slower than March’s high for the year of 9.92%. (…)
May’s report showed revolving credit outstanding, mostly credit cards, rose at a 2.97% annual pace, bringing the total to its highest level since mid-2009. That followed a 1.71% rise in April. (…)
Nonrevolving credit outstanding, including student and auto loans, rose at a 7.33% annual pace in May compared with April’s 5.47% growth rate. (…) (Charts from Haver Anaytics)
Foreign and domestic auto makers shipped 1.78 million cars—sedans, sport-utility-vehicles and minivans—to dealers last month, 18% more than year earlier, the China Association of Automobile Manufacturers said on Monday.
The gain benefited from a weak year-over-year comparison that will continue for another two months, analysts said. Sales in the world’s biggest auto market fell three months in a row last summer, as a plunge in stock prices ate into household wealth.
Sales bounced in the fourth quarter last year after Beijing halved the purchase tax on small-engine vehicles to 5% from 10%.
In the first half of this year, car sales from manufacturers to dealers were up 9.2% from a year earlier to 11 million vehicles, the government-backed group said. Combined sales of passenger and commercial vehicles were up 8.1%, to 12.8 million units. (…)
An index measuring inventory levels rose to 60% from 51% in May, according to the China Automobile Dealers Association, a government-backed trade group comprising 20,000 dealers. A reading above 50% indicates inventories at worrisome levels.
Higher inventories pushed dealers to offer bigger discounts—10.3% on average in June, compared with 10% in May, according to Ways Consulting Co., a Chinese consulting firm focused on the automotive industry.
Another looming concern is the expiration of the tax break at the end of the year: Analysts have cautioned that the break could be pulling demand forward, meaning growth could once again stall when it ends. (…)
Backed by generous government subsidies, about 126,000 plug-in vehicles—hybrid and pure electric—were sold in the first five months of 2016, 134% more than a year earlier, said the auto-manufacturers’ group.
Market researcher Nielsen Holdings PLC said its latest survey shows stronger consumer interest in alternative-energy cars than a year earlier, though nearly 50% of respondents said government subsidies still matter greatly in the buying decision.
BoE set to cut rates to avert predicted Brexit slowdown Bank predicts slowdown following vote to leave EU
(Goldman Sachs via Daily Shot)
We know that bond investors are uncertain enough to keep buying bonds at such low yields. We don’t know why stock investors are certain enough to buy equities at current high P/Es. But don’t worry, the WSJ has the answer:
Stock Calculus Suggests Room to Run An assessment of stocks that includes bond yields lately has produced higher valuations for shares, contrasting with many investors’ concerns that stocks are overpriced and due for a pullback.
Think stocks are expensive? To some investors, the global rally in government bonds suggests valuations could go even higher.
Investors use many valuation methods for stocks, and the ones that include bond yields lately have produced higher valuations for shares, contrasting with many investors’ concerns that stocks are overpriced and due for a pullback. The reason: Dividing the expected cash flows of a stock by a smaller number produces bigger results. (The equation’s divisor incorporates a Treasury yield and a stock’s risk premium.)
So, using ever-smaller yields in one part of the equation produces higher valuations for stocks. The risk premium is the return investors demand to hold stocks over relatively safe government debt. The yield on the 10-year Treasury note fell to a record low on Friday, at 1.366%, compared with 1.387% on Thursday. Bond yields move inversely to prices.
“The entire equity market probably should be more highly valued if we really are going to be lower for longer,” said Jim Tierney, chief investment officer of concentrated U.S. growth at AllianceBernstein Holding LP, referring to interest rates generally. (…)
“Is the world really a much more risky place than it was two years ago? I’d argue not,” said David Kelly, chief global strategist at J.P. Morgan Asset Management. “It’s not so much that stocks are behaving illogically, it’s that central banks are. By promoting exceptionally low yields around the world, they’ve made stocks cheap relative to bonds.” (…)
“Everyone’s looking at the market price-to-earnings ratio and calling it expensive, and, yes, relative to the past 10 to 15 years, it is,” said Mr. Tierney. “But you also have to look at interest rates in that time period, and they were a heck of a lot higher.”
We seem to have entered the period when everybody can find reasons to historically high valuations and justify buying equities. Back in 2009, everybody could rationalize historically low valuations to justify selling equities. We have gone full cycle.
BTW, one “new” theory going around these days: there are not many sellers left! Given that investors have pulled $153B out of equity mutual funds and ETFs in the past 2 years, there must not be many sellers left. Yet, investors pulled $11B (!) out of equity mutual funds and ETFs just last week. Any ammo left? I wrote “new” because this “no sellers left” theory has been used before…
Back to serious stuff. Central banks are “illogically” driving bond yields down to artificially low levels and we should buy expensive equities on that basis?
We could argue through the night whether “the world really is a much more risky place than it was two years ago” but we cannot argue much whether equities are more risky. These charts going back to after WWII clearly illustrate that equities are in “buy high” range:
As to the low bond yields argument, just consider how rare it has been for real Treasury yields to dip and remain into negative territory. Sure looks like “buy high” to me!
One way to avoid falling into the central-banks-driving-yields-down trap is to use inflation like the Rule of 20 does, eliminating the fluctuations in real yields.
Nobody knows what the future will really be. We can only measure the risk and play the probabilities. The known knowns are:
- equities are in “buy high” territory;
- same for bonds;
- bond prices are distorted by central banks activities;
- central banks are in the dark and experimenting like never before;
- central banks fear deflation and want higher inflation;
- if inflation rises, bond prices and P/Es will decline;
if inflation remains “too low”, profits could decline;
Speaking of earnings, after all still the prime and most dependable fuel for equity markets, the earnings season has quietly commenced:
Factset’s weekly summary:
(…) analysts made smaller cuts than average to earnings estimates for Q2 2016. On a per-share basis, estimated earnings for the second quarter fell by 2.8% during the quarter. This percentage decline was smaller than the trailing 5-year average (-4.4%) and trailing 10-year average (-5.5%) for a quarter.
In addition, a slightly smaller percentage of S&P 500 companies have lowered the bar for earnings for Q2 2016 relative to recent averages. Of the 113 companies that have issued EPS guidance for the first quarter, 81 have issued negative EPS guidance and 32 have issued positive EPS guidance. The percentage of companies issuing negative EPS guidance is 72% (81 out of 113), which is slightly below the 5-year average of 74%.
As a result of the downward revisions to earnings estimates, the estimated year-over-year earnings decline for Q2 2016 is -5.6% today [-5.4% last week], which is larger than the expected earnings decline of -2.8% at the start of the quarter (March 31). Four sectors are predicted to report year-over-year earnings growth, led by the Telecom Services and Consumer Discretionary sectors.
If the Energy sector is excluded, the estimated earnings decline for the S&P 500 would improve to -2.1% from -5.6%.
Nine of the ten sectors have recorded a decline in expected earnings growth since the beginning of the quarter due to downward revisions to earnings estimates, led by the Information Technology sector. The only sector that has recorded an increase in expected earnings growth since the start of the quarter due to upward revisions to earnings estimates is the Industrials sector [mainly GE].
As a result of downward revisions to sales estimates, the estimated sales decline for Q2 2016 is -0.7%, which is larger than the estimated sales decline of -0.5% at the start of the quarter. Six sectors are projected to report year-over- year growth in revenues, led by the Telecom Services and Health Care sectors. Four sectors are predicted to report a year-over-year decline in revenues, led by the Energy and Materials sectors.
If the Energy sector is excluded, the estimated revenue decline for the S&P 500 would improve to 2.2% from -0.7%.
Twenty-three S&P 500 companies have reported Q2 so far and 61% beat on EPS and 52 on revenues according to Thomson Reuters. The EPS surprise factor is +1.1% overall. Nonetheless, there must have been downward revisions because TR now calculates that Q2 EPS will decline 4.8%, down from –3.8% last week. Here’s one of them:
Wall Street analysts cut big banks’ profit forecasts Expectations hit ahead of quarterly earnings season because of fears Fed will hold off on rate rise
(…) Analysts at Credit Suisse have stripped out any expectation of higher rates from its estimates for US banks’ profits in 2016 and 2017. Barclays and Morgan Stanley have also docked forecasts, noting that investors rate the chances of a rate rise from the Fed this year at about 20 per cent, down from about 75 per cent before the Brexit vote.
This year just one of the big six US banks — Wells Fargo — is now expected to make a double-digit return on equity, according to consensus forecasts. (…)
Analysts at Morgan Stanley expect year-on-year falls in quarterly earnings per share at Bank of America (-27 per cent), Citigroup (-23 per cent), JPMorgan Chase (-8 per cent) and Wells Fargo (-2 per cent). Only Goldman Sachs, which took a big litigation charge in the same period a year ago, is likely to see an increase.
Management teams will probably guide down expectations for full-year results, said Betsy Graseck, Morgan Stanley’s lead analyst, in view of the “pessimistic” outlook for rates. (…)
There is more than NIM as this chart reveals (via Zerohedge):
TR data show that Q2 EPS for Financials are expected down 5.7%, worse than the –2.3% expected July 1.
Brexit fears fading away and the June employment surprise pumped the S&P 500 Index by 7.2% since the June 27 low of 1986. This while inflation is perking up and earnings keep declining. Trailing EPS are now expected to slip some 3% to around $114 after Q2 from $117.46 at the end of 2015 (per TR).
Citigroup’s Economic Surprise Index (via Ed Yardeni) got a boost from the employment report and finally perked up in positive territory after a loooong stretch below the line.
At 2123 on the S&P 500, the actual trailing P/E is 18.6. The Rule of 20 P/E is back into the “Rising Risk” area at 20.8 where it peaked in July 2015.
Corporate guidance better be positive to sustain this renewed enthusiasm. So far, analysts seem to be leaning toward more conservatism as Q3 and Q4 estimates are being shaved: Q3 estimates from +4.7% on April 1 to +2.0% on July 1 to the current +1.7% and Q4 estimates from +10.6% to +9.5% and to +9.3%. Analysts continue to expect Q3 and Q4 margins to return to their Q3’15 peak of 10.4% on revenue growth accelerating from +0.3% in Q2 to +2.0% in Q3 and +4.5% in Q4. Good luck on that!