Soft Jobs Data Cools Market Expectations on Fed Rate Increase U.S. employers did just enough hiring in August to keep unemployment in check and maintain steady—though unspectacular—wage growth. But cooling job growth from recent months reinforced market expectations that the Federal Reserve will push off a rate increase until December at the earliest.
(…) Investors, who have been eager for signals on the rate outlook, seemed to struggle Friday to interpret the Fed implications of the report. Before the jobs report, the futures market showed a 27% chance of an increase this month. Shortly after the report was released, those odds fell to 12%, but then rose during the day, settling at 24% at close. Similarly, the Dow Jones Industrial Average jumped in the opening minutes of trade Friday, only to give back most of those gains by early afternoon before settling modestly higher on the day, up 0.4%. (…)
Once again, what was expected to settle and close the discussion to go or not go turned out to be weak enough and strong enough to keep everybody guessing until the next “crucial†stat.
Some of the few positives from the NFP:
- Private sector employment held up at +176.9k in August down from +194.2k in July. Averaging the last 2 months (+185.6k), we get exactly the year’s average (+184.3k). However, the recent numbers require some faith in the BLS’ assumptions on new biz formations…
- With total payrolls for both June and July having been very strong, the average increase for the past three months is a robust 232,000, its highest since February
- August is a quirky month. In the last 16 years, the initial estimate of August payroll growth has been revised up 13 times by an average 38,500 jobs in those months. This trend didn’t hold last year, when August’s initial estimate of 173,000 jobs was revised down. (WSJ) On the other hand, Markit’s PMI surveys, which have proven pretty accurate in forecasting employment levels, suggested August payrolls up only 130k.
In truth, just about every important number in Friday’s NFP was on the soft, no-go, side:
- +151k is below the 2016 monthly average of 182k and last year’s 229k. The trend is clearly down, especially when considering that governments have apparently created 75,000 new jobs in August…
- The Household survey showed a weak +97k gain and the payroll-concept adjusted number, which places both surveys on the same footing, was down 128k..
- A big bummer was the decline in the work week to 34.3 hours from 34.4 during the previous 6 months. This 0.3% drop is equivalent to some 300k layoffs and could be a signal that corporations are trying to prune costs without immediately letting people go. The decline in the work week has been very broad across industries.
- As a result, aggregate hours worked in the private sector are up 1.0% YoY and are in a sharp deceleration over the past 18 month. Before companies start hiring again, they are likely to lengthen the work week. Overtime hours peaked at the end of 2014 at 4.5 hours and have been stable between 4.2 and 4.3 since.
- The last element of labor income is hourly wages which rose only 0.1% for the second time in 3 months and are +2.4% YoY, down from +2.7% in July. Note here that “food service and drinking places†raked up the largest number of new jobs in August at 34k (23% of the total). These are the lowest paying jobs in the economy. So, aggregate weekly earnings, otherwise known as the weekly paycheck, are growing +1.5% YoY, down from 2.2% since February. If the FOMC members look closely, they could see little wage pressures, just yet at least, and, importantly from a policy risk/reward viewpoint, that it might be challenging for Americans to sustain their +3.6% growth in nominal consumption of the past 6 months when their weekly income is rising at only 40% that rate.
No surprise, then, that growth in Gross Domestic Income is so weak, and weaker than GDP. While GDP measures the economy by what is produced, GDI measures the economy by the income generated from the production. The BEA explains: “In practice, GDP and GDI differ because they are constructed using different sources of information. The different source data produce different results for a number of reasons, including sampling errors, coverage differences, and timing differences with respect to when expenditures and incomes are recorded. (…) Over time, however, GDI and GDP provide a similar overall picture of economic activity.â€
The growth in real GDP seems to have stabilized at +1.0% SAAR, actually accelerating a little in Q2. Real GDI, however, keeps decelerating and was a mere +0.2% in Q2. Which of GDI or GDP currently provide the correct picture of economic activity?
As seen above, weekly earnings are up 1.5% YoY, down from 2.2% since February. Now look at personal taxes collected by state and local governments:
And here’s the federal government’s income trend:
I don’t know about you but I find these charts pretty scary.
Why would the FOMC seriously consider tightening when the income side of the economy is so weak, given that consumer spending is the only leg still walking reasonably steadily?
As to the production side, which as been in recession since June 2015, recall that Markit’s PMI and the ISM both weakened in August with poor new order trends, declining backlogs and contracting employment. Finally, Markit’s Services PMI for August
indicated that the U.S. service sector continued to struggle for momentum, with both business activity and incoming new work expanding at slightly slower rates than in the previous month. This contributed to a moderation in job creation to its weakest since December 2014.
David Rosenberg:
So if the Fed is data dependent, then why on earth would it be openly discussing the need for higher rates?
Maybe this is what is needed to assist the Banks. Or help the beleaguered money market, insurance and pension sectors (like the near $5 trillion of unfunded public sector pension funds). Or maybe to pop the perceived excesses in some of the “yield†trades that have become so crowded of late. Or maybe this is aimed at bolstering the savings accounts for pensioners.
Either way, if there is a reason for tightening policy, it cannot be because of the data. Perhaps this is all about raising rates now in order to have some room to cut it later down the road if need be (after all, the central bank already hinted loudly that of all the tools at its disposal in the future, negative rates are a last resort, at best).
You see the irony in Rosenberg’s comments: the only reasons that can explain the Fed’s continuous we-need-to-raise-rates jawboning is that it wants to correct the problems created by all its recent actions.
Maybe it has more to do with the Fed, perhaps mainly its chair, being caught in its self-designed box, its desire for transparency and/or its need to keep financial markets up. Kevin Warsh, a former member of the Fed, touched on that in a recent WSJ op-ed:
The Fed’s mantra of data-dependence causes erratic policy lurches in response to noisy data. Its medium-term policy objectives are at odds with its compulsion to keep asset prices elevated. Its inflation objectives are far more precise than the residual measurement error. Its output-gap economic models are troublingly unreliable.
The Fed finds uncritical support from the “guild†of sell-side economists and strategists and most mainstream media whose interests are aligned towards cheer-leading admittedly expensive financial markets. From Ben Hunt’s recent Epsilon Theory piece Magical Thinking:
I was dumbfounded by the stultifying, excruciating more-of-the-sameness that came out of Jackson Hole. Oh my god, are we really saying that the entire FOMC decision-making process comes down to whether there’s a good jobs report on Friday? Why don’t we just inspect the entrails of a goat? Are we really still arguing about one-raise-or-two when LIBOR is now pushing 90 basis points? Was there any mention — any mention at all — of LIBOR during the entire Jackson Hole meeting? Do these people, and it’s not just the central bankers themselves but all the courtiers — the journalists, the academics, the hangers-on — do they even recognize that a world exists outside of their imaginations and theories? Answer: NO.
Indeed, what was revealed in the papers and discussions and then in the interviews that followed the conference alarmed me and in some cases truly outraged me to the point that I was spitting epithets. When the dust settled, I was left with a profound sense of sadness over our global economic leadership’s obvious lack of understanding of the real world.
The truth is that the Fed is really playing a communication game, trying to achieve its goals (?) while avoiding investors’ wrath. Extract from the WSJ’s John Hilsenrath’s with James Bullard from Jackson Hole on August 27:
Mr. Hilsenrath: What kind of compromise would it take to get the FOMC to move in September? I mean, so the tradition is there’s some kind of — like you say, some kind of agreement. What would it take to get them there?
Mr. Bullard: Well, I have no idea, so — and it’s really — it’s really the chair’s job to fashion that. But I will say that — I’ll talk historically about the FOMC, the kinds of things that the FOMC would do. You would trade off. You would say, OK, we could hike today, but then we’ll not plan to do anything in the future. That would be one way to — one way to go about a consensus. So that often happens on the FOMC. Or vice versa. If you read the Greenspan-era transcripts, he’ll do things like, OK, we won’t go today, but we’ll kind of hint that we’re pretty sure we’re going to go next time.
Mr. Hilsenrath: Right.
Mr. Bullard: And so you get this inter-tempo kind of trade-off, and that often — that often is enough to get people to sign up.
Mr. Hilsenrath: So, hike today and then delay.
Mr. Bullard: Yeah. (Laughs.)
Mr. Hilsenrath: Or, no hike today and then no more delay.
Mr. Bullard: Yeah, yeah.
Mr. Hilsenrath: Something like that.
Mr. Bullard: Yeah, those kinds of trade-offs are, historically speaking — I’m not saying I know what Janet’s doing, because I don’t. But, historically speaking, those are the kinds of things that the FOMC has done.
The problem is that it is now pretty clear that the Fed is totally uncertain of what is going on and what it should do. So it gets involved into various narratives to please the street and keep investors on side as long as possible, hoping that “the data†will eventually provide the way out. The irony is that investors themselves don’t seem to know what they really want…
Libor Surge Reverberates All the Way to China’s Currency Market
A surge in the U.S. borrowing benchmark to a seven-year high is making it more expensive for Chinese companies to service $585 billion of dollar debt, encouraging firms to pay back their overseas loans and adding to pressure for the yuan to weaken. (…)
“Chinese corporates’ dollar debt is mostly based on Libor, so when Libor rises, foreign-exchange pressure will increase,” said Ming Ming, head of fixed-income research at Citic Securities Co., who used to work in the monetary policy division of the People’s Bank of China. (…)
The repayment of overseas debt has been one of the primary drivers of yuan weakness since China devalued the currency last August. Global bank claims on the nation fell to $695 billion at end-March from a peak of $1.1 trillion in 2014, according to the latest data from the Bank for International Settlements. An estimated $60 billion left China in the first quarter of this year to pay down foreign credit, bringing the total to $1.6 trillion, Goldman Sachs Group Inc. said in a report in July. (…)
US construction spending
– which came in weaker than expected – was dragged down by sharp declines in public non-residential construction (such as educational facilities). (The Daily Shot)
U.S. Trade Deficit Narrowed Sharply in July The U.S. trade deficit narrowed in July as American exports picked up, a sign of strengthening global demand.
(…) Imports fell 0.8% while overall exports rose 1.9%.
The export bump was largely due to record shipments of foods, feeds and beverages, especially soybeans. While the monthly increase in exports will support third-quarter growth, some economists warned it could be a one-off.
“The massive surge in soybean exports likely will reverse,†said Ian Shepherdson, chief economist at Pantheon Macroeconomics. “In the meantime, though, these data suggest that foreign trade is set to make a positive contribution to third-quarter GDP growth.â€
July’s 1.9% rise in exports was the largest increase in more than two years.(…) The fall in imports was led by a drop in imported consumer goods, especially pharmaceutical preparations. (…)
Through the first seven months of this year, exports fell 4.8% compared with the same period a year earlier, and imports decreased 4.0%. The deficit was roughly the same, down just 0.2% over the period.
(Haver Analytics)
Eurozone’s retail sales rose more than expected – by a sizeable margin.
G-20 Reaches Consensus on Economy, China’s Xi Says China rallied the Group of 20 around a call to use new levers to revive global growth, though the group’s nine-page statement was short on concrete steps and there were few signs that Beijing would lead by example.
Eurozone Investment Spending Stalls in Second Quarter
(…) Figures released by the European Union’s statistics agency also revealed slowdowns in spending by households and governments that left the eurozone largely reliant on a sharp rise in exports for the modest economic growth it recorded during the second quarter. (…)
Eurostat Tuesday confirmed that in the three months to June, the combined gross domestic products of the eurozone’s 19 members increased by 0.3% from the first quarter of 2016, and by 1.6% from the second quarter of 2015.
That was in line with two previous estimates. But Eurostat also lowered its estimate of quarter-to-quarter growth in the three months through March to 0.5% from 0.6%, leaving growth in the first half as a whole weaker than previously calculated.
The statistics agency also released details of the pattern of growth for the first time, and they showed that investment spending was unchanged on the quarter, having grown by 0.4% in the three months to March, and 1.4% in the three months to December. (…)
Consumer spending increased by just 0.2% during the three months to June, while government spending rose by just 0.1%, having jumped by 0.6% in each of the previous quarters. (…)
EARNINGS WATCH
From Factset’s weekly summary:
Overall, 498 of the companies in the S&P 500 have reported earnings to date for the second quarter. Of these companies, 70% reported actual EPS above the mean EPS estimate, 11% reported actual EPS equal to the mean EPS estimate, and 19% reported actual EPS below the mean EPS estimate. The percentage of companies that reported EPS above the mean EPS estimate was equal to the 1-year (70%) average, but above the 5-year (67%) average.
In aggregate, companies reported earnings that were 4.1% above the estimates. This surprise percentage was slightly below both the 1-year (+4.2%) average and the 5-year (+4.2%) average.
The blended, year-over-year earnings decline for Q2 2016 is -3.2%, which is smaller than the expected earnings decline of -5.5% at the end of the quarter (June 30). Five sectors reported year-over-year earnings growth, led by the Consumer Discretionary and Telecom Services sectors. Five sectors reported a year-over-year decline in earnings, led by the Energy and Materials sectors.
If the Energy sector is excluded, the blended earnings growth rate for the S&P 500 would improve to 0.8% from -3.2%.
The blended, year-over-year revenue decline for Q2 2016 is -0.2%, which is smaller than the expected revenue decline of -0.8% at the end of the quarter (June 30). Five sectors reported year-over-year growth in revenues, led by the Telecom Services and Health Care sectors. Five sectors reported a year-over-year decline in revenues, led by the Energy and Materials sectors.
If the Energy sector is excluded, the blended revenue growth rate for the S&P 500 would improve to 2.6% from -0.2%.
At this point in time, 111 companies in the index have issued EPS guidance for Q3 2016. Of these 111 companies, 78 have issued negative EPS guidance and 33 have issued positive EPS guidance. The percentage of companies issuing negative EPS guidance is 70%, which is below the 5-year average of 74%.
Factset’s tally now shows that analysts expect Q3 EPS down 2.1% compared to +0.4% on June 30th. This 2.5% decline in the bottom-up EPS estimate recorded during the first two months of the third quarter is smaller than the 1-year (-3.9%), 5-year (-3.4%), and 10-year (-3.8%) averages. At the sector level, the Energy sector witnessed the largest percentage decline in the bottom-up EPS estimate of all ten sectors at -24.0%.
However, and most worrisome, is the big revision in estimates for Consumer Discretionary companies, from +7.6% to +2.3% while Industrials EPS are seen down 7.9%, much worse than the –3.3% actually recorded in Q2.
Thomson Reuters’ estimate remains at –0.6% for Q3 but its estimate for CD companies also dropped sharply from +9.6% to +4.1% while Industrials profits are expected down 1.9% at TR. Full 2016 estimate is at $117.94 for TR, 0.5% below Factset’s $118.52. Both Q4 numbers assume a turn in margins…
We ended August with a trailing P/E of 18.9 and a Rule of 20 P/E of 21.1, both into the higher risk zone where the downside risk on valuation is greater than the upside potential (HARD HAT ZONE). Given the lack of backwind from earnings, investors sentiment remains crucial. As the chart shows, equities (blue) have been rising against a declining Rule of 20 fair value (yellow) which essentially plots trailing EPS and inflation. This meaningful decline in the fundamental underpinnings of equity markets has been more than offset by the sharp rise in valuation (black) since February.
Since the May 2012 trough in valuations (P/E of 13.4 and Rule of 20 P/E of 15.1), the S&P 500 Index is up 66%, two-thirds of which is from rising valuations. In 2016, the Index is up 18% from its early year trough, all of the upswing stemming from rising valuations.
The bull/bear ratio has jumped to the high range and the correction camp has all but been almost deserted (charts from Ed Yardeni). The stage seems set for a good surprise…
…or a bad one.
Given the most recent NFP and PMI surveys, we could be in for a spate of negative surprises, again.
Speaking of surprises:
Trumps Regains National Lead Over Hillary In Latest CNN Poll
SENTIMENT WATCH
Morgan Stanley Throws In The Bearish Towel, Sees S&P At 2,300 On A 19x “Bull Case” PE Multiple
(…) Well, several months later, with the central banks refusing to allow his bearish narrative to manifest itself, this morning Parker flip-flopped again, and once more threw in the towel, this time reverting back to his old bullish ways, when overnight he released a note titled that “We Think the US Stock Market Is Going Higher“, something he didn’t think for most of 2016.
The justification of his racent change of heart was the same one used by so many other analysts who have zero fundamental legs to stand on: the Fed Model, or low bond yields resulting in high equity valuations. This is what he said:
We are raising our 12-month price targets for the S&P 500 – base case from 2200 to 2300, bear case from 1600 to 1800, and our bull case from 2400 to 2500. Our bull-bear skew is balanced, and our base case upside is now mid-single-digit, consistent with our continued optimistic outlook. While we have argued many times that we think forecasting the market-level price-to-earnings ratio is difficult, our best guess is that growth and interest rates ultimately matter in the long term. In fact, we have shown that historically, there was a relationship between real yields and price-to-earnings ratios for the markets Exhibit 1). (…)
Sharp decline in retail money market fund holdings.
This trend is likely to be unrelated to the new regulation. Instead, it suggests that retail investors are now coming back into the equity markets (which they exited during the sharp selloff early in the year). Perfect timing as always. (The Daily Shot)
Bank of America “Thinks The Unthinkable”
“The unthinkable: BB yields about to become negative. Such has been Draghi’s influence across the whole credit market that we are close to seeing our first negative yielding BB-rated bond. But if debt costs for speculative grade companies become “invertedâ€, then the economics of LBOs will be transformed, and the quality of the assets they are buying will become secondary. We see a growing risk that another private equity cycle emerges in Europe.”
Time to Worry: Stocks and Bonds Are Moving Together
(…) A generation of traders have grown up with the idea that stock prices and bond yields tend to rise and fall together, as what is good for stocks is bad for bonds (pushing the price down and yield up), and vice versa.
This summer, the relationship seems to have broken down in the U.S. Share prices and bond yields moved in the same direction in just 11 of the past 30 trading days, close to the lowest since the start of 2007. (…)
The simplest explanation is that expectations of interest rates being lower for longer—some central bankers have suggested lower forever—pushes the price of everything up, and yields down. When the focus is on the discount rate used to value all assets, bond and stock prices rise and fall together, creating the inverse relationship between bond yields and shares.
Such a focus on monetary policy isn’t healthy. It leaves markets more exposed to sudden shocks, both from changes in policy and from an economy to which less attention is being paid. (…)
There is an alternative explanation for the breakdown in the U.S. equity-bond correlations. It could be that shares are tracking improving economic developments, while Treasurys are being driven by British, Japanese and European money fleeing super-easy monetary policy.
Such an explanation leaves investors vulnerable to a snapback in prices if either global growth improves, prompting foreign money to leave again, or global growth worsens, hurting U.S. corporate profits. (…)
Boom in Junk Debt Draws Concern High-yield corporate bonds have been a hot investment in 2016. Now, some investors are fretting that the debt may have gotten too popular.
(…) Sprint Corp., for instance, has a bond due in 2018 that is yielding roughly 4%, according to MarketAxess. In June, the same bond yielded around 6%. The wireless carrier, which has fallen to fourth-largest in the U.S. in terms of subscribers, posted a $302 million loss in its latest period and has lost more than $7 billion over its past three fiscal years. (…)
Understanding VIX ETFs
Must read if you intend to use VIX-related products. From Factset’s Dave Nadig, Director of Exchange Traded Funds.
