Recovery Watch

U.S. EMPLOYMENT

Jobs Growth Jumps as Economy Gains Steam U.S. employers in April added jobs at one of the fastest paces of the recovery, rekindling hopes for an upturn strong enough to alleviate the economy’s longstanding ills.

Nonfarm employment grew by 288,000 in April and the jobless rate sank to 6.3%, the Labor Department said Friday. The new jobs—spread across an array of industries from retail to construction—put total payrolls closer to the all-time peak, reached near the recession’s start, after a long and grinding recovery. (…)

Still, the report included numerous worrisome signs, among them another exodus of workers from the labor force and persistently weak wages. (…)

After revisions to prior estimates, job growth over the past three months has averaged 238,000—far above last year’s pace—and other metrics this week showed new momentum in the manufacturing sector and a rebound in consumer spending.

But the economy has seen regular bursts of momentum broken by sudden downswings. Looking beyond the monthly volatility, employment growth has averaged about 197,000 jobs over the last year—roughly in line with the pace of the past few years. (…)

The month-over-month plunge in the jobless rate reflected a sharp contraction in the pool of American workers, with far fewer people seeking jobs. That sent the labor-force participation rate back to a three-decade low of 62.8%, puzzling economists and policy makers who have been expecting participation to pick up as jobs increased.

Workers’ wages—stagnant for years—budged little last month despite the apparent hiring spree. Wages rose just 1.9% from a year earlier, limiting Americans’ ability to significantly raise their living standards. (…)

Nearly 10 million Americans remained unemployed in April, more than a third of them out of work for at least six months. About 7.5 million Americans were stuck in part-time jobs because they couldn’t find full-time work.

A broader measure of unemployment that includes involuntary part-time workers and people too discouraged to search for a job fell to 12.3% last month. But it stood at 8.4% just before the recession started in December 2007.

(…) Public-sector employment appears to be stabilizing, with local and state governments adding 15,000 jobs in April to help offset a small decline at the federal level.

(…) The retail sector grew by 35,000 jobs in April, and employment in food services—including restaurants and bars—climbed by 33,000.

More facts from the FT:

• In retrospect, the freezing winter that caused so much angst earlier this year was barely a blip in the data, as the numbers have been steadily revised up. The figure for January now stands at 144,000 after the initial report of 113,000; February is at 222,000 compared with the initial report of 175,000. That vindicates the Fed’s decision to disregard those seemingly weak months.
• Over the past three months, job gains have averaged a healthy 238,000. In the private sector alone, the average was 225,000.
• The six-month moving average for non-farm payrolls – the best way to read the volatile data – is now at 202,000. That is one of the strongest readings of the recovery, consistent with steady progress in bringing down the unemployment rate.

The big question mark:

• According to Wrightson ICAP’s chief economist, Lou Crandall, the monthly drop in the labor force has run more than 200,000 seven times since early 2012, and each time has rebounded in subsequent months. The average initial decline has averaged 377,000; the average rebound, 345,000. What is happening, then, is that when rebounds follow declines, the labor-force entrants are just as likely to be employed as to be unemployed. Thus, most of the initial decline in the jobless rate turns out to be confirmed, as it will probably be in this case. (Barron’s)
• Participation has just gone back to where it was at the start of the year, however, so overall the gains on the unemployment rate this year do reflect people gaining jobs.

Ms. Yellen thought participation had bottomed:

“Labour force participation, which had been falling, has ticked up this year,” she said in a speech a few weeks ago.

In summary, courtesy of Goldman Sachs’ chief economist Jan Hatzius:

• Since the start of the Great Recession in late 2007, the labor force participation rate has fallen by more than three percentage points, including a sharp drop in April back to the late-2013 lows. The extent of the decline has surprised many economists, ourselves included. What accounts for it, and will it continue?
• The first question is relatively easy to answer. Using an approach similar to that of a recent Philadelphia Fed study, we can show that the decline reflects a combination of 1) more retirements, 2) more disability, 3) higher school enrollment, and 4) more discouraged workers.
• The second question is more difficult, but we believe the answer is no. The most important reason is that the big increase in retirements in the last three years looks far less “structural” to us than generally believed. Many people seem to have pulled forward their retirement because of the weak job market. This leaves correspondingly fewer retirements for future years, and it means that the impact of retirements on participation is likely to become much less negative.
• The other drags on participation are also likely to abate or reverse. Inflows into disability insurance are now slowing sharply, consistent with past cyclical patterns. The school enrollment surge has started to reverse as young workers are finding better job opportunities. And stronger labor demand is likely to pull many discouraged workers back into the job market.
• If participation does stabilize or rise a bit, the decline in the unemployment rate should slow even if payroll growth stays at the sturdy levels seen in recent months. This is one key reason why we believe Fed rate hikes are still far off.

But the Philadelphia Fed paper, in fact, concludes that

(…) it is not clear whether the overall participation rate will increase any time soon, given that the underlying downward trend due to retirement is likely to continue.

Still driving blind…

Markit says that employment growth has already begun to slow:

There are signs that the pace of job creation will start to moderate. For sure the 0.1% annualised rate registered by official GDP in the first quarter is insufficient to sustain anything like the average pace of job creation seen throughout the past two years. Even the more buoyant PMI survey data, which have typically provided a reliable guide to the trend in the non-farm payrolls data, suggest that the underlying pace of private sector job creation has eased from over 200,000 at the start of the year to just over 100,000 as the rate of economic growth has cooled.

While the flash PMIs for April indicated that the underlying pace of economic growth has been stronger than the official GDP numbers so far this year, the survey data suggest that the pace of expansion has slowed since late last year to around 2.0% at the start of the second quarter, a rate of growth which historically generates around 100,000 extra jobs per month. On this basis, the surprising 288k rise in April may be the best we see for a while.

The overall picture from the employment report is therefore one that adds to the sense that Fed talks will increasingly move towards the timing of the first rate hike and away from worries about whether the QE taper could cause the recovery to stall, but the first rate rise still looks some way off.

However, ISI’s company surveys are now clearly above anything seen in this expansion.

Our Overall Company Surveys advanced from 54.0 to 54.4, the highest since July 2006 led by Autos, homebuilders, and tech cos.  More importantly, breadth improved with the Company Survey Diffusion Index which leads the regular surveys from +8.8% to +9.6%, a three year high. As summer approaches, there is  risk that momentum fades as we have seen frequently since 2010 in both our Company Surveys and some government series.  Encouragingly, some growth multipliers like bank lending and employment are also better, and capex is stronger as measured by our cap goods cos. survey and the durable goods report. Our Retailer Survey which has been a good indicator at turning pts  moved down from 52.3 to 51.7 this week while pricing power moved down from 26.5 to 26.0.  Our Trucking Survey (highest correlation with Real GDP at 90%) moved down from 63.1 to 62.1. ISI’s Homebuilders’ Survey improved this week, moving up from 59.8 to 62.6, the highest level on the survey since June 2013. Participants reported a better week of sales post holiday and spring break, with events also helping to draw in the consumer.

Atlanta Fed Tool Suggests Full Employment Could Be Reached In Six Months The Federal Reserve’s Promised Land for the unemployment rate could be here as soon as six months from now, a development that could rev up the debate over when to start raising short-term interest rates.

If the economy can keep up something like the current rate of monthly job gains, unemployment could fall by year end to the top of the range Fed officials’ say they expect over the long run, according to a jobs calculator offered by the Federal Reserve Bank of Atlanta on its website.

This level is often referred to as “full employment,” the lowest unemployment rate consistent with stable inflation at the Fed’s goal of 2%. The Fed’s “central tendency” estimate of that range is 5.2% to 5.6%. The central tendency excludes the three highest and three lowest of the 16 officials’ projections submitted before the March Fed meeting.

According to the Atlanta Fed’s calculator, the unemployment rate could decline to 5.6% in six months if employers added on average 239,000 jobs per month. That’s well below the number added in April, and roughly the same as the average 238,000 jobs added over each of the past three months.

The calculator has a number of factors that can be adjusted. For example, to get to that 5.6% unemployment rate, it assumes the labor force participation rate holding steady at its current level of 62.8%.

But the idea of a stable labor force participation rate may be unlikely. This measure — the share of adults holding or actively seeking jobs — has been falling for some time. The rate was 62.8% last month, down from 63.2% in March and 63.4% in April of the previous year.

The participation rate’s decline in April played a big role in driving the rapid decline in the jobless rate. As people drop out of the labor force, they are no longer counted as unemployed.

The possibility the economy could reach full employment in a mere six months could test the central bank’s outlook for short-term rates. Most Fed officials projected in March they would start raising short-term rates from near zero in 2015. If the unemployment rate falls closer to full-employment, some policy makers could press to raise rates sooner. Some officials have signaled they could support interest rate increases when the jobless rate hits around 5.5%.

However, Fed Chairwoman Janet Yellen and several other officials say the jobless rate overstates the degree of improvement in the labor market and too much of the drop in labor force participation is driven by discouraged workers who’ve stopped looking for employment. (…)

INFLATION WATCH

• Wage Pressure Begins to Build

A wide range of companies have reported upward pressure on wages in the early months of the year, including asset-manager State Street Corp., coatings manufacturer PPG Industries Inc. and eatery operators Chipotle Mexican Grill Inc. and Darden Restaurants Inc.

Martin Ellen, chief financial officer at drinks maker Dr Pepper Snapple Group Inc. projected a $30 million rise in “people-related costs” for the current year, “reflecting both general inflation in our field labor costs” and higher health and benefit expenses. Mr. Ellen told investors he expected to see compensation costs rise more significantly in the third and fourth quarters of the year, with wage inflation pushing employee costs up about 2% and accounting for about two-thirds of the year’s total increase.

The comments are at odds with broader economic data—U.S. Labor Department figures on Friday showed private-sector nonfarm hourly wages grew just 1.9% in April from a year earlier—and economists aren’t finding much evidence of a strong uptick in wages five years after the recession ended.

Still, executives at more than two dozen large companies—including manufacturers as well as financial and services companies—reported rising wages in significant portions of their businesses, much of it in the U.S., as they discussed first-quarter results.

(…) Employee compensation as a share of national income has fallen to its lowest point since 1951, at 66%, while profits rose to a level not seen since around the same time, at about 16%, said Christopher Probyn, chief economist at State Street Global Advisors, a unit of State Street Corp. (…)

State Street Chief Financial Officer Michael Bell said the company raised base salaries an average of 3%, effective in April. “I would certainly acknowledge that the 3% is a fair amount higher than the last couple of years where we had very small increases,” Mr. Bell told investors. “We thought it was important given the competitive landscape and the importance of keeping our top talent.” (…)

For Houston chemical maker LyondellBasell Industries NV, rising wages have surfaced in new investments, particularly a series of plant expansions in Texas. Construction on a $1.3 billion project to expand ethylene production capacity has already begun, and wages are climbing amid plans for similar projects at other companies, LyondellBasell executives said.

Addressing investors and analysts in March, Sergey Vasnetsov, the company’s senior vice president of strategic planning, cited “escalation of wages” and “tight availability of qualified labor.”

LyondellBasell CEO James Gallogly elaborated last week, saying labor quality had declined as well, reducing productivity. He predicted both trends would intensify as competing projects are started in the next several years.

“We’re still in the early phases, so when some of those big projects ramp up, I think it’s going to get worse, not better,” Mr. Gallogly told investors. “I would expect cost to be higher, and I expect things to come in a little slower.”

Some of the increases at railroad Kansas City Southern were the result of scheduled pay increases under railroad union contracts, spokesman William Galligan said.

A few companies stand to gain directly from wage increases. One is Robert Half International Inc., a staffing and consulting firm, which earns more when the temporary employees it places are paid more.

“We saw rising pay rates for our temporary staff, which, in turn, meant rising bill rates,” Chief Financial Officer M. Keith Waddell told investors and analysts. “So we’re very encouraged that we’re starting to see some wage inflation, which is usually indicative as you’re beginning to start the growth part of a cycle in earnest.” (…)

Some companies said the impact of wage increases was damped by productivity gains and cost-cutting efforts.

Quest Diagnostics Inc., the medical-laboratory chain, said new savings from a multiyear cost-cutting program helped offset inflation in the company’s wage bill, as well as recent lower-margin acquisitions.

Darden Restaurants, which operates the Olive Garden and LongHorn Steakhouse chains, among others, reported that productivity gains and improved insurance and unemployment expenses “mostly offset the effect of wage rate inflation” and sagging sales. (…)

Label-maker Avery Dennison Corp. told investors that productivity gains and sales growth barely overcame “higher employee-related expenses” during the quarter. A spokesman described the increases as merit raises, plus broader wage inflation in a segment that operates extensively in emerging markets.

Asked by analysts in the company’s April 23 earnings call whether the rise in labor costs reflected additional hiring or simply higher pay, the company pointed to the latter.

“It’s all wage inflation, 90-plus percent of it,” Chief Financial Officer Mitchell Butier said.

• FedEx Raises Fuel Surcharge, Adjusts Ground-Delivery Pricing

FedEx Corp. said it would raise its freight-delivery fuel surcharge for some deliveries and next year start charging for ground delivery based on package volume for all packages.

The 3-percentage-point fuel-surcharge increase, effective June 2, applies to shipments by its FedEx Freight segment within the contiguous U.S., within Canada, and between the continental U.S. and Alaska, Hawaii, Puerto Rico, the Virgin Islands and Canada, the company said.

FedEx said its freight business updates fuel surcharges for the U.S. and Canada every week based on published average diesel fuel prices.

In addition, the company said its FedEx Ground division will start applying so-called dimensional-weight pricing to all shipments, effective Jan. 1. FedEx Express already applies this pricing to all packages.

Currently for FedEx Ground, dimensional-weight pricing, which bases shipping rates on package volume, only applies to packages measuring three cubic feet or greater.

Friday’s announcement follows a 3.9% increase in shipping rates for FedEx’s freight and domestic express-shipping businesses, announced earlier this year.

The rate increases come as FedEx and rival United Parcel Services Inc. face increased pressure from smaller companies offering lower-priced shipping services, as well as from retailers, such as Amazon.com Inc. and Wal-Mart Stores Inc., who are testing their own deliveries.

• Intel’s Sway Lifts Server Chip Prices

China wakes up to growing pension problem Issue sparks largest Chinese factory strike in decades

(…) Workers at Yue Yuen Industrial, which makes running shoes for Nike and Adidas at a big factory complex in Gaobu, said it underpaid their pensions for years.

After 11 days of protest, the Dongguan municipal government handed them a rare victory by saying the company should have based contributions on a higher pay level. Yue Yuen estimates that it will have to pay an additional $31m just this year after agreeing to base pension payments on workers’ total pay, including overtime.

The strike cast a harsh spotlight on Yue Yuen, the biggest employer in Gaobu, one of many towns that form the manufacturing metropolis of Dongguan. But workers, labour activists and factory managers say the practice is widespread in the Pearl River Delta – the manufacturing workshop of the world – in south China.

Local governments are allowing manufacturers to pay lower pension contributions than required as they worry about companies leaving, particularly as factories face double-digit wage rises each year. (…)

Local authorities are finding themselves increasingly in a bind. While they want to keep factories, they also want to avoid the kind of strikes that raise concerns in the eyes of potential investors. Some factory managers say multinationals will now pay closer attention to the pay practices of their suppliers in China. (…)

EARNINGS WATCH

From Factset:

Overall, 371 companies have reported earnings to date for the first quarter. Of these 371 companies, 74% have reported actual EPS above the mean EPS estimate and 26% have reported actual EPS below the mean EPS estimate. The percentage of companies reporting EPS above the mean EPS estimate is above the 1-year (71%) average and above the 4-year (73%) average.

In aggregate, companies are reporting earnings that are 5.4% above expectations. This surprise percentage is above the 1-year (+3.1%) average, but slightly below the 4-year (+5.8%) average. If this is the final percentage for the quarter, it will mark the highest earnings surprise percentage since Q1 2011 (7.0%).

In terms of revenues, 52% of companies have reported actual sales above estimated sales and 48% have reported actual sales below estimated sales. The percentage of companies reporting sales above estimates is below both the 1-year (54%) average and the 4-year average (58%). In aggregate, companies are reporting sales that are 1.1% above expectations. This surprise percentage is above the 1-year (+0.3%) average and above the 4-year (+0.6%) average.

The blended earnings growth rate for the first quarter is 1.5% this week, above the blended growth rate of 0.3% last week. Seven of the ten sectors are reporting higher earnings relative to a year ago, led by the Telecom Services and Utilities sectors. Three sectors are reporting lower earnings relative to a year ago, led by the Energy and Financials sectors.

The blended revenue growth rate for Q1 2014 is 2.8%, which is above the estimated growth rate of 2.5% at the end of the quarter (March 31). Eight of the ten sectors are reporting revenue growth for the quarter, led by the Utilities sector. On the other hand, the Financials sector is the only sector reporting a decline in revenue for the quarter, while the Energy sector is reporting flat sales (0.0%).

At this point in time, 72 companies in the index have issued EPS guidance for the second quarter. Of these 72 companies, 53 have issued negative EPS guidance and 19 have issued positive EPS guidance. Thus, the percentage of companies issuing negative EPS guidance to date for the first quarter is 74%. This percentage is above the 5-year average of 65%.

But it is way lower than that of the past year at the same time in the quarter.

Although companies are reporting slight earnings growth (1.5%) for Q1, earnings growth for the S&P 500 is projected to be much higher for the remainder of the year. For Q2 2014, Q3 2014, and Q4 2014, analysts are predicting earnings growth rates of 6.5%, 10.0%, and 10.3%. For all of 2014, the projected earnings growth rate is 7.8%.

Trading Falls at J.P. Morgan J.P. Morgan Chase sounded an alarm on Wall Street, warning that a slump in its trading revenues will deepen in the second quarter of the year.

The largest U.S. bank by assets said in a regulatory filing late Friday it expects its markets revenue, which includes fixed-income and equities trading, to decline 20% in the quarter, sharper than the 17% drop it posted in the first quarter.

That drop, in turn, was worse than the 15% decline the bank’s chief executive, James Dimon, in late February had said J.P. Morgan was seeing so far in that quarter.

The biggest driver of J.P. Morgan’s weakness: a decline in revenue from its fixed-income, currencies and commodities, or FICC, unit.

Fixed-income trading at the nation’s biggest banks has been hampered in recent quarters by a slow economic recovery, both at home and abroad. Investors have pulled back from exotic fixed-income securities in favor of low-risk government bonds, which are less profitable for banks. New regulations, meanwhile, have prompted Wall Street firms to exit from once-lucrative businesses such as energy trading.

Bank of America Corp. BAC +1.06% and Citigroup Inc. C -0.06% also released their quarterly regulatory filings this past week, but neither mentioned markets revenue. (…)

Big U.S. banks have reported varied results from their fixed-income units of late, mainly due to the differing mixes of the components inside the businesses.

For the first quarter, Goldman Sachs Group Inc. GS -0.93% reported a 13% decline in its FICC trading business, excluding debt adjustments, a slump that wasn’t as severe as analysts had expected. Bank of America logged a 15% decline in its FICC business in the first quarter from a year ago, after stripping out a large one-time number that weighed down first-quarter 2013 results. Meanwhile, at Citigroup, first-quarter FICC revenue fell 18% from a year earlier.

Morgan Stanley, MS -1.70% a smaller player, recorded a 35% rise, or 9.2% when adjusted for the value of the company’s debt.

Both Morgan Stanley and Goldman benefited from a business mix more skewed toward commodities, which did well in the first quarter, aided by bad weather that jostled energy markets. Banks that have bond-trading activities more exposed to macroeconomic headwinds, in businesses such as interest-rates and currencies, meanwhile, did worse in the first quarter, according to ISI analyst Glenn Schorr.

Stock trading, by contrast, has held up relatively well at most banks. While a spate of new rules on capital and risk-taking have curbed activity in FICC, which had been the industry’s biggest profit engine in the years leading up to the financial crisis, stocks are easily traded and rarely held for long on balance sheets, making them more attractive under the new rules.

Morgan Stanley posted a 16% rise in equities revenue in the first quarter from the same quarter a year earlier. Citigroup posted a 7% increase in equities trading for the first quarter over the same quarter a year earlier. Bank of America was flat, while J.P. Morgan registered a 3% decline. Goldman suffered a 17% decline in equities-trading revenue in the first quarter.

J.P. Morgan addressed another problem on Friday: Russia. The bank said it has shrunk its total exposure to the country, just as Citigroup and Bank of America have done, in the wake of the imposition of U.S. economic sanctions against Russia for its dealings with Ukraine.

J.P. Morgan said its total exposure to Russia was $4.7 billion as of March 31, down 13% from $5.4 billion on Dec. 31. The decrease bounced Russia from the list of top 20 countries in which J.P. Morgan is exposed.

SENTIMENT WATCH

Takeovers Put Fuel in Stocks’ Empty Tank The biggest surge in corporate takeovers since before the financial crisis is revving up an otherwise sputtering stock market.

U.S.-based companies this year have proposed or agreed to $637.95 billion worth of mergers or acquisitions—either as the buyer or the target—the most at this point since Dealogic started tracking these figures in 1995. That includes Pfizer Inc. PFE -1.28% ‘s $106 billion offer forAstraZeneca AZN.LN -0.15% PLC, which rejected the offer.

Shares of the companies getting snapped up have jumped an average of 18% the day after the deal news, according to Dealogic.

And contrary to conventional wisdom, shares of the buyers in proposed deals have risen. Buyers’ shares are up an average of 4.6% the day after a deal’s announcement. That is the highest postdeal share jump on record, according to Dealogic.

In contrast, from 1996 through 2011, the acquirer’s shares fell 1.4% the day after a takeover was announced.

Jeremy Grantham on Bubbles: ‘I Am Sure It Will End Badly’

Legendary investor Jeremy Grantham predicts the bull market still has plenty of room to keep rallying, perhaps for another year or two. But another move higher will be followed by an inevitable crash, one in which pain will be felt far and wide.

Stocks aren’t as frothy now as they were at previous market peaks, he says, and the Federal Reserve is also keeping interest rates pinned near zero while maintaining accomodative monetary policies. That’s why he doesn’t think the market has topped now. But the day of reckoning is coming.

“I am sure it will end badly,” Mr. Grantham, founder of the Boston-based money-management firm GMO, wrote in his quarterly letter to investors.

Mr. Grantham expects this year “should continue to be difficult” through October (he didn’t specifically allude to “sell in May and go away” but his prediction matches that adage). He then predicts the rally will regain steam in the fourth quarter and continue through the end of 2016.

He sees at least 20% rally in the S&P 500 through the presidential election, one that would take the index to at least 2250. After that, it’ll get ugly.

“Around the [presidential] election or soon after, the market bubble will burst, as bubbles always do, and will revert to its trend value, around half of its peak or worse, depending on what new ammunition the Fed can dig up,” says Mr. Grantham of GMO, which manages about $112 billion in assets for large pension funds, endowments and accredited investors through private accounts. (…)

In his quarterly letter, Mr. Grantham estimates the market is currently overvalued by 65%, predominately because of the types of investors driving the market in the short-term.

“Purist value managers may try to block out the siren call because they don’t wish to be tempted, and some may hear it and do nothing because the gains are never certain and the lack of prudence is painfully obvious in the end,” he wrote. “Yet long-term value managers are outnumbered by momentum managers – always were and probably always will be – and momentum managers have no such qualms. Why this time, then, would they not play the game with even more enthusiasm, at least enough to drive the market to…2,250 and perhaps a fair bit beyond? And although nothing is certain in the market, this is exactly what I believe will happen.” (…)

“The bull market may come to an end any time, indeed as I write it may already have happened,” Mr. Grantham said. “It could be derailed by disappointing global growth, profits sagging as deficits are cut, a Russian miscalculation, or, perhaps most dangerous and likely, an extreme Chinese slowdown. But I believe it probably (i.e., over 50%) will not end for at least a year or two and probably not before it reaches a level in excess of 2,250 on the S&P 500.”

Another smart investor reneging his valuation indicator importantly based on margins mean-reverting. Even though “the market is currently overvalued by 65%” (!!), he elects to rest on the Fed put and on past market seasonality, hoping that momentum investors will carry us all to new highs before we all dive into the abyss.