Trade Data Indicate U.S. Economy Contracted in First Quarter The U.S. economy likely contracted in the first quarter for the first time in three years, private forecasters said Tuesday after the nation’s trade gap narrowed less than expected in March.

Both exports and imports rose in March, a sign of strengthening demand at home and abroad that should bolster the economy into the spring. But the Commerce Department had assumed a larger decline in the trade deficit when it estimated last week that U.S. economic output barely expanded in the first three months of 2014.

A revised reading of U.S. gross domestic product, expected at the end of May, could be downgraded from the current estimate that the economy expanded at a seasonally adjusted annual rate of 0.1% in the first quarter.

J.P. Morgan Chase economists now estimate GDP contracted at a 0.8% pace in the first three months of 2014. Macroeconomic Advisers pegged the decline at 0.6%. Even some of the more optimistic estimates point to slight output shrinkage in the first quarter. Barclays Capital economists see a 0.2% decline and BNP Paribas put the GDP drop at a 0.1% pace. (…)

In March, U.S. exports rose a seasonally adjusted 2.1% from February to $193.91 billion, while U.S. imports rose 1.1% to $234.29 billion, the Commerce Department said Tuesday. The trade deficit shrank 3.6% to $40.38 billion.

Exports in March were up 5% from a year earlier, and imports were up 5.9%. The U.S. exported more capital goods and industrial supplies in March, and imported more consumer goods and food. Exports of services rose to $58.81 billion, the highest level on record, and total exports rose at their fastest monthly pace since last June.

U.S. petroleum exports rose, and petroleum imports fell to their lowest level since December. Not including petroleum, exports and imports both hit record highs in March. (…)

Remarkably, imports of non-petroleum goods rose at a 45% annualized rate in Q1.

Hollande Promises to Turn Around French Economy With Tax Cuts

French President François Hollande said Tuesday he will forge ahead with his plans to cut public spending and grant tax breaks to business, acknowledging French people are angry after he failed to deliver on pledges to turn around the economy.

(…) He said France must quickly implement tax cuts for business as this is the only way to boost jobs.

“We must go faster still because it is unbearable for French people,” Mr. Hollande said. He also said he has brought forward plans to ease the tax burden for the poorest and will fast-track overhauls to cut down on layers of local government. (…)

CASES AGAINST WAGE INFLATION

In the past month, I wrote THE U.S. LABOR MARKET: WHERE IS GODOT? and THE BIG WAGER, erring on the side of rising wage pressures on the basis of developing real world trends. Here’s the academic rebuttal:

• From Bank of America (via Zerohedge):

By some accounts inflation is always just around the corner. Rising gold prices, surging bank reserves and a weak dollar have each taken their turn “predicting” imminent inflation. The latest concern is that tight labor markets will trigger a surge in wages. Indeed, the hottest inflation chart these days shows average hourly earnings for production and non-supervisory workers, troughing at 1.3% in October 2012 and accelerating to 2.3% for the latest reading. As one of our competitors argues: “it should be obvious to everyone by now that there is wage inflation in the pipeline.”

How worried are we? In our view, the wage measure that Inflationistas like to point to is the least reliable of four major measures of compensation growth. Plotting this series alone is a blatant example of “cherry picking” to tell a story. A number of years ago the Labor Department replaced the old average hourly earnings series with a better, broader measure. The older series only exists because it has a long history. The three most important measures of labor compensation—including the new and improved average hourly earnings series—remain glued to 2% (Chart 1).

So far, so good, but doesn’t the drop in the unemployment rate signal rising wages? In particular, since the long-term unemployed have a very hard time finding a job, shouldn’t we focus on the short-term unemployment rate, which at 4.1% is already 0.6pp below its historic average (Chart 2)?

Don’t hold your breath: serious wage pressure is a long way off for four reasons.

1. First, it is not at all clear that we should ignore the long-term unemployed. As Fed economist Michael Kiley points out, short-term and long term unemployment are normally highly correlated, so studies that try to distinguish their impact on inflation must rely on just a few years of data. Small sample and “multicollinearity” problems make these estimates very unreliable. Kiley gets around these problems by using regional data. Using data for 20 metro areas over a 20-year period, he finds that both short- and long-term unemployment matter, with similar coefficients. We prefer to split the difference between Kiley’s results and others that focus only on the short-term rate: while more weight should be given to the short-term unemployed, the weight on the long-term jobless for wage determination should not be zero.
2. Second, if we are going to throw out the long-term unemployed in our measure of slack, surely we should also take into account hidden unemployed such as discouraged workers, those opting for additional schooling, and involuntary part-timers. We could easily boost the unemployment rate by a percentage point if we try to capture hidden unemployment.
3. Third, even if we are at full employment, it does not mean surging wages. Most of the recent research on wage and price inflation finds a very slow, lagged response to labor market tightness. The Phillips Curve appears very flat. For example, in Kiley’s estimates, a one percentage point drop in the unemployment rate adds 0.1 to 0.2pp to inflation in the first year and 0.2 to 0.3pp in the second year. Most of the discussion of inflation risks ignores this important empirical result and makes it sound like inflation is an explosive process. Both history and models show that it takes a long time to get going (but can also be hard to reverse if it gets too high).
4. This brings us to our final point: rising wages are a good sign for the economy, not something the Fed would want to prevent. As Fed Chair Janet Yellen has suggested, in a normal labor market we would expect wages to grow at about a 3.5% rate: 2% to cover the rising cost of living and 1.5% to cover productivity gains. Currently, downward pressure from high unemployment is holding wage growth to just 2%.

The upshot is that investors should not be on the edge of their seats waiting for the first hint of wage acceleration. As labor market slack shrinks, we would expect wage growth to slowly pick up. In our view, the Fed would probably be comfortable with wages accelerating by about 0.5% per year, bringing wage inflation back to normal by the end of 2016.

• From Ed Yardeni:

I am inclined to believe that the unemployment rate remains a relatively accurate measure of the labor market. It continues to be very highly correlated with the jobs-hard-to-get series in the monthly Survey of Consumer Confidence. If the labor market has gotten tighter as suggested by the unemployment rate, why aren’t wages rising at a faster rate? During Q1-2014, the Employment Cost Index showed wages and salaries up just 1.7% y/y. Average hourly earnings for all workers increased just 1.9% y/y during April. I believe that employers won’t respond to tightening labor markets by bidding up wages. Instead, they will use technology, when possible, to keep a lid on their labor costs.

• Now, the necessary more technical debate (via FT Alphaville) that I spare you (with a link if you really care) because it is the usual “one the one hand, on the other hand…). (US labour market slack: the difficulty with “structural” vs “cyclical” labels). Here are the main charts from the Goldman analysis:

• And if you really want to go technical, this newly published research paper by Michael Kiley, a senior economist on the Fed staff.

My only comment on the above: do not believe what the BofA economist when he says “Most of the recent research on wage and price inflation finds a very slow, lagged response to labor market tightness.” The reality is that when the wage train leaves the station for good, it’s tough to stop:

Final word on ISI’s Ed Hyman, voted the best economist on Wall Street for just about as long as I have known him…

US wages are likely to accelerate because the zeros are going away, i.e., if fewer workers get zero pay increases, wages overall will accelerate. NYC teachers, who have gotten zero pay increases for the past five years, will now receive almost +4.0% per year.

SENTIMENT WATCH

Small Caps Flash Warning Small-cap stocks have lost their mojo, and that doesn’t bode well for the broader market.

(…) The small-cap Russell 2000 closed below its 200-day moving average on Tuesday for the first time since November 2012, snapping a streak of 363 trading days above the closely watched technical indicator, according to Bespoke Investment Group. That marked the index’s third longest streak dating back to its inception in 1978. The two prior streaks came in the mid-1990s.

Chart watchers use the 200-day moving average as a proxy to gauge a market’s long-term trend. When a stock or index trades above the 200-day, it is in an uptrend. But when it falls below, it is in a downtrend that could lead to more declines.

In 11 prior instances when the Russell snapped a lengthy streak above its 200-day average, the index averaged a 1.1% drop over the following three months, according to Bespoke.

The Russell 2000 dropped 1.6% Tuesday to 1108.01. It’s down 7.1% from the record high hit in March. As Dan Greenhaus of BTIG points out, about half of the Russell’s components are down 20% or more from their respective 52-high weeks. Some 80% of them are down at least 10% from their respective highs, showing how the declines across small-cap stocks have been broad and deep this year. (…)

But the 200-day m.a. is still rising…

Not a Good Year for Analysts Either

2014 has so far been an extremely difficult year for stock market investors.  As noted by Goldman Sachs yesterday, “nearly 90% of largecap growth mutual funds and 90% of value funds were underperforming their benchmarks year-to-date.”  We would bet that the numbers are similar for smallcap and midcap mutual funds as well as a large number of hedge funds.  Performance like this doesn’t just happen in a normal market environment.  After a 2013 that saw Tech and Consumer Discretionary go up by 30-40%, investors came into 2014 overweight all of the areas that had shown strength, and underweight the sectors that had been lagging. Over the last two months, we have seen the most heavily owned and followed sectors like Technology and Consumer Discretionary go down, while under-owned sectors like Utilities have been charging higher.  Not many funds are fully invested in Utilities and other defensive plays, especially after the year we had in 2013. Given that the broad market has remained flat year-to-date even as the overweighted sectors have fallen, it’s easy to see why so many are underperforming.   

Analysts haven’t exactly helped investors recently either.  Below we have broken up the S&P 500 into deciles (10 groups of 50 stocks each) based on analyst ratings.  Decile one contains the 50 stocks that are the most loved by analysts (most buy ratings vs. sell ratings), while decile ten contains the 50 stocks that are the most hated by analysts.  For each decile, we have calculated the average performance of its stocks over the last two months going back to March 5th, which was the day the Nasdaq peaked.

As shown below, the 50 stocks in the S&P 500 that have the most positive analyst ratings are down an average of 2.4% over the last two months, while the 50 stocks that have the most negative analyst ratings are up an average of 3.5%!  That’s a pretty huge difference, and it certainly helps in part to explain why so many investors are underperforming.  Lots of fund managers and individual investors (especially) rely on the analysts at their brokerage firms for individual stock ideas.  As is evidenced by the performance data below, owning the most loved stocks has been a losing trade in the current market environment.  

Earlier today over at Bespoke Premium, we analyzed decile performance for a number of other stock characteristics like valuation, market cap, short interest, dividend yield, institutional ownership, and international revenues.  The data really helped to quantify how difficult the last two months have been for investors.  To check out the report and also try out all of our other products, sign up for a 5-day free trial to Bespoke Premium today