Edge and Odds

The enemy of knowledge is not ignorance, it’s the illusion of knowledge (Stephen Hawking)

It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so (Mark Twain)

Edge and Odds

Invest with smart knowledge and objective odds

THE U.S. LABOR MARKET: WHERE IS GODOT?

How tight is the U.S. labor market? Not a trivial question given current low interest rates and elevated equity multiples.

Josh Wright, Bloomberg Economist sets the debate:

imageFed Chair Janet Yellen has taken an assertive tone in the debate on labor market slack, both in her speech on March 31 and at the post-FOMC press conference two weeks ago. First, in response to a question, Yellen dismissed as “tremendously premature” arguments that recent declines in short-term unemployment could lead to inflation generating tightness in the labor market, since long-term unemployment remains elevated. Then in her speech she took an even stronger stance, pointing to low wage growth as a sign of slack.

She reiterated her hope that if growth picks up, the decline in the labor force participation rate and the rise in long-term unemployment could be reversed. For economists, the clear implication was that monetary stimulus could help draw these people back into the labor market. (…)

A growing body of evidence from researchers and comments from policymakers indicates that a structural shift is at least partly to blame for the disappointing job growth at this stage of the recovery. (…)

imageThe latest of the studies on short-term unemployment and wage pressures comes from a Princeton team led by Alan Krueger (http://goo.gl/jxIYah). As in prior studies, Krueger et al. found that short-term unemployment is a better predictor of wage pressures and inflation than total unemployment. Significantly for this camp, short-term unemployment is declining toward the point where they anticipate wage pressures might take off. One of their less celebrated findings is that the long-term unemployed are unlikely to change industries.

This is bad news for Yellen’s hopes to draw potential workers back in, given recent shifts in U.S. job creation. While the total number of jobs in the U.S. economy has recovered to close to the level seen immediately prior to the Great Recession, a disproportionate share of the new jobs has come in service sectors. Many of the jobs in goods-producing sectors have not returned, and that means there are a large number of former construction and manufacturing workers who are still waiting for jobs that may not come back just because growth picks up — or at least, not before either their motivation or skills have eroded sufficiently to take them out of the running.

At the same time, the shift toward service sector jobs may bolster Yellen’s broader view of slack and undermine the academic concerns about declining short-term unemployment. If much of that decline has been led by growth in service-sector jobs that are part-time, then that would reinforce Yellen’s view of elevated underemployment as a sign of slack. In other words, if the decline in short-term employment largely reflects workers being drawn into just another area of slack, the wage pressures aren’t likely to materialize. Such employment dynamics would give Yellen a more direct counterargument to the recent studies. While Yellen might lose ground in the battle over interpreting long-term unemployment, she may still win the war on the level of slack in the labor market.

San Francisco Fed President John Williams recently said that the slack in the labor market could be “much less than assumed,” cautioning that inflation could rise more quickly than currently anticipated. The WSJ explains:

According to economists who have analyzed Labor Department data, 6.6 million people exited the workforce from 2010 and 2013. About 61 percent of these dropouts were retirees, more than double the previous three years’ share.

People dropping out because of disability accounted for 28 percent, also up significantly from 2007-2010. Of those remaining, 7 percent were heading to school, while the other 4 percent left for other reasons [often for family responsibilities].

In contrast, between 2007 and 2010, retirees made up a quarter of the six million people who left the labor force, while 18 percent were classified as disabled. About 57 percent were either in school or otherwise on the sidelines.

These 3.4M “slack” or potential workers of 2007-2010 are now a mere 726K by the same calculation.

David Rosenberg, clearly in the “tightening market camp”, notes that in spite of the on going economic recovery, those who have left the labor force (i.e. not looking for work actively) and who want a job are down more than 10% YoY. Those who do not want a job at all are up 4%. There will also be 1.5M new retirees per year for next 15 years.

On the other side of the ledger, Rosenberg points out that job openings are at a 5 year high at 4M but that 22% of firms say they can’t fill these positions (25% at the 2007 peak) with 40% of businesses claiming that there are few or no qualified applicants for job openings (45% at 2007 peak). More specifically, the Fed beige book cites shortages in health care, tech, transportation, engineering and construction.

Baby boomers can’t be the whole story, though, since the participation rate has declined for younger workers too. This part of the drop is a function of various factors, including simple discouragement, poor work incentives created by public policies, inadequate schooling and training, and a greater propensity to seek disability insurance. Globalization and technological change have also reduced employment and wage growth for low-skilled workers—which raises questions about whether current policy is focused enough on helping workers to achieve the skills necessary to work productively and earn decent incomes. (WSJ)

Rosie goes on showing that Americans are not studying optimally: in 2010, nearly 70% of bachelor’s degrees were in social sciences, psychology, visual and performing arts and communication and journalism while less than 25% graduated in engineering (13%), computer sciences (7%) and maths (3%). Americans appear ill-prepared for a new on-going revolution in the job market spurred but the powerful combination of data, software and sensors:

To understand how automation and robotics will affect the job market, Louis-Vincent Gave presents four classifications of skill-sets, which, he says, “depending on what skill-set you’re in, determines whether you get replaced.” They are: 1) non-repetitive and non-complex, 2) non-repetitive and complex, 3) repetitive and complex, and 4) repetitive and non-complex.

The first category, he says, is actually the biggest source of job growth in the developed and emerging markets and not in danger of being replaced. Examples of these include gardener, plumber, ski instructor, etc.

The second category, non-repetitive and complex, is also not in danger of being widely replaced and sees increased wage growth. The only caveat, Gave points out, is that these typically require a much higher level of education and are much more competitive. Examples include pharmaceutical research, software coding, civil engineer, or a hedge fund manager, just to name a few.

The third and fourth categories, both containing a repetitive element, are clearly in danger of the Robolution and include, on the more complex side, airline pilots, surgeons, or equity traders. On the other hand, manufacturing jobs, low-end farming, packaging, and other less complex, repetitive occupations have almost disappeared in the western world where robots have become commonplace on factory floors.

Interestingly enough, Gave sees a major problem brewing where college debt and tuition costs continue to skyrocket for an area of the job market where employment opportunities continue to diminish due to automation. (Financial Sense)

The Economist adds (The future of jobs, The onrushing wave):

The case for a highly disruptive period of economic growth is made by Erik Brynjolfsson and Andrew McAfee, professors at MIT, in “The Second Machine Age”, a book to be published later this month. Like the first great era of industrialisation, they argue, it should deliver enormous benefits—but not without a period of disorienting and uncomfortable change. (…)

The combination of big data and smart machines will take over some occupations wholesale; in others it will allow firms to do more with fewer workers. Text-mining programs will displace professional jobs in legal services. Biopsies will be analysed more efficiently by image-processing software than lab technicians. Accountants may follow travel agents and tellers into the unemployment line as tax software improves. Machines are already turning basic sports results and financial data into good-enough news stories.

Jobs that are not easily automated may still be transformed. New data-processing technology could break “cognitive” jobs down into smaller and smaller tasks. As well as opening the way to eventual automation this could reduce the satisfaction from such work, just as the satisfaction of making things was reduced by deskilling and interchangeable parts in the 19th century. (…)

There will still be jobs. Even Mr Frey and Mr Osborne, whose research speaks of 47% of job categories being open to automation within two decades, accept that some jobs—especially those currently associated with high levels of education and high wages—will survive (see table). Tyler Cowen, an economist at George Mason University and a much-read blogger, writes in his most recent book, “Average is Over”, that rich economies seem to be bifurcating into a small group of workers with skills highly complementary with machine intelligence, for whom he has high hopes, and the rest, for whom not so much. (…)

While economists debate, things are happening in the real world.

  • Average hourly earnings have been accelerating from +1.2% YoY in October 2012 to the recent +2.2-2.5% range even though core inflation is slowing. Such divergence is rather rare and actually seems to be happening when the short-term unemployment rate is below 5.0% like during the late 1990s. That rate is currently 4.2% and falling. It troughed at 3.5% in 2003 and 3.6% in 2007, meaning that from that measure, the U.S. is near full employment.

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These charts show YoY changes in hourly wages in some industries where labor is reportedly in tighter supply (last 6 months annualized in brackets)

CONSTRUCTION (+2.8%)                                         TRUCKING (+2.6%)

   image image

INFORMATION (+5.1%)                                              SOFTWARE (+8.5%)

 image image

  • Recent surveys from the National Federation of Independent Business, the prime job creators in America, reveal that more owners are planning to pay workers more. Forty-nine percent of the owners hired or tried to hire in the last three months and 41 percent reported few or no qualified applicants for open positions. Twenty-two percent of all owners reported job openings they could not fill in the current period, a 6-year high, and very near the normal cyclical peak when, in reality, we are nowhere near the peak in labor utilization.

imageRosenberg goes on:

Recall that last August, the WSJ noted that in a report on the status of families, “the Census Bureau said 13.6% of Americans ages 25 to 34 were living with their parents in 2012, up slightly from 13.4% in 2011. Though the trend began before the recession, it accelerated sharply during the downturn. In the early 2000s, about 10% of people in this age group lived at home.”

A Gallup 2013 poll showed that the proportion rose to 14% by the end of 2013, also revealing that nearly one adult under age 35 in three lives with his/her parents… …and that:

Employment status ranks as the second-most-important predictor of young adults’ living situation once they are beyond college age. Specifically, 67% of those living on their own are employed full time, compared with 50% of those living with their parents.

Some may debate what is the cause and what is the effect but the fact is that these unemployed young adults have found a way to go by. For how long?

Ms. Yellen says that we need more time and more data before we can really assess what is going on:

(…) most research suggests that due to demographic factors, labor force participation will be coming down …. I think there is also a cyclical component in the fact that labor force participation is depressed, and so it may be that as the economy begins to strengthen, we could see labor force participation flatten out for a time… There are different views on this, within the committee, and it’s hard to know definitively what part of labor force participation is structural versus cyclical.

“As the economy begins to strengthen”. We have not seen much inclination of that yet, have we? Long term GDGP growth is 3.3% but the 10 year average is half that and keeps declining (chart from Doug Short). image

Waiting for the economy to “begin” to strengthen on its own in order to create the workers needed to grow the economy is like waiting for Godot. Who knows? He may be disabled and living with his parents…Winking smile

NEW$ & VIEW$ (7 APRIL 2014)

U.S. Reaches a Milestone on Lost Jobs U.S. employers hired at a steady pace in March, moving past the labor market’s winter chill and putting the economy on firmer footing for the spring.
  • Nonfarm payrolls rose a seasonally adjusted 192,000 in March and figures for the prior two months were revised up by a combined 37,000, the Labor Department said on Friday. The unemployment rate held steady at 6.7%.
  • The private sector remained the engine of job growth, while government payrolls were flat, as firms cautiously recoup revenue and rebuild payrolls.
  • the labor force participation rate, the share of the 16-and-over population with a job or looking for work, rose to 63.2% from 63% in February. That is still well below the 66% it was at when the recession began. To get back there, the labor force would need to expand by nearly seven million people, which would push unemployment to 10.7%.
  • Still, almost all of the 503,000 people who re-entered the job market in March found work. Another measure of the labor force, the ratio of workers to total population, climbed to its highest level since August 2009.
  • Some 7.4 million were working part time but would have preferred a full-time job, an increase of 225,000 from the prior month. A broader measure of unemployment that includes people working part time but who want a full-time job and others who are marginally attached to the workforce edged higher to 12.7% in March.
  • Over the past year, average hourly earnings are up 2.1%, barely ahead of inflation. While Friday’s report showed that average earnings slipped by 1 cent to $24.30 an hour, the average workweek increased 0.2 hour to 34.5 hours. More hours mean more money in consumers’ pockets, spurring purchases of higher-priced goods that could propel broader hiring.

Also from BloomberBriefs:

  • About 47 percent of those jobs created last month were in the low-wage category – accommodation and food services (33,100), temporary staffing agencies (28,500), retail (21,300), and social assistance (7,600). This is an improvement from the better-than 55 percent registered in recent months.
Five lessons from the US payroll numbers

(1) It really was the weather . . .

When analysts blamed weak jobs numbers for December and January on cold weather there was a lot of scepticism. It sounded like an excuse. (…) The patterns in the March data suggest it really was the weather. In particular, while hours worked fell and average hourly earnings rose in the winter months, the effect neatly reversed itself in March. That is exactly what one would expect if cold weather had kept some lower-paid workers, such as those on construction sites, at home for a while.

But construction workers did not stay at home, except perhaps in December when construction employment declined 20k after jumping 32k in November. Construction employment rose 51k in January, 19k in February and 18k in March seasonally adjusted. Last 5 months: +20k monthly average. 2013 average: +13k.

(2) . . . but the reversal was not as strong as expected

(…) If the weakness in the winter was just people stuck at home because of the weather, went the theory, then there would be a huge rebound as spring’s warm breezes arrived. (…) The weather was still cold in March, but the lack of a big rebound suggests that, while the US economy is chugging along, there is not much acceleration.

(3) Has participation turned the corner?

(…) It is too early to call, but there are now signs of a stabilisation, or even a reversal. The participation rate has risen in the past three months to its highest level since last summer. The number of people not in the labour force has fallen by 778,000. If this continues it will be a big economic change for the better.

(4) Good news for the Fed

(…) A turn in participation would be even better news for the Fed: if people come back into the labour force then it means potential output is higher and the economy can grow faster for longer. Furthermore, if people come back when the unemployment rate is still well above 6 per cent, then the Fed can comfortably keep interest rates low without fearing higher inflation as a result.

It may not be such good news for equity markets as Friday showed. Are we in a “good news/bad news” mode?

(5) Private payrolls recover their pre-recession peak

It has taken six years, but private payrolls in the US have finally regained their peak level from before the recession. (…) That shows the protracted and painful nature of the recovery. It also shows how the weakness of public-sector hiring has held back overall growth. Total payrolls are still 400,000 below their pre-recession peak.

Temp Jobs Surge as Firms Cut Expenses

The “short-term” staffing industry is enjoying a long-term boom, with temps accounting for more than one-tenth of all job growth since 2009, according to government data.

The job-matching firm CareerBuilder says that in cities such as Cincinnati and Milwaukee, more than half of all jobs created since 2009 are for temp or contract work. In Stockton, Calif., temp posts account for virtually all net jobs added since 2009.

Temp hiring often accelerates after downturns, as companies look to control labor costs. But many labor experts now believe the continued hiring of short-term workers marks a structural, lasting shift in the job market.

Last month’s numbers were particularly vivid. The economy added 28,500 temporary-help services jobs, representing 15% of all job gains in March. The number of temp jobs has risen almost 10% in the past year, the greatest increase of any of the 150 categories tracked by the Labor Department. (…)

All this comes as large corporations such as Wal-Mart Stores Inc. andAmazon.com Inc. have used temp hiring as a core part of their business structure, leading others to follow suit. More than 2.8 million workers were categorized as having temp jobs in March—about 2.5% of the workforce—up from 1.7 million in August 2009. (…)

The practice has moved deep into traditional manufacturing zones. Close to 40% of all temp jobs are now in manufacturing, a ratio that has risen steadily for several decades, said Susan Houseman, a labor economist at the W.E. Upjohn Institute for Employment Research in Michigan.

(…) “The employers see it as a quick way to easily be able to downsize without an impact on their core” workforce. (…)

But in an illustration of how short term these jobs can be, about 11 million people had a temp position at some point last year, compared with the 2.8 million people that currently have one, the American Staffing Association estimated.

(…) The average weekly pay of temp jobs, $554, is one-third less than the pay for all jobs, on average, according to the Bureau of Labor Statistics. And temp-job wages have risen more slowly than those for other jobs. (…)

“What’s driving this?” said Jim Link, chief human-resources officer at Randstad North America, a large employment company. “Lessons learned from a tough recession.”

When it comes to hiring, he said, employers are reluctant to invest “in the same way that they did before the recession.”

But there is a cyclicality in temp jobs as this BloombergBriefs chart shows. The problem is that it seems to always peak at the peak of the economic cycle…

image

Canadian hiring hits seven-month high

The economy added a better-than-expected 42,900 jobs in March, after months of stagnant employment growth, as young people landed work and the public sector added to the head count.

The job gains, the largest in seven months, sent Canada’s jobless rate down one notch to 6.9 per cent. But smoothing out the monthly volatility, overall job growth in Canada has been “subdued” since August of last year, Statistics Canada said Friday. The six-month average for monthly job gains rose to a still-muted 10,000 from 3,000 in the prior month. (…)

Details of the jobs report were soft. Part-time positions rose by 30,100 in March while full-time jobs grew by 12,800. The country’s participation rate stayed at 66.2 per cent, its lowest level since 2001.

The public sector has seesawed in recent months, adding 39,300 positions in March after a slide of 50,700 jobs in February. Confused smile The private sector added just 3,900 positions last month. In the past year, employment growth has come from the private sector while the public sector has been flat.

Manufacturing was another weak spot, shedding 9,200 jobs, while agriculture cut 12,400 positions.

Wage growth eased to 2.2 per cent from a year earlier, suggesting the one-month pickup in the labour market is not yet generating inflationary pressure. Wage increases are still below the 2.3-per-cent average gain over the past three years, though above the rate of inflation, noted Bank of Montreal chief economist Douglas Porter. “That’s enough of a real increase in wages to help provide some moderate support for consumer spending, but light years away from presenting a clear and present danger to higher inflation.” (…)

Canada: An economy in transition?

The Canadian trade data for the month of February showed some encouraging developments. The balance moved into a small surplus of $289 million for the second time in six months on the back of surging exports (+3.6%, the best showing since December 2011). As today’s Hot Chart shows, harsh winter conditions in the United States helped propel Canada’s energy trade surplus to an historical high of $7.2 billion. Though this figure is certain to come down with improving weather
conditions, we would note that energy accounted for only one-third of the rise in exports in February.

Nine of the eleven major merchandise groupings were actually up on the month, the best diffusion in over two years. A cheaper currency coupled with a better U.S. economy should continue to help exporters in the months ahead. Still, do not expect a significant improvement in the trade balance to be muted if business investment begins to rise in Canada: in February alone, higher demand for industrial machinery & equipment accounted for half of the rise in total imports. As shown, we stand at a record so far in Q1.

Interestingly, we also note that Ontario (Canada’s industrial hub) is seeing faster growth than the national average for imports of business investment goods for the first time in a decade. Early in 2014, the economy appears to be transitioning along the script written by the Bank of Canada. That is encouraging.

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ECB ‘must spend big to lift prices’ Central bank would have to buy €1tn in bonds to raise inflation

The European Central Bank would need to buy assets worth €1tn to lift inflation by as little as a fifth of a percentage point, according to an internal assessment of quantitative easing.

The estimate, first reported by Frankfurter Allgemeine Zeitung newspaper but confirmed by a person familiar with its contents, comes a day after the ECB gave its strongest hint yet that it is prepared to embrace bond-buying to prevent the eurozone from sliding into deflation, or even a long period of low inflation.

The estimate, which is based on just one of a number of options for QE that policy makers are considering, shows that €1tn of purchases of euro-denominated securities over the course of a year, or €80bn a month, could add between 0.2 and 0.8 percentage points to inflation in 2016.

The ECB is expecting a figure of 1.5 per cent in two years meaning QE could also potentially take inflation above the central bank’s target rate of just below 2 per cent. (…)

EARNINGS WATCH

Q1 earnings season gets underway this week.

From Zacks Research:

imageExpectations for the Q1 earnings season as whole remain low, with total earnings expected to be down -2.6% from the same period last year on +1.0% higher revenues and modestly lower margins. As has been the trend for more than a year now, estimates for Q1 came down sharply as the quarter unfolded. The current -2.6% decline in total earnings in Q1 is down from +2.1% growth expected at the start of the quarter in January.

Estimates for Q1 have fallen across the board, but the trend is particularly notable for the Retail, Basic Materials, Autos, Consumer Staples, and the Energy sectors, as the chart below shows.

19 companies have reported so far:

Total earnings for these 19 companies are up +0.5% from the same period last year, with 57.9% beating expectations. Total revenues for these companies are up +4.3%, with 47.4% beating revenue expectations. It’s premature to draw any conclusions from this small sample of results, but the growth rates and beat ratios for these 19 companies in Q1 are weaker than what we have seen from them in other recent quarters. It has overall been a fairly uninspiring start to the Q1 earnings season.

Consensus estimates for 2014 Q3 and Q4 have held up quite well, even as expectations for Q1 and Q2 came down over the last few months. Total earnings are expected to be up +8.3% in the second half of the year after the +1.4% growth pace in the first half of the year. We started last year with somewhat similar hopes, but had to sharply ‘revise’ those estimates as the year unfolded, with the starting point of the hope-for growth turnaround getting pushed to this year instead.

SENTIMENT WATCH

As of March 31, corporations had borrowed 38 so-called covenant-lite loans, according to data tracker Dealogic. That’s up from 35 at a similar point last year, and the highest first-quarter tally since 1995, as far back as the data goes. (…)

Dealogic noted the covenant-lite loan volume totaled $38.2 billion for the first quarter, the second-highest year-to-date total, behind the $41.1 billion borrowed in 2007.

Wall Street’s financial engineers are getting creative again.

Commercial real-estate investor H/2Capital Partners bundled a hodge podge of its holdings — from bonds tied to skyscrapers and malls to junk-rated bank loans — into about $400 million of securities. The deal, similar to the pre-crisis transactions known as collateralized debt obligations, included one portion that Moody’s Investors Service gave its highest rating of Aaa.

Sales of CDOs tied to commercial real estate are accelerating after the market lay dormant for five years. While anticipation started building three years ago that they would reemerge, the first post-crisis offering wasn’t completed until September 2012, Morgan Stanley data show.

About $3 billion of securities in 15 deals have been sold since, with six of the offerings brought to market in the second half of 2013, Hill said. He’s predicting that other investment firms will offer similar deals this year. (…)

  • GrubHub Shares Surge in Debut Investors’ appetite proved hearty for the stock-market debut of GrubHub Inc., as shares of the operator of websites and apps for ordering takeout food online rose 31%.

Punch  And this (prescient) warning from Prince Street Capital Management (via John Mauldin):

Very strange month. First, the Fed reaction function is changing but the market don’t care – term risk premium barely moves, the 10y rallies a bit, and EM and high vol FX get stronger. Second, the most owned stocks in SPX, the ones that have been providing leadership to the market, sell-off, but this fails to trigger a sell-off in the broader market. Third, China has horrible economic data and the market rallies on the hopes of economic stimulus. Using different words to say the same thing: had you told me that Yellen was going to make the 6 month comment, that China growth was going to be close to 5% on a sequential basis, that Putin would invade Ukraine, and that biotech and the internet would have +10% sell-offs, I would have forecasted a very different set of prices for global markets than the one we got.

So to now make forecasts based on macro variables, would probably lead me to forecast equally wrong prices for the month ahead. Markets have increasingly become disassociated from macro; large macro variables were the primary drivers of markets since 2007, and so we are intuitively conditioned to the idea of markets responding to them. But in the mid to late stages of bull markets, macro is usually ignored; people are focused on whatever assets they own, and have a reluctance to believe that large macro variables will affect the value of the assets they hold. Correlations fall, hedge funds do well, and economists fret about their irrelevance.

A more technical take, is that market behavior in the past couple of weeks seems to be the result of everyone having the same trades and no one being there to take the other side: everyone was short the 10Y, short EM, short FX, long biotech and internet. This feels like a fragile equilibrium and one where people will want to de-risk their portfolios further. Whatever the framework that explains the market moves in the past month, it is not one that I feel confident about forecasting; the prudent thing to do in this environment is to de-risk the portfolio, and wait for more clarity to take aggressive bets. With the VIX at 14, I would also buy some puts.

Clock How prescient?

This past week looked as if markets were going to make a decisive breakout to the upside. Alas, that was not to be the case as a brutal Friday sell-off took away all but a fraction of the week’s gains. In the end, the markets wound up where they began, stuck in their current trading range.

The much uglier story is the continued crushing of the previous “momentum” stocks. Many of the low share float, high momentum stocks (which are a favorite of high frequency trading programs) have been aggressively sold off in recent weeks. (Lance Roberts)

Zerohedge:

The breakdown in tech stocks, with the NASDAQ Comp. closing below its 100d avg for the 1st time since Dec’1212, says that equities are likely to suffer more in the week ahead. This threatens the developing Treasury bear trend, particularly after Friday’s Bullish Reversal Candles across much of the curve.

Historically, the 1st close below the 100d avg in 6 months or more has resulted in significant underperformance, with the avg 1wk, 2wk, and 1m returns all falling into negative territory. Beware, the 3968, Feb-05 low is vulnerable.