THE DAILY EDGE: 5 AUGUST 2019: Recession Watch

RECESSION WATCH

Steady Jobs Growth Keeps U.S.’s Record Expansion on Track Employers added jobs at a steady pace in July and unemployment held at a historically low level, providing a solid foundation for the decadelong U.S. expansion at a time of global headwinds.

Completely reassuring headline from the WSJ.

David Rosenberg, who keeps looking for a recession through the economic fog, claims that payrolls actually declined 210k in July because the workweek shrank 0.3% to 34.3 hours, “equivalent to a job loss of 375k”. Tackling manufacturing more specifically,

a 0.7% contraction in the workweek (to 40.4 hours) and a 5.9% drop in overtime hours (to 3.2 hours) actually means that (in person-equivalent terms) jobs declined 79k last month. This spells contraction for the upcoming industrial production report and comports nicely with the downbeat tone of the ISM report that was released yesterday. Not just that, but the work-based income figure –average weekly earnings- was flat last month and negative in real terms. That suggest that the 4-handle on real consumer spending in the second quarter GDP report was little more than aberration, and always had to be taken in the context of two prior quarter of 1%-ish growth.

Here is all you have to know. The index of aggregate hours worked for production and nonsupervisory employees has dipped at a 0.7% annual rate over the past six months. My friends, that is recession factoid. This actually is weaker than the near-flat pace in December 2007 that represented the peak in that cycle. The current six-month trajectory precisely matches the rate of change in total labor input in December 2000 and this led to the 2001 recession by three months. Go back to July 1990, when that recession actually began, and the trend in aggregate hours worked was right where it is today. Ignore the hood (the headline print) and focus on the engine (the entire labor input).

Follows a 35-year chart proving his points, except that there is more to know: 2 other occurrences proved to be false alarms, rather disturbing against only 3 good calls. A good economist, but unable to sport a statistician label.

National Bank Financial: Soaring full-time employment lifts wages

The U.S. economy and its labour market continue to defy doomsayers. Coming just one week after consensus-topping Q2 GDP results, employment reports for July suggest the expansion has legs. While showing downward revisions to prior months, the establishment survey was nonetheless encouraging given overall healthy gains (+164K). Those concerned about a downturn may feel reassured by continued gains in cyclical sectors such as construction and manufacturing but also in temporary employment which is a decent leading indicator. Wage inflation also picked up as hourly earnings climbed to 3.2% on a year-on-year basis.

The household survey showed even more impressive job creation (+283K), allowing the jobless rate to remain unchanged at 3.7% (i.e. close to 50-year lows) despite an uptick in the participation rate. Full-time employment soared, taking its share of overall employment to almost 83%. As today’s Hot Chart shows, this increasing share coincides with the ramp up in wage inflation. That should not be surprising considering full-time positions tend to be better remunerated. All in all, this morning’s jobs reports are consistent with continued expansion and higher inflation pressures. While that validates the Federal Reserve’s current stance of being careful with rate cuts, the escalating trade war between the U.S. and China could force the FOMC’s hand into being more aggressive than it would have liked.

Unfortunately, full time employment has proven to be a lagging indicator as employers tend to first part with part-timers when things get tougher.

I tend to focus on a combination of all the above mentioned indicators, considering that people don’t buy goods and services with hours and workweeks but with weekly checks. It so happens that trends in consumer spending correlates quite well with trends in aggregate weekly payrolls (jobs x hours x wages). Not a clean recession indicator, but given that the U.S. consumer seems to be the only growth engine in the world, very much worth following.

There is a definite slowdown in weekly payrolls growth, from 5.7% YoY in January to 4.4% in July, the causes of the decline being split almost evenly between jobs and hours as wages were roughly unchanged. Total inflation being fairly steady in the 1.5-1.7% range, consumer expenditures also slowed, with the spending brakes all applied last December. 

A similar “preventive spending cut” was seen in the fall of 2015 after the 60% collapse in oil prices as workers in oil-sensitive sectors braced for tougher times. This year, many Americans likely prepared for the government shutdown (Dec. 22- Jan. 25) and to took a cue from investors and fretted about trade wars and a possible economic slowdown, until Powell pivoted right after Christmas.

The growth in month-over-month nominal aggregate weekly payrolls has been very volatile this year but its annualized growth rate over the first 7 months and the last 3 months has been steady at 3.2%. At a constant savings rate, consumer spending should thus rise 3-4% in nominal dollars or 1.5-2.5% in real terms, barely enough to sustain an economy running on this sole cylinder. If I were a FOMC voter focused on risk management I would work with these premises and ease monetary policy going into the important spending season from Back-to-School to Thanksgiving to Christmas.

Even more so given that the odds of a quick and agreeable resolution to the China-USA trade war are getting slimmer by the tweets.

Even more so given that Americans have shown a growing preference for savings since the Great Financial Crisis and the Lower-For-Longer interest rate policy.

Forecasting the savings rate is as important as it is challenging. Imagine if Americans were to go back to saving 10-12% of their income. Not that stupid an idea considering aging demographics, health care costs, negative real savings rate, unfunded pension plans when they exist and youths’ distaste for overconsumption. Trying to list factors favouring lower savings is much more demanding.

The savings rate averaged 7.1% since 2013 but it rose to 7.7% on average in 2018 and 8.3% in the first half of 2019.

For me, here is all I have to know: unless job and hours growth accelerates meaningfully, real aggregate weekly payrolls should not be growing faster than 2.5% and rising savings could really hurt this economy. From my lens, the risks to the forecast for the U.S. consumer economy seem to be generally tilted to the downside.

From the July U. of Michigan Survey of Consumers:

Consumer sentiment remained unchanged in late July from the mid-month reading, with all component questions showing only small and offsetting changes. Economic confidence has been remarkably stable since the start of 2017, despite ongoing trade uncertainties. The resilience displayed has been primarily due to a renewed sense of personal financial optimism. Indeed, recent surveys have recorded the most favorable net personal financial expectations since May 2003. Positive job and income prospects, gains in net household wealth, and low inflation have bolstered optimism. At present, consumers do not anticipate a rapid acceleration in income growth rates, nor do they expect significant changes in inflation and unemployment rates.

Consumers have not ignored mounting policy uncertainties as they have begun to take precautionary measures to increase savings and reduce debt. Favorable buying attitudes toward homes and vehicles have significantly receded from their cyclical peaks despite declining interest rates.

To conclude on Friday’s employment report, the Household Survey (HS-red line) shows employment growth slowing much faster than the more widely followed Payroll Survey (PS-blue). These lines will eventually meet again and let’s hope that the more volatile HS line (+0.9% YoY in Q2, +0.8% in July) is the one reaching out.

Note also that the YoY growth in employment for the important 25-54-year main breadwinners (black) actually turned negative in July. This group, comprising 64% of all employment, has lost 519k workers since peaking in October 2018. Over the last 50 years, the YoY rate of growth in this cohort has turned negative 13 times and only twice this was not immediately before or during a recession. Rosenberg seems to have missed that one…

One more scary chart from CMG Wealth:

Last week, the New York Federal Reserve Bank published an update to their recession probability index, indicating an increase in the probability of a U.S. recession in the next 12 months. It’s important to note that, every time since 1960 that this index breached 30%, a recession occurred.  Best guess within the next six to nine months.

Also scarier and scarier:

Trump Ordered New Chinese Tariffs Over Advisers’ Objections President Trump overruled advisers to ramp up tariffs on China after a heated exchange in which he insisted it was the best way to make China comply with demands.

(…) Mr. Trump, who has speculated the Chinese may be waiting to negotiate with a possible Democratic successor, says a strong U.S. economy gives Washington the upper hand if the dispute drags on. But advisers argued that a new round of tariffs could hurt the U.S. economy and further strain relations with China. (…)

After returning, the trade negotiators and other top advisers congregated early Thursday afternoon in the Oval Office to brief Mr. Trump on the talks. Messrs. Lighthizer and Mnuchin conveyed that they didn’t yield the kind of results that Mr. Trump had intended, the people said.

Mr. Trump, who had a re-election rally scheduled in Ohio later that day, wanted to be able to assure farmers—who have been hardest hit by the trade fight as China scaled back purchases of U.S. corn, soybeans and pork—that he had at least secured concrete commitments from the Chinese that they would boost their purchases of U.S. agricultural exports.

But to his frustration, Messrs. Lighthizer and Mnuchin couldn’t give him any guarantees. (…)

All of them [6 advisers], save Mr. Navarro, a China hawk, adamantly objected to the tariffs, the people said. That spurred a debate lasting nearly two hours, one of the people said. Beijing insists that tariffs must be dropped in return for concessions demanded by the U.S.

The president said his patience had worn thin and stood by his argument that tariffs were the best form of leverage, the person said. (…)

The decision followed weeks of advice from some of Mr. Trump’s advisers, including his son-in-law Jared Kushner, to put China talks on the back burner, according to the people and a former administration official.

The president’s advisers urged Mr. Trump to focus on other trade pacts, including the pending deal with Canada and Mexico, which still needs congressional approval, as well as talks with Japan, which in recent weeks have gained momentum, these people said. (…)

Elsewhere in the WSJ:

Trump’s “trade war with China has failed and he is doubling down on a failing strategy,” said Edward Alden, a senior fellow at the Council on Foreign Relations. “The whole purpose of the tariffs was to force China to make structural changes to its economy. But the tariffs have failed to do that. China is prepared to live with the pain rather than make the changes the U.S. wants.”

China Hits Back at Trump by Weakening Yuan, Halting Crop Imports

China responded to Donald Trump’s tariff threat with another escalation of the trade war on Monday, letting the yuan tumble to the weakest level in more than a decade and asking state-owned companies to suspend imports of U.S. agricultural products. (…)

In a rare statement, the central bank attributed the yuan move to protectionism and expectations of additional tariffs on Chinese goods, while saying it can still maintain a steady currency.

By linking today’s devaluation with the renewed tariff threat, the PBOC “has effectively weaponized the exchange rate,” said Julian Evans-Pritchard at Capital Economics in Singapore. “The fact that they have now stopped defending 7 against the dollar suggests that they have all but abandoned hopes for a trade deal.” (…)

Tweetless way of ending the trade conversations…

Powell’s Off-the-Cuff Approach Leaves Investors on Edge The highly uncertain U.S. economic outlook is complicating Federal Reserve Chairman Jerome Powell’s effort to bring a more plain-spoken style to communicating with the public.

(…) Before last week’s Fed meeting, officials had argued that lower rates were needed to immunize the economy against the effects of slower global growth and trade uncertainty and to boost low inflation.

That left many market participants expecting a rate cut and an open door to more reductions over coming months.

So some investors were jarred when Mr. Powell described the quarter-percentage-point cut in the Fed’s benchmark rate as a more technical “mid-cycle adjustment,” leaving them to wonder if he was ruling out more reductions. (…)

“The Fed keeps overconfidently predicting the future of an unpredictable economy,” said Lawrence Summers, who served as Treasury secretary under President Clinton. “More communication given the inevitable errors means less credibility as the Fed runs from one side of the boat to the other.” (…)

Higher Prices Drive Sales for Restaurants, Food Makers McDonald’s, Mondelez and Chipotle are among companies charging more; ‘U.S. consumer continues to be strong’

(…) The restaurants subset of the S&P 500 has risen 32.2% this year through Friday, while the broader index has gained 17%. (…) “We are seeing no resistance,” to the higher prices, Chipotle’s Chief Financial Officer Jack Hartung said in an interview last month. (…)

Prices at McDonald’s restaurants in the U.S. have risen by about 2% on average in each of the past several quarters, helping to push up sales overall as guest counts have fallen. (…)

TDn2K’s July 11 Restaurant Industry Snapshot

The restaurant industry experienced a summertime slowdown, with comp sales down -0.01 percent in June [and comp traffic down 3.1% with only 55% of markets posting positive sales compared to 78% in May]. As long as traffic counts continue to suffer, sustained sales growth is unlikely for restaurants. Relying on menu price increases will not keep the industry afloat for long, especially as chains keep adding new units, giving guests more dining options.

Brands that post positive sales results tend to have higher to-go sales than the rest of the industry, signaling an opportunity for restaurants. The trend of consumers shifting preferences toward off-premise dining does not appear to be going away.

TECHNICALS WATCH

Lowry’s Research says that “In the intermediate term, the balance of Supply and Demand, as represented by Lowry’s Selling Pressure and Buying Power Indexes, remains positive, with Demand dominant to Supply.  However, the short-term trends of each measure are showing some degradation.” Degradation very close to a crossing point. “A signal in the next few weeks would be a sign of short-term weakness and caution, but based on the probabilities, would not signal calling for all out defensive measures.”

For now, a retreat back to its 200-dma (2787) would set the S&P 500 Index back 4.8%.

EARNINGS WATCH

Can earnings support this weak market? Refinitiv provides the facts:

Through August 2, 380 companies in the S&P 500 Index have reported earnings for Q2 2019. Of these companies, 73.9% reported earnings above analyst expectations and 18.2% reported earnings below analyst expectations. In a typical quarter (since 1994), 65% of companies beat estimates and 20% miss estimates. Over the past four quarters, 76% of companies beat the estimates and 18% missed estimates.

In aggregate, companies are reporting earnings that are 6.0% above estimates, which compares to a long-term (since 1994) average surprise factor of 3.3% and the average surprise factor over the prior four quarters of 5.3%.

Of these companies, 59.0% reported revenues above analyst expectations and 41.0% reported revenues below analyst expectations. In a typical quarter (since 2002), 60% of companies beat estimates and 40% miss estimates. Over the past four quarters, 63% of companies beat the estimates and 37% missed estimates.

In aggregate, companies are reporting revenues that are 1.0% above estimates, which compares to a long-term (since 2002) average surprise factor of 1.5% and the average surprise factor over the prior four quarters of 1.0%.

The estimated earnings growth rate for the S&P 500 for 19Q2 is 2.7%. If the energy sector is excluded, the growth rate improves to 3.4%. The estimated earnings growth rate for the S&P 500 for 19Q3 is -0.7%. If the energy sector is excluded, the growth rate improves to 0.6%.

The estimated revenue growth rate for the S&P 500 for 19Q2 is 4.5%. If the energy sector is excluded, the growth rate improves to 4.9%.

These better results have prompted analysts to revise their estimates upward, at least for large caps:

Preannouncements for Q3 are better than they were at the same stage during Q2. However, let’s hear from consumer-centric and technology reporters which comprise 31% and 19% of remaining S&P 500 companies to report. These groups’ earnings growth rates are sub-par so far in Q2.

Trailing EPS climbed slightly above their end of June level at $164.17 which is 2.3% above their level at the December low on the S&P 500. At the same Rule of 20 P/E of 16.83, the S&P would be 2418. At today’s pre-opening of 2890, the Rule of 20 P/E is 19.7.