Weekly Update: The dark underside of job growth

07-18-2014

I just got back this morning from a visit to Columbus, a beautiful city and Ohio’s largest (though it's often overshadowed by Cleveland to the north and Cincinnati to the south). When speaking to advisers there late yesterday, they were not at all disturbed about geopolitical events—the downing of a Malaysian passenger jet over the Ukraine and Israel’s decision to send troops into Gaza. Those events sparked Thursday’s sell-off that saw the S&P fall by more than 1%, ending a string of more than 60 trading days in which the index had gone without a 1% move either way. What had the advisers worried was the quality of jobs being created. The headline on June’s jobs report was clearly bullish. The 288,000 jump in payrolls was well above consensus and marked the fifth straight month nonfarm job gains exceeded 200,000, putting employment growth near a 15-year high. But what was disconcerting was the separate household survey. It suggested the increase was solely concentrated in part-time jobs, which rose 799,000 on the month while full-time jobs plunged 523,000! There’s nothing good to say about that. The thing that keeps us on edge is that our bullish call at Federated over the next several years does not rely on heroic P/E multiple expansion at all; it relies on earnings growth. And to get that, we need the economy to continue to expand. And to get that, we need more jobs—not part-time, but full-time jobs that allow consumers to go out and buy houses, fix up homes, get that new car and maybe splurge a little bit. Perhaps not surprisingly, this morning’s initial take on July consumer sentiment  slipped to a four-month low, indicating the recent job surge hasn’t made consumers feel better yet.

That’s the dark underside of last month’s job growth. It was the sort that New York Fed President William Dudley, citing Fed models, suggested is to be expected. The Fed models indicate that enactment of the Affordable Care Act, the 2013 tax hike as part of the fiscal-cliff compromise and adoption of the sequester, also part of that compromise, are costing the economy 1.75 percentage points of GDP growth annually. Under Obamacare, the public is taking on responsibility previously borne by employers—either by subsidizing 85% of new private plans on the marketplaces, or paying a premium for expanded Medicaid enrollment. All the while, Ned Davis Research notes, corporations continue to work to lessen their insurance burden via private exchanges, defined contributions, and pushing part-timers onto Obamacare. Even before the ACA kicked in, companies shrank their health insurance rolls by 13.4 million from 2010 to 2012, even while the economy added more than 2 million jobs.

To be sure, the worry over the quality of jobs is a longer-term one for a market beset by a lot of positives of late. Second-quarter earnings so far have been solid, with 56% of the companies that have published results exceeding consensus EPS expectations and 67% beating revenue forecasts. The Fed’s latest Beige Book showed an expansion in activity in all 12 districts for the second consecutive time. Fed Chair Janet Yellen, in her testimony on Capitol Hill, suggested it’s too early to consider an earlier-than-expected move on the target rate, signaling rates will remain low through the remainder of the year. Oil prices, which today appeared to be giving back yesterday’s blip on the Ukraine-Gaza news, are now basically back to where they were  before the events in the Middle East, putting  them down slightly for the year and 5% below year-ago levels. Cornerstone Macro says this should lay the groundwork for stronger-than-expected economic data points in the fourth quarter of this year and possibly into 2015 as gas prices tend to do a great job of forecasting consumer confidence trends and spending patterns. Finally, this morning’s increase in leading indicators, while slightly less than expected, was broad-based by components other than housing permits and, according to the Conference Board’s economist, was indicative of expanding growth that may accelerate in the second half. This is bullish near-term. But all those part-timers know that in the end, all roads lead to full-time jobs.

Positives

Retail sales trending in the right direction June’s headline increase was the smallest of five consecutive gains, but May was revised up and, for the quarter, retail sales hit a 9.6% annual pace, well above Q1’s weather-depressed 0.9% uptick. Vehicle sales fell for the first time in five months, which seems a little odd given automaker reports put the annual sales rate at its highest in eight years. But core sales, which exclude autos, building materials and gasoline, rose an above-consensus 0.6% on increases in a broad range of discretionary categories. And year-over-year, sales were up 4.5%, indicating steady growth.

Robust regional readings The Empire and Philly manufacturing gauges surprised in July, the former jumping to its highest level since April 2010 and the latter hitting a 40-month high. Strength in new orders, shipments and employment lifted the two gauges, with the new orders and shipments components of the Fed’s Philly index at 10-year highs. If these two reports prove indicative of manufacturing nationwide, then third quarter activity is off to a very robust start and June’s slight disappointment on industrial production (more below) was just that.

Inflation pressures lessen Although June PPI rose slightly more than expected, the core rate was in line with forecasts and the headline rate was driven solely by energy prices. But energy prices have hooked down this month and food prices have declined significantly, both suggesting slowing inflation heading into Q3. Food commodity prices in particular have fallen more than 15% from their recent peak (nearing a downside breakout) on larger crop forecasts and are now down 0.5% year-over-year, suggesting the PPI for food slows. Import prices also remain well behaved, up 1.2% year-over-year. The reports provide breathing room for a Fed that, based on Yellen’s testimony, appears more focused on the labor market.

Negatives

Industrial production slightly disappoints June’s 0.2% increase, the fourth gain in five months, was slightly below consensus and May was revised down. But April was revised up, and for the quarter, production advanced at a 5.5% pace, up from 3.9% in Q1 and the biggest gain since Q3 2010. This suggests a modest boost to GDP growth for the quarter. On a year-over-year basis, industrial production is up 4.3%, the most since June 2012, and above the 3.4% gain per annum historically. This suggests upward momentum in output growth, consistent with stronger economic activity in the second half.

Housing mixed The NAHB sentiment index rose in July to a well-above consensus 53, its highest level in six months, on improvements in present single-family sales, future single-family sales and prospective buyer traffic. But the improving mood among builders wasn’t reflected in June’s housing starts, which unexpectedly fell to their weakest reading since last September. The decrease was concentrated by a big decline in the South (which seems odd), as starts rose in the other three regions. Housing permits also were down, but only in the multifamily area—single-family permits rose. June’s rise in single-family permits and improving builder sentiment suggest starts are likely to increase in the coming months.

We’re watching Germany Its ZEW survey declined a seventh straight month, with both the current situation and expectations components missing badly. ZEW’s president called the decline “sobering’’ but said while activity in Europe’s largest economy has declined, the medium-term outlook remains “favorable.’’ One positive is a sluggish Germany, on top of a struggling France, bolsters the case for more unprecedented easing by the European Central Bank. The market would love that. Also, Germany’s issues have helped pushed bund yields down to a record low 1.19%. Given the 92% correlation between U.S. and German 10-year yields, this helps explain why yields remain so low here.

What else

Debt is still U.S. The Congressional Budget Office’s new 10-year baseline budget projection indicates deficits should stay between 2.5% and 3.0% of GDP from 2015 through 2018, a big improvement from almost 10% in 2009. The CBO also is projecting federal debt issued and held by the public to remain between 72% and 74% of GDP through 2020, which seems like great news. But 74% is still the highest level seen since 1950, when the U.S. was recovering from mounds of WWII debt. And to keep debt-to-GDP stable at this level, the federal government must still address its long-term health-care costs and responsibilities, i.e., Medicare/Medicaid.

Janet’s past According to CNBC, a recent New Yorker piece notes that both Yellen and her husband were strongly affected by their parents' experiences with unemployment, citing papers the couple have published stating that people's economic behavior is not mechanically rational and that the Fed can manage the economy better than the markets.

50 years of futility The former head of the Federal Housing Finance Agency, Edward DeMarco, recently made an astounding and disturbing observation in the Wall Street Journal. He noted that homeownership rates in the U.S. are the same as they were 50 years ago, despite all the government efforts to promote affordable housing.  “Let’s say it was a failed effort…”


 
 
 
 
 
 
 
 
 
 
 
Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.
Gross Domestic Product (GDP) is a broad measure of the economy that measures the retail value of goods and services produced in a country.
Price-earnings multiples (P/E) reflect the ratio of stock prices to per-share common earnings. The lower the number, the lower the price of stocks relative to earnings.
Producer Price Index (PPI): A measure of inflation at the wholesale level.
S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.
The Conference Board's Composite Index of Leading Economic Indicators is published monthly and is used to predict the direction of the economy's movements in the months to come.
The Empire State Manufacturing Index gauges the level of activity and expectations for the future among manufacturers in New York.
The Federal Reserve Bank of Philadelphia gauges the level of activity and expectations for the future among manufacturers in the Greater Philadelphia region every month.
The National Association of Home Builders/Wells Fargo Housing Market Index is a gauge of how well or poorly builders believe their business will do in coming months.
The University of Michigan Consumer Sentiment Index is a measure of consumer confidence based on a monthly telephone survey by the University of Michigan that gathers information on consumer expectations regarding the overall economy.
The ZEW Indicator of Economic Sentiment polls financial experts to gauge whether they are optimistic or pessimistic about the subsequent six months.
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