5/2/16: Three Facts from the U.S. Labor Markets & Reality of the U.S. Economy

Three interesting snapshots of the U.S. economy: Non-Farm Payrolls, Initial jobless claims and Labour Productivity. Individually - they are important to traders. Jointly, they are important to investors.

But, first, what has been happening.

Let’s start with jobless claims. Initial jobless claims rose in the last week of January by 8,000 to a (seasonally-adjusted) 285,000. This was worse than consensus forecast by some 5,000 jobs. And worse, 4-week average rose to 284,750 at the end of January, up 2,000.

For history wonks, numbers below 300,000 are considered a sign of tight labour market, so no surprise here that claims can rise with a bit greater volatility when the labour markets are running some overheating.

But last two weeks of January also marked something that has not happened in the markets in some three years - they marked two consecutive weeks of y/y increases in new claims. As always, weather is being blamed, and as always, two weeks are just two weeks. So far, nothing hugely significant. Just a hiccup.

Which brings us to today’s release of NFP. Going into it, consensus forecast was for a ca 180,000 new jobs print (Marketwatch) and ca 190,000 (Bloomberg & Reuters) for January, to compensate for a large 292,000 print in December. What was delivered? Revised December Non-farm payroll figure to 262,000 and January figure of 151,000. Revision to December was large, but smaller than under-shooting in January. January preliminary estimate came as third weakest preliminary figure printed in the last 13 months.

Yes, everyone is running around with 4.9% unemployment figure - sub-5% expected. Good news. However, U-5 unemployment (Total unemployed, plus discouraged workers, plus all other persons marginally attached to the labor force, as a percent of the civilian labor force plus all persons marginally attached to the labor force) rose on seasonally-adjusted basis from 6.1% in November and December 2015 to 6.2% in January. And U-6 Unemployment (U-5, plus all employed part time for economic reasons) was static at 9.9% for the third month in a row, having previously been at 9.8% in October 2015.

And average hourly earnings up 2.5% y/y (same as previous month growth) and m/m growth of 0.5% (better than 0.3% consensus forecast and way better than 0% growth in December). These look like positives. Another positive is labour force participation - up to 62.7% in January, against 62.6% in December. But this positive is questionable: not seasonally adjusted participation rate in January 2016 was 62.3% which is lower than same for January 2015 at 62.5%.

So now we have: wages up, unemployment rate down, claims down by a lot less than expected, and participation rate is virtually flat. All at high levels of employment. 

Which gets us around to the last bit: productivity. Per U.S. latest data, non-farm labour productivity has fallen a whooping 3% y/y in 4Q 2015 - third biggest decline in productivity for any period since 1Q 2007 and the largest 4Q decline in productivity over the same period. Consensus was for 1.8% drop on foot of 2.2% rise in 3Q 2015. The Unit labour costs went up 4.5% over the same period of time (against consensus forecast of 3.9% rise and up on 1.8% increase in 3Q 2015). Labour costs were up in three quarters of 2015.

Problems with productivity growth have been plaguing the U.S. recovery - in 2015, non-farm productivity was up only 0.6%, which is massively below historical averages (more than x3 2015 rate of expansion).

Here’s the real problem, folks: U.S. economy is struggling to sustain growth absent real investment and absent new technological improvements. It is that simple. And the jobs markets are starting to show the strains of this. Productivity growth being weak, while employment rising and remaining high amidst rising labour costs means only one thing: the U.S. is currently running above its potential rates of growth. It is, in other words, overheating. And that at roughly 2% annual growth rates against pre-crisis averages above 3%. One of two things will have to happen:

• One: employment moderates and labour costs growth abates; or
• Two: business investment has to rise (note: explicitly not public investment, because raising public investment in these labour markets conditions will simply exacerbate the twin problem of tighter labour markets and low productivity growth).

Good luck taking an investment strategy on one. Which leaves us with taking a strategy on two… or going defensive on an expectation that stagnation will be setting in...

12/4/15: Economic Divergence: U.S. v Europe

Recently, I have highlighted couple of signs of emerging weaknesses in the U.S. economy relative to the positive news momentum in the euro area. You can see Manufacturing Sector evidence here and Business Activity evidence here. Meanwhile, economic surprise indices have also been pointing to the same: here.

An interesting chart from Pictet summarising the trend by plotting Economic Surprise Indices for euro area and the U.S. side by side:

Source: Pictet

The above shows divergence in the two series from Q4 2014 on.

And the overall markets valuations heat map showing stronger over-valuation (lighter colouring) in Q1 2015 in the euro area core compared to the US:

Source: BBVA Research

In cyclical terms, the above reinforces the view that the U.S. economy is settling into the growth range around 3.1% of GDP, while the euro area economy is moving closer to 1.1-1.4% growth. The divergence in two economies' core signals of future activity is in part driven by the differences in the monetary policies expectations, with ECB driving deeper into its QE programme, while the Fed is now shifting toward tighter stance.

In particular, recent statements from the Fed are fuelling uncertainty about the dollar and the U.S. interest rates environment. Median analysts outlook suggests a 50bps hike by the end of 2015 on the Fed side, with my own view that the Fed is most likely to hike around September. This outlook is highly uncertain, due to divergent signals coming from the Fed. Another point of uncertainty is what will follow the initial hike in U.S. rates. My view is that we can see a relatively long period of time over which the Fed will do nothing, before hiking the rates for the second time. The reason for this is that the Fed is fully aware of the risk of making a policy error on its first hike size and timing, and it will leave a wide enough period to collect evidence on the effects of its first intervention before moving again.

Meanwhile, the ECB has delivered twin push on its expansionary monetary policy in March, completing EUR60 billion in purchases of bonds and also deploying EUR97.8 billion TLTRO lending. The balancesheet of the ECB is growing, finally, and with it, Frankfurt has delivered a big stimulus to the euro area financial markets. This pushed bond yields to record lows: German yields are negative out to 6 year maturity, with 10 year Bunds trading at around 0.2% yields, and UST-Bund 10 year spread widening to 180 bps. It also shifted liquidity into risk assets, such as stocks and corporate bonds. Stock markets rallied: Germany up 25% in 2015 so far, France up 22%, Portugal up 31%, Spain up 14% and so on. Virtually none of these gains can be attributed to improved corporate balancesheets or companies' performance.

Here is a neat summary by Pictet of markets moves over Q1 2015:

Source: Pictet

The above highlights two things:

1. European equities outperformance over Q1 2015 is massive and is completely unjustified by the macroeconomic fundamentals and companies' performance; and
2. European equities outperformance accelerated in March

As Pictet notes, virtually all of the above outperformance is down to monetary policy-induced revaluation of the exchange rates: "Shares, in local currency terms and with dividends reinvested, are up by 16.8% in Europe, well ahead of the S&P 500’s 1.0% gain. However, European investors who

had invested in US equities will have benefited from a 13.7% rise in the S&P 500 when translated into euros, considerably reducing Wall Street’s underperformance in the year to date. Japanese shares have been the top performers though, advancing by 10.5%. If we add in the euro’s fall in value against the yen, that translates into a rise of just over 24.5%." 

Excluding energy sectors, corporate earnings growth forecasts currently put expected earnings uplift of 9.0% in the U.S. against 15.8% in the euro area over 2015, again predominantly on the back of currency valuations changes.

All in, the worrying trend of economic performance fully dependent on unorthodox monetary policies and relatively unanchored in the real economy remains. Rising divergence between the U.S. - euro area signals shows inherent weaknesses and risks present in such  environment.