The headline on my LinkedIn page on Friday (October 4th) read: “Jobless rate reaches half-century low, HP plans to cut up to 9,000 jobs…” Is this good news about jobs, or bad?
I’ve learned many times over the years to rely on the preponderance of the evidence, and not on any single indicator. The jobs numbers, themselves indicate that the economy is still expanding. But, the lower level of job creation, along with the very weak manufacturing and slowing service sector data, paint a picture of a slowing economy, one whose momentum is moving in the wrong direction.
But, “the unemployment rate (U3: 3.5%) is at a 50-year low,” you say. “That shows the economy is still strong.” Employment is a lagging indicator. While the media let you know that we haven’t seen this low level since December 1969, what they left out was that a recession began the very next month, January 1970. That’s how lagging unemployment can be.
Furthermore, we have demographic differences in the jobs environment that weren’t present 50 years ago. Fertility rates in the U.S. have been falling for decades while life expectancy has risen. As the population has grown and become skewed to older generations, those in their prime working years, as a percentage of the total, fall. So, while the economy wants to expand to feed, clothe and entertain the rising population, the pool of labor for that expansion is simply not available. The biggest business complaint this cycle has been the lack of qualified workers. And, when positions can’t be filled, companies have a hard time growing. Today’s low unemployment rate appears to have been more influenced by demographics than by economic growth.
In addition, we haven’t seen any real upward pressure on wages. The old Phillips Curve theorem (the lower the unemployment, the more upward pressure on wages) doesn’t seem to be present in the current economic environment. Despite the record low unemployment rate, average hourly earnings in September were flat (actually -0.04% to the second decimal), and the Y/Y gains are falling: from 3.3% in July, to 3.2% in August, to 2.9% in September. That really feels deflationary.
Finally, there were some disconcerting details in that unemployment report (there always are!). The Birth/Death plug number added 63k jobs, so only 73k of the 136k reported were actually counted. In addition, much of the increase came from non-cyclically sensitive sectors like government, education/health care, etc. The cyclically sensitive sectors (like transportation, construction, real estate, retail and manufacturing) registered declines.
The Evidence: U.S.
· ISM Indexes (above 50 = expansion; below 50 = contraction)
- Manufacturing: 47.8 (Sept.) vs. 49.1 (Aug.); the consensus before the release was 50.1 and this index has fallen 7.5 points in the last six months. This index hasn’t been this low since June, ’09. Looking at history, 80% of the time that this index has hit this level, a recession has ensued. Every other important sub-index also showed contraction with Employment at 46.3 and New Export Orders at a lowly 41.0. This last sub-index was at 51.0 last May;
- Non-Manufacturing (Services): This index also disappointed falling to 52.6 (Sept.) from 56.4 (consensus was 55.0). The New Orders sub-index fell hard to 53.7 from 60.3, and Employment (50.4) barely stayed in expansion territory; not very encouraging for a service dependent economy.
· Consumer Confidence (Conference Board) fell to 125.1 (Sept.) from 134.2 (Aug.) and 135.8 (July). The quarterly CEO Confidence sub-index fell to 34 (Q3) from 43 (Q2), the lowest this index has been since Q1/09. In the history of this survey, back to the ‘80s, a recession has occurred 100% of the time when the CEO Confidence Index is at such a level.
· The Dallas Fed Manufacturing Index: +1.5 (Sept.) vs. +2.7 (Aug.). The Six-Month Forward Expectations Index was -6.8, a fall from +1.4. New Orders, Unfilled Orders, and Production all fell, but the Employment (+18.8 s +5.5) and Capex (+23.3 vs. +17.3) sub-indexes both rose.
· In Chicago, the Fed’s National Activity Index fell to 47.1 (Sept.) vs. 50.4 (Aug.), so from slight expansion to contraction. New Orders, Production, Inventory, and Employment all showed contraction.
· The U.S. Housing data, for all the attention it gets, won’t have a significant impact on growth until the first-time home buyer crowd approaches 40% of sales (currently near 30%). Home prices and student debt are likely playing a large role here. Falling mortgage rates do appear to be helping, but likely, alone, won’t turn the tide. Think of it this way: without first-time buyers, what you end up with is existing buyers trading homes with each other. This has very little aggregate economic impact.
· U.S. factory orders: -0.1% (-0.5% ex-defense) and -2.88% Y/Y (Aug.).
· Challenger, Gray, and Christmas: new job announcements are lower by -23% Y/Y (Sept).
· U.S. Mall vacancy rates are 9.4%, an 8-year high. This is consistent with the falling number of retail employees.
· New York City apartment/condo prices have fallen -25% in Q3 from year earlier levels.
· S&P 500 earnings, which begin their 3rd quarter reporting soon, are expected to be lower by -3.5% from year earlier levels. Worry if they are much lower than that. That makes three quarters in a row of falling earnings. Some call that an earnings recession.
The Evidence: Rest of the World
Manufacturing PMIs (Aug.)
· Japan: 48.9;
· So. Korea: 48.0 (Exports down -11.7% Y/Y and -22% to China);
· Indonesia: 49.1;
· Taiwan: 50.0 (49.96 to second decimal);
· Malaysia: 47.9;
· Euro area: 45.7 (Sept); the lowest in seven years with New Orders at 43.4 (in contraction now for 12 months in a row);
- Germany: 41.7 (Services: 51.4);
- France: 50.1 (barely in positive territory);
- Sweden: 46.3;
· Hong-Kong: Retail Sales were down 25% in August vs. a year earlier, and this is likely to continue given the social unrest in the region.
The Financial Arena
- The world’s central banks continue to drop rates. Australia’s and India’s central bank each dropped 25 basis points this past week.
- The U.S. Fed still can’t explain why it was surprised at the liquidity squeeze in bank reserves over the past two weeks causing it to inject about $100 billion. This, like QE, expands the Fed’s balance sheet and provides liquidity. Unlike QE, it is temporary (matures daily). But, if the Fed is intent on keeping overnight bank lending rates (the Fed Funds rate) at its target, this may as well be permanent, as a withdrawal of the funding would cause overnight rates to spike like they did the week of September 16th.
- The Bank of Japan (BOJ) withdrew some of its market support for newly issued Japanese Government Bonds at the government auction last week and this caused interest rates, worldwide, to become quite volatile for a few hours. There was no explanation. Is the BOJ having a change of policy after decades of such support? And, if so, why would they do this the week that Japan’s sales tax rose to 10% from 8%? More likely, like the Fed, they just missed something.
- Of concern, despite a significant fall in the Treasury yield curve last week (15 basis points, i.e. .015 percentage points), high yield bonds sold off. High yield bonds trade at a spread to the Treasury yield curve. Since such bonds fell in price, that meant that the spreads to Treasuries widened out more than the fall in the Treasury yield curve, i.e., significantly more than 15 basis points. This tells us that investors are shedding risk, something they do when they are worried about the future! I have discussed this worry several times in past writings, and now, risk-off in this sector appears to have taken hold.
Final Thoughts and Conclusions
Whether we actually have a recession or not, the slowing economy leads to excess capacity which reduces capex spending and leads to lower interest rates (the clearing mechanism for the savings/investment (demand/supply) function). Demographic trends in the developed economies are only exacerbating the trend toward deflation.
While the employment report for September looked positive on the surface, it wasn’t so hot when examined more closely. The preponderance of the data do point to slower growth or, dare I say, recession, which has already engulfed much of Europe and likely China. The U.S. is not immune with manufacturing now in contraction and the service sector slowing significantly. We are approaching the holiday season. Likely, U.S. consumers will have one last hurrah. But, if trends continue, watch out for fireworks in Q1.
Robert Barone, Ph.D. is a Georgetown educated economist. He is a financial advisor at Four Star Wealth Advisors. www.fourstarwealth.com. He is nationally known for his writings and Robert’s storied career includes his having served as a Professor of Finance, a community bank CEO, and a Director and Chairman of the Federal Home Loan Bank of San Francisco. Robert is currently a Director of CSAA Insurance Company (the AAA brand) where he chairs the Finance and Investment Committee. Robert is the co-portfolio manager of the UVA Unconstrained Medium-Term Fixed Income ETF (FFIU).
