Friday, June 1, 2018

America's Unstoppable Economy?

Jeff Cox of CNBC reports, The US economy suddenly looks like it's unstoppable:
In the face of persistent fears that the world could be facing a trade war and a synchronized slowdown, the U.S. economy enters June with a good deal of momentum.

Friday's data provided convincing evidence that domestic growth remains intact even if other developed economies are slowing. A better-than-expected nonfarm payrolls report coupled with a convincing uptick in manufacturing and construction activity showed that the second-half approaches with a tailwind blowing.

"The fundamentals all look very solid right now," said Gus Faucher, chief economist at PNC. "You've got job growth and wage gains that are supporting consumer spending, and tax cuts as well. There's a little bit of a drag from higher energy prices, but the positives far outweigh that. Business incentives are in good shape."

The day started off with the payrolls report showing a gain of 223,000 in May, well above market expectations of 188,000, and the unemployment rate hitting an 18-year low of 3.8 percent.

Then, the ISM Manufacturing Index registered a 58.7 reading — representing the percentage of businesses that report expanding conditions — that also topped Wall Street estimates. Finally, the construction spending report showed a monthly gain of 1.8 percent, a full point higher than expectations.

Put together, the data helped fuel expectations that first-quarter growth of 2.2 percent will be the low-water point of 2018.

"May's rebound in jobs together with yesterday's report of solid income growth and the rise in consumer confidence points to the economy functioning very well," National Retail Federation chief economist Jack Kleinhenz said in a statement. "Solid fundamentals in the job market are encouraging for retail spending, as employment gains generate additional income for consumers and consequently increase spending."

The most recent slate of widely followed barometers could see economists ratchet up growth expectations.

Already, the Atlanta Fed's GDPNow tracker sees the second quarter rising by 4.8 percent. While the measure also was strongly optimistic on the first quarter as well, at one point estimating 5.4 percent growth, other gauges are positive as well. CNBC's Rapid Update, for instance, puts the April-to-June period at 3.6 percent.

Andrew Hunter, U.S. economist at Capital Economics, said the ISM number alone is consistent with GDP growth of better than 4 percent, though he thinks the second quarter will be in the 3 percent to 3.5 percent range.

"With global growth set to hold up fairly well in the near term, this suggests that manufacturing activity should continue to expand at a solid pace," Hunter said in a note. "That said, if the Trump administration continues to pursue protectionist policies and provoke retaliation from other countries, the export-focused manufacturing sector would be most exposed."

Indeed, there are a spate of headwinds still out there, and trade continues to top the list.

The White House's decision this week to forge ahead with steel and aluminum tariffs stoked fears that the administration could be its own worst enemy on the road to 3 percent-plus growth. While the tariffs themselves are expected to have minimal economic impact on their own, fears remain that they could spark retaliatory measures and, ultimately, an all out trade war.

Exports make up just 12.4 percent of the U.S. economy, but S&P 500 companies generate about 43 percent of their sales internationally. That's why markets tend to recoil every time the administration saber-rattles about tariffs.

Still, manufacturers remain largely upbeat.

Respondents to the ISM survey released Friday relayed mostly positive sentiments. One typical statement, from an unidentified transportation equipment firm, said, "We are currently overselling our forecast and don't see an end to the upswing in business," while noting that "we are very concerned" about the tariff situation and "are focusing on alternatives to Chinese sourcing."

Others noted price pressures, while an index that tracks order backlogs hit its highest level since April 2004. The pricing index also registered its highest since April 2011, as firms noted that inflationary pressures are building heading into the second half.

That's consistent with news out of the trucking industry, which is reporting a shortage of drivers amid huge demand for delivery vehicles.

While inflation could prompt more aggressive action in the form of Federal Reserve interest rate hikes, PNC's Faucher sees an economy resilient enough to withstand that and other headwinds.

"The tight labor market is going to lead businesses to invest in capital that makes their workers more productive. Then you've got stronger government spending with the increase in discretionary spending caps," he said. "I think we'll see growth better than 3 percent in the final three quarters of the year."
Jeff Cox followed up with another article looking at the 5 most important numbers from Friday's jobs report:
A quick look at the five most important numbers from Friday's nonfarm payrolls report:

1) Payroll growth hit 223,000 for May, its highest level since February, beating market expectations for 188,000.

2) The headline unemployment rate fell to 3.8 percent, the lowest reading since April 2000, while the "real" rate, which includes discouraged workers and the underemployed, dropped to 7.6 percent, its best since May 2001.

3) Average hourly earnings rose 2.7 percent, in line with expectations and enough to convince markets that the Fed will raise interest rates at least two more times in 2018.

4) Full-time jobs rose an eye-popping 904,000 for the month, while part-time positions declined by 625,000.

5) Unemployment for blacks continues to decline, with the rate falling to a record 5.9 percent, down a full point from March.

What it all means: From Eric Winograd, U.S. economist at AB (formerly AllianceBernstein): "We remain in a virtuous circle: the labor market is strong, which supports consumption, which drives production, which keeps the labor market strong. Until something disrupts that cycle, we should expect the good economic times to continue."
It's Friday, time to relax and give you some of my market thoughts.

First, there's no doubt the US economy is on fire. The economy is producing jobs, unemployment is at 3.8%, the lowest reading since April 2000, and manufacturing data (ISM) signals the expansion will continue in the near term.

All this good economic news is fueling consumption and you saw it this week in retail stocks like Dick's Sporting Goods (DKS),  Movado Group (MOV) and Lululemon Athletica (LULU), all of which rallied hard this week (click on images):




In fact, as shown above, shares of Movado Group (MOV) and Lululemon Athletica (LULU) are making new 52-week highs which always brings out the bulls on Wall Street who tell you 'don't fear the trend' (I say never chase after stocks or hedge funds no matter how hot they are!!).

Last week, shares of Tiffany & Co. (TIF) popped after beating earnings but there too, I wouldn't chase after the stock at this time (click on image):


But not all retail stocks are doing well. On Thursday, shares of Dollar Tree (DLTR) got whacked hard  after the retail chain announced disappointing fiscal first-quarter results (click on image):


Now, I purposely put up these charts for a reason and it's not to tell you to buy the rips or dips although the contrarian in me would tell you if shares of Dollar Tree fall below their 200-week moving average, you should start nibbling.

The reason why I put up these charts is that while the American economy is hot, it's much hotter for the affluent few than the restless many, a point Charles Hugh Smith of the OfTwoMinds blog made in his latest post, The U.S. Economy in Two Words: Asymmetric Gains.

Let's face it, it's mostly well off women who sport Movado watches, practice yoga wearing their Lululemon Athletica clothes and shop at Tiffany's for their jewellery, not those stuggling to make their mortgage payment and feed the kids.

In a way, this is good news. Why? Because it tells me women are moving up in the world and doing well for themselves and they're increasingly gaining share in the overall employment market even if gender discrimination is alive and well.

Last month, Warren Buffett came out to say he's bulish on the American economy because he's bullish on women and I completely agree.

The Oracle of Omaha also had some wise investment advice which he shared with CNBC's readers which is focus on the facts, don't get emotional and stick to what you know.

I completely agree, when you're investing, not trading (two totally different things), you're better off knowing the company you're buying and knowing their products. And if you look at Berkshire's top holdings, Buffett practices what he preaches, sometimes with success and sometimes without much success (like IBM but over the long run, he's picked a lot more winners than losers).

Till this day, when people ask me which is the best investment book they should read and their kids should read, I don't flinch to recommend Peter Lynch's classic, One Up on Wall Street. You won't learn to trade but you will learn about how to make great investments using some down to earth common sense (Buffett would recommend Benjamin Graham's classic, The Intelligent Investor, but I find Lynch's book much more relevant for our time and much more fun and easier to read).

Anyway, back to America's unstoppable economy. It's very hard when things are going so well for people to sit back and worry about what could go wrong.

Nevertheless, this is the time when professional asset and risk allocators worry the most because in the back of their mind, it's as good as it gets and there are a lot of things that can blow up and wreak havoc on their portfolios.

But let's say nothing "blows up" in Europe, emerging markets and there are no black swans that spell the end of days for stocks. Let's even say the market is underestimating great earnings and sell in May and go away is a bunch of baloney.

I'll even go further, let's say we finish 2018 with a positive not negative "bang" and continue soaring in 2019, what then?

Well, I'm not so confident the second half of the year will be a lot better than the first half but even if I'm wrong, I'm also on record stating the longer this bull market goes higher and the longer we go without a recession, the worst it will be when the downturn hits, both in terms of magnitude and duration.

I recently warned my readers that there is a looming wave of junk bond defaults headed our way. Admittedly, it's laughable to discuss defaults when the US economy is roaring like this but one distressed debt titan expert is already warning of a flood of troubled credits topping $1 trillion as rising interest rates overwhelm low-quality loans and bonds.

Even more worrisome, the longer-term effects of America's protectionist trade policies. A full-blown trade war will wreak havoc in Canada and the rest of the world, cause a lot more distress outside the US than within the US, but it will hurt American corporations' bottom line and will undoubtedly cause unemployment to rise there too.

By the way, it's critically important to remind all of you that employment is a coincident, not leading economic indicator and inflation is a lagging indicator. One of my astute blog readers sent me Kessler's latest comment on the last time US unemployment hit 3.8%:
The US unemployment rate, released today, is 3.8%. This rate ties the lowest rate observed over the last 48 years! There was one print of 3.8% in April of 2000 and today’s. No number has been lower since late 1969.


Intuitively, this is good economic news as very few people in the labor force are wanting of a job, but empirically, the last time unemployment was this low was directly ahead of the end of the then 10yr-long economic expansion. As we have previously shown here, low unemployment numbers are a late-cycle indicator.

It is interesting to examine the time surrounding the last time we saw a 3.8% unemployment number; here is what happened. The 10yr US Treasury rose by 10.5 basis points in the two trading days after the number’s release, but amazingly, that high yield print of 6.57% on 5/8/2000 has never since been seen; rates have only been lower since. Two weeks after this number was released, the Federal Reserve raised rates for the last time in that cycle, from 6% to 6.5%

Within one month of that number, the 10yr had fallen 31 basis points, within 3 months had fallen 56 basis points, within a year had fallen 128 basis points, and in 3 years had fallen 255 basis points. The US was in recession in 10 months from the number. The US stock markets made their cycle peak two months before this number in March. While the S&P 500 would later re-test the highs in September of that year, the Nasdaq was in free-fall throughout this period. From peak to trough, the S&P 500 fell 49% and the Nasdaq fell 78%.

With a comparison this specific, it is dangerous to expect the same outcomes in the same amount of time, but if one is looking for another sign to indicate the end of the stock bull market and the beginning of the US Treasury bull market, this is a good one.
When I tell you to hedge your portfolio using US long bonds (TLT), I'm thinking of nasty surprises out of Europe or elsewhere but I'm also thinking about the coming economic slowdown which is very bond friendly.

This week, US Treasuries rallied on Tuesday, mostly owing to fears out of Italy prompting a massive flight to safety and liquidity, but yields moved back up by the end of the week.

Still, if we do get an external shock and we start seeing economic weakness ahead from lagged effects of Fed rate hikes, mounting protectionism or other factors, then you should start hunkering down and de-risking your portfolio by investing at least 50% in US long bonds (TLT) and overweighting safer sectors like consumer staples (XLP) and interest-rate sensitive sectors like utilities (XLU), telecoms (IYZ) and REITs (IYR) and underweighting cyclical sectors like energy (XLE), financials (XLF), metals and mining (XME), industrials (XLI) and emerging market shares (EEM).

And if things get really bad, stick it all in US long bonds (TLT) because there won't be any place to hide in the stock market.

I don't want to scare you but I think it's important to take a step back here and really think about where we are and where we will be in ten years.

In fact, John Mauldin recently wrote an article for Forbes stating the 2020s might be the worst decade in U.S. history:
I recently wrote about a looming credit crisis that’s stemming from high-yield junk bonds. The crisis itself will have massive consequences for investors. But that’s not the worst part.

The crisis will create a domino effect and trigger global financial contagion, which I usually refer to as "The Great Reset."

The collapse of high-yield bonds will hit stocks and bonds. Rising defaults will force banks to reduce their lending exposure, drying up capital for previously creditworthy businesses.

This will put pressure on earnings and reduce economic activity. A recession will follow.

Global Recession

This will not be just a U.S. headache, either. It will surely spill over into Europe (and may even start there) and then into the rest of the world. The U.S. and/or European recession will become a global recession, as happened in 2008.

Europe has its own set of economic woes and multiple potential triggers. It is quite possible Europe will be in recession before the ECB finishes this tightening cycle.

As always, a U.S. recession will spark higher federal spending and reduce tax revenue. So I expect the on-budget deficit to quickly reach $2 trillion or more. Within four years of the recession’s onset, total government debt will be at least $30 trillion.

This will further constrain the private capital markets and likely raise tax burdens for everyone—not just the rich.

Political Backlash

Meanwhile, job automation will intensify, with businesses desperate to cut costs. The effect we already see on labor markets will double or triple. Worse, it will start reaching deep into the service sector. The technology is improving fast.

The working-class population will not like this and it has the power to vote. “Safety net” programs and unemployment benefit expenditures will skyrocket.

Studies show that the ratio of workers covered by unemployment insurance is at its lowest level in 45 years. What happens when millions of freelancers lose their incomes?

The likely outcome is a populist backlash that installs a Democratic Congress and president. They will then raise taxes on the “rich” and roll back some of the corporate tax cuts and increase regulatory burdens.

At a minimum, this will create a slowdown but more likely a second recession. Recall (if you’re old enough) the back-to-back recessions of 1980 and 1982. That was an ugly time for those of us who lived through it.

Of course, that presumes a recession before the 2020 election. It may not happen—I put the odds at about 60%–70%.

The Great Reset

Unemployment may approach the high teens by the end of the decade and GDP growth will be minimal at best.

What do you call that condition? Certainly not business as usual.

Long before that happens, the Federal Reserve will have engaged in massive quantitative easing.

As this recession unfolds, we will see the Fed and other developed world central banks abandon their plans to reverse QE programs. I think the Federal Reserve’s balance sheet assets could approach $20 trillion later in the next decade.

Not a typo—I really mean $20 trillion, roughly five times as much as what we had after 2008.

The world simply has too much debt, much of it (perhaps most) unpayable. At some point, the major central banks of the world and their governments will do the unthinkable and agree to “reset” the debt.

How?

It doesn’t matter how, they just will. They’ll make the debt disappear via something like an Old Testament Jubilee.

I know that’s stunning, but it’s really the only possible solution to the global debt problem. Pundits and economists will insist “it can’t be done” right up to the moment it happens—probably planned in secret and announced suddenly.

Jaws will drop, and net lenders will lose.

While all that is brewing, technology will keep killing jobs. As we get into the 2020s, the presidency and Congress will again be whipsawed, and we will begin to discuss Bernie Sanders’ “crazy” universal basic employment idea, or others like it.

By then, the idea will not be considered crazy, but the only feasible choice. Even conservative politicians can see the light when they feel the heat.

All of this is going to lead to the most tumultuous decade in U.S. history, even if we somehow (hopefully) avoid throwing a war into the mix, as is typical of a Fourth Turning.

Typically, the end of a Fourth Turning (which started in 2007, according to Neil Howe), has been accompanied by wars. This one could, too, though I think we will more likely see multiple low-grade skirmishes.

If we somehow get through all that, and particularly the Great Reset, the 2030s should be pretty good. In fact, think incredible boom and future. No one in 2039 will want to go back to the good old days of 2019. Our kids will think it was the Stone Age. But we have to get there first.
I wonder what John thinks of Trump's tariffs on America's allies. I personally think they're idiotic and he should be targeting better trade deals without imposing tariffs which will only hurt the global and US economy.

Where I agree with John Mauldin is we will see QE infinity but not a global debt reset because it will bankrupt the banks (listen to Lacy Hunt below). I can't tell you about the timing but we aren't going to muddle through like this for another decade without rising populist tensions and possibly something far worse (like war).

In this environment, market timing will become more important and investors will need to readjust their return expectations and prepare for lower returns for a lot longer.

I better stop here, I'm depressing myself and this comment was supposed to be all about America's unstoppable economy. Thank God more and more women are doing well in this economy, that's a positive long-term trend.

Below, we are not in a phase of synchronized growth, says Mohamed El-Erian, Allianz chief economic advisor, providing insight to the markets both domestic and globally. The only economy that has real "legs" to it is the US economy, says El-Erian.

Yes, America's economy is unstoppable, for now, but you'd better prepare for a slowdown ahead.

On that note, embedded once again a discussion where  Erik Townsend and Patrick Ceresna welcome Dr. Lacy Hunt to MacroVoices. I want you all to take the time to listen carefully to Lacy Hunt as he explains why the (Treasury) bond bull market isn't over and why we cannot get out of the current predicament through more debt and why it will take a long time to recover after the next crisis hits. You can also download the podcast transcript here.


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