Nasdaq and S&P500 meet resistance

July labor stats are out and shows the jobless rate fell to a 16-year low at 4.3%. Unemployment below the long-term natural rate suggests the economy is close to capacity and inflationary pressures should be building.

Unemployment below the long-term natural rate

Source: St Louis Fed, BLS

But hourly wage rates are growing at a modest pace, easing pressure on the Fed to raise interest rates.

Hourly Wage Rates

Source: St Louis Fed, BLS

Fed monetary policy remains accommodative, with the monetary base (net of excess reserves) growing at a robust 7.5% a year.

Hourly Wage Rates

Source: St Louis Fed, FRB

Our forward estimate of real GDP — Nonfarm Payroll * Average Weekly Hours — continues at a slow but steady annual pace of 1.79%.

Real GDP compared to Nonfarm Payroll * Average Weekly Hours

Source: St Louis Fed, BLS & BEA

The Nasdaq 100 has run into resistance at 6000. No doubt readers noticed Amazon [AMZN] and Alphabet [GOOG] both retreated after reaching the $1000 mark. This is natural. Correction back to the rising trendline would take some of the heat out of the market and provide a solid base for further gains. Selling pressure, reflected by declining peaks on Twiggs Money Flow, appears secondary.

Nasdaq 100

The S&P 500 is also running into resistance, below 2500. Bearish divergence on Twiggs Money Flow warns of moderate selling pressure but this again seems to be secondary — in line with a correction rather than a reversal.

S&P 500

Target 2400 + ( 2400 – 2300 ) = 2500

Bob Doll: Lack of  infrastructure stimulus might benefit stocks

Bob Doll at Nuveen makes a good point about Trump’s failure to get infrastructure spending through the House.

Washington, D.C. seems mired in gridlock, despite the fact that Republicans control the House, Senate and White House. No significant economic legislation has been passed, and the optimism from January about health care reform, infrastructure spending and tax cuts has all but vanished. Political attention will soon be focused on the 2018 midterm elections, and the window for pro-growth policy action is closing.

The lack of fiscal stimulus is disappointing, but it comes with a silver lining: We are unlikely to see the significant and sharp advance in interest rates or in the U.S. dollar that would probably result from such stimulus. The lost opportunity on the political front might therefore have the ironic effect of prolonging the bull market in stocks.

It seems crazy when you consider that both Clinton and Trump campaigned on a platform of major infrastructure programs to boost the economy. Just shows how dysfunctional Washington has become.

But I agree with the silver lining. Infrastructure spending would have boosted employment — the US is already below its long-term natural rate of unemployment — and upward pressure on wage rates. Which would have drawn a sharp increase in interest rates from the Fed, to combat inflation. Populist policies often ignore the hidden/unforeseen consequences and can produce the opposite result to that intended.

Unemployment v. LT Natural Rate

Source: Weekly Investment Commentary from Bob Doll | Nuveen

Australia: Job gains

ABS June figures reflect solid gains for the labor market. Justin Smirk at Westpac writes:

“….The annual pace of employment growth has lifted from 0.9%yr in February to 2.0%yr in May and it held that pace in June. In the year to Feb there was a 106.9k gain in employment; in the year to June this has lifted to 240.2k. The Australian labour market went through a soft patch in 2016 that was particularly pronounced through August to November when the average gain in employment per month was a paltry 2.2k. We have clearly bounced out of this soft patch and now holding a firmer trend.”

My favorite measure, monthly hours worked, jumped (year-on-year) by 3.1%.

Monthly Hours Worked

Infrastructure spending, particularly in NSW and Victoria, is doing its best to offset weakness in other areas.

Wage rate growth remains subdued, indicating little pressure on the RBA to lift rates.

Monthly Hours Worked

US Retail & Light Vehicle Sales slow

Retail sales growth (excluding motor vehicles and parts) slowed to 2.4% over the 12 months to June 2017.

Retail Sales ex Motor Vehicles & Parts

Source: St Louis Fed & US Bureau of the Census

Seasonally adjusted light vehicle sales are also slowing.

Light Vehicle Sales

Source: St Louis Fed & BEA

Seasonally adjusted private housing starts and new building permits are starting to lose momentum.

Housing Starts & Permits

Source: St Louis Fed & US Bureau of the Census

The good news is that Manufacturer’s Durable Goods Orders (seasonally adjusted and ex Defense & Aircraft) are recovering.

Manufacturing Durable Goods Orders ex Defense & Aircraft

Source: St Louis Fed & US Bureau of the Census

Cement and concrete production continues to trend upwards.

Cement & Concrete Production

Source: US Fed

And estimated weekly hours worked (total nonfarm payroll * average weekly hours) is growing steadily.

Estimated Weekly Hours Worked

Source: St Louis Fed & BLS

All of which suggest that business confidence is growing and consumer confidence is likely to follow. Bellwether transport stock Fedex advanced to 220, signaling rising economic activity in the broader economy.

Fedex

Target: 180 + ( 180 – 120 ) = 240

The S&P 500 broke resistance at 2450, making a new high. Narrow consolidations and shallow corrections all signal investor confidence typical of the latter stages of a bull market. The immediate target is 2500* but further gains are likely.

S&P 500

Target: 2400 + ( 2400 – 2300 ) = 2500

The stock market remains an exceptionally efficient mechanism for the transfer of wealth from the impatient to the patient.

~ Warren Buffett

Australia faces headwinds

Australian wage rate growth, on the other hand, is declining. is in a worse position, with a dramatic fall in investment following the mining boom.

Australia: Wage Price Index

Source: RBA & ABS

As is inflation.

Australia: Inflation

Source: RBA & ABS

Growth in Household Disposable Income and Consumption.

Australia: Household Income and Consumption

Source: RBA & ABS

And Banks return on shareholders equity.

Australia: Banks Return on Equity

Source: RBA & APRA

But not Housing.

Australia: Banks Return on Equity

Source: RBA, ABS, APM, CoreLogic & Residex

At least not yet.

Falling house prices would complete the feedback loop, shrinking household incomes, consumption and banks ROE.

US adds 222 thousand jobs

From the Wall Street Journal:

U.S. employers picked up their pace of hiring in June. Nonfarm payrolls rose by a seasonally adjusted 222,000 from the prior month, the Labor Department said. The unemployment rate ticked up to 4.4% from 4.3% the prior month as more people joined the workforce…..

Job Gains

Source: St Louis Fed & BLS

Forecast GDP for the current quarter — total payrolls * hours worked — is rising, showing an improving economy.

Real GDP Forecast

Source: St Louis Fed, BLS & BEA

Declining corporate profits as a percentage of net value added (RHS) is typical of mid-cycle growth, while employee compensation (% of net value added) is rising at a modest pace. Peaks in employee compensation are normally accompanied by troughs in corporate profits…..and followed by a recession.

US Corporate Profits and Employee Compensation as percentage of Value Added

Source: St Louis Fed & BEA

Average wage rate growth, both for production/non-supervisory and all employees, remains below 2.5% per year. Absence of wage rate pressure suggests that the Fed will be in no hurry to hike interest rates to curb inflationary pressure.

Hourly Wage Rate Growth

Source: St Louis Fed & BLS

Which should mean further growth ahead.

Investment the key to growth

Elliot Clarke at Westpac recently highlighted the importance of investment in sustaining economic growth:

The importance of sustained investment in an economy cannot be understated. Done well, investment in real capacity begets greater production volume and employment as well as a productivity dividend. Its absence in recent years is a key factor behind sustained soft wage inflation and the US economy’s inability to consistently grow at an above-trend pace despite the economy being at full-employment and household balance sheets having more than fully recovered post GFC.

The graph below highlights declining US investment in new equipment post GFC.

S&P 500

source: Westpac

There are three factors that may influence this:

  1. Accelerated tax depreciation allowances after the GFC encouraged companies to bring forward capital spending in order to stimulate the recovery. But the 2010 to 2012 surge is followed by a later trough when the intended capital expenditure was originally planned to have taken place.
  2. Low growth in personal consumption, especially of non-durable goods and of services, would discourage further capital investment.

US Net Debt & Equity Issuance

  1. The level of stock buybacks increased as companies sought alternative measures to sustain earnings (per share) growth. The graph below shows debt issuance has soared while net equity issuance remains consistently negative.

US Net Debt & Equity Issuance

source: Westpac

Net capital formation (the increase in physical assets owned by nonfinancial corporations) declined between 2015 and 2017. While this is partly attributable to the falling oil price curtailing investment in the Energy sector, continuation of the decline would spell long-term trouble for the economy.

US Net Capital Formation

The cycle becomes self-reinforcing. Low growth in personal consumption leads to low levels of capital investment ….which in turn leads to low employment growth…..leading to further low growth in personal consumption.

Major infrastructure investment is needed to break the cycle. In effect you need to “prime the pump” in order to create a new virtuous cycle, with higher investment leading to higher growth.

It is obviously important that infrastructure investment target productive assets, that generate income, else taxpayers are left with increased debt and no income to service it. Or assets that can be sold to repay the debt. But the importance of infrastructure investment should be evident to both sides of politics and any attempt to obstruct or delay this would be putting political ahead of national interests.

Australia

Australia is in a worse position, with a dramatic fall in investment following the mining boom.

Australia: Business Investment

source: RBA

If we examine the components of business investment, it is not just Engineering that has fallen. Investment in Machinery & Equipment has been declining for the last decade. And now Building Investment is also starting to slow.

Australia: Components of Business Investment

source: RBA

You’ve got to prime the pump…. You’ve got to put something in before you can get anything out.

~ Zig Ziglar

Westpac Leading Index counters jobs surge

In stark contrast to the buoyant recent ABS jobs numbers, the Westpac Leading Index slowed:

From Matthew Hassan at Westpac:

The six month annualised growth rate in the Westpac-Melbourne Institute Leading Index, which indicates the likely pace of economic activity relative to trend three to nine months into the future, eased from 1.01% in April to 0.62% in May.

…..The index is pointing to a clear slowing in momentum. While the growth rate remains comfortably above trend, the pace has eased markedly since the start of the year….

Read more at Westpac.

Australia: Jobs surge

The May 2017 ABS Labour Force Survey surprised to the upside, with employment increasing by 42,000 over the previous month (full-time jobs even better at +52,100). These are seasonally adjusted figures and the trend estimates are more modest at 25200 jobs.

Australia Jobs and Unemployment

Seasonally adjusted hours worked also jumped, reflecting an annual increase of 2.3%.

Australia Hours Worked and Real GDP

The Australian Dollar surged as a result of the impressive numbers but Credit Suisse warns that there may be some issues with the latest strong NSW estimates:

By state, the gains in full-time employment were particularly strong in NSW…..

But beware the sample rotation bias ….the ABS has confessed that for the sixth time in seven months, it has rotated the sample in favour of higher employment-to-population cohorts. Officials report that this has had a material impact on the NSW employment outcomes.

If the numbers are correct, there are only two areas that could account for the job growth: apartment construction and infrastructure. The former is unlikely to last and the latter, while an important part of the recovery process, are also not a permanent increase.

I would prefer to wait for confirmation before adjusting my position based on a single set of numbers.

One swallow does not make a spring, nor does one day.

~ Aristotle