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Employee Compensation as a percentage of Net Value Added (by US Corporate Business) has fallen sharply since the GFC, boosting corporate profits. Again we can observe an inverse relationship, with corporate profits spiking when compensation rates fall, and vice versa.
A sharp fall in unemployment would send wage rates soaring, as employers bid for scarce labor. But that is not yet on the horizon and we are likely to experience soft wage rates until the economy recovers.
Low interest rates clearly boost corporate profits. The inverse relationship is evident from the strong profits recorded in the 1950s, when corporate bond rates were lower than at present, and also the big hole in profits in the 1980s, when interest rates spiked dramatically during Paul Volcker’s reign at the Fed.
The outlook for inflation is muted and the rise in interest rates likely to be gradual over several years, rather than a sharp spike, if the Fed has its way.
Sharp spikes in the US Industrial Commodities PPI (producer price index) often precede a drop in Corporate Profits (expressed below as a ratio to GDP). And sharp falls in the PPI tend to precipitate a surge in profits.
The 5-year chart above shows PPI growth close to zero since 2012. With wages, raw material costs and interest rates near long-term lows, there is little wonder that corporate profits have surged. The question is: how long will the three remain low? That depends on how fast the global economy recovers. And how long rising demand (from the recovery) is able to withstand rising input costs.
A long-term view of Corporate Profits/GDP compared to Industrial Commodities PPI shows the relationship is not a perfect inverse, but profits clearly tend to run counter to the rate of PPI growth.
From a paper by Samuel Kapon and Joseph Tracy at the Federal Reserve Bank of New York:
As the economy recovered and growth resumed, the unemployment rate has fallen to 6.7 percent. …..The employment-population (E/P) ratio frequently is used as an additional labor market measure. The E/P ratio is defined as the number of employed divided by the size of the working-age, noninstitutionalized population. An advantage of the E/P ratio over the unemployment rate is that it is not impacted by discouraged workers who stop looking for employment.
Since the end of the recession, the E/P ratio has largely remained constant—that is, virtually none of the decline in the E/P ratio from the Great Recession has been recovered to date. An implication is that the 7.6 million jobs added since the trough of employment in February 2010 has essentially just kept pace with growth in the working-age population. In its failure to recover, the E/P ratio would seem to depict a much weaker labor market than indicated by the unemployment rate. An important question is whether this is a correct or a misleading characterization of the degree of the labor market recovery…….
Read more at A Mis-Leading Labor Market Indicator – Liberty Street Economics.
Hat tip to Barry Ritholz.
The S&P 500 broke support at 1770, confirming a secondary correction. At times like this it pays to look at monthly charts to gain a long-term perspective. The first line of support is at 1700. Respect of the secondary trendline would flag a weak correction indicative of a strong up-trend. Breach of that level, however, would suggest a strong correction to 1550 and the primary trendline. The scale of the bearish divergence on 13-week Twiggs Money Flow, when compared to the divergence in 2007, suggests medium-term selling pressure — typical of a secondary correction rather than a (primary) reversal.
CBOE Volatility Index (VIX) crossed to above 20, suggesting moderate risk, but not yet cause for concern.
The Nasdaq 100 retreated below 3500, warning of a correction. Again, the bearish divergence on 13-week Twiggs Money Flow appears secondary and no threat to the primary up-trend.
I wish I had a dollar for every time the 1929 Dow has been superimposed over the current index. Like this effort at Zero Hedge.
Why did the analyst select a period of two years? Because that is the period that fits.
If we compare the period 1920 to 1933 to the last 13 years, 2001 to 2014, there is a significant difference.
By 1929 the Dow had climbed roughly 400%, while by 2014 the Dow gained roughly 50% over a similar time period.
Superimposing charts one on top of the other has no sound basis in technical analysis and should be viewed as an attempt to scare the market into a sell-off. A correction may be overdue, but there are always potential buyers hoping for much lower prices.
Hat tip to John B. for sending me the Zero Hedge chart.
The yield on ten-year Treasury Notes broke support at 2.75 percent after penetrating the rising trendline. Both warn of trend weakness. Bearish divergence on 13-week Twiggs Momentum strengthens the signal and reversal below zero would warn of a primary down-trend. Breach of support at 2.50 still seems unlikely, but would offer a target of 2.00 percent*.
* Target calculation: 2.50 – ( 3.00 – 2.50 ) = 2.00
The Dollar Index, on the other hand, appears headed for another test of resistance at 81.50. Breakout would signal a primary advance to 83.00*, while recovery of 13-week Twiggs Momentum above zero would strengthen the signal. Reversal below 79.80 cannot be ruled out, with long-term rates falling, and would warn of another test of primary support at 79.00.
* Target calculation: 81.5 + ( 81.5 – 80 ) = 83
Gluskin Sheff’s David Rosenberg:
The Fed’s Beige Book contained no fewer than two dozen references to wage pressures and skilled job shortages and in sectors that cover around 40 million workers. I realise the average hourly and weekly earnings data from the non farm payroll survey are tepid but a big disconnect seems to have emerged between those measures and the broad wage/salary growth numbers out of the National Accounts data……
Read more at ROSENBERG: There Are More Signs Of Wage Inflation Becoming A Reality | Business Insider.
I have just read John Mauldin’s warning that the market is overvalued:
Not only does today’s CAPE of 25.4x suggest a seriously overvalued market, but the rapid multiple expansion of the last few years coupled with sluggish earnings growth suggests that this market is also seriously overbought, as I pointed out last week and as we are seeing play out this week.
Robert Shiller’s CAPE ratio compares the current index price to a 10-year simple moving average of inflation-adjusted earnings in order to smooth out earnings and provide a long-term indication as to whether the market is under- or over-valued. But ratios are far from infallible. One of the first things fundamental investors/traders learn is: do not buy a stock simply because the Price-to-Earnings (PE) ratio is low, and never short a stock simply because the PE ratio is high. The reason is fairly obvious. In the first case, current earnings may be expected to fall and, with high PE ratios, earnings are likely to grow.
Let’s examine CAPE more closely. First, we have experienced the worst recession in almost a century; so does a moving average of the last 10 years adequately reflect sustainable long-term earnings? In the chart below I removed the highest and lowest quarter’s earnings in the last 10 years [dark green]. Note the visible difference losses reported in Q/E December 2008 make to the long-term average.
The chart also highlights the fact that Shiller’s CAPE is relatively low compared to the last 15 years, where the average is close to 30. The normal PE of 18.4, calculated on the last 12-month’s earnings*, is also low compared to an average of 28 for the last 15 years.
*Reporting for the December quarter is not yet completed and unreported earnings are based on S&P estimates.
As novice investors learn, it is dangerous to base buy or sell signals on a PE ratio, whether it is CAPE or regular PE based on 12-months earnings. Using CAPE, we would have sold stocks in 1996 and again in 2003, missing two of the biggest bull markets in history. And we would have most likely bought in 2008, when CAPE made a new 10-year low, right before the collapse of Lehmann Brothers.
I submit that CAPE or PE ratios are not an end in themselves, but merely a useful tool for highlighting expectations of future earnings. At present both ratios are rising, suggesting that earnings prospects are improving.
US markets were overdue for a correction and continuation of the advance for much longer would have resulted in instability, from an imbalance between buyers and sellers.
At Research & Investment we do not attempt to time entries and exits on secondary corrections. Our research shows that this is expensive and erodes performance. What we do pay a lot of attention to, on the other hand, are macro-economic and volatility indicators of market risk, exiting to cash when risks become elevated.
With a long-term view of the market, secondary fluctuations are relatively insignificant, but they do present opportunities to increase investment in the market.
The S&P 500 broke support at 1810, signaling a correction. Bearish divergence on 21-day Twiggs Money Flow strengthens the signal. Expect support at the Setember 2013 high of 1730.
A monthly chart places the latest breakdown in perspective. Respect of support at 1700 — and the secondary trendline — would confirm a healthy primary up-trend. A 13-week Twiggs Money Flow trough above zero would again strengthen the signal.
* Target calculation: 1800 + ( 1800 – 1700 ) = 1900
The VIX is rising steeply, but continues to indicate low risk and a bull market.
