Category: GDP and Activity

Posted on

If earnings undershoot, stocks will fall

Annual employment growth is falling while average hourly earnings growth remains high. This is typical. Ahead of the last two recessions (gray bars below), average hourly earnings growth (green) held steady while employment growth (blue) declined.

Employment Growth & Average Hourly Wage Rate

If annual employment growth (blue line on the above chart) falls below 1.0% then a Fed rate cut is almost guaranteed. Not something to celebrate though, as the gray bars and further job losses illustrate.

Declining growth in hours worked points to lower GDP growth in the second quarter.

Real GDP & Hours Worked

From Bob Doll at Nuveen:

“China is taking a tough stance toward the U.S. on trade. Chinese officials appear open to ongoing negotiations, but a recently released statement denies the country’s role in intellectual property theft, blames the U.S. for negotiation breakdowns and calls out the damage done to the American economy as a result of the dispute. All of this suggests that trade issues will persist for some time.”

The CCP is upset that they are now being called out for bad behavior when this should have been addressed years ago. Conflict can no longer be avoided and is likely to last for a generation or more.

“On Monday, US President Trump told reporters that he would impose tariffs on an additional USD 300 billion of Chinese goods if Xi Jinping doesn’t meet with him in Japan.” ~ Trivium China, June 12, 2019

Trump is doing his best to kill any chance of a trade deal. He is making it impossible for Xi to turn up for a G20 meeting. Kow-towing to Trump would totally undermine Xi’s standing in China.

Xi wants a trade deal that is a handful of empty promises, so the CCP can continue on their present course. The US wants an enforceable undertaking, so that the CPP is forced to change course. Chances of both achieving what they want are negligible.

Both sides need to guard against economic war (time to call it what it is) slipping into a full-scale conflict. All it takes is a spark that sets off tit-for-tat escalation where neither side will back down.

Proxies such as North Korea, Syria and Pakistan are especially dangerous as they are capable of dragging great powers into direct confrontation (think Serbia before WWI, Korea after WWII).

Wannabe great powers like Russia will also do their best to foment conflict between their larger rivals. Stalin achieved this with the Korean War in the 1950s and Vladimir Putin is more than capable of attempting the same. The world is a dangerous place.

Upside potential for stocks is declining while downside risks are growing. Investors are flowing out of equities and into Treasuries despite minimal yield (10-year yield is negative after inflation and tax).

Stocks are being supported by buybacks but that can only continue for as long as cash flows (from earnings) hold up. Buybacks plus dividends for the S&P 500 exceeded reported earnings by more than $100 billion in Q4 2018.

S&P 500 Buybacks, Dividends & Reported Earnings

That is unsustainable. If earnings undershoot, stocks will fall.

Posted on

S&P 500: Short-term versus long run

The market is excited at the prospect of Fed rate cuts (in response to the US-CCP trade war), with the S&P 500 headed for another test of its earlier high at 2950. A Trend Index trough above zero indicates short-term buying pressure.

S&P 500

Falling bond yields, however, warn of a flight to safety. 10-Year Treasury yields have fallen close to 120 basis points (bps) since late 2018, as investors shift from equities to bonds. Prices are being supported by stock buybacks rather than investor inflows.

10-year Treasury Yields

The Yield Differential between 10-year (purple) and 3-month (lime) Treasury yields is now negative, a reliable early warning of recession.

Yield Differential: 10-Year and 3-Month Treasuries

Corporate bond spreads, the difference between lowest investment grade (Baa) and Treasury yields, are rising. An indicator of credit risk, a spread above 2.5% (amber) is an early warning of trouble ahead, while 3.0% (red) signals that risk is elevated.

10-Year Baa minus Treasury Yield

Falling employment growth is another important warning. Annual employment growth below 1.0% (amber) would normally cause the Fed to cut interest rates. In the current scenario, that is almost certain.

Employment Growth & FFR

What is holding the Fed back is average hourly wages. Annual growth above 3.0% is indicative of a tight labor market and warns against cutting rates too hastily.

Average Hourly wage Rate

Stats for Q1 2019 warn that compensation is rising as a percentage of net value added, while profits are falling. As can be seen from the previous two recessions (gray bars), rising compensation (as % of NVA) normally leads to falling profits and a recession. Cutting interest rates would accelerate this.

Profits & Compensation % of Value Added

Annual GDP growth came in at 3.2% (after inflation) for the first quarter, but growth in hours worked is slowing. GDP growth is likely to follow.

Real GDP & Hours Worked

Personal consumption expenditure for Q1 was largely positive, with an uptick in services and non-durable goods. But consumption of durable goods fell sharply, warning that consumer confidence in the medium-to-long-term is declining.

Consumption

On the global stage, commodity prices are falling, indicating an anticipated drop in demand, especially from China.

DJ-UBS Commodity Index

Nymex crude is following, and expected to test support between $40 and $45 per barrel.

Crude Oil

Short-term prospects may appear reasonable, but the long-term outlook is decidedly negative.

In the short run, the market is a voting machine but in the long run, it is a weighing machine.

~ Benjamin Graham

Posted on

Employment lifts but S&P 500 tentative

Growth in total non-farm payrolls ticked up to 1.76% for the 12 months to April 2019, supporting Fed reluctance to cut interest rates.

Payroll Growth

The Philadelphia Fed Leading Index has been revised upwards, above a comfortable 1.0%.

Leading Index

Real GDP growth came in at a healthy 3.2% for the 12 months ended 31 March 2019 but growth in total hours worked sagged to 1.47%, suggesting that GDP growth is likely to slow.

Real GDP and Total Hours Worked

Growth in average hourly earnings came in at 3.23% (total private), suggesting that inflationary pressures remain under control. Little chance of a Fed rate hike either.

Average Hourly Earnings

The S&P 500 retracement respected support at 2900. Rising Money Flow indicates buying pressure but gains seem tentative.

S&P 500

US growth looks to continue but commodity prices warn that global growth is slowing.

Nymex crude penetrated its lower trend channel, warning of a correction. Despite the supply impact of increasing sanctions on Iran and Venezuela, and the threat of supply disruption in Libya.

Nymex Light Crude

A similar correction on DJ-UBS Commodities index reinforces that global demand is slowing.

DJ-UBS Commodities Index

Posted on

Australia’s irrelevant election

Satyajit Das spells out the challenges facing the Australian economy in the next decade:

The centerpiece of both major contenders’ campaigns are large tax cuts and significant government spending on infrastructure and welfare. Both parties pay lip service to sound public finance. But the sustainability of policies based on outbidding political opponents and financing permanent expenditure with impermanent revenues is questionable.

….This striking lack of control that Australia has over its economy is grounded in four factors.

….Sadly, no party’s manifesto addresses these fundamental challenges. Tax cuts will not reform a system which needs to be overhauled. Infrastructure spending provides a short-term increase in demand. Bad choice of projects and poor delivery, evidenced by the disappointing National Broadband Network which is over-budget and slow by the best international standards, may not enhance longer-term efficiency and productivity.

The narrowness of the economic base is ignored. No political party is willing to address over-investment in housing, the total value of which is around $6 trillion or around 4 times gross domestic product and constitutes a large proportion of household wealth. Encouraged by complex subsidies, capital is locked up in property, unavailable for more productive activities such as new industries. Leaders are reluctant to champion forceful structural reforms to improve education and skill levels as well as streamline regulation. Instead, all contenders seem happy to rely on windfalls to finance the nation’s living standards through ever shorter electoral cycles.

Worth reading the full article at Nikkei Asian Review

Hat tip to Macrobusiness.

Posted on

Nasdaq breaks resistance

Real GDP growth came in at a healthy 3.2% for the 12 months ended 31 March 2019. Growth in total hours worked is lagging below 2.0%, suggesting that further acceleration is unlikely.

Real GDP and Total Hours Worked

Growth in total non-farm payrolls continues at close to 2.0%, minimizing the chance of an interest rate cut by the Fed.

Payroll Growth

The S&P 500 is testing its previous high at 2940, while a rising Trend Index (13-week) indicates buying pressure.

S&P 500

The Nasdaq 100 broke resistance at 7700, signaling another advance. Expect retracement to test the new support level. The long-term target is 9000.

Nasdaq 100

A rapid advance would outstrip earnings growth, with high earnings multiples warning of elevated risk. The market is quite capable of continuing this behavior for an extended time but I urge readers to be cautious and look for rising sales and earnings to support the stock price.

Posted on

S&P 500: Expect slower earnings growth but no sign of recession

Credit growth in the US above 5% shows no signs of tighter credit conditions from an inverted yield curve. Growth in the broad money supply (MZM plus time deposits) has also not slowed, remaining close to 5%.

Credit Growth and Broad Money Supply

Growth in hours worked has slowed to 1.71%, suggesting that real GDP growth will dip below 2% in 2019 but remain positive.

Hours Worked and Real GDP growth

The Fed is unlikely to cut interest rates when average hourly earnings are growing at 3.2% (Total Private for the 12 months ended March 2019).

Average Hourly Wage Rate

The Leading Index from the Philadelphia Fed fell below 1%, giving an early warning that GDP growth will slow.

Philadelphia Fed Leading Index

A similar dip below 1% occurred ahead of the last three recessions. A second, stronger dip would warn of recession ahead.

Philadelphia Fed Leading Index

The S&P 500 is advancing to test resistance at 2950/3000, while the Volatility Index crossed below 1%, signaling that risk is no longer elevated.

Treasury Yields

Real GDP is likely to slow this year but remain positive. S&P 500 earnings growth is expected to slow and the index is likely to meet stubborn resistance at 2950/3000. The Fed is still a long way off cutting interest rates (a strong bear signal) and there is no sign of recession on the 2019 horizon. An extended top is the most likely outcome.

Posted on

Buybacks, interest rates and declining growth

The Fed did a sharp about-turn on interest rates this week: a majority of FOMC members now expect no rate increases this year. Long-term treasury yields are falling, with the 10-Year breaking support at 2.55/2.60 percent. Expect a test of 2.0%.

10-Year Treasury Yields

While the initial reaction of stocks was typically bullish, the S&P 500 Volatility Index (21-day) turned up above 1.0%, indicating risk remains elevated.

S&P 500

The reason for the Fed reversal — anticipated lower growth rates — is also likely to weigh on the market.

Stocks are already over-priced, with an S&P 500 earnings multiple of 21.26, well above the October 1929 and 1987 peaks. With earnings growth expected to soften, there is little to justify current prices.

S&P 500 Price-earnings (PEmax)

The current rally is largely driven by stock buybacks ($286 billion YTD) which dwarf the paltry inflow from ETF investors into US equities ($18 billion YTD). We are also now entering the 4 to 6-week blackout period, prior to earnings releases, when stock repurchases are expected to dip.

Why do corporations continue to repurchase stock at high prices? Warren Buffett recently reminded investors that buybacks at above a stock’s intrinsic (fair) value erode shareholder wealth. If we look at the S&P 500 in the period 2004 to 2008, it is clear that corporations get carried away with stock buybacks during a boom and only cease when the market crashes. They support their stock price in the good times, then abandon it when the market falls.

S&P 500 Buybacks
source: S&P Dow Jones Indices

Shareholders would benefit if corporations did the exact opposite: refrain from buying stock during the boom, when valuations are high, and then pile into the stock when the market crashes and prices are low. Why doesn’t that happen?

The culprit is typically low interest rates. It is hard for management to resist when stock returns are more than double the cost of debt. Buybacks are an easy way of boosting stock performance (and executive bonuses).

Treasury Yields: 3-Month & 5-Year

Corporations are using every available cent to buy back stock. Dividends plus buybacks [purple line below] exceed reported earnings [green] in most quarters over the last five years.

S&P 500 Buybacks & Dividends compared to Earnings

That means that capital expenditure and acquisitions were funded either with new stock issues or, more likely, with debt.

Corporate debt has been growing as a percentage of GDP since the 1980s. The pace of debt growth slowed since 2017 (shown by a down-turn in the debt/GDP ratio) but continues to increase in nominal terms.

Corporate Debt/GDP

Low interest rates mean that stock buybacks are likely to continue — unless there is a fall in earnings. If earnings fall, buybacks shrink. Declining earnings mean there is less available cash flow to buy back stock and corporations become far more circumspect about using debt.

S&P forecasts that earnings will rise through 2019.

S&P 500 Earnings

But forecasts can change. Expected year-on-year earnings growth for the March 2019 quarter has been revised down to 3.5%. Forecasts for June and September remain at 12.0% and 11.4% (YoY growth) respectively.

S&P 500 Year-on-Year Earnings Growth Forecast

If nominal GDP continues to grow at around 5% (5.34% in Q4 2018) and the S&P 500 buyback yield increases to 3.0% (2.93% at Q3 2019 according to Yardeni Research) then earnings growth, by my calculation* should fall to around 8.2%.

*1.05/0.97 -1.

With an expected dividend yield of 2%, investors in the S&P 500 can expect a return of just over 10% p.a. (dividend yield plus growth).

But the Fed now expects growth rates to fall by about 1.1% in 2019 and 1.2% in 2020, which should bring investor returns down to around 9% p.a. Not a lot to get excited about.

I knew something was wrong somewhere, but I couldn’t spot it exactly. But if something was coming and I didn’t know where from, I couldn’t be on my guard against it. That being the case I’d better be out of the market.
~ Jesse Livermore

Posted on

“Stocks rebound but sentiment soft”

From Bob Doll at Nuveen Investments. His weekly top themes:

1. We think the odds of a U.S. recession are low, but we also believe growth will remain soft for a couple of quarters. U.S. growth may bottom in the first half of 2019 following a relatively disappointing fourth quarter and the recent government shutdown. We expect growth will improve in the second half of the year.

Agreed, though growth is likely to remain soft for an extended period. The Philadelphia Fed Leading Index is easing but remains healthy at above 1.0% (December 2018).

Leading Index

2. Inflation remains low, but upward pressure is mounting. With unemployment under 4% and average hourly earnings rising to an annual 3.6% level, we may start to see prices rise. So far, better productivity growth has kept the lid on prices, but this trend bears watching.

Agreed. Average hourly earnings are rising and inflation may follow.

Hourly Earnings Growth

3. Trade issues remain a wildcard. The U.S./China trade dispute appears to be making progress, but the timeline is slipping and significant disagreement remains over tariff levels and intellectual property protections.

This is the dominant issue facing global markets. Call me skeptical but I don’t see a happy resolution. There is too much at stake for both parties. Expect a drawn out conflict over the next two decades.

4. We do not expect Brexit to cause widespread market issues. We think the risk of a hard Brexit is low, since no one wants to see that outcome. Some sort of soft separation or even a Brexit vote redo appears more likely.

Agreed. Hard Brexit is unlikely. Soft separation is likely, while no Brexit is most unlikely.

5. The health care sector may remain under pressure due to political rhetoric. Health care stocks in general, and managed care companies in particular, have struggled in light of talk about ending private health care coverage. We think Congress lacks the votes to enact such legislation. But this issue, as well as drug pricing policies, are likely to remain at the center of the political dialogue through the 2020 elections.

Health care is a political football and may take longer to resolve than the trade war with China.

6. Downward earnings revisions may present the largest risk for stocks. As recently as September 30, expectations for first quarter earnings growth were +7%. That slipped to +4% by January 1 and has since fallen to -3%.

A sharp fall in earnings would most likely spring from a steep rise in interest rates if the Fed had to combat rising inflation. That doesn’t seem imminent despite rising average hourly earnings. The Fed is maintaining money supply growth at close to 5.0%, around the same level as nominal GDP, keeping a lid on inflationary pressures.

Money Supply & Nominal GDP growth

7. Equity returns may be modest over the next decade compared to the last. Since the bull market began 10 years ago, U.S. stocks have appreciated over 400%. It’s nearly impossible to imagine that pace will be met again, but we feel confident that stocks will outperform Treasuries and cash over the next 10 years.

Expect modest returns on stocks, low interest rates, and low returns on bonds and cash.

Posted on

China slowdown

Consumer durable sales are falling sharply:

And from Trivium China:

Premier Li Keqiang reiterated that big stimulus isn’t coming:

“An indiscriminate approach may work in the short run but may lead to future problems.”
“Thus, it’s not a viable option.”
“Our choice is to energize market players.”

….It’s a decidedly different tack than the credit-fueled stimulus of yesteryear, and the practical outcomes of this new policy response are two-fold:

  • Given that it’s a new strategy, the transmission channels from policy to actual economic growth support are not well understood.
  • The one thing we do know – this approach will take longer to impact the economy than the credit-driven responses of previous cycles.

The bottom line: It will take China’s deceleration longer to bottom out than markets and businesses currently expect.

China’s stated intention is to avoid big stimulus, so a policy reversal, if we see it, would signal that the slowdown is far worse than expected.

Posted on

ASX 200 gravestone

Australian housing prices are falling.

Australia: Housing Prices

Fueled by declining credit growth.

Australia: Housing Credit growth

With falling contribution to GDP growth from dwelling investment, and mining investment shrinking….

Australia: GDP Contribution

GDP growth is expected to weaken further.

Australia: GDP growth

The gravestone candlestick on the ASX 200 weekly chart warns of selling pressure. The primary trend is down and the index unlikely to break through resistance at 6300. Expect a correction to test support at 5650; breach would warn of another decline.

ASX 200

I remain cautious on Australian stocks and hold more than 40% in cash and fixed interest in the Australian Growth portfolio.

Powered by WordPress / WordPress Maintenance Service By Website Helper