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Analysis of the global economy
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.
From Markit Economics, released February 3rd, 2014:
The strong upturn in manufacturing production was maintained in January, as companies scaled up output in response to stronger inflows of new orders. There were reports of improved demand from the domestic market and rising levels of new business from overseas…..
Read more at Markit/CIPS UK Manufacturing PMI: Strong UK manufacturing rebound continues.
Warren Mosler, from a talk in Chianciano, Italy, on January 11, 2014 entitled Oltre L’Euro: La Sinistra. La Crisi. L’Alternativa.
What a good economy should look like
I just want to say a quick word about what a good economy is because it’s been so long since we’ve had a good economy. You’ve got to be at least as old as I am to remember it. In a good economy business competes for people. There is a shortage of people to work for business. Everybody wants to hire you. They’ll train you, whatever it takes. They hire students before they get out of school. You can change jobs if you want to because other companies are always trying to hire you. That’s the way the economy is supposed to be but that’s all turned around. For one reason, which I’ll keep coming back to, the budget deficit is too small. As soon as they started tightening up on budget deficits many years ago, we transformed from a good economy where the people were the most important thing to what I call this ‘crime against humanity’ that we have today……
So what you do is you target full employment, because that’s the kind of economy everybody wants to live in. And the right size deficit is whatever deficit corresponds to full employment…….
Read more at Beyond The Euro: The Left. The Crisis. The Alternative | New Economic Perspectives.
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 followed Patrick Chovanec on Twitter for several years and really enjoy his insights. His latest Quarterly Report for Silvercrest Asset Management is no exception.
For the past several decades, the U.S. has served as the world’s consumer of last resort. That allowed developing countries – namely Japan, and later China – to turbo-charge growth by producing more than they consumed, confident in the knowledge that Americans would provide the demand by consuming more than they produced. (A parallel pattern emerged within the EU, with Germany playing net producer and the rest of Europe net consumer). The surplus countries kept the game going by taking their export proceeds and lending them back to their customers so the deficit countries could keep buying. This is the global growth model we all became comfortable with……
Listen to most market commentators: while they may say that the financial crisis showed us the error of our ways, their every word belies a tacit wish to return to the world we knew before 2008. “When,” they ask, “will the U.S. consumer start spending again? When will Chinese output get back on track?” Europe, they dare to hope, will turn out okay as long as more countries learn to imitate Germany. Maybe a cheaper Yen will give a renewed boost to Japan’s exports.
These hopes are misplaced. We’re not going back to the past. The old growth model is broken. Here’s what will replace it…..
Read Patrick’s outlook at SILVERCREST ASSET MANAGEMENT GROUP LLC 1Q 2014: Desperately Seeking Demand
Hat tip to Leith van Onselen at Macrobusiness.com.au
This discussion on SBS Insight from April 24th, 2012 covers the Australian manufacturing dilemna:
There are three major costs in manufacturing: material costs, labor costs and other operating expenses. Roughly equal in size. Material costs are roughly the same, whether you are in Australia or China. Labor costs are radically different, with labor costs of $15 compared to $1 in China. But Australia also can’t compete on other operating expenses, which are far higher because of the labor cost and related benefits…….I can’t see why Australia hasn’t got the sense to turn around. We have been on this path for 30 years…
~ Peter Rodeck, Australian manufacturer EnvironData.
The S&P 500 followed through above 1810, signaling another primary advance. Troughs high above zero on 13-week Twiggs Money Flow indicate strong long-term buying pressure. Short corrections such as the recent retracement are normally followed by strong gains, but there is no reliable method calculating targets in an accelerating up-trend. The target of 1910* calculated by the conventional method may well underestimate the advance.
* Target calculation: 1810 + ( 1810 – 1710 ) = 1910
My favorite bellwether, transport stock Fedex, is surging ahead on the monthly chart, suggesting a strong recovery for the US economy in the year ahead.
CBOE Volatility Index (VIX) readings below 20 also suggest a bull market.
When the Deutsche Bank AG equity strategist [John-Paul Smith] looks at the country [China], he says he detects some of the same signs of a financial meltdown that led him to predict Russia’s 1998 stock market crash months in advance. China’s expansion is being fueled by soaring corporate borrowing, a high-risk model that needs to be replaced by the kind of free-market measures and budget cuts that fed Russia’s growth in the aftermath of the country’s default and subsequent 44% monthly tumble in the Micex Index, Smith said.
There is potential for a debt trap in industrial companies which can trigger an economy-wide financial crisis as early as next year, Smith said in an interview from London on 12 December, a day after he issued a report predicting China’s slowdown will lead to a 10% decline in emerging-market stocks next year. “If I am wrong on China, I am wrong on everything.”
Read more at Russia 1998 crisis haunts Deutsche Bank analyst seeing China bust – Livemint.