Weekly Update: Did you ever wonder who is kicking the can down the road?
This was a holiday-shortened week, but I still managed to make some special visits to Stamford, Conn., and beautiful Bedford Springs, Pa. In Connecticut, I added a new venue to my list of places where I have spoken—the lounge of a squash court. So, I now have spoken at a country club, a deli, art museum, department store, church, indoor golf facility, nursery (flowers), hospital, assisted-living facility, theatre stage (decorated for “La Cage aux Follies”), winery and a squash club lounge. Seems I only need an invitation to speak at a jail and my list will be complete—preferably a jail in Alaska, the only state I have not visited. The huge (this is an understatement) squash facility was very busy, filled with youngsters on “kiddie break’’ for the week, playing hard at squash, racquetball, hockey and, we were told, soccer and more on other floors. In the lounge, we were exercising our minds, and I spoke with an extremely friendly group of lawyers, CPAs and other small businessmen. (I even saw a priest in the group, although that certainly didn’t require me to change my message or style of presentation.)
In our discussion, a banker told me about the very successful, wealthy businessmen with whom he deals who, although they are having a great couple of years, refuse to hire. One lawyer noted that technology has allowed him to grow his business nicely while holding the lid on hiring. This is a long-term structural issue few are really talking about—the replacement of workers with technology. You may recall a mention in a piece I did late last year of a study by 13D Research that concluded creative destruction will drive job loss in the next 20 years in a variety of ways: the power industry through microgrids, transportation via autonomous self-driving vehicles, education through technology-based self-teaching, manufacturing via 3D printers, and robotics virtually everywhere. Some of this may already be reflected in the unemployment rate, which remains stubbornly high and well above the 6.5% target that Fed policymakers have suggested would warrant a pullback from unprecedented easing. Of course, how closely the Fed policymakers will hew to this guidance appears to be a matter of debate within their tight circle.
While minutes released this week from late January’s Federal Open Market Committee (FOMC) meeting judged the recovery in the labor market to be “far from complete,’’ they also said “many participants” were less supportive of quantitative easing than the capital markets had expected. A significant amount of space was devoted to discussion of the potential costs of QE, including inflation risks, financial imbalances, capital losses during exit, and impairing financial market functioning. You mean the Fed doesn’t have this figured out? This is a worry for the markets. “Many” is a qualifier that is not used lightly in the minutes and we should take it seriously. Wednesday’s release of the minutes sparked the biggest down day in the equity markets this year. The lack of any real movement on the sequester, which kicks in March 1 (more below), raised further questions about the odds of kicking that can (how many cans are there???). The market’s latest up move has come on very narrow trading, a sign of a lack of conviction, and on expectations the Fed and Congress will keep kicking the can. If those expectations are disappointed, then the market may disappoint, too. We’ve been saying a correction is likely at some point. Sell in March and go away? March is next week!
Positives
Are housing inventories too tight? January existing home sales rose more than 9% year-over-year, and the only region where sales fell was the West, where the National Association of Realtors said inventory constraints impeded buyers. Nationally, the supply of existing homes is at its lowest level in 13 years. Even so, January housing starts surprisingly plunged, though the drop-off was concentrated in the multifamily sector that had soared the month before. Building permits rose, as did single-family starts, which are up 20% over the last 12 months. While builder sentiment also slipped on reduced buyer traffic (which was concentrated in the South and likely reflected bad weather), it remained near a seven-year high. Housing should be a key contributor to subdued GDP growth this year.
It’s too early to worry about inflation Year-over-year core PPI slipped to 1.8% from 2.0% in January, reflecting disinflation, while headline CPI was unchanged for a second straight month and year-over-year core CPI held at 1.9% a third straight month. Core prices likely will feel some upward pressure in coming months as energy costs appear to be rising again, led by gasoline (more below); new and used vehicle prices also are climbing. Still, this benign inflation picture gives Fed policymakers plenty of reason to talk about removing the punch bowl but do little anytime soon.
The benefits of energy independence Energy imports, which nearly tripled from 1995 to 2005, have subsequently retreated by 18%. Energy exports, which languished for 26 years, have soared 127% over the past six years. As a result, the ratio between imports and exports has plunged to 2.8 times, the lowest since 1982. The closing of this gap has significantly lessened the impact of rising oil prices, which are up $10 since mid-November, on the economy. The rule of thumb is each $10-per-barrrel increase in crude prices shaves GDP growth in oil-consuming nations by 0.1 to 0.5 percentage points in the ensuing quarter; the U.S. now falls at the lowest end of that range.
Negatives
It’s not too early to worry about higher gas prices AAA says the average price for a gallon of regular gasoline jumped nearly 50 cents in the past month, the fastest increase since 2005. It blamed refinery maintenance and shutdowns, decreased production from Saudi Arabia, unrest in Iraq and Iran, and economic recovery prospects in Europe, China and the United States. Coming on top of the reinstatement of the 2% payroll tax, the spike in prices at the pump is weighing on consumers: falling consumer sentiment was the biggest negative in January’s in-line 0.2% increase in the leading indicators. Wal-Mart, Kraft Foods and other leading retailers are lowering sales forecasts on expectations that the hit to discretionary income will prompt consumers to curtail spending.
Manufacturing’s momentum slows The Markit U.S. PMI dipped modestly below expectations in February, although new orders and employment components remained entrenched in expansion territory and output hit a two-year high. The Philly Fed’s manufacturing gauge was more negative, contracting much more than forecast in February. But the details were not as weak as the headline. Employment rose, shipments strengthened and the six-month outlook improved. One of the biggest headwinds continues to be a lack of business investment, which fell longer and harder than all prior post-war recessions and remains well below the cyclical norm.
Europe and China disappoint The euro-area manufacturing and services PMIs unexpectedly slipped in February, indicating eurozone GDP will contract 0.3% in the current quarter. The ZEW gauge of German investor expectations did surge in February to nearly a three-year high, beating expectations, but the current situation component declined, providing downside risk to the main measure of consumer sentiment, the IFO survey. In China, retail sales data from the Ministry of Commerce showed spending during the week-long Lunar New Year break grew at their slowest pace since 2009.
What else
Washington’s ‘theater of the absurd’ Encima Global notes the FOMC has the authority to borrow $85 billion a month (or any amount it chooses) to invest in its choice of assets, at a time when President Obama and the rest of the government is tying itself in knots over cutting annual spending of that amount. The sequester that would start March 1 would lop $85 billion off a $3.6 trillion spending program, or only 2% off the federal budget. Maybe that’s why it’s not getting a lot of traction with the public. In one poll, when asked which definition best applies to “the sequester,” only 36% of likely voters knew what it was; 25% said they weren’t sure; and the rest guessed wrong.
It’s premature to call it a ‘great rotation’ There is no evidence yet supporting talk of a “great rotation” out of bonds into equities. While year-to-date inflows into equities total $33 billion, a U-turn from the past five years and a nine-year high, year-to-date inflows into bonds have been an even stronger $39 billion. This continues an unabated five-year trend that has seen $1.1 trillion flow into bond funds, a record by an incredible margin.
I resemble that remark NBC reports on a study that finds women speak on average 20,000 words per day—17,000 more than men.
