Weekly Update: It's spring—time to worry?
Will the upcoming first-quarter earnings season that kicks off Monday be a disappointing one? The answer won’t really be known for a while, making the biggest problem for this tape the news vacuum facing investors over the coming two weeks. (This news vacuum is being mentioned a lot). The breadth of pessimism by management is pronounced, with the negative-to-positive earnings preannouncement ratio at its highest level since 2001 and a quarterly accounting of corporate guidance near previous lows. In prior earnings seasons, we saw a steady decline in estimates as each quarter-end approached, and these downward revisions opened the door to positive surprises once earnings season began. That doesn’t appear to be happening this time. Also, Dudack Research’s industry price-momentum model revealed an extreme level of positive momentum at the end of March, suggesting this is “as good as it gets” before a correction ensues. Last year’s correction started on April 2 and resulted in a nearly 11% move lower into June. Ironically, this year’s peak (so far)—and new closing high—also was on April 2. Miller Tabak, in fact, says 2013 is shaping up eerily similar to 2012. If we take the low on Dec. 30, 2011 to the high on April 2, 2012, the S&P 500 rallied 13.12%. If we take the Dec. 31, 2012 low to this past Tuesday’s high, the S&P rallied 12.56%.
Although March’s ISM manufacturing gauge disappointed, it still marked a 43rd straight month of expansion. Goldman Sachs says the expansion’s duration is impressive—since 1950, there have been only two that were longer (52 months from September 1962 to January 1967 and 48 months from August 1975 to August 1979). It also notes the S&P has posted negative annualized returns in only one of the 11 business-cycle expansions that lasted more than 20 months, when the index was down 3.9% per annum during the 29 months from August 1967 to January 1970. With competing factors at play, there are reasons to expect the recent market choppiness to continue. On the one hand, the resolution to the fiscal cliff has delayed the tax refund process; 2013 refunds continue to trail the prior two years, and retail gasoline prices dropped 12 cents in March, a month they typically increase. Both could provide tailwinds to consumer spending. On the other hand, sequestration still looms, likely resulting in further slowing in hiring on top of March’s plunge (more below). Perhaps the seasonal pattern in both the U.S. economy and stock market has more to do with the seasonal pattern of the European financial crisis. Since 2010, it has tended to flare up during spring and early summer, depressing economic and market confidence around the world. Then European leaders scramble to devise another Grand Plan just in time to enjoy their month-long vacations in August.
And here we go again, with Cyprus as the most recent epicenter of the European crisis. The two Cypriot banks at the heart of the country’s troubles in effect were proxies for Greece, as they had held large quantities of Greek sovereign debt. After the troika (European Central Bank, European Commission and International Monetary Fund) imposed haircuts on Greek debt as part of its bailout, the two banks reportedly suffered combined losses equal to 24% of Cyprus’ GDP—this even though both banks had passed 2010 and 2011 stress tests. If these tests were meaningless, and eurozone sovereign debt is not guaranteed, and banks throughout Europe hold much of that debt, then no banking system is really safe because depositors now know they might be on the hook for future bail-ins. This has very important implications because the banking systems of Spain and Italy hold very high levels of sovereign debt, much of it bonds of their home countries. In my travels, I have been saying there is every possibility that Spain and/or Italy will become a summer issue again. As I sit in my Pittsburgh office this morning, I welcome the warmer temperatures and sunny skies that have been missing for too long. Spring is finally here (!) … Uh-oh.
Vehicle sales revving up More new cars and trucks were sold in March than in any other month since 2007, and annualized vehicle sales averaged 15.3 million in the first quarter, 7.4% above the Q4 level. Moreover, consumer spending is likely stronger than it looks. Renaissance Macro notes last year’s fourth quarter saw the steepest drop in household utilities spending since 1990. So, headline spending looks artificially weak because consumers are spending less on energy goods. That frees up money to spend on other items, such as cars.
Construction spending rebounds It increased more than expected in February and, excluding volatile residential improvements, regained most of its January losses. There was continued strength in residential spending ex-improvements, and trend growth in private spending remains strong—a booming 19.2% year-over-year for residential and 6.1% for nonresidential. But public sector spending is down 1.2% year-over-year, led by a 10.5% drop in federal construction. This isn’t likely to get better anytime soon given the sequester.
A capex catalyst As of 2011, the average age of U.S. capital equipment was 5.8 years and the average age of U.S. manufacturing plants was 15.5 years, the oldest on records dating to 1965. Although capital expenditures have increased, they’re still at a historically low 10.5% of GDP, vs. a previous high of 14%. For many reasons, including a budding manufacturing and energy renaissance, ISI says capex’s share of GDP could move back up to its previous peak of 14% over the next five years. If this occurs, it would be very positive for employment and GDP growth.
March jobs disappoint Nonfarm payrolls rose just 88,000, though there were significant upward revisions (61,000) to the prior two months. The fact temp hiring was solid despite the overall soft tone gives some optimism the stall will be short-lived. Average weekly hours also rose. But the biggest decline in its employment component in four years was a major reason the March ISM services index surprised, falling to a still expansionary seven-month low of 54.4. Services account for 80% of payrolls. Once again, the jobless rate declined (7.6% vs. 7.7%) for the “wrong” reasons. Labor force participation fell to its lowest level since 1979! And the employment-population ratio (a metric oft-cited by Fed Chairman Bernanke) fell to a very low 58.5%. Dovish policymakers have cited the need for this series to meaningfully recover before they would consider tapering asset purchases.
Dollar’s export threat February’s trade gap unexpectedly narrowed in part on an export rebound—exports have been one of the economy’s bright spots, accounting for more than 40% of GDP growth the last three years despite representing less than 15% of total GDP. But 13D Research cautions this may not last, as simultaneous efforts by the Bank of England and Bank of Japan to reduce the value of their currencies, and prospects for a weaker euro, could drive the dollar up. Exports already have slowed dramatically, from a 15%+ growth rate in early 2011 to less than 3% growth in Q4 2012—a contraction that coincided with a rising trade-weighted broad dollar index. If a stronger dollar puts a lid on export growth, what else will the economy depend on to generate jobs and growth?
The elephant in the room The effects of a rapidly aging population on the U.S. budget are just starting to be felt. The Congressional Budget Office estimates the annual budget deficit will begin rising again (in dollar terms and as a percent of GDP) after 2015 partly as tens of millions more beneficiaries are added to the roles of Medicare and Social Security, and partly by rapidly rising interest expenses. About 75% of the future increase in Medicare spending will be due to the effects of aging and growth in the number of beneficiaries. A dangerous development from high deficits and rising interest rates is the growth of interest expense. At 20% of last year’s total deficit, this is the budget’s fastest-growing line item.
For better and worse Though the U.S. economy faces its share of challenges, what has gone largely unnoticed is the extent to which its global competiveness has improved. A new report says U.S. unit labor costs have grown much more slowly relative to other major economies. For example, after rising at about the same pace as Germany from 1950 to 1992, they have fallen 23% since while Germany has been flat … Falling labor costs haven’t been as kind to workers at the bottom of the pay and skills scales. The U.S. Census Bureau puts the number of Americans in poverty at levels not seen since the mid-1960s when President Johnson launched the federal government's so-called War on Poverty. Nearly 50 million Americans—one in six—are living below the income line that defines poverty, $23,021 for a family of four. The bureau said 20 percent of the country's children are poor.
Blame Baxter The humanoid-looking robot with a can-do attitude may one day replace assembly-line workers all around the world and make cheap labor redundant; it costs only $22,000 and works 24/7 without any complaints. No wages and benefits are necessary, just some WD-40 occasionally. It is estimated to cost $4 an hour to operate, well below the minimum wage. Last October, Boston-based Rethink Robotics started selling Baxter, which can be trained to handle manual assignments and carry out simple on-screen computer tasks, such as loading, machine operation, light assembly, sorting and inspecting, and packing and unpacking.
Light’s out Look at a picture of the earth at night. When you find South Korea and Japan, you will see a high concentration of lights. You will notice that the line of light runs straight across the Korean peninsula and north of that line there is darkness—that’s North Korea.