Weekly Update: Congratulations!
In these next few weeks, I will be celebrating the graduation of one child from high school and another from college. They are among the 86 million millennial cohort, the largest demographic group this country has ever produced, including baby boomers like me. They represent our hopes for the future and, despite a reputation as self-obsessed slackers (the same was said about baby boomers), there are a lot of reasons to believe they will fulfill them. A recent Barron’s cover article concludes this generation’s influence could approach that of their baby-boom parents. In its latest edition, a Time magazine cover story went further, calling millennials the “next greatest generation.’’ The headline and subhead were particularly telling: “The Me Me Me Generation. Millennials are lazy, entitled narcissists who still live with their parents. Why they’ll save us all.’’ A new book by former Education Secretary William Bennett questions whether a college degree is worth it for most young people. I would say you bet your life it is. The issue is matching that diploma with the jobs of a 21st century global economy. There’s no doubt the past several years have been difficult as college students have graduated with record debt loads and into the most inhospitable labor market since the great Depression. But there are signs the job market is improving (more below). And the National Association of Colleges and Employers said businesses expect to hire 2.1% more graduates than they did a year ago, the best showing since 2007.
I’m reading a lot of commentary about a stock market bubble. If there is a risk of a bubble, it would be tied to the fact that too many investors believe the Fed’s actions guarantee a higher stock market. There is evidence to support the “don’t fight the Fed” mantra. Stocks tend to do well when the Fed is increasing its balance sheet as the money and credit flow into the economy and stimulate activity. But all the Fed’s quantitative easing since 2008 has failed to produce substantial GDP growth. In short, the more equities are driven higher by Fed policy rather than earnings growth, the greater the risk a bubble may be forming. Valuations suggest this worry is premature. Over the past 50 years, the sum of inflation and the P/E has averaged around 20, creating the so-called “Rule of 20.” So if inflation stays around 2%, then the P/E would normally be 18, well above the current forward P/E on the S&P 500 of around 14.5. Miller Tabak notes the S&P has yet to correct 4% or more this year—since 1980, there has been only one year that did not see at least a 4% correction by May. That was 1995, which the S&P in 2013 so far is tracking. Through May 8, 1995, the S&P was up 14.09% year-to-date. As of May 8 this year, it was up 14.48%. If we extrapolate the return from 1995, which rose 34% on the year, the S&P is on pace to hit 1,900! One major difference is 1995 followed a slightly down year—1994 lost 1.55%. The S&P gained over 13% last year. In other words, there was lots of pent-up demand from a lackluster 1994, likely adding fuel to the fire in 1995. We cannot say the same about 2013.
What’s the next catalyst? That is the question everyone is asking as bulls and bears alike search for “the event” that will prompt a pullback, JP Morgan observes. Even those positive toward equities are reluctant to chase prices at present levels and insist a 3-5% dip is needed before reengaging on the long side. The bear camp (which remains very large) continues to view the rally as nothing more than a mirage destined to end in tears. The problem is there just aren’t many major catalysts on the calendar for the next few weeks (and maybe even the next couple months). Equities will require some rest occasionally and can be accused of being tired at times but rotations (such as we’ve seen for months) can refresh just as well as a broad sell-off can. The burden of proof appears to be on the bears for now as simply maintaining the present narrative will be enough to reinforce an ongoing steady grind higher. Ned Davis Research says its work suggests we’ll have a sideways market in the summer, but low yields suggest there are not a lot of places to hide in the fixed-income world or cash. The bears will have to pick their poison. The bears might benefit from walking along a college campus where this optimism is infectious!
All roads lead to jobs Initial jobless claims fell again this week, dropping the four-week average to its lowest level since November 2007. The data indicate the pace of layoffs is easing despite an apparent slowdown in real GDP growth in the current quarter, a sign companies see the slowing as somewhat temporary and are responding by cutting hours and hiring at a less rapid pace—both of which were evident in the April employment report—rather than increasing the pace of layoffs. The one caveat is jobless claims only look at job losses, not job creation. But the latest Job Openings and Labor Turnover Summary (JOLTS), also released this week, showed openings rising from December to March. Combined with the downward trend in claims and April’s upward employment revisions, this counters claims that the economy is slowing much.
Banks ease loan standards There was a much more pervasive easing in the three months through mid-April than in the prior three months, according to the Fed’s Senior Loan Officer Survey. Notably, about a fifth of banks eased standards for commercial & industrial loans, including real estate and small businesses, where C&I loan standards were their most lax since 2005’s second quarter. Standards for household loans also eased, although not so broadly. Banks attributed the easing to increased competition among banks, with their willingness to make business loans near a record high and to make consumer loans at elevated levels. The broader easing and increased competition indicates the Fed’s accommodative policy is beginning to trickle down through banks to customers.
Global green shoots Germany industrial production rose a seasonally adjusted 1.2% in March, well above the consensus expectations for a slight decline; February production was revised up, as well. On the other side of the globe, China’s export growth unexpectedly accelerated to 14.7% year-over-year in April, up from 10% in March. The consensus was looking for a marginal slowdown. Improvements in Asia's and Europe's leading economies would represent another problem for the bear case.
All roads lead to jobs Renaissance Macro notes that, in a healthy labor market, you want to see hirings and separations rise. That is, firms have the confidence to add to staffing levels while workers have the confidence to leave their jobs in search of new, and presumably better paying, ones. Unfortunately, the latest JOLTS report shows while openings were up, private-sector hirings fell 4.2% in March and were down 4% year-over-year to 3.967 million. So, how is it that employment managed to pick up? At 3.92 million, separations were even lower. It is hard to see separations declining any more at this stage; thus, stronger employment growth will require a faster pace of hiring in coming months.
Overextended and overwrought The S&P is now 13.4% above its 350-day moving average—it has never been more extended since this rally commenced in March 2009. In fact, the S&P has not been as overbought since the peak of the Great U.S. Stock Bubble, when the S&P hit 16.37% above its 350-day moving average for the week of March 24, 2000. Even as the S&P has hit new highs, Bank of America/Merrill Lynch clients were net sellers of U.S. stocks for the sixth consecutive week.
Unintended (not unanticipated) consequences Since all of the net hiring that takes place in the economy is from small businesses and start-ups, the Affordable Care Act is probably already having a material negative impact on employment, research firm Cornerstone Macro says. That’s because workers who do not have health insurance overwhelmingly work for small and medium-sized firms, often in low-wage jobs, and uncertainty over the law’s impact is causing many of these firms to be cautious in their hiring, in part because some will face higher costs.
All roads lead to jobs April’s headline number of 165,000 new jobs may be enough to move the market higher but it could prove a hollow victory. While April’s jobless rate edged down to 7.5%, the U6 rate increased from 13.8% to 13.9%. While the year-over-year rates of change in both the establishment and household surveys turned up, both remain below their long-term averages and neither the employment population ratio nor labor participation ratio improved. After revisions, the three-month average of job growth rose to 211,670, yet there are 2.6 million fewer jobs today than at the December 2007 peak. Average weekly earnings are rising, but the 1.7% year-over-year rate is barely keeping up with inflation. And wages now represent less than 52% of personal income, down from the 67% at the end of 1967; transfer payments represent 17.9% of personal income, up from 7.2% at the end of ’67. In short, the U.S. needs much better job and wage growth to keep incomes, corporate revenues and earnings rising in 2013.
Debt-ceiling drama likely to be on hold this summer Through April, tax revenue is coming in above expectations and spending is coming in below expectations before sequestration cuts actually take hold. And the deficit is falling quickly, down $300 billion over the past year. The 12-month rolling deficit now stands at $857 billion, nearly the level the CBO is forecasting for the entire fiscal year ending in September. Throw in the expected Fannie Mae and Freddie Mac repayments and we could get a $150 billion to $200 billion reduction in the deficit from current expectations, pushing back the debt ceiling and causing Congress’ appetite for tax and entitlement reform to wane.
Room to run The replacement cycle is a powerful force for the auto sector. The average vehicle can last for about 200,000 miles over its lifetime of about 16 to 20 years. With an average of 3 trillion miles driven, the units “consumed” each year should support at least 15 million in annual sales. We can, therefore, think of this as the “replacement” rate. Auto sales have been well below this pace for the past five years.