Satya Pradhuman founded Cirrus Research in 2007 after more than 20 years on Wall Street as an executive in the equity research departments of E.F. Hutton, Lehman Brothers, and Merrill Lynch.
Harlan Levy: Does the December jobs report - a disappointing 74,000 gain, not the expected 197,000 - and weak retail sales temper optimism about the economy in 2014 prompted by fewer initial unemployment claims, record exports, good consumer spending, hefty corporate profits, and the hot stock market?
Satya Pradhuman: What the weak jobs report does suggest is that whatever interest rate risk investors were expecting has just been tempered by the soft jobs report.
What we continue to see is very soft loan-growth data. This is consistent with a slower jobs recovery. The reality is we do have some form of recovery that is under way. But it has never been a very robust recovery, nor do we expect this to change very soon.
In many ways, we were surprised by the tapering by the Federal Reserve, [of its monthly purchases of Treasury bonds and mortgage-backed securities] because of how soft the corporate loan data have been.
Generally, the jobs report is consistent with the overall economic backdrop. The reality is that in a soft recovery you're going to see the jobs data come in fits and starts. So we would not be surprised if the subsequent jobs report appears to be more robust and then a repeat of a softer patch again.
What I believe is underneath the weak loan environment is that business owners are not willing to take on more risk, and their visibility for growth remains poor, which limits the need to borrow, and therefore the increase in hiring.
HL: Actually, where are the jobs?
SP: I think the jobs are in the medical areas, information technology, and more administrative jobs.
HL: The labor participation ratio at 62.8 percent is the lowest in 35 years. What do you deduce from that?
SP: Embedded in that number is the latest stage of the baby boomers retiring. That may be playing a role in this ratio. Some of it is that if you're discouraged and nearing retirement, you may make that decision sooner. So it's not a clear data point.
HL: How serious a headwind for the economy is the current inequality between the rich and the poor and unemployed?
SP: I think income inequality can hinder the sluggish recovery. The inequality that we've seen has been increasing for 30 or 40 years. To some degree this is a secular issue, not necessarily something that was exacerbated just by this last recession.
That said, the unemployment data will likely remain soft because of the rise in inequality. It makes it tougher, but I don't have a good answer as to how serious it is, but we do know inequality will continue to retard growth.
HL: Do the latest data make it unlikely that the Fed will quickly pull back its monthly purchases more than the newly announced $10 billion drop?
SP: Even if the jobs data were stronger this reporting period, it was unlikely to increase the amount of tapering. Therefore, this weaker jobs report can only support a very easy-money environment. This will have a twofold result: allowing interest rates to remain low, and forcing investors further onto the risk curve. Therefore, riskier assets like equities will continue to inflate. You're not going to continue to buy bonds, and therefore you'll chase stocks. By definition, less risk means bonds, not stocks. I don't know if stocks are less risky when interest rates are low, but I do know that stocks are riskier assets compared to bonds.
HL: If the Fed's monthly bond and equity purchases continue for a long time, what does that do to the economy?
SP: On the margins we'll continue to see a steady economic recovery, because a low-rate environment will support that.
But there may be some unintended side effects because of the extended easy-money policy. It could lead to an over-inflated housing market. It could lead to an overly speculative stock market. Those could be examples of unintended consequences.
One area that could also see some sort of adverse reaction would eventually be inflation. I don't think it's likely, but it is certainly a possibility. The traditional interpretation of easy money is typically inflation, because the economy gets overheated. But this time around we have such an extended disinflationary period an inflationary spike is less likely.
HL: Do you see a surge in mergers and acquisitions this year and beyond? If so, what might be the result, more job cuts?
SP: We're seeing an increase in M&A activity. However, the overall deal flow has been slow. We think part of the reason for the softer-than-expected M&A background is the result of very slow loan activity. In order to see a robust M&A environment, private equity investors need to utilize leverage. Currently, loan activity remains soft.
HL: What do you see happening to the 10-year Treasury bond yield now hovering around 3 percent, and what's the probable effect on equities?
SP: We believe that while the Treasury yield will remain around 3 percent with a slight upward bias, we think that the volatility of interest rates will continue to rise. That will create a challenging backdrop for certain kinds of equity investments.
If we see the rise in volatility in interest rates, one of the side effects will be the high-dividend-yielding stocks will be penalized. In the summer of last year, we wrote a short comment for our clients who are equity investors asking if they knew their bond beta, how susceptible they were to the rising interest rates and the volatility. One of the side effects is that when you see rising rates or rising volatility, higher-yielding dividend equities under-perform. We saw that in pretty dramatic fashion in 2013. When the chatter on Fed tapering increased in the summer we saw a back-up in yield and a sell-off in high-dividend strategies.
HL: What are the strongest sectors of the equity market and the weakest?
SP: Examples of areas where we think there should be fundamental strength are some select groups in technology, like semiconductors and the overall financial sector. The credit markets will continue to improve, so regional banks and smaller investment banks look good and some areas in the housing sector, such as home builders and construction and engineering. In addition, the human resources companies should also do well.
Where we see some added stress is in some of the home-related retailers, specialty retail, trucking, and a few consumer staple groups like beverages and restaurants.
HL: What do you see happening in the stock market?
SP: Generally, we think the stock market will continue to rise. As I look out there's still a constructive outlook. There is some volatility in these opening months of this year, because it has had such a sharp rise in the past 18 months.
HL: Do think Congress is a big negative factor retarding a robust recovery?
SP: I think. The lack of clarity in Washington will continue to retard growth.
HL: What's your biggest fear about the economy?
SP: It does go back to risk-taking. My concern is that business owners will continue to sit on their hands by not choosing to take on projects to grow. Therefore, loan activity will remain soft, and so too will the jobs data.