By Jack Rivkin
Employment, GDP, Geopolitics, Oil, US Politics and Market Expectations
The markets are no longer one-way markets. Expect dispersion to increase.
The employment numbers at 320,000 last Friday beat almost all expectations-even ours (we had a 287,500 number in the CNBC #nailthenumber contest. This is a Twitter exercise that occurs every month and certainly focuses one's attention on this variable. The reward is a CNBC hat signed by the on-air personalities. You don't have to take the hat.).
The second estimate of GDP for the third quarter at 3.9% - an increase from the first estimate also surprised most.
And, the OPEC (Saudi Arabia) inaction accelerated a decline in oil prices and raised the odds of financial accidents in the oil patch and globally in Russia, Venezuela (and Cuba), and Iran. See "OPEC and the Logic of Lower Oil Prices."
Geopolitically, Putin's annual "State of the union" speech, was very nationalistic, anti the west, and hinted at the tough times ahead while Russia tries to re-establish its empire in the face of falling oil, falling ruble and rising expectations for the rate of GDP decline. This is against a backdrop of supposed sufficient financial reserves to withstand at least a year of reduced oil revenues and the re-financings of sovereign and corporate debt. We next may hear a questioning of the reserves. At the same time China is using the expectations of lower growth rates to take some steps to re-adjust its economy while establishing itself as a major force in the global economy with increasing global transactions occurring in Yuan. The question is whether China's effort is to strengthen or weaken the currency in the face of mostly declining currencies elsewhere vs. the US dollar. The recent trade numbers reflect lower growth patterns internally and the benefit of lower oil prices, but could portend the beginnings of a major shift strategically in the quality of China growth. The Middle East continues to boil, with Israel entering the picture with forays into Syria.
The noise out of Washington after the mid-term elections has turned from the few calls for bi-partisanship to acrimony. This does not bode well for a smooth path to funding the government.
In the meantime, with some increased volatility, the S&P 500 tries to push to new highs even though most measures of valuation are a bit stretched and earnings dispersion is increasing. The hint of QE actually happening in the Eurozone as well as talk of major infrastructure spending draws investor interest on certain days of the week.
Re the economic numbers: I think one has to be a little careful about declaring victory on the jobs front or GDP growth. 320,000 is the first estimate of the seasonally adjusted jobs number for November. An early start to the holiday retail season could have had an effect with hiring taking place earlier than historically has been the case, pushing up the early data. It was encouraging that the September and October numbers were revised up. This has historically been the case as discussed in "Past Performance is not…". And the Quit Rate in this most recent JOLTS report was close to an interim high going back many years. The Quit Rate could stop going up if companies start raising wages to retain workers. The wage gains at 0.4% were a step up and in that direction. These are all indications of a labor market tightening, which could very well result in some language change, i.e. "considerable time…" in the next Fed missive. However, I wouldn't be surprised if the forthcoming revisions on the jobs front are down and there is some payback in the December employment report. December is also a significant seasonal adjustment month. In reality, employment is usually down in December with seasonal adjustments typically bringing the adjusted number to a positive report, oftentimes, with strange results. If we continue to see good numbers, then we really have a tightening market.
I put the US 3Q GDP number in the same camp as the employment numbers - a little too good to be totally believed. We could continue to get surprised by the trade numbers with the lower cost of imported oil. And the near term dollar gains will take a while to work their way into demand on the export front. Most likely, we could easily find ourselves back into the 2.5-3.5% range depending on weather, trade and the Holiday shopping season. Certainly, specific results in the energy sector, financial sector, transportation sector, retail sector and in the international segment of many companies' businesses will be much more dispersed. This will likely continue into next year and beyond as the US finds itself in a more "normal" environment.
It looks like geopolitics will be an investment factor for some time. I was able to have a conversation with John Mauldin and Ian Bremmer of EurAsia Group just recently. The net of the discussion was a general view that the US is not taking as directive a role in international affairs and is, in general, buffered from what is going on while its immediate neighbors, Canada and Mexico, are doing okay. To an extent, others are also dealing well with their neighbors except for the Middle East and Russia. As China works through its internal economic reforms as growth is slowing it has become less belligerent with its neighbors. The same can be said, in return, for Japan and India. China is taking a pan-Asia stance unilaterally. Its neighbors are wary but maybe no more so than they would be of the US effort to do the same. Lower oil prices actually buy some time politically for the current leaders to move through their reform programs, away from a dependence on low value-added exports and more on internal growth and technological development. China is putting in the transportation infrastructure that connects the country on its eastern, western and southern borders to the rest of the world, not dissimilar from the US in the 1950s. And, in 2012, China surpassed the US and Japan in filings of patents in all four types of IP, invention, utility models, trademarks and industrial design. That is continuing and accelerating. Innovation exists. Implementation is yet to come. The question is how low will the growth numbers go as China makes this transition. My view would be lower than the current expectations. A 5% number is not unrealistic and is tolerable. Russia bears watching. As described above, Russia is taking a belligerent stance in the face of deteriorating economics. Putin appears to have the power to do this. In a global world, this may prove to be self-defeating. In my view, it ultimately leads to regime change, particularly if the financial situation worsens. However, Europe may blink before Russia does. As Ian would characterize the Eurozone, the economy is improving but the domestic politics are worsening. With the prospect of actual QE combined with some fiscal stimulus, some view the market as attractive. I view it as interesting, and would want to be able to participate on both sides of the markets. Private equity/distressed credit could also be an interesting way to approach the markets there.
Where does this leave us when it comes to investing? I would still want to stay close to home. The Americas offer everything from defaults, to disappointments, to some major opportunities. We are entering into a different period, certainly from what we experienced the last five years, but possibly longer. There will still be winners and losers but with more dispersion among sectors and companies than we have seen recently. I don't think investors have thought about how a portfolio needs to be shifted to take advantage of this return to a different "normal." We will find ourselves in a different interest rate environment, a more globally interactive environment, and possibly a different energy environment. In addition, Moore's law keeps marching on. Understanding the characteristics of your investments, individually and in a portfolio context will be more important over the next 5 years, at least, than it has been since March, 2009. Pay Attention to these changes and adjust accordingly.