April Jobs, Q1 GDP Mostly Allay Our Fears

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by: J.G. Collins
Summary

Consistent 200,000 average jobs resolve many of the fears we had in November.

The Fed's signal of a relatively dovish stance likely reversed a slowing/recessionary economy.

There are remaining risks, principally coming from outside the US economy, but failing a military/political crisis abroad (e.g., Straits of Hormuz), we are confident of moderate growth.

Slight 1% real annual wage growth and productivity speak to a better economy.

New York (May 3, 2019): The April jobs report printed at 263,000 new jobs. The consensus estimate had been just 181,000. Revisions for February (+23,000) and March (-7,000) netted 16,000 more jobs.

The revisions resulted in average three-month job creation of 169,000 jobs and six-month average job creation of 204,000. That compares to 185,000 average three-month new jobs and 206,000 six-month new jobs for March 2019 and 218,000 and 204,000 jobs for those same periods, respectively, for April of last year. Job creation was up 50.2% from the same month last year, which had printed at 175,000. It was up 29.2% over March, which printed at a revised 189,000.

The unemployment rate was 3.6%, down 2/10ths of a percent, but down 2/10ths of a percentage point from March 2019 and 3/10ths of a percent from April 2018. The U-6 Unemployment at 7.3% unchanged from March, but down 5/10ths of a percentage point since last year. The two months are the lowest U-6 number since March 2001. Nominal average weekly wages increased by 2.94% year on year at a rate that is higher than inflation. Real wages increased by just 0.98%, assuming the January Trimmed Mean PCE annual inflation rate of 1.96%.

Analysis: Details and Outlook

We have been saying since our November jobs report that we see a flashing red light, requiring investors and businesses to stop and assess conditions before moving forward. In March, we urged investors who were in or near retirement to move toward cash. But since then, our confidence has improved in light of the following.

China’s reduction in its reserve ratio in early January, apparent progress in a China/U.S. trade agreement, the Fed’s more dovish stance on interest rates, a headline 3.2% 2019 Q1 GDP report that vastly exceeded expectations, and the strongest labor productivity in 2019 Q1 at 3.6% since 2010 Q3 have made us more optimistic.

Nevertheless, we still have considerable concerns about the global economy and its impact on the U.S. These concerning data points are discussed further below (in "Other Macro Data") and include:

  • Germany’s substantial slowdown (Italy, which had also concerned us, has just moved out of recession);
  • China reducing its reserve ratio over obvious concerns about its economy and the rollover of dollar, euro, and pound denominated debt it owes American, European, and British banks;
  • continuing short-term yield curve inversions;
  • some disconcerting data on housing starts and rising gas prices;
  • the length of the recovery;
  • no deal Brexit;
  • overall concerns about demographics; and
  • some odd trading patterns in currency pairs and interest rates and some “window dressing” in European banks, as pointed out by Gillian Tett in her Financial Times column last month.

All things considered, our stance remains at a "yellow flashing light", but soon to be a green light.

We anticipate 2019 Q2 GDP to print at just 1.9% to 2.4% after what we viewed as an outlier in 2019 Q1 data.

Let's look at our exclusive jobs creation by average weekly wages for the April jobs report:

0418 Jobs by Average Weekly Wages April Jobs Creation by Average Weekly Wage Source: The Stuyvesant Square Consultancy, compiled from BLS Establishment Data for April 2019.

The number of people employed in March was 156,645,000, down by 103,000 from March, but up 1,297,000 from the same period last year. Some 162,470,000 individuals were in the workforce, down by 490,000 from the 162,960,000 who were in the workforce last month. The labor participation rate slipped 2/10ths of a percentage point to 62.8%, down from 63.0% last month, but up from the 62.7% rate from April 2018.

The JOLTS survey for February, the latest available data, released April 9th showed 538,000 fewer new job openings from January. That’s 910,000 fewer new job openings than were created from December to January, but 550,000 more jobs created than in February of 2018. Still, that is down significantly from the year-on-year change from the January 2019 JOLTS report, when 1.686 million new jobs had been created.

Oil Pricing And Geopolitical Concerns

We're heartened to see fuel prices continuing below the $3 per gallon threshold. Gasoline prices for April are 11.1% higher than last month and 0.3% higher than last year.

But oil prices, as measured by West Texas Intermediate crude, have climbed 10.7% from last month as of April 4th, but are 1.4% lower than the same day last year.

U.S. sanctions against Iran will also adversely affect the economy of its neighbor, Iraq, thereby putting pressure on the country’s political regime. The effect of the White House announcement late last month that it was ending waivers of sanctions on those countries that still imported Iranian oil - China, Turkey, Japan, and India, among others - remains to be seen, as the waivers officially ended at 12:01 AM this morning. There is resistance, and several of the countries with expiring waivers have asked for more time, but there seems to be compliance, provided the Trump Administration does not move too aggressively to impose sanctions on the importers.

We remain concerned of some flashpoint occurring in the region. Iran Foreign Minister Mohammad Javad Zarif made the rounds among TV networks and U.S. think tanks late last month, offering both threats and accommodation. As Iran moves further from Joint Comprehensive Plan of Action (JCPOA) and becomes further estranged from the West, it further enhances the odds Iran will abandon the USD as the currency for its oil trading, as we discussed in greater detail here.

Iran can do more damage to the US by joining the nations which have tried "de-dollarizing" oil because it could greatly diminish the USD's status as the world’s reserve currency and wreak economic hardship upon the US. Iran’s other threats seem less troubling. The Republic has said several times it would cease all flow of oil through the Straits of Hormuz if Iran could not sell oil because of the U.S. sanctions. The regime has engaged in more missile testing, causing the U.S. to request even stronger sanctions from the UN. In February, it announced it had developed an indigenous surface-to-surface missile, Hoveyzeh. As of April 29, the Kearsarge AFG is posted off the coast of the Straits of Hormuz and the USS Lincoln (CVN-72) carrier strike group is off the coast of Egypt, approaching the Suez Canal. Clearly, the national command authority will continue to deter, if not intimidate, Iran’s leadership from pursuing misadventures in the straits, particularly given that the U.S. has now completely shut down Iranian oil exports. The situation in Venezuela continues to unfold and continues to concern us, largely because Venezuela supplies oil to India. But, so far, it is too early to judge what might happen there, notwithstanding predictions earlier this week that the Maduro government would fall.

A Lessening Of Concerns

Our concerns in earlier months about the U.S. possibly sanctioning Saudi Arabia ("KSA") over the murder of Washington Post columnist Jamal Khashoggi have largely dissipated and KSA will be pumping more oil to replace oil prohibited from import from Iran.

Dollar Denominated Debt

Similarly, in earlier months, we had concerns that higher rates and a stronger dollar impinge developing nations' ability to repay dollar- and euro-denominated debt they owe to American and European banks. While the Fed has signaled it will be more dovish, we note, nevertheless, that the DXY:CUR is at one of its highest point in nearly two years.

Moreover, the Central Bank of China’s attempts at easing are yet to prove they will resuscitate the country's slowing economy. And the increasing amount of loans, including to struggling small Chinese businesses, estimated up 7% year-on-year as of March raises the risk of higher defaults. So we continue to be concerned about foreign debt held by China as well as the strength of the overall economy. China has $750 billion in USD-denominated Offshore Corporate Dollar Bonds (or “OCDB”). Toward the end of last year, Nomura had warned to monitor the situation, and expressed concerns about the bond rollovers could be problematic, given the decline of the yuan. We have similar concerns, but mostly related to a weakening Chinese economy.

With other developing economies, particularly India, where the USD:INR exchange rate had ended 2018 at 1:70, we’re seeing recovery, presumably because the Fed has pulled back (The INR traded at its lowest point in history in October, 1:74. As of today, it was 1:69). War tensions with Pakistan seem to have flared again overnight over a vote at the UN labeling a Pakistani a "terrorist". The move allows India to petition to declare Pakistan a terrorist-financing nation. Our earlier fears, which had largely been allayed, are heightened this morning.

Other Macro Data

Note that we have substituted the Department of Transportation statistic, the Transportation Services Index, TSI, in our model because the data is produced more closely to the monthly jobs report, and it has a closer correlation to GDP than the North American Transborder Freight numbers we had been using. For February, the TSI printed at -0.1%, down from 0.4% last month. We continue to be heartened that people are taking home more cash from the tax cut, so that debt service will account for a lesser percentage of disposable income. Data released early last month for 2018 Q4 continued to support our thesis we have expected since the tax bill passed. That will be offset, though, by higher gasoline prices to slightly weaken consumer spending. We note these other developments since our last jobs report:

  • The wholesale trade report for February, reported April 17th, showed sales up 2.1% year-on-year and 0.3% month-on-month. Inventories were up 6.9% from last year and 0.2% month-on-month. The inventory to sales ratio was 1.35%, up from the 1.29% of February of last year.

  • Building permits for March, released April 19th, dropped 1.7% from January and were down 7.8% from last year. Housing starts dropped 0.3% month-to-month and -14.2% year-on-year.

  • The ISM Manufacturing report for February, released Wednesday, showed continuing growth at 55.3, up from 54.2 The ISM Non-manufacturing report for April, released this morning, printed at 55.5 points, down from 56.1 in March.

  • Personal Income & Outlays for March 29, released April 29th: Personal income is 0.2% in current dollars and chained 2012 dollars were not available.

    • March disposable personal income declined by 0.2% in current dollars; chained 2012 dollars were not available.

    • Personal consumption expenditures (PCE) for March were up 09% in current dollars. In chained 2012, PCE was up 0.7%.

  • The IBD/TIPP Economic Optimism Index, released April 9th, dropped 2.7 percentage points to 54.2 (Anything above 50 indicates growth).

Fed Normalizing

For now, we continue to be heartened by the Fed moving away from tightening rates too much, too quickly. While inflation for personal consumption expenditures, less food and energy, or "Real PCE", had hit the Fed's target of 2 percent, we’re seeing that slip somewhat in the last couple of months. We continue to believe that moves toward normalization should take place more slowly and only after growth had become decidedly more robust over several more quarters; at least four quarters of a consistent 3% GDP growth. We are only halfway to that goal as of 2018 Q4. We would also like to see more stable growth in Gross Domestic Investment, with growth in that component of GDP of at least 1% to 1.5%, excluding inventory. As we have illustrated in our GDP report for 2018 Q4, the 2018 Q3 and 2018 Q2, the better-than-expected GDP reports for those quarters included a lot of “shifting” from and to earlier or later quarters. Similarly, 130 bps of the stunning 2019 Q1 GDP figure came from a Net Export figure that is unlikely to be repeated by some inventory restocking. We would like to see steady, consistent growth in each of the four categories of GDP growth. We have long held the view that trimmed mean PCE, produced by the Dallas Fed, is a better measure of inflation in the day-to-day costs of most Americans; it is currently 1.8%, but it has been volatile. The 2 ¼% to 2 ½% Federal Funds rate the Fed continued in its May meeting and the stable 2% inflation will likely put a damper on further Fed normalizing.

The yield curve, of which we have been gravely concerned in the last several months, is now simply dangerously volatile. The Fed rate hikes, which have their greatest effect on short-term rates (and why we use the 3Mo/10Yr curve) in 2018, were premature and outpaced the economy's growth. We started 2018 with a spread of the 3-Month/10-Year yield curve of nearly 102 bps, just half the 200 or so bps that started 2017. As of May 2, the 3 Month/10 year yield curve was just 8 bps apart. We’re also seeing repeated yield curve inversions among the shorter-term rates, as illustrated here:2019 YTD Daily Treasury 3Mo to 5Yr Yield Curve 2019 YTD Treasury Yield Curve, 3Mo to 5Yr.

The 10-year rate is barely able to sustain 2.50% so far in 2019, increasing the likelihood that yield curves will invert. We would like to see a minimum of two quarters of at least a 75 bps spread (pulling back from the higher 150 bps spread we had cited earlier) between the 3 Mo and 10 Yr yield before the Fed even considers another rate increase after what we view was an erroneous increase last year.

We are simply not seeing any holistic appetite among investors for increased risk, as signaled by moving away from Treasuries and into “risk-on” assets, which would tend to drive rates higher. (Treasury yields are inversely proportional to risk appetite, so the lower the Treasury rate, the more dollars invested there and not in risk-on assets). Even with weakening foreign economies, we see an outflow versus an inflow of foreign capital to the U.S., further heightening our concerns of a “risk-off” U.S. economy. With Asia, Europe and North America all showing evidence of a slowdown, or at least early signs of one, we think it is vitally important for the finance ministers and central bankers of all three major economies agree a strategy to address what we foresee as a very challenging time later this year for the global economy.

We remain unperturbed by the trade dispute with China and by the Trump tariffs, but we’re not willing to ignore the “herd instinct” of ignorant investors who buy into the lie that “tariffs cause (or worsen) depressions”. (Milton Friedman’s estate has a Nobel Prize that says otherwise). We’re seeing, it appears, increasing signs his threats of tariffs are bringing China to heel on its mercantilist trade policies. That said, we would like to see the president engage America’s Asian and European allies to step up to join a "coalition of the willing" to challenge China's decades-old unfair trade practices and thefts of intellectual property because the one-on-one dispute could simply trigger mutual retaliation. There is more power in American dealings with Xi from a multilateral “we” than a unilateral “us”. We’re circumspect about the rate of GDP growth reflected in the last three reported quarters. We think the 2018 Q4 GDP of 2.6% will likely presage just moderate growth for 2019. 2019 Q1 was an outlier, skewed by a strong 1.03% increase in Net Exports, as we explained here. Our doubts will continue until we see two consecutive quarters of increases in all four categories of GDP (i.e., Personal Consumption Expenditures, Net Exports, Gross Domestic Investment, and Government Consumption Expenditures).

For now, we're expecting just moderate growth around 2% for most of 2019 barring unforeseen political considerations. We expect 2019 Q2 to print at 1.9 to 2.4 percent. The narrowing yield curve, concerns about China and Europe, the increasing likelihood of a “No Deal” Brexit, the failed summit in Hanoi and Iran’s increasing isolation from the west all give us pause.

Investors who are at or near retirement can up their levels of risk, but should do so cautiously until we see additional data. We simply don’t think there is sufficient capital growth prospect for equities to justify a high level of equity risk given risks of a sharper market downturn on a grey or black swan event, such as a resumption of North Korean nuclear testing, Iran totally abandoning the JCPOA to further embrace China and Russia, or further political troubles in the US or Europe.

Investment Summary

In equities, we’re mostly inclined to stand pat with these sectors from our 2019 Q1 summary, but in less proportion, and with some changes, as follows:

  • Outperform: Consumer discretionaries in the mid- to high-end retail sector; trucking on speculation of consolidation and acquisition; and companies or REITs that own real estate in sectors identified as "opportunity zones" under the Tax Cut and Jobs Creation Act of 2017; CHF.

  • Perform: Consumer staples, energy, utilities, telecom, and materials and industrials. Lower-end consumer discretionaries like dollar stores; the asset-light hospitality sector on speculation of stabilizing franchisee property values and room rental costs; certain leisure and hospitality; and healthcare.

  • Underperform: Financials and technology; lower-end, low-quality QSRs (e.g., MCD, DPZ, YUM, etc.) on greater US delivery competition and a slowing economy; lower end hospitality on gasoline prices; currencies of developing nations, such as INR; and the GBP and EUR.

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