FMX | Connect – www.fmxconnect.com - (Reported 9/02/2010)
Excerpt from MARKET MUSINGS & DATA DECIPHERING
DODGING A BULLET, YES — OUT OF THE WOODS, NO
The U.S. employment report for August, much like the previously released ISM and chain store sales numbers, had the “muddle through” thumbprints all over it, which is why an equity and bond market bracing for a “double dip” scenario have reacted so violently in recent days. The data are hardly strong but admittedly are not consistent with the economy contracting this quarter. But the data do not alter our outlook for a double-dip scenario unfolding before year-end as the policy stimulus continues to fade and the inventory cycle subsides.
While capital spending remains a lynchpin as businesses replace obsolete machinery and equipment, its contribution to overall growth is actually showing signs of receding and we see nothing really in the consumer, housing, commercial construction, net exports or State & local government sectors to get us excited over the macro backdrop.
Now that the financial market sentiment is moving away from the “double dip” outcome, equity investors still have to confront what a “muddle through” scenario is going to mean for corporate profits because we had such a “muddle through” in the second quarter with 1.6% volume GDP growth, which translated, at a time of cycle-high margins, into virtually flat sequential corporate earnings growth. So, it would stand to reason that if there is vulnerability, it is highly unlikely that we will see profits rise 20% in the coming year as is currently the consensus view in the marketplace.
The jobs report was uninspiring in the aggregate but the bright spots cannot be readily dismissed. First, the private payroll number came in at +67,000, which was above the consensus estimate of +40,000, not to mention the ADP print of -10,000. This, along with the upward headline revisions of 123,000 and the 0.3% MoM gain in the wage number has the bulls rather excited.
But there were many other parts of the nonfarm report that left much to be desired. Here’s an unlucky seven examples of softness beneath the surface:
1.Aggregate hours worked were flat.
2.All the employment gains were part-time — full-time employment, as per the Household Survey, plunged 254,000.
3.Those working part-time for “economic reasons” surged 331,000 — the biggest increase in six months.
4.While private payrolls were better than expected, 10,000 of that +67,000 tally reflected returning construction workers who had been on strike.
5.Manufacturing employment was down 27,000 and total goods producing jobs were flat — hardly signs of a robust economic backdrop.
6.The diffusion index for private payrolls actually fell to 53.0 from 56.7 in July — a seven-month low. It was 68.0 at the April high, which is consistent with an economy slowing down to stall-speed.
7. The labour market gap widened with the all-inclusive U6 unemployment rate rising to a four-month high of 16.7% from 16.5% in July. This is why the odds are stacked against a sustained acceleration in wages.
There are a few more takeaways.
The latest batch of data has been highly confusing, to say the least. The chain store sales data were skewed by one-offs, such as retroactive jobless benefit checks that were mailed out in early August and the growing number (17 this year) of States offering sales tax holidays. We estimate that absent these influences, year-on-year sales growth would have been closer to 1% than 3%.
The spending data also belied the information contained in the Conference Board’s consumer confidence survey, as the facts-on-the ground ‘present situation’ index sagged to 24.9 in August from 26.4 in July — only 5% of the time in the past has it been so low. The ISM manufacturing index, which really got the ball rolling on this ‘take out the double-dip’ trade, managed to spike even though the three leading sub-indices — new orders, backlogs and vendor performance — all declined in what was a 1-in-100 event.
Not only that, but the employment component of the ISM surged to its highest level since December 1983, and yet the manufacturing employment segment of the payroll survey fell 27,000 — the first decline this year and the sharpest falloff since last October. Furthermore, the manufacturing diffusion index slumped to a seven-month low of 47 from 53 — in other words, fewer than half of the industrial sector was adding to staff requirements last month. It begs the question as to what exactly the ISM is measuring.
The list of inconsistencies in the data didn’t stop there. The entire increase in private sector employment in August was in the service sector — mostly health and education, which says little about the cyclical state of the economy. Yet 90 minutes after the jobs number was released, we got the ISM non-manufacturing survey and it flashed a contraction in services employment to a seven-month low of 48.2 from 50.9 in July.
Just a tad confusing, but the newly found bullish view of the economy is sort of corroborating evidence.
The employment report did not detract from the view that the economy is losing steam. The fourth quarter of a recovery typically sees real GDP growth of over 6% at an annual rate, but in this post-bubble credit collapse, what we got this time was 1.6% at an annual rate in Q2.
Moreover, there is nothing in the data to suggest anything but a further slowing in Q3, and the only reason why there is no contraction this quarter is because it looks as though we are getting another lift from inventories — though now the buildup looks involuntary, which will cast a cloud on fourth-quarter GDP barring a sudden reversal in the declining trend in real final sales.
Private payrolls were +247,000 when the equity market peaked in April, it slowed to +107,000 by July and was +67,000 last month. What does that suggest about the trend? Ditto for goods-producing employment, which was +67,000 in April, subsequently softened to +37,000 by July, and in August was the grand total of zero.
One can easily draw the conclusion from the data that we have dodged a bullet. But that does not mean we are out of the woods. Employment is a coincident indicator. Leading indicators, such as the ECRI, continue to deteriorate and to levels still consistent with nontrivial double-dip risks. Keep this in mind — private payrolls came in at +97,000 in November 2007 and the “Great Recession” began the next month. In other words, the +67,000 tally we saw today basically tells you nothing about how the pace of economic activity is going to unfold as we move into the fall.
PRODUCTIVITY A TAD LESS MIRACULOUS
The revised Q2 U.S. data showed real nonfarm business output growth throttling back to a 1.6% annual rate in Q2 from 5.0% in Q1 and from the 6.7% peak in the fourth quarter of 2009. Since businesses slashed the workweek this cycle to record lows, they have the luxury of saving on costs by having their existing staff work longer before embarking on a hiring spree; hence the continued high level of jobless claims.
As a result, hours worked did jump at a 3.5% annual rate, the fastest since Q1 2006. The difference is that back then, with the housing and credit boom in full swing, output growth was 6.8% — not 1.6%. Of course, at that time too the labour market was drum tight, so compensation per hour (in nominal terms!) was running at a 5.3% annual rate; in Q2 of this year, it deflated 0.7% at an annual rate after a 0.9% dip in Q1. Wages are indeed deflating in each of the last two quarters.
Meanwhile, productivity is weakening — declining actually at a 1.8% annual rate in Q2, the steepest falloff in four years, and double the decline initially reported. Keep in mind that this followed four quarters of unprecedented growth. What this means is that unit labour costs swung to a +1.1% annual rate in Q3 from -4.6% in Q1, -4.2% in Q4 and -3.3% in Q3 of last year. We can’t get worked up about +1.1% unit labour cost growth from an inflation standpoint, but this swing is affecting profit margins, which the nonfarm business sector tried to cushion by raising prices at a 2.6% annual rate. However, the spread between the growth rate in prices and costs narrowed to +1.5% from +5.8% in Q1 and this was the narrowest margin since the “green shoots” began to sprout in the second quarter of last year.
This showed through loud and clear in the Q2 national accounts profits data (pre-tax without inventory valuation and capital consumption adjustments), which slowed dramatically to a 2.3% quarter-over-quarter rate from 14.5% in Q1, 13.1% in Q4, 12.3% in Q3 of last year, and the lowest pace since earnings were declining sequentially in the fourth quarter of 2008. As an aside, after-tax profits completely flattened on a quarter-over-quarter basis last quarter after a five quarter run in double-digit terrain.
So, while national account profits show a healthy YoY pace of +49%, this masks an underlying erosion on a quarterly sequential (and seasonally adjusted) basis. The YoY trend actually peaked at +80% in Q1 and +57% in Q4 for those who like to focus on “momentum” or second derivative movements.
This is the prime reason why the equity market has sputtered, profits are doing likewise, and overly optimistic earnings estimates are coming down and there is more to come on this score.
David A. Rosenberg
Chief Economist & Strategist Economic Commentary
drosenberg@gluskinsheff.com
+ 1 416 681 8919
Source: Market Musings & Data Deciphering
http://www.fmxconnect.com/
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