As we enjoy a holiday weekend here in the U.S., here are some passing thoughts on the first half just in and the second half that has just begun.
The S&P and Dow Jones indices fell during the quarter, though not by very much. Through the end of the first half, the two stood virtually unchanged on the year at +0.2% and (-1.1%) respectively, with only the NASDAQ managing a gain (+5.3%) amongst the majors. The NASDAQ is benefiting from reallocation and the relentless rise of biotech, the latter benefiting from money desperately looking at a dwindling number of sectors for returns, as well as a concentrated dose of the current eat-or-be-eaten merger and acquisition fever.
Earnings maven FactSet has the S&P 500 consensus earnings growth estimate for this year pegged at 1.5%, accompanied by a 1.9% revenue decline. That the estimate is positive at all is heavily dependent on fourth quarter earnings doing the heavy lifting, an annual story that rarely comes true and certainly has not done so since the crash. One never knows, but whether it’s zero percent or one percent, valuations are sky-high for a market with no earnings growth. It’s a long way to the ground, folks.
The June jobs number of 223,000 (seasonally adjusted, or SA) appeared to come close to the consensus of 230,000, but that was an estimate designed to be beaten. Real market expectations were closer to a repeat of May’s 280K, a figure that turned out not to be a repeat when it was hit with a revision down to 254K. I saw investment managers proclaiming how solid a report it was and that the economy would create 3 million jobs this year, based on the first-half average of 250K. I should think fund managers would be better at simple arithmetic, the first half average being in fact 208K. Oh well, there goes a half-million jobs.
Only employment, a lagging indicator, is putting up good numbers in the domestic economy this year. S&P 500 profit growth is zero (negative in real terms), consumer spending growth is minimal and business spending is running below last year. There’s a word for periods when spending and profits are declining, but don’t expect the Street to acknowledge it until it’s too late.
The business cycle is going to end with or without interest rate hikes. The last cycle ended in the fourth quarter of 2007; this fall will mark eight years since that time. Eight years is ordinarily a full cycle. The end of this current cycle will be the first and only economic news to get the market to stop obsessing over the false god of the Fed.
The Greek situation referred to in this week’s title, personified by the war of words between Greek Prime Minister Alexis Tsipras and German Chancellor Angela Merkel, is everywhere in the media this weekend. Many good and interesting takes can be found elsewhere and I will spare you yet another bit of pedantry about what simply has to happen. Beneath all of the bluster and counter-bluster that has become reminiscent of a rumble in an elementary schoolyard, largely designed for domestic consumption anyway, lies the danger that someone will get tired and stupid and do something regrettable. It happens.
The greater danger, however, is unlikely to be visible in the immediate wake of any Greek-EU meltdown. Markets are prepared for an adverse outcome (though never as much as they think they are), and indeed we could see quite a July relief rally in the stock market if the situation gets sorted out, a proposition I have to believe is at least fifty-fifty.
The real problems would come later, most likely beginning with quarterly statements filed down the road and in annual statements that don’t meet banker satisfaction. Most of all is this: once the unthinkable happens, it is by definition no longer unthinkable. If Greece goes, what will happen not next week but when the current business cycle ends, as it inevitably must? Whose exit will no longer be unthinkable then?
The Economic Beat
The jobs report was its usual weekly highlight, reporting a good number at 223K (SA), as noted above good but not great. The year-on-year (y/y) comparison for June (223K vs. 286K, SA) is nearly the same as the y/y comparison for the 3-month average: 221K vs. the year-ago 284K. I make it that the first five months this year have all been revised downward from initial estimates, sometimes first down and then up a bit, but still net down. I don’t know if June will join the list, but when I connect five downward revisions to a 20%+ drop in the 3-month average and a 9% decline in the year-to-date total (SA), I have to conclude that the peak part of the job growth cycle has passed.
Another way to look at employment is through jobless claims, which I estimate to have reached the peak phase last August. Cyclical employment peaks commonly run about six to eighteen months, with a rough average of a year. There is no real sign yet of any weakness in that data – so far, so good. The next useful comparisons are available in late July, after the usual mid-year lay-offs have been tallied up. The recent string of jobs reports may be a harbinger that the end of the peak phase is nigh, but it’s still too early to say. That said, the pattern of a slower 2015 has been consistent.
One big disappointment for the market was that hourly earnings for April were revised back down to 0.2% from 0.3%. The 0.3% had been given lavish attention by bulls as evidence of a jobs market taking off, soon to be followed by the good variety of inflation, mild rate hikes and other portents of nirvana. Alas, it disappeared and June followed in the same path, with the result being that annual hourly earnings are up only 2%. It has certainly been a weak recovery for worker earnings. I wonder if it has anything to do with corporate profit margins being at all-time highs, or the corporate profit share of GDP at an all-time high.
Another less-than-wonderful aspect of the jobs report was the drop in the labor force, largely responsible for the unemployment rate falling to 5.3%. The household survey, quite volatile from month to month, actually showed a decline (-56K) in the number of employed, but a big increase in the not-in-labor-force (NILF) category. Over the last year, the survey shows a 1.3mm increase in the civilian labor force alongside a 1.5mm increase in NILF! That’ll certainly help the unemployment rate, though it must be allowed that the survey also shows a 2.5mm increase in the number of employed people.
Manufacturing growth has not been as steady as employment, and that is some cause for concern, as it tends to be more of a leading indicator. Most of the critical new information in the factory orders report for May consisted of downward revisions to the seasonally adjusted data from the durable goods report, so the overall impression was muted, but year-on-year comparisons in the business cap-ex spending category have been negative for five months in a row.
The Dallas and Chicago regional purchasing surveys were both negative, with the energy-centric Dallas area at (-7.0) and the auto-centric Chicago region at 49.4, below its neutral level of 50 but still quite close. The national manufacturing survey for June, the ISM report, reported a result of 53.5, slightly above consensus (53.2) and a small improvement over the prior month’s 52.8. The number of sectors reporting growth fell to 11, however (out of 18), and the comments were less ebullient. The Wall Street Journal further burnished its credibility with a puff-piece touting the number as a sign of hope, but these diffusion surveys are coincident indicators that can stay positive right into a recession. Broadly speaking, the number was a spot-on result that exactly reflected the kind of soft rebound from the weak first quarter predicted in these parts. No more, no less. Barring a Grexit, we should expect similar results through the summer.
On the consumer side, don’t look for a banner June retail sales report. Though the annual run rate for auto sales was still strong for the month, it did represent a decline from May and Redbook chain-store data was soft. In housing, the rate of price increases in the Case-Shiller home price index slowed to 4.9%, a substantial decline from the April rate of 5.4%. It’s only the initial estimate for one month, so while it may be a portent, it may also be nothing at all. The pending home sales index rose 0.9%, taking it to its highest level since 2006. Home sales are on fire! Not really, as new-home sales are only a third of their 2006 levels. Construction spending rose 0.8% in its initial estimate, and I have to agree that commercial real estate is in its peak phase.
Consumer confidence rose to 101.4. The numbers don’t correlate with actual spending, but have consistently been very good contrarian indicators throughout history. The good news is that the downturns usually follow about a year later, so we could have some time.
Next week is a quieter one apart from Greece. The ISM non-manufacturing survey comes out Monday, international trade comes on Tuesday morning, followed by the labor turnover report (JOLTS), and the all-important Fed meeting minutes Wednesday afternoon. Did Janet Yellen look upward or downward when she crossed the road? What color were her shoes last week? It’s all a kabuki-style farce. Wholesale trade data on Friday will round out the week.