August Employment: There is None

Morris Segall      Capital Markets, consumer sentiment, Economic stagnation, economy, employment, employment report, future trends, government, government stimulus, manufacturing, private sector investment, recession, slowdown, unemployment

Today’s employment report for August continued a worsening trend in the job market we have noted in our blog and website articles since June. Rather than another month of paltry job growth seen since May, job creation in August was zero. The last time the monthly employment report recorded an absence of job creation was last September. In addition, job creation for the months of June and July were revised downward a combined 58,000 jobs. Thus, over the last three months, job creation has averaged 35,000 jobs versus an average of 153,000 over the first five months of this year. Even the private sector, which has been creating a moderate level of jobs so far this year, dropped to nearly zero in job creation in August. More distressing is the event we have feared since the economy and employment faded through the second quarter. That is the shift by employers from reduced job hiring to job layoffs. In the August report, a number of industries recorded job losses including: manufacturing; construction; retail trade; transportation and information technology. The latter includes striking Verizon employees but that does not account for all of the job loss in this sector. The government sector also shed another 17,000 jobs in August. Year to date, the government sector has reduced employment by over 260,000 jobs.

As bad as these numbers are, other data in the employment report for August are even more negative. The already weak average workweek declined to 34.2 hours from 34.3 hours in June and July and is at the low level of last August. Average hourly earnings declined from July levels and are less that 2% above year ago levels, well below nominal inflation. The number of involuntary part time workers increased by approximately 400,000 to over 8.8 million workers from July and is at the highest level since last August. As we reported in prior employment report articles, the number of unemployed 5-14 weeks had been expanding in recent months. Now those people are unemployed over 15 weeks and that category has expanded to almost 59% of the number of unemployed persons.

Combined with the very weak manufacturing data reported yesterday showing major declines in orders, shipments, backlogs and employment and the plummeting levels of consumer confidence in recent surveys, and we have an economy that is “stalled out” and on the verge of sliding back into recession. We have previously cautioned about such a prospect in previous blog articles if economic data over the summer did not improve materially and fast. It hasn’t.

The private sector is doing what we expected in a weakening economic environment-cutting back. The President is expected to announce new economic stimulus measures next week to help create jobs. They will not turn the economy around. The Fed will inaugurate a QE3 program to add more liquidity if recession is imminent. The impact will be similar to that of QE2- a temporary respite but damaging to the bond market and the value of the U.S. Dollar. Without the full participation of the private sector to invest heavily into the economy and hire workers, the current economic trends and pessimistic outlook will not change. This also does not augur well for U.S. and overseas capital markets.

Morris R. Segall

Second Quarter backsliding

Morris Segall      consumer sentiment, consumer spending, Economic Growth, employment report, GDP, industrial production, inflation, retail sales, unemployment

Last week saw a number of important economic reports for the month of June, including wholesale and retail inflation, consumer sentiment from the University of Michigan/Reuters survey. There were no surprises to us in these reports. We expected inflation to recede from the elevated levels of the first five months of this year as energy prices declined in the month of June. We also expected consumer sentiment numbers to decline reflecting the weak stock market in May and most of June and the very weak employment situation in both months (See our blog article of July 8 on June unemployment).  For us however, the two economic reports of most importance were retail sales and industrial production. If there were going to be signs of improvement from the very weak data reported in May, it would be seen in these two reports.

Unfortunately, while retail sales, excluding grocery store and gasoline station sales, increased .3% in June from depressed May levels, June retail sales were essentially flat with the level of April and lower than the peak level of sales in March. So it would appear consumer discretionary spending is down at the end of the second quarter from the peak levels at the end of the first.

We were anxious to see the Fed’s June report on industrial production and capacity utilization to see again if our expectations of a June rebound in industrial activity would be fulfilled. Here too we were disappointed with the results. Similar to the retail sales report, June industrial production did improve from weak May data but only by a slim .2% and all of the increase came in mining and primarily from utilities. The latter benefitting from increased usuage of power for cooling in the extended and massive heat waves last month. Given the continuation of hot weather in July, utility consumption is expected to be high again this month. More importantly, industrial production in manufacturing showed no increase in June from May and prior months industrial production in April and May were revised downward to negative readings. Indeed the revised numbers indicate overall industrial production in the second quarter showed no improvement from the first quarter. In addition, total industry capacity utilization declined in June from March levels. Manufacturing capacity utilization is also down in June from March levels and has not increased above the 74.4% level since April. As a point of comparison, this level of capacity utilization is well below the 79% long term average utilization rate of 1972-2010 .

Concurrent with the weak employment numbers already reported and the increase in the trade deficit reported for May, the weak retail sales and manufacturing data for June point to GDP growth in the second quarter lower than the 2% growth recorded in the first quarter. We raised concerns about this in our July 8th blog article. It now appears second quarter GDP growth will be in the 1.5%-2% range. Furthermore, we are increasingly pessimistic about a catlyst in the private sector that would rejuvenate the economy in the second half. Given the pessimism amongst consumers, and the retrenchment we have seen in the business sector, we are hard pressed to see what will “jump start” this economy in the absence of another Federal stimulus program which is not expected.

Morris R. Segall

The June Employment Report: Now we are getting pessimistic

Morris Segall      business spending, Capital Markets, consumer sentiment, consumer spending, debt default, deficit reduction, democrats, Economic Growth, economic recovery, future trends, inflation, job creation, June employment, obama, recession, Republican Party

Today’s employment report for the month of June is unequivocally a blow to expectations that May’s weak report was an aberration.  Instead of rebounding from May results, the June report deteriorated in virtually all key aspects  of employment. Nonfarm payrolls increased by a neglible 18,000 jobs, the weakest level of job growth in nine months. To make matters worse, the Labor Department revised downward its previous readings on job creation in April and May by a combined 41,000 jobs, including a 29,000 job reduction in May to 25,000 from an already weak level of 54,000 jobs. The June report and the April-May revisions reveal a virtual absence of job creation since April. Of the 18,000 jobs created in June, 57,000 were created in the private sector, offset by a reduction of 39,000 jobs in federal, state and local governments. Of the 57,000 private sector jobs the vast bulk of these, (34,000),  were in the Leisure and Hospitality sector- low paying, seasonal and tenuous given its sensitivity to the economy. According to the Household survey, the unemployment rate reached a year to date high of 9.2% in June despite a contraction in the labor force of over 270,000 from May levels. In addition, the June Household survey showed an increase of 173,000 in the number of unemployed workers and an increase of nearly 450,000 persons not in the labor force. Other statistics from the June monthly report include: a recessionary employment/population ratio of 58.2%; a $.01 decrease in average hourly earnings resulting in no increase in average hourly earnings since April; a decrease in the average workweek and factory overtime; an increase of 100,000 in the number of discouraged workers from May to nearly 1 million persons; an overall increase of 474,000 in those categorized as marginally attached to the labor force from May to a level of 2.7 million people; and an increase of over 400,000 from May in the number of unemployed less than 5 weeks to over 3 million persons. In June, the percentage of workers unemployed, those marginally attached to the labor force and those working part time because they can’t find full time work amounted to over 16%, the highest level this year. Two years after the recession ended, these numbers are unprecedented in post-war economic recoveries.

In our June 7th website article on May unemployment data, we concluded that the May data had been suppressed by the severe storms in the south and mid-west in April and May and the supply dislocations in Japan. We saw reassuring data in the May report that encouraged us to believe we were not on the verge of a double dip recession. Unfortunately, the June report contained none of those positives and should be relatively unimpeded by exogenous events. We believe  the June data confirms our fears that the business sector has retrenched in its spending since March, insecure in the outlook for consumer and customer end demand given the high levels of inflation and pressure on incomes and profit margins and deteriorating economic conditions in major markets overseas. This is confirmed in the underlying weakness in the June ISM manufacturing survey ( See our website article on the June Manufacturing Survey), and the weakness in the June ISM non-manufacturing survey, both released earlier this week. This retrenchment now appears to include a reduction in hiring.

This business spending retrenchment will have enormous implications for economic growth for the remainder of this year and into next if not reversed. An economy that does not provide job growth cannot grow. We have long focused on business and consumer spending as the drivers of economic recovery in the absence of contributions from housing and the government sector. Business retrenchment in spending and hiring will remove both of those drivers from the economy. The absence of private sector job creation will soon be reflected in reduced consumer sentiment and spending. Reduced consumer spending will slow business sales and pressure corporate profits causing businesses to retrench further. The net result is an economy that does not grow and one that could easily fall back into recession. We commented in our last website article how important the June employment report would be for the future direction of our economy. With the June numbers showing such employment weakness, we are now pessimistic the second half of this year will show renewed economic growth and the outlook for 2012 has become decidedly less sanguine. We expect to revise downward our expectations for GDP growth for this year to the bottom of our 2%-3% range and we may have to reduce our projections further if current economic trends persist.

We expect the weak June employment data to complicate if not preclude an agreement on raising the nation’s debt ceiling. The weakness of the June report will, in our opinion, harden the resolve of Republicans to reject revenue raising measures advocated by the President. The same employment weakness will, in our opinion, also strengthen the resolve of Democrats to avoid stringent federal spending cuts, particularly in entitlement programs. The current weakness in the economy will widen the ideological chasm between the political parties. Thus, we are not optimistic a far reaching deficit reduction program will be reached in the next two weeks. Rather we now believe a stopgap measure to avoid government default, possibly through the end of the current fiscal year, will be the only agreement that can be fashioned.

Clearly these events and the current economic environment are not conducive to stock market appreciation. In view of the recent rally in stock prices at the end of June and the first week in July, we believe the equity markets have increased downside risk and less upside potential. We would advise a more defensive and risk averse capital market strategy in light of present circumstances.

Morris R. Segall

S & P Joins the U.S. Budget Debate

Morris Segall      austerity programs, bailout, business confidence, business landscape, Capital Markets, consumer sentiment, consumer spending, Economic Growth, economic recovery, federal deficits, future trends, GDP, national debt, politics, recession, tight credit

This morning, Standard and Poor’s downgraded the U.S. credit rating outlook from stable to negative. The rating agency cited the high level of public debt as a percentage of GDP and the uncertainty that adequate actions to significantly reduce the U.S. debt level and maintain it at manageable levels would be undertaken in the forseeable future. The negative outlook and the reasoning behind it portend a “one in three likelihood of a lower long-term credit rating on the U.S. within two years” according to the text of the S & P release. Standard and Poor’s states the leverage on the U.S. balance sheet and accumulating annual deficits are higher than other countries with sovereign debt ratings of AAA.

We are not surprised by the S & P action. Indeed, in our website article of September 8, 2008, “Stocks, Recession and the Bail Out” we cautioned that the massive federal bailout of the housing and banking industries would add billions to annual deficits and the national debt. We further stated “The cumulative effect of ballooning annual federal deficits, the secular pressure on the federal budget from increasing entitlement spending and the continuing balance of trade deficit may lead to a downgrade in the U.S. government credit rating and a further aversion to U.S. dollar denominated assets longer term”. The extended decline in the U.S. dollar versus other currencies has reached historical proportions in the first four months of this year, even against the financially questionable euro. 

While we are not surprised by the S & P action, we are surprised at the timing of the ratings outlook. Why now in the heat of the budget debate between Congress and the President? Why didn’t Standard and Poor’s wait until mid May after some decision on the federal budget and increase in the debt limit would have been forthcoming? It is our opinion that by releasing this downgraded credit outlook now, it would have a significant impact on the budget deliberations and possibly tilt the argument in favor of more draconian spending cuts as advocated by the Republicans in Congress. It is not unreasonable to believe that outside credit analysts, rating agencies and economists have come to the conclusion that the U.S. must adopt an austerity spending program similar to those adopted by the European Union as a solution to its excessive debt burden. By using a time frame of three years (similar to that employed in the European austerity programs) to measure progress, S & P makes the same mistake such a short time period has created on the countries in Europe. It is simply too short a period of time to deleverage sovereign balance sheets without stifling critically needed economic growth to provide the means to paydown debt (See out website articles of December 17, 2010 and March 15, 2011).

Today’s ratings outlook release by Standard & Poor’s misses important differences between the U.S. economic situation and those of Ireland, Greece, Portugal and Spain. The U.S. economy is in recovery led by manufacturing, exports and more recently consumer spending. Employment gains have accelerated since last November. While the recent surge in inflation has slowed U.S. economic growth coming out of the first quarter of this year, the recovery trend is not aborted. It will be if the Federal government is forced to make drastic spending cuts which will reverse its role as an economic stimulant to an economic depressant at this sensitive point in the U.S. economic recovery. We argued in our economic articles on Europe and once again, that longer periods of time are required to deleverage these balance sheets. A longer period of time will allow the national economy to grow at a rate to raise tax receipts and pay down debt. We have long been advocates for greater fiscal discipline by the U.S. government that includes large spending cuts and higher taxes. However, a nation in recession cannot reduce its debt to GDP ratio.

By releasing its downgraded U.S. ratings outlook today, Standard and Poor’s has entered the political debate and abandoned its role as a neutral and impartial arbiter of credit conditions. Furthermore, the surprising timing of this release has caused capital markets here and around the world to decline significantly, further eroding asset values and wealth and business and consumer confidence already battered by overseas events in Japan, the Middle East and Europe. Declining capital markets and consumer and business confidence will lead to tighter credit conditions at a time when credit was just beginning to “loosen up”. This in turn will lead to investment and spending retrenchment, threatening the nascent economic recovery here in the U.S. The worries of a deteriorating U.S. financial condition in 2012 and beyond could be self fulfilling as a result of what we believe is an ill timed alarm. We will have to see in the coming days if the S & P action is transitory or longer lasting in its impact. 

Morris R. Segall

Charge!

Morris Segall      consumer credit, consumer sentiment, consumer spending, consumer spending sea change, credit card debt, Economic Growth, future trends, GDP

This past Monday afternoon, February 7th, the Federal Reserve released its report on consumer credit for the month of December, 2010.  Since peaking in the third quarter of 2008 consumer debt has steadily declined over the past two years by over $150 billion. Most of that reduction has been in revolving debt, largely credit card debt. This has reflected a combination of consumer debt repayment and the write-off of consumer loans in default by lending institutions and credit card issuers. After a further decline in November of last year, consumer revolving debt increased by nearly $2 billion on a seasonally adjusted basis or a 3.5% annual rate in December. This was the first increase since August of 2008 and most of that increase came in consumer credit card debt. Non seasonally adjusted data is more impressive, showing a better than $9 billion increase in revolving credit led by credit card gains at commercial banks. This change in credit card debt balances could be a signal the consumer de-leveraging is about over and consumer evaluations about their finances are sufficiently improved to allow them to begin increasing credit card purchases. If the December increase is not an aberration and continues in 2011, it will signify a dramatic change in the consumer spending dynamic.

 Up until last year’s fourth quarter, consumer spending had been anemic due to high unemployment and lagging consumer income growth, in addition to the de-leveraging of consumer balance sheets. That changed in the fourth quarter as consumer spending surged to pre-recession levels. The Federal Reserve data would indicate expansion of consumer spending in December was supported by the use of credit cards. This would explain the large increase in consumer spending (.7%) in the month of December, well above the .4% increase in consumer income growth in that month. If the December data portends a return to credit card financing by consumers, the prospect of continued high levels of consumer spending in 2011 is heightened. The willingness of consumers to increase credit card debt will counteract the suppressing forces of moderate consumer income growth and a continued high level of unemployment. This will promote a greater consumer spending contribution to the economy than one would have expected and augments the outlook for improved GDP growth this year, importantly led by the consumer.

 It remains to be seen if the December data is the beginning of a trend and we will be looking at future data to confirm or deny this important development. However, a note of caution. If consumers abandon the financial discipline of the past two years and return to spending in excess of income growth, a consumer spending renaissance will be short lived and a financially weak consumer sector will re-emerge, constricting long term economic growth.

Morris R. Segall, CFA, CIC

The Stock Market: Economy over Earnings

Morris Segall      aborted stock market rally, consumer sentiment, oversold stock market rallies, peaking in corporate earnings cycle, pessimistic Fed outlook

In our July 6th website article, “Economic and Capital Markets Update”, we concluded our bearish forecast with the advice, “we would use an anticipated market rally in July from good second quarter corporate earnings to move towards our intermediate-longer term strategy”.  Despite our negative assessment of the economic data of the last two months and our downgraded economic forecast for next year, we expected the combination of an oversold stock market and strong second quarter corporate earnings reported in July, would produce a strong equity market rally that we would use to sell equity positions in favor of the re-allocation we advocated for the intermediate-longer term. As if on cue, the equity market rally we were expecting arrived the next day, July 7th, as the major U.S. equity market averages rose approximately 3%. Over the next five trading sessions, the major averages added another 3%-4%, peaking on July 14th on the backs of strong earnings from major bellweather companies like Alcoa, CSX and particularly Intel. However the economic news released last week continued a string of weak reports including retail sales and industrial production for June, a pessimitic Federal Reserve economic outlook and finally another collapse in consumer sentiment, this time in the University of Michagan survey reported on Friday. The weakening economic data and outlook  undermined the earnings rally and accompanied by weak operating earnings from major international banks, the stock market rally of July 7-14 reversed with a 3% decline in the major averages on Friday. Importantly, the rallies in virtually all of the major U.S. equity indices failed at or around the 50% retracement from the June market lows, a key development for market technicians and traders who now believe the aborted rally at such a key technical level spells the end of the July rally and a resumption of the market decline begun this past May.

From a technical standpoint they may be right. From an economic standpoint they could also be right. The stock market is a forward looking mechanism and the increasingly weak economic data being reported look like it is corroborating our stated belief that the economy is stalling. The Fed’s downwardly revised economic outlook and the huge decline in consumer sentiment in both the Conference Board and University of Michigan surveys portend the kind of economic retrenchment we warned about in our July 6th website article. The consumer sentiment readings are particularly worrisome because they reflect a deep level of pessimism that can be a self fulfilling contraction in consumer spending, already weak in this recovery. We still expect a summer spike in consumer spending from increased vacation travel and we think it may provide another oversold rally in the equity markets when reported in August and September. However, the stock markets could be at or below the June lows when the news hits and the economic outlook for late this year and next could have eroded further.  This week will be crucial to see whether Q’2 earnings can halt the market reversal and give investors a better exit point. We still believe stock market rallies in July or later should be sold into. The stock market uptrend from March, 2009 is over.  Current earnings no matter how strong cannot outweigh a deteriorating economic outlook that portends a peaking in the earnings cycle over the next four quarters.

Morris R. Segall, CFA, CIC

Beware Over-Exuberant Reactions to this Week’s Economic News

Morris Segall      consumer sentiment, economic

This week the Conference Board Consumer Confidence Index for the month of May came in at an impressive 54.9, a surprisingly strong increase over the rise in the index in the month of April. The strong increases in the Conference Board’s and Michigan Consumer Sentiment Surveys in April and May we believe are largely due to the continued strong gains in U.S. stock prices since mid March.

Indeed, we mentioned in our Economic Update of May 1, 2009 that the March reading in this index in the mid 30s would likely be the low point for consumer sentiment in the current cycle. The news of the cycle results and its  attribution to perceived improved labor conditions, mentioned in the  survey, were the catalysts for the recent strong stock market rally.

What Does it REALLY Mean?

There has always been a strong correlation between strong stock markets and rising levels of consumer sentiment. We, along with many other market analysts,  are skeptical of the intermediate and long term predictive value of consumer sentiment surveys. One of the unexpected measurements of  strength in the survey was a perceived improvement in job availability  among consumers to 44.7 from 46.6. Such a slight statistical  improvement is not a convincing improvement in trend particularly when one notes the absolute high level (approximately 45%) of respondents reporting “jobs are hard to get” versus the level of approximately 6% reporting “jobs are plentiful”.

We stated further in our May 1 Economic Update that consumer sentiment surveys can be fickle and inaccurate as a predictor of actual consumer spending trends. To be sure, we believe the just concluded Memorial Day holiday will show a strong increase in consumer spending as more Americans hit the road for vacation travel. We are expecting strong retail spending numbers for the first holiday weekend of summer. Our concern is that the current depressed economic environment may become one of a “sawtooth” pattern of economic activities. One month of increased retail sales and factory orders and industrial production followed by a retrenchment due to the continued  high levels of unemployment and weak consumer and business demand.

In short, we do not believe there is sufficient strength in consumer finances and psychology to sustain a consistent rise in consumer spending in the near term.

Take a Look at the Hard News

Conversely, the news coming into the Memorial Day holiday was far more disturbing for the following reasons:

1. Rising Interest Rates

The yield on the U.S. 10-year Treasury Note rose on Friday to nearly 3.5%, up from 3.17% since the middle of May and 2.53% since the middle of March. This is the highest yield on 10-year U.S. Treasury securities since last November. We have warned in previous blog and website articles the massive negative impact on longer term U.S. economic growth from rising interest rates and a large decline in the U.S. Dollar. Both of these developments are occurring now despite the action of the FED to buy Treasures to keep interest rates low.

2. Federal Budget Deficits

Coincident with the dramatic rise in intermediate and long term U.S.  Treasury interest rates have been equally dramatic increases in the projected Federal budget deficits for fiscal 2009 and 2010 and the chronic increase in the government’s national debt. This deterioration in the U.S. financial condition is causing alarm among national and world investors, including foreign governments and world banking institutions that the U.S. credit rating would be downgraded like that of Great Britain last week.

3. Credit Crunch on Farmers

Deteriorating credit availability for farmers which may affect the procurement of fertilizer, seeds, animal feed and farm equipment. The credit crunch on farmers could negatively impact upcoming harvests and thus cause a rise in food prices next winter.

4. The State of California

The continuing chronic fiscal woes of the State of California whose  budget deficits are projected to rise to more than $40 billion in fiscal 2010. We fear the Federal government will have to bail out the state within the next two-three years to avert a major state default and cutbacks to state services that would be injurious to the public wellbeing. A federal “bailout” of California would rank among the largest and most expensive and long lasting in this current financial crisis. It would certainly add to the deterioration of the Federal balance sheet and pressure our credit rating and currency. It would also lead to further  demands from severely depressed states for increased Federal assistance.

Reality Check

We continue to be wary of over-exuberant stock market reactions to encouraging news du jour which needs to be confirmed by improved and sustained underlying improvement in unemployment, a bottoming in residential housing and a peaking in bank loan losses.

Until we see that, we maintain that we have hit a DEMAND bottom at the end of the first quarter but not a recession bottom. The second and third quarters of  this year will be “less worse” than the first but not an end to the  recession. We might see some slight improvement in GDP in this year’s  fourth quarter but more likely we will have to wait until 2010 for gradual economic recovery. Bullish reactions to this week’s economic news is  premature.