July Employment: Not Good Enough

Morris Segall      business retrenchment, Capital Markets, Economic Growth, economic recovery, employment report, GDP, job creation, recession, unemployment

July’s employment report was hailed with a sigh of relief. Total new job creation was over 100,000 with private sector job creation in excess of 150,000. This was the highest level of private sector job creation since 241,000 jobs were created in April. In addition, May and June employment was revised upward by a total of 56,000 jobs. Revised job creation for the two months amounted to 99,000 rather than the 43,000 previously reported. These numbers were interpreted to allay fears the economy was about to recede into recession.

While the July employment gain and previous months revisions were encouraging, in our opinion, the gains were not much more than statistical and change little in our view of the weak current employment environment.  In virtually all of the key measures of the job market, the July data continued the picture of a diminishing and discouraged work force, working stagnant hours and suffering from diminished employment.

According to the Household Survey, the civilian labor force contracted by almost 200,000 in the month of July and is 400,000 persons lower than year earlier levels. The employment/population ratio has fallen to 58.1% from 58.4% in July, 2010 and is at a 28 year low. The number of people not in the labor force has risen to 86.4 million, an increase of 374,000 from June and 2.1 million higher than year earlier levels. The unemployment rate for July was 9.1%, virtually unchanged from the May-June levels and only fractionally lower than the 9.5% of July, 2010. In addition, 2.5 million people could find only part time work in July, an increase of 116,000 from June and over 200,000 higher than year earlier levels. The average workweek continued to be an anemic 34.3 hours, virtually unchanged for a year.  The average duration of unemployment in July rose to 40.4 weeks, up from 33.0 weeks in July, 2010. The total number of unemployed plus all persons marginally attached to the labor force and those working part time involuntarily, remained over 16%, virtually unchanged since April of this year and only fractionally lower than the 16.5% of July 2010.

On a more positive note, the important Professional and Business Services segment continued to show important progress with further gains in Computer systems design, Management and technical consulting services and Administrative jobs while temp jobs actually declined from May levels.

In summary, private sector job growth accelerated in July from weak levels of May and June. The job creation in the private sector continued to be offset by large job losses in the government sector, averaging 39,000 over the last three months. In fact, even with the increased job growth in July, net employment growth over the last three months averaged 111,000, down from an average of nearly 180,000 over the first four months of this year. This just isn’t good enough to foster increased economic growth or business expansion. While we do not believe we are currently in recession, an absence of improvement in recent economic data, including employment, will in our opinion, lead to further business retrenchment. This business retrenchment will be intensified by the recent downgrade of the U.S. sovereign debt rating and the resulting deterioration in worldwide capital markets. This has raised the possibility of a recession later this year and next.

Morris R. Segall

In addition

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

Prices Thwarting Housing Market Recovery

Morris Segall      economic recovery, home prices, home sales, homeowners, housing market, new homes

How many times recently have you heard homeowners complain that they are in the market for new homes, but wouldn’t even consider moving because they know they can’t get what their current houses are worth? That, in short, is the problem with today’s U.S. housing market. The demand is there. Unfortunately, pricing is not. As a result, prices are thwarting a recovery in the housing market. Morris Segall, President of SPG Trend Advisors, predicts the housing market won’t return to pre-recession levels until prices on existing homes firm and start moving up. That could be 2013, at the earliest. See Segall’s comments in a recent article in the Baltimore Business Journal: http://www.bizjournals.com/baltimore/print-edition/2011/06/17/is-latest-baltimore-area-housing-data.html?page=all

May Manufacturing: Pause or Peak

Morris Segall      consumer spending, Economic Growth, economic recovery, economy, manufacturing, slowdown, stock market, trends

The ISM national manufacturing survey for May fell precipitously from April levels, confirming the trend seen in regional manufacturing surveys released over the past two weeks. For a number of reasons, the economy, including manufacturing, is slowing as we proceed into the second quarter. This looks very much like the pattern in economic activity we experienced last year as economic growth peaked last March-April and receded over the summer before reviving in the fall and winter. The reasons for the slowdown this year are primarily related to the surge in inflation since last summer, led by huge jumps in food and energy prices. This has been a restraining factor on consumer discretionary spending and has put pressure on corporate profit margins. It appears the rising level of prices is causing businesses to reduce spending to a greater extent than consumers as the experience of the recent recession has taught businesses to move quickly to cut spending to protect profitability.

Another factor hurting manufacturing currently is the dislocation of orders and shipments from and to Japan as a result of the earthquake and tsunami that has devastated that nation and created havoc with its industrial production and shipments.

In addition, the contraction in economic growth in Europe and ongoing sovereign debt issues are suppressing exports to the weaker economies in the Euro zone.

The unrest in the Middle East and North Africa has dislocated business orders and shipments from that region.

Lastly, the huge decline in shipments reported in the regional and national manufacturing surveys in May, reinforce our belief that a significant factor in May’s manufacturing weakness is due to the severe storms experienced in April and May in the Eastern U.S. and particularly the Midwest. In all of the manufacturing surveys production measures experience some of the biggest declines in the month of May.

It is noteworthy that the category of “No Change” increased significantly in many of the regional and national surveys in May. The increase in this category in May raised the absolute readings in this category to levels that far overshadowed the levels of weakening responses in the surveys. We interpret this that more of the weakness in these manufacturing diffusion indices is due to a “flattening” in the key metrics rather than massive deterioration. In addition, employment in virtually all of the manufacturing surveys remained positive. We acknowledge that employment is a lagging indicator and further weakening in orders, shipments and backlogs will result in weakening trends in employment going forward. Surprisingly, in many of the manufacturing surveys, including the national, respondents were generally positive regarding the future and expected key trends in orders and shipments to improve from May levels. If we are correct in our assessment of the impact of weather on the May surveys, we would concur. Finally, it should be noted that in the national survey, 14 of 18 industries reported growth in May with only 3 industries reporting contraction and those three industries were not major capital goods sectors.

It remains to be seen if the manufacturing growth trends rebound in June and beyond. If so, the capital investment cycle that has led the economic recovery will remain intact. If not, and the May surveys are signaling a weakening trend, then we will have to face the possibility this cycle may have peaked.

We are not optimistic that if such is the case, the federal government will resuscitate it with further stimulus as it did last year. The absence of further strong growth in manufacturing will lead to reduced overall economic growth this year and into next. Because of the flagging growth in manufacturing and net exports so far this quarter, we will be re-evaluating our economic growth projections for the second quarter and the rest of this year. We will evaluate the May employment report before we make our revisions.

The weakness in the May manufacturing report along with a forecast of weak employment growth by the independent payroll processing firm, ADP, caused a major sell-off in the U.S. equity markets on Wednesday that is being replicated by Asian markets Thursday morning and likely will spread to Europe. The world capital markets are nervous about the outlook for world economic growth and financial stability and have become very volatile. Those outlooks will dim further if the U.S. economic recovery stalls out. This is why we have emphasized private equity and the investment themes of merger and acquisition, infrastructure investment and business growth financing in our capital market strategy for the intermediate and longer term (See our website article of January 6, 2011 and our website Economic and Capital Market Presentation of February 2, 2011). Recent events overseas and the fragility of our own economic recovery plus our long term financial difficulties, reinforce this strategy.

Morris R. Segall

First Quarter GDP will be a slowdown

Morris Segall      consumer spending, corporate profit margins, Economic Growth, economic recovery, first quarter GDP growth, flattening corporate profit growth, housing weakness, inflation, inventory reorder cycle, Japanese catasrophes, overseas political unrest, rising commodity prices, sovereign debt woes, weak housing prices

We have been expecting first quarter GDP, which will be preliminarily reported this Thursday, April 28, to be slower than the growth reported for the fourth quarter of 2010 (+3.1%) because we did not expect consumer spending to be sustained at the elevated level (approximately 7% annualized rate of growth in domestic sales) achieved in last year’s fourth quarter. Therefore, we had expected first quarter GDP growth to be in the vicinity of 2.5% with reduced consumer spending being offset by strong manufacturing shipments, including exports, and a beginning of an inventory reorder cycle to replenish the strong movement of goods in the fourth quarter of last year.

However, we have been telling our clients and audiences since early April, that first quarter GDP growth could be weaker than our initial 2.5% estimate due to the rising cost of food and fuel that was stifling consumer spending more that we expected and also causing a pause in the level of discretionary business spending as businesses evaluated the impact of higher fuel and commodity prices on near term profitability. In our February 2nd economic and capital market presentation to our clients, we highlighted the flattening slope of corporate profit growth being seen in the second half of 2010 and expected to continue in 2011. We pointed out to our audience that the easy and geometric gains in corporate profits coming out of the recession were going to have be replaced by greater unit volume growth and profit margin maintenance as the economic recovery progressed. The escalation in energy, commodity and service costs is definitely pressuring corporate profits in the first quarter of this year.

In addition, to weaker than expected consumer and business spending, housing weakened dramatically in the first quarter from bad winter weather and most importantly, excess housing inventory from high levels of foreclosures, which in turn caused a further weakening in housing prices. We have been forecasting the latter since last summer but the level of housing sales in the first quarter was extraordinarily weak. This will be a further depressant to the first quarter GDP.

Given the additional negative impacts on world economic growth from continued sovereign debt woes in Europe, the earthquake and nuclear catasrophes in Japan and spreading political unrest in North Africa and the Middle East, a slowdown in first quarter GDP in likely to be incrementally weaker. At this juncture, we have been using a revised estimate of approximately 2%, plus or minus for the quarter. The weakness in the first quarter could be made up over the remainder of the year if inflation pressures recede, geopolitical events stabilize and further gains in manufacturing and employment continue. At this point we are not reducing our full year estimate of 2011 GDP growth from approximately 3% but current trends are troubling. We will have further to say after this week’s preliminary GDP announcement and the upcoming publication of our updated economic outlook presentation on our website.  

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

Intel’s Second Quarter Earnings—A real “Green Shoot”

Morris Segall      2009 economy, business landscape, earnings report, economic, economic recovery, economics, GE, Intel, trends

In our July 5th blog entry, “June Employment Report–Green Shoots Fading“, we commented that a doubtful economic recovery expected in the third quarter and pessimistic earnings guidance from companies reporting second quarter earnings this month would in our opinion herald stock market corrections here and abroad near term. Since that posting the Dow Jones Industrial Average declined approximately 5% in the ensuing five trading sessions before rebounding on expectations of robust bank earnings to be reported this week. Indeed, Goldman Sachs reported a “blowout” quarter led by its investment banking activities. However the more significant earning news yesterday came from Intel that reported a surprisingly strong second quarter highlighted by a surge in revenues and unexpected expansion in gross margins from increased unit volumes of consumer products. Even more importantly, the company reestablished earnings guidance for the remainder of the current fiscal year as the outlook for its business became more visible and positive. This is the kind of earnings encouragement that is necessary to sustain the market recovery begun last March. To be sure, Intel’s business turn may be truly singular to itself and not indicative of a broader upturn in the technology sector but as a bellwhether in the industry and in the major market averages, the substantial improvement in Intel’s performance and outlook lead us to believe we are at or near the bottom of the earnings cycle for non-financial companies. Indeed, we feel Intel’s results signal the same kind of shift in corporate earnings we saw at the opposite end of the spectrum in early 2008 when we wrote our article, “GE, the Earnings Cycle and Food”, April 14, 2008. In that article, we noted the deterioration in GE’s first quarter 2008 earnings and the very negative implications for the rest of S & P 500 corporate earnings last year.

The Intel results reflect successful new product introductions, stringent cost control, inventory reduction and strong sales. The strong sales reflect strong demand for PC products from China and the U.S. aided in the latter by bargain selling prices by the company’s resellers and buying stimulus from accelerated write-offs offered by the Federal government. The higher sales volume and cost reductions allowed the company to record much expanded gross margins in the quarter despite lower average selling prices and lower unit margins on consumer products. This has been a theme of ours supporting a positive outlook for common stocks led higher by rapidly increasing corporate profits from increased gross margins from increased unit sales volume.

The new, improved visibility for increased unit sales, continued cost controls and tight inventory control is allowing the company to forecast improved gross margins for both the third and fourth quarters of the current fiscal year which may force analyst earnings forecasts to be raised. This is also reinforcing another of our themes for the recovery cycle, namely the pent up demand for computers that can only be deferred for so long before a new sales cycle begins. Currently, the new demand is coming in consumer products but the company expects business demand to pick up next year for the same reasons. Importantly, the higher end business products carry higher unit margins which should amplify Intel’s earnings when the economy recovers.

Thus, we are encouraged that the Intel earnings report contains the seeds of a bottoming in earnings in the technology sector and possibly other areas of Producers Durable Equipment sector, i.e. capital goods as pent up demand, bargain purchase prices, accelerated equipment write-offs and fast return on investment and increased productivity lead to a recovery in this sector. We expected this sector to be a leading element in the economic recovery forecasted for next year due to short lead times for purchase and profitable returns. The Intel earnings report and new guidance give us reason to believe in that forecast. And yet we still believe in our comments of July 5th that many companies will not have the positive guidance outlooks of Intel, i.e. consumer discretionary, real estate, transportation to name a few. In view of this and the continued weak near term economic environment, we still believe the capital markets are vulnerable near term to the downside as economic and corporate earnings remain weak. Neverthless, our intermediate and longer term outlooks are reinforced by the Intel results.

Morris R. Segall, CFA, CIC