Thursday, August 14, 2014 - The Circular Capex Spending Problem

The Circular Capex Spending Problem
by Sinclair Noe

DOW + 61 = 16,713
SPX + 8 = 1955
NAS + 18 = 4453
10 YR YLD - .01 = 2.40%
OIL - .39 = 97.20
GOLD + .70 = 1313.90
SILV + .05 = 19.95

Iraqi Prime Minister Nouri al-Maliki stepped down today, a surprising reversal for a prime minister who a day earlier had assured his supporters that he wouldn’t step down unless forced out by Iraq’s high court.

President Obama says the US operations have broken the ISIS siege of Mount Sinjar. Thousands of Yazidi refugees were stranded on the mountain. Many of those displaced had now left the mountain and further rescue operations are not planned, however US airstrikes against ISIS will continue for now. And Iraqi and Kurdish forces fighting ISIS will continue to receive US military assistance.

Russian President Vladimir Putin said Russia would stand up for itself but not at the cost of confrontation with the outside world, which sounded like a softer, gentler Putin. Trust him about as far as you can throw him. Intense fighting continues as the Ukrainian military kept up its offensive to retake separatist strongholds in Eastern Ukraine.

A new, five-day truce between Israel and Hamas appeared to be holding despite a shaky start, after both sides agreed to give Egyptian-brokered peace negotiations more time. The second extension of the ceasefire, this time for five days rather than three, has raised hopes that a longer-term resolution to the conflict can be found; maybe.

The Missouri State Highway Patrol will take over the supervision of security in the St. Louis suburb that's been the scene of violent protests since a police officer fatally shot an unarmed black teenager.

Earnings season continued to wind down. WalMart reported earnings and revenue that met expectations, but the company cut its forecast for coming quarters. Last night, Cisco Systems offered a weak outlook for its current quarter and announced massive job cuts despite reporting revenue that beat expectations.

We’ve all heard of jobs offshoring; US jobs that once built the world’s biggest middle class, have been sent overseas, and it’s been going on for quite some time. The idea was heralded as free trade globalism and the argument was that it was merely mutually beneficial free trade; but American jobs have been lost and continue to be lost, not to competition from foreign companies, but to multinational corporations that are cutting costs by shifting operations to low-wage countries.

One result of offshoring is lower labor costs, but that also means lower wages. University graduates in the US are just as likely to be employed as bartenders or baristas as they are to get a job as a software engineer of plant manager. And there’s a good chance that recent grads are still living at home with their parents. More than half with student loans are having a hard time paying down student loan debt; 18% are either in collection or delinquent; another 34% have student loans in deferment or forbearance. And if they do find jobs, they find those jobs don’t pay well. Wages have stagnated.

Even though the economy has been adding jobs, it has not been enough to push a recovery in wages. In July, average hourly wages rose a penny to $24.45, a disappointing result after strong gains in June and May. In 23 of the past 24 months, the yearly increase in hourly pay has ranged from 1.9% to 2.2%, or about one-third less than usual during an economic recovery. The 12-month increase in wages as of July was just 2%; and inflation wiped out about three-fourths of that gain. There’s been no change since the start of 2014. While it might seem counterintuitive that wages are flat while jobs are being added, the likely reason is that there are a lot of poor paying jobs plus a few very good paying jobs. According to revised data from the Commerce Department, employee compensation, including wages and benefits, was lower for each year from 2011 to 2013 than previously calculated.

Jobs off-shoring, by lowering labor costs and increasing corporate profits, has enriched corporate executives and large shareholders, but the loss of millions of well-paying jobs has made millions of Americans downwardly mobile. Between October 2008 and July 2014 the working age population grew by 13.4 million persons, but the US labor force grew by only 1.1 million. In other words, the unemployment rate among the increase in the working age population during the past six years is 91%. Since the year 2000, the lack of jobs has caused the labor force participation rate to fall, and since quantitative easing began in 2008, the decline in the labor force participation rate has accelerated. Clearly there is no economic recovery when participation in the labor force collapses. In addition, jobs off-shoring has destroyed the growth in consumer demand on which the US economy depends with the result that the economy cannot create enough jobs to keep up with the growth of the labor force.

Some people argue that the problem with economic growth doesn’t start with wages and jobs, but rather with credit, and they point to graphs of the recent rise in auto loans; just as mortgages once fueled a housing boom, now, subprime lending is fueling a boom in auto sales. Credit tightened in the wake of the housing collapse and the housing market remains weak, while auto lenders have become aggressively permissive and US auto sales have made a huge recovery, leading some to argue that consumption depends on access to credit. This is wrong. Access to credit is the lubricant for the engine of economic commerce; it is not the engine. The real driver of the economy is good paying jobs.

There have been magnificent innovations in transportation, medicine, communication, and technology as commerce has spread globally. Credit did not create technological advances, people did. Money and credit could always be used to purchase the tools to make money in business, but money could never produce anything by itself; food, clothing, shelter, cars, and thousands of other worthwhile things were always made by the labor of people, not the sweat and intelligence of a coin or a plastic credit card.

The Federal Reserve just released a report showing that two-thirds of American households have no savings set aside for an emergency, and 40% are unable to raise $400 cash without selling possessions or borrowing from family and friends. Offshoring, by lowering labor costs and increasing corporate profits, has enriched corporate executives and large shareholders, but the loss of millions of well-paying jobs has made millions of Americans downwardly mobile. In addition, jobs off-shoring has destroyed the growth in consumer demand on which the US economy depends for expansion. Corporations are borrowing money not to invest for the future but to buy back their own stocks, thus pushing up share prices.

A new report from Morgan Stanley shows the average age of industrial equipment in the US is now almost 10.5 year old. That’s the oldest since 1938, at the height of the Great Depression. Nonresidential capital expenditure; in other words, spending on equipment, nonresidential buildings like factories, and intellectual property, has fallen short of the long-term trend by 15% per year. That means businesses have pumped into the economy $400 billion less than they normally would have every year. That's $1.6 trillion over the past four years, and it's affecting every sector. Spending has been down 14% on buildings, 16% on equipment, and 6% on intellectual property.

Instead of investing that money, corporations have been hoarding cash; by some estimates, corporations are sitting on a pile of almost $2 trillion. Occasionally they dip in for share buybacks. S&P 500 companies bought back an estimated $160 billion in stock in the first quarter; that would lag only the $172 billion in the third quarter of 2007, shortly before the worst bear market since the Great Depression. Repurchases are all the rage, but are all too often made for an unstated and ignoble reason: to pump or support the stock price. Another corporate incentive for buybacks is that a pumped-up share prices make the stock grants and options held by senior executives more valuable. Occasionally they dip into the cash pile for mergers and acquisitions. North American M&A activity stands at $1.2 trillion year to date, up 83% from last year. This year is almost certain to be the best year for M&A since the crisis. Boosting growth and returns through long-term investment in their business hasn't registered nearly as highly.

The problem then becomes circular: weak demand holds back capital expenditures, which drags on growth, which depresses demand. Productivity growth in the United States, the rate of growth in the level of output per worker, is near a 30 year low. Spending on research, development and technology, would surely improve this trend. Productivity alone does not spur capex spending. Rather, spending increases when demand increases. You don’t buy a new factory or new equipment unless your customers are spending. However if your customers are spending, you will happily invest in the facilities to fill their orders. But real median household income fell 10% between 2007 and 2012. And since the financial crisis, demand across the US economy as a whole has been far below trend.

Several of America’s great cities, such as Detroit, Cleveland, St. Louis have lost between one-fifth and one-half of their populations. Real median family income has been declining for years, an indication that the ladders of upward mobility that made America the “opportunity society” have been dismantled. So, now we face a tipping point, where we either start to reinvest in industrial production or watch the infrastructure turn to rust, and the US becomes a third world country.

The good news is that we are making progress in some areas. We add jobs every month, more than 200,000 jobs per month for the past six months. Capacity utilization is now up to 79%. US exports now top $2 trillion, the highest level in history. Despite the numerous false dawns since the Great Recession, analysts still expect capex to pick up. If it does, then the broader economy should benefit. Factories and equipment will have to be replaced, eventually. It might represent an opportunity; if we’re lucky.

Friday, May 02, 2015 - April Jobs Report

April Jobs Report

by Sinclair Noe

DOW – 45 = 16,512
SPX – 2 = 1881
NAS – 3 = 4123
10 YR YLD - .01 = 2.59%
OIL + .57 = 99.99
GOLD + 15.70 = 1301.60
SILV + .44 = 19.56

Today is another Jobs Report Friday. We will go into quite a bit of detail here because really, most everything we talk about in regard to economics begins with work and jobs. It is my hope that you will join us here on the first Friday of each month to get your comprehensive, fact based coverage of the jobs report.

Last month the economy added 288,000 net new jobs, and the unemployment rate dropped to 6.3%. April marked the biggest monthly gain in jobs since January 2012, when the economy added 360,000 jobs. Employment gains for February and March were revised higher by a combined 36,000; that raised the monthly average to 214,000 jobs a month since the start of the year. Through the first 4 months of 2014, the economy has added 857,000 payroll jobs, slightly better than the first 4 months of 2013, despite the harsh winter this year.

In the current 58 month expansion, employers have added more than 200,000 jobs per month in 38% of the months. Current job creation performance is stronger than it was in the business-cycle expansion that occurred during the recovery in the early 2000s, even when a real estate construction bubble fueled growth.  Today’s job creation pace lags well behind previous recent economic recoveries, such as 1970, or 1975 that saw job creation above 200,000 in about 60% of months. Needless to say, 200,000 jobs a month means a lot less today with a population that is more than 100 million people larger than it was in 1970. Total employment is now only 113,000 below the previous peak, so we should top that next month; however, the overall population has increased in the past 6 years, so there are still millions of people without jobs.

The report came in far above expectations. The consensus estimates called for 210,000 new jobs and the unemployment rate inching down to 6.6%, however there was a wide range of estimates.

The drop in the unemployment rate to 6.3% was the biggest monthly drop in 31 years and the unemployment rate is at the lowest level since 2008, but the drop in the headline rate was for the wrong reasons; the participation rate declined to 62.8% from 63.2%, meaning the labor pool fell by 806,000 workers. The unemployment rate is measured against a labor pool of people who are considered actively looking for work or working. When someone stops looking for work, they stop being counted, although it doesn’t necessarily mean they wouldn’t like work.

There are 2 major reasons why the participation rate has dropped: the first reason is demographics, and the second is the economic downturn.

Looking at demographics, the baby boomers are retiring in massive numbers, and not always voluntarily. However, many boomers are re-entering the workforce in a stealthy manner; the highest rate of entrepreneurship activity belongs to the 55-64 age group. It turns out the recession spurred new-business formation. In a "necessity is the mother of invention" scenario, it appears that many people who lost jobs started their own businesses. Of course, it might take some time for a new venture to be profitable and in the meantime, those people might not be counted as actively seeking jobs.

Meanwhile, younger people are staying in school, either going back to school for training or re-training, or dragging out school because of the high cost of education. An interesting point here is that unemployment for young adults age 20-24 dropped from 12.2% to 10.6% in April. Millennials getting jobs; or dropping out of workforce. We don’t know for certain, but one possible explanation is that graduates from the Class of 2013, that have been biding their time looking for a job or just unable to find a job, suddenly got very serious about taking any kind of job as the Class of 2014 prepares to enter the workforce.

Another age group we watch is the 25 to 54 year olds; they’re in their prime working years, too young to retire and unlikely to be in school. The 25 to 54 participation rate declined in April to 80.8% from 81.2% in March, and the 25 to 54 employment population ratio decreased to 76.5% from 76.7%. The participation rate for this age group should increase as the economy improves.

The other reason is the economic downturn, many people lost jobs and have had a very difficult time finding work, driving long term unemployment to unacceptable levels. The recent loss of unemployment benefits for the long-term unemployed is another way in which people fell from the ranks; in order to receive unemployment benefits, one has to actively look for work. As the benefits were cut, people still unemployed were cut from the ranks. Extended benefits were cut off beginning in late December. If the expiration of benefits was causing hundreds of thousands of people to drop out of the labor force, it should have showed up in the data in January, or February. It didn’t. Maybe the unemployment rate fell because of 806k drop in labor force, a lagged effect from expiration of unemployment insurance, or maybe there is just some statistical noise. We won’t know for sure until we see a few more months data.

What’s also odd about the decline in the labor force is how it happened. The number of so-called re-entrants, unemployed workers who have started looking for jobs again, fell by 417,000. That’s the biggest drop since the government began keeping records in 1967.  And new entrants into the labor force, such as graduates or immigrants, fell by 126,000. That’s the biggest decline in more than five years. Put another way, two-thirds of the drop in the labor force stemmed from people choosing not to enter in the first place. Normally a decline takes place when workers exit the labor force.

According to the BLS, there are 3.452 million workers who have been unemployed for more than 26 weeks and still want a job. This was down from 3.739 in March. This is trending down, but is still very high. And it does not mean that 300,000 long term unemployed workers found jobs; they just stopped being counted.

And there is still quite a bit of slack in the labor market, with approximately 7.5 million workers employed part-time for economic reasons; people who have had their hours cut back or people working part-time because they can’t find full-time work. When you add in those under-utilized workers, you get a different measurement known as U-6, which dropped to 12.3% from 12.7% in March. The number of people holding multiple jobs jumped by 133,000 from April 2013 to April 2014. Women almost entirely led this statistic, with the number of employed single mothers increased 1.4% over the past year.

Hiring was widespread and it doesn’t look like there was any one industry or sector that had an unusual jump. Professional services added 75,000 jobs, but about one-third were temporary positions. Employment and temporary help services added 28,000 jobs. Retailers added 35,000 jobs, bars and restaurants added 33,000 and the construction industry hired 32,000 workers. Industries where minimum-wage employment is most prevalent in the economy, accounted for 40% of total new private-sector job creation in April, excluding health care. Manufacturers generated 12,000 jobs, but this was disappointing in light of recent economic data pointing to increased manufacturing activity; yesterday, the ISM reported it manufacturing index had increased to 54.9 last month, up from 53.7 in March. Government also added 15,000 jobs, with state and local governments adding 18,000 jobs and federal cutting 3,000 positions.

Average hourly wages were unchanged at $24.31, reducing the year-over-year gain to just 1.9%. Consumer spending has been outpacing income growth, resulting in low saving rates, meaning workers have less discretionary funds, meaning a dwindling likelihood they will go out and spend at an increasing rate. Paychecks have actually become leaner since the recession officially ended. Real median weekly earnings for full-time wage and salary workers during the first three months of this year were down 3% from the end of the recession.

Looking at the types of jobs making up employment also provides a cause for concern. Among 13 industries that make up total US private-sector employment, the 5 with the lowest nominal average weekly earnings represented about 52% of private-sector employment gains over the past year. Leisure and hospitality employment showed the strongest growth among low-earning industries, added 412,000 jobs over the year through April, representing about 17% of total private-sector job gains.

Middle-earning industries, professional and business services, construction and manufacturing, represented about 40% of annual job gains. While higher-earning industries made up about 8% of added employment. Among the five industries with the highest weekly earnings, private-sector employers added about 194,000 of these jobs over the past year. Longer-term trends show lopsided jobs growth, with lower-wage employment ramping up in recent years. During the recession, lower-wage industries made up 22% of job losses. But over the past four years, these jobs made up 44% of employment growth, according to a recently released report from the National Employment Law Project. One indication that workers aren’t particularly confident is that quitting is below pre-recession levels, signaling that many workers are unwilling to trade some job stability and security to advance their careers.

Today’s jobs report was good, one of the best months we’ve seen in a long time, and we have a 58 month trend of job gains, which is a heck of a lot better than bleeding jobs, but the trend is still not strong enough. Nearly five years since the economy began expanding, the labor market continues improving, but at a frustrating pace for the 10 million unemployed workers and 3 million people not counted as unemployed who still currently want a job. Ongoing elevated unemployment is not only a serious drag for those families enduring it, but it will continue to drag on the overall economy until lawmakers get serious about full employment and creating quality jobs that deepen and secure the middle class. 

Thursday, April 17, 2014 - The Growth Industry for the Next 20 Years

The Growth Industry for the Next 20 Years

by Sinclair Noe

DOW – 16 = 16,408
SPX + 2 = 1864
NAS + 9 = 4095
10 YR YLD + .08 = 2.72%
OIL + .83 = 104.59
GOLD – 7.60 = 1295.60
SILV + .02 = 19.75

Stocks ended a holiday-shortened week with mixed results. Stock markets will be closed tomorrow in observance of Good Friday. The S&P 500 had its best week since last July. For the week, the Dow rose 2.4%, the S&P 500 added 2.7% and the Nasdaq advanced 2.4%.

With less than one-fifth of S&P 500 companies having reported results so far, about 63% have topped earnings expectations and 52% have topped revenue expectations. Of course that’s part of the dance between corporations and analysts, but it does move stock prices. For example, Goldman Sachs reported an 11% drop in quarterly profit and revenue fell 8%, but the results were better than estimates and share price was higher on the day.  Among the other earnings related movers today, Google, IBM, Mattel, and United Health were down on poor earnings news, while Morgan Stanley, GE and Pepsi moved higher.

The number of Americans filing new claims for unemployment benefits rose less than expected in the latest week and came near pre-recession levels. The Labor Department also reports weekly earnings of the typical full-time worker rose 3% in the first quarter compared to a year earlier, the fastest pace since 2008. Median earnings came in at $796, that’s the point where half of all workers made more and half made less. This means that earnings growth is now outpacing inflation in consumer prices, which increased at 1.4%. Earnings that rise faster than costs mean workers will have more money to spend on discretionary purchases, or maybe to shore up their personal finances.

This might indicate that the labor market is getting tighter, or at least working through some of the slack, as companies have to pay a bit more to retain or attract workers. Consumers that spend more, boost business profits, which means companies respond by producing more, which means more hiring and an even tighter labor market, which leads to higher worker earnings. Of course, this is just one report, and one report does not make a trend.

One of the reasons it might not be a trend is that the income is not evenly distributed. Recent Labor Department research shows that the top 20% of earners accounted for more than 80% of the rise in household income from 2008-2012. Income fell for the bottom 20%. That had a direct impact on spending. The top households increased spending by about $2,300 from 2008-2012, notably on health care, transportation and education. The 20% of households with the lowest incomes cut spending by about $150.

Top diplomats from Ukraine, Russia, the European Union and the United States have agreed on a set of measures to ease mounting tensions in eastern Ukraine. In Geneva today, Secretary of State John Kerry said the measures include disarming pro-Russian militants occupying buildings in eastern Ukraine and the return of the buildings to their legitimate owners. A joint statement from the four powers says amnesty will be granted to protesters who surrender weapons and leave the buildings, except for those found guilty of capital crimes.

Speaking at the White House, President Obama said he hopes Russia will honor the agreement but he also said that given past practices, there are no assurances of cooperation from Moscow. He said the administration is holding talks with European allies about possible new sanctions if Russia reneges on the deal.  The agreement does not specifically require Moscow to withdraw 40,000 troops massed on its border with Ukraine, and does not reference Russia's annexation of Ukraine's Crimean peninsula last month. It also does not obligate Moscow to hold direct talks with the interim government in Kiev. Peace monitors will be put in place and dialogue will continue, but this is a very real diplomatic move toward de-escalation. That’s good.

This has been a most unusual geopolitical act of aggression in Ukraine; it has revealed the use of sanctions as an economic weapon going up against the threat of cutting off natural gas supplies as an energy weapon.

In Russia, the economic costs have been masked by recent patriotic fervor but could soon haunt the Kremlin, as prices rise, wages stall and consumer confidence erodes; the major Russian stock market index dropped 10% in March; by some accounts, more than $70 billion in capital has fled the country so far this year; key interest rates jumped to 7% from 5.5% to combat inflation and support the ruble, a step that could slow growth; and unemployment has spiked. Beyond the whipped up patriotic fervor there isn’t much reason for Russians to feel good about their situation. The only thing positive for the Russian economy is its energy supplies.

And when Russia intervened in Crimea, they threatened to turn off the energy supply to Ukraine and Europe. The clock is ticking. Europe has about 6 months before the cold weather returns, to wean themselves from dependence on Russian nat gas.

One way to replace Russian gas is through home-grown renewable energy production. Today, the Ukrainian embassy in Washington DC hosted officials from the renewable energy industry to try and lure investment in green energy such as solar, wind, and biofuels. It will be interesting to see where this goes.

The oil industry would like to take the crisis in Ukraine and use it as an opportunity to flood the European market with fracked-in-the-USA natural gas. For this ploy to work, it's important not to look too closely at details. Like the fact that much of the gas probably won't make it to Europe because any gas fracked in the US would actually be sold on the world market to any country belonging to the World Trade Organization.

Plus, it would require massive infrastructure bailout in Ukraine and Europe; a single LNG terminal can cost $7 billion and it still requires massive infrastructure beyond the terminal. There could be a couple of very cold winters in Europe before those massive industrial projects are up and running.

Plus, there is the environmental problem of even more fracking in the US; Americans might put up with fracking in their own back yard if it results in energy independence and more jobs, but when you switch the argument to energy security for Ukraine and Europe, it becomes a tougher sell.

Plus, there is the concern about expanding fracking in light of the recent studies coming out in very plain and blunt language stating the climate is changing and fracking and burning carbon based fuels is a huge culprit. The gas industry itself, in 1981, came up with the clever pitch that natural gas was a "bridge" to a clean energy future. That was 33 years ago. That’s a long bridge.., to nowhere.

The answer is in renewable energy sources. If Russia wasn’t threatening to take away the nat gas, nobody would pay any attention to Putin. Real energy independence is also energy security, and it will be impossible to achieve as long as we rely on the oil and gas industry. So, how long would it take to become energy independent? Less than you might imagine.

It would take a big change in thinking and in political will, but we’ve done it before. During World War II, the US retooled automobile factories to produce 300,000 aircraft, and other countries produced 485,000 more. In 1956 the US began building the Interstate Highway System which eventually extended more than 47,000 miles and changed commerce and society. Clean technology is the answer, and not just because fossil fuels are cooking the planet but because the clean tech is more efficient.

Today the maximum power consumed worldwide at any given moment is about 12.5 trillion watts, according to the US Energy Information Administration. The agency projects that in 2030 the world will need almost 17 trillion watts of power as the global population and living standards rise, with almost 3 trillion watts being consumed by the US. That forecast is based on the idea that we continue with the current mix of energy sources we use today, which is heavily dependent on fossil fuels.

If, however, the planet were powered by clean technology, with no fossil fuel or biomass combustion, an intriguing savings would occur. Global power demand would only be about 11.5 trillion watts and the US demand would drop to only about 1.8 trillion watts. That means that in 2030, we would need less wattage than we need today; and that decline occurs because, in most cases, electrification is a more efficient use of energy. For example, less than 20% of the energy in gasoline is used to move a vehicle and the rest is wasted as heat, whereas 85% of electricity delivered to an electric vehicle is used to provide motion.

Of course clean technology would require massive infrastructure investment as well. The good news is that it is not money handed out by government or consumers but rather an investment that is paid back through the sale of electricity and energy, and because of the efficiencies and the advances in the technologies, it is cheaper than fossil fuel based energy. Energy will be the growth industry of the next 20 years; it is essential for a growing population and a standard of living; and as Putin’s intervention in Crimea has reminded us, it is essential for geopolitical stability.

Monday, March 10, 2014 - Disconnected

Disconnected
by Sinclair Noe

DOW – 34 = 16,418
SPX – 0.87 = 1877
NAS – 1 = 4334
10 YR YLD - .01 = 2.78%
OIL – 1.64 = 100.94
GOLD + .30 = 1340.80
SILV - .05 = 20.94

This is a pretty quiet week for economic data; Thursday brings a report on February retail sales; we’ll also see reports Friday on inflation at the wholesale level and on consumer sentiment. That’s about it.

Today, we ran across the Economic Report of the President, compiled by the White House Council of Economic Advisors, which discusses the progress of the recovery. The economic report serves as the administration’s analysis of the president’s $3.9 trillion budget, which he unveiled last week. The president’s top economic advisors say the nation is on track to make economic progress over the next two years, but say it would do even better if Congress would enact the additional spending he proposed in his most recent budget. Yea, that’s not going to happen.

Even without new government spending, the economy should pick up a little, in part because the budget cuts moving forward won’t be as bad as what we’ve already seen. The economists think consumer spending has adjusted since the payroll tax cut expired more than a year ago. Increases in housing construction and greater business investments should give the economy a boost as well.

The report says gross domestic product should expand by 3.1% this year and 3.4% next year, which would be the best performance since 2005. The economy grew at a 1.9% pace last year. The jobless rate will average 6.9% this year, which may not be good news considering the rate is currently at 6.7%; but they think unemployment will decline to an average of 6.4% in 2015.

The report also says the two-year budget agreement in Congress through 2015 that ends “budget brinksmanship” and means “some stability during the coming year” will aid the economy. Also, households are building wealth, housing demand is gathering momentum, inflation remains subdued and global markets “are stable or improving.”

The report says the unemployment rate remains elevated and wages have been slow to rise for many Americans. Long-term unemployment presents a major challenge because these individuals may face stigmatization from employers or experience skill deterioration.

The report also looks at income inequality, stating: “Economic growth is an important determinant of poverty … as long as the gains are shared with those in the bottom of the income distribution. When growth fails to benefit the bottom, it cannot play a role in eradicating poverty. As such, the distribution of income can have a profound impact on the level of poverty. While the real economy grew at an annual rate of about 2.1 percent during the 1970s and 1980s, since 1980 economic growth has not produced the “rising tide” heralded by President Kennedy, as rising inequality left incomes at the bottom relatively unchanged.”

“Incomes in the top 20 percent of the income distribution rose dramatically until the 2000s and are about 50 percent higher today than in 1973. By contrast, real household incomes in the bottom 60 percent of the income distribution stagnated until the mid-1990s expansion, and today are little changed from the business cycle peak in 1973. A large group of poverty scholars have pointed to this rise in inequality as a leading explanation for the lack of progress in reducing poverty since 1980.”

The report also says “starting in the 1970s, inequality began its relentless rise and productivity growth became increasingly disconnected from compensation growth for typical families.” In other words, the American worker is very productive, we just aren’t getting paid for that productivity.

Of course much of the money made in the past 5 years has come in the form of stock markets returns compared to housing market recovery. When the economy slows down and there is a sharp decline in house prices, it is debtors’ net worth that is most heavily impacted, and from a recovery standpoint it is the debtors’ net worth that is in most need of repair.

The Fed’s bailout for the big banks further fueled the casino mentality of the big banks, which really further propelled the Wall Street rally. The Fed directly controls short term interest rates, and the area where the Fed had the strongest and quickest influence was on bond prices. Bond prices are inversely related to interest rates, so those holding long term bonds profited handsomely from the decline in interest rates. And it could well be argued that the housing market rebound was driven primarily by investors buying up foreclosed properties. As a result, we should not expect it to fuel household spending as we saw before.

We’re marking a 5 year anniversary of the bull market, back to March 09, 2009, with about 200% total return on the S&P 500. We should also mark the 14 year anniversary of the bear market of 2000. Back on March 10, 2000 the Nasdaq closed at 5,048; that followed an 86% gain in 1999. What followed? March 10, 2000 was the absolute peak of the market bubble: In one of the worst crashes in history, NASDAQ plunged 34% to the close on April 14th at 3,321; and the carnage continued with a 60% drop over the next 12 months.

And so, with the disconnection between the markets and the economy, you might wonder where we are headed. Nobody knows, but we have seen market inefficiency in the past and it usually gets ugly.

We’ve seen a lot of attention on the situation in Ukraine, but there has been some economic data out of China that bears a look. The first batch of Chinese February data was out over the weekend and showed some staggering shifts. Exports collapsed 18.1% year on year. There appears to be a sizable hit from the US winter as well with the trade surplus down two thirds month on month. And some contagion in emerging markets, which were down 20%. Imports were up more than forecast by 10.1% year on year but down 0.4% month on month. All of that added up to a crazy swing in China’s trade balance from a $32 billion surplus in January to a $23 billion deficit in February, a $55 billion dump in one month, and a big question mark about Chinese growth prospects.

Also, on Friday there was a default of a Chinese Solar company; not a big issue, in and of itself, but it points to further possible defaults. Today, the Shanghai Composite dropped almost 3%. Copper slipped 1.5%.  Copper tends to be sensitive to Chinese industrial demand and is having a horrible year.  The Chinese Yuan continues to slide, and is now at its lowest level since late last year.  Meanwhile, the ripples were felt across Asia, with Hong Kong losing 1.7%, Korea down 1%, Japan off 1%, and Australia off 0.9%. That little default in China may have set off some big ripples.

In today’s edition of banks behaving badly, the New York Times reports “Credit Suisse Documents Point to Mortgage Lapses”. Which is a big understatement of the problem. Anyway, Credit Suisse is being sued in Massachusetts, and a big batch of emails have turned up, and they paint a bad picture of how Credit Suisse, a major player in the American mortgage market, operated as the housing bubble inflated. The documents suggest that top officials at the bank routinely pressed subordinates to override due diligence standards and accept questionable loans that were subsequently bundled into mortgage investments.

The documents are noteworthy because Credit Suisse, unlike many other major banks, has refused to settle large lawsuits stemming from the mortgage crisis. The bank has long maintained that its operations were held to a high standard and that the mortgage investments it sold lost value largely because of the broad housing collapse, rather than its practices.

The documents, which were made public on Friday, include internal audits indicating that the mortgage unit’s activities worsened over time in 2004, and concluding that the unit could expose the company “to a significant and unacceptable level of operational, financial or reputational risks.”

The previously confidential documents raise questions about the bank’s decision to fight, rather than settle, cases filed by plaintiffs including the Federal Housing Finance Agency and the New York attorney general. In its lawsuit against Credit Suisse, the F.H.F.A. is asking for damages relating to $14 billion in mortgage securities purchased from the bank by Fannie Mae and Freddie Mac, the government-sponsored mortgage giants.  The New York attorney general’s case is seeking $11.2 billion to cover losses incurred by investors in the state who bought mortgage securities from Credit Suisse.

Many of the emails show the struggle between executives interested in keeping loan volumes high and those worried about the perils posed to the bank by its acceptance of risky mortgages.  In June 2006, for example, one Credit Suisse executive wrote an email about a fellow executive that said, “I spend my time playing defense from a guy supposedly on my team who won’t stop waiving credit guidelines until we’ve taken on so much water the firm will pull the plug. Trust me, when this Titanic goes down,” the executive concluded, that colleague “will be the guy on the bow proclaiming ‘I’m the king of the world!!!!!’ ”

Friday, March 07, 2014 - Jobs Report Friday and Aiming Higher

Jobs Report Friday and Aiming Higher

by Sinclair Noe

DOW + 30 = 16,452
SPX + 1 = 1878
NAS - 15 = 4336
10 YR YLD + .05 = 2.79%
OIL + 1.00 = 102.56
GOLD – 9.50 = 1341.90
SILV - .51 = 21.03

This is a jobs report Friday. Here’s what you need to know. The economy added 175,000 net new jobs in February; this topped estimates of 150,000. The unemployment rate moved higher to 6.7%, up from 6.6% in January. After two months of very bad jobs reports, we returned to just below average levels of 189,000 per month; not a great showing but not ugly. The December and January reports were revised higher by 25,000 jobs. So why did the unemployment rate go up?

The labor pool got bigger; more people were looking for work. The ranks of the short-term unemployed declined by 61,000 to 2.3 million, while the ranks of the  long-term unemployed jumped by 200,000 to 3.85 million, and the labor participation rate held steady at 63%, just above the generational low of 62.8% in December. That seems to be a discrepancy, but the unemployment rate is based on a separate survey of households from the one that tracks hiring by employers, and the household survey showed an increase of 264,000 in the labor force. The participation rate is still well below the range of 66% to 67% where it had been for the past 20 years or so.

The unemployment rate went up slightly because that 264,000 gain swamped an increase of 42,000 in the number of people who were employed in the survey, but was positive over all because it showed more people are looking for work. And in the age group of people we expect to be working, the 25 to 54 year olds, participation rate increased in February to 81.2% from 81.1%, and the 25 to 54 employment population ratio was unchanged at 76.5%. 

Last month 10.5 million people were unemployed; including 3.8 million who have been out of work for six months or more; while 5.5 million have moved to retirement, intentional or not; and 3 million are disabled and the number of people applying for Social Security disability benefits has spiked in recent years. Even though February saw more people returning to the labor force, the percent of the population working or looking for work remains near a 30-year low due to millions of dropouts during the recession. One of the consequences of long-term unemployment is the loss of job skills, or for younger workers, they never really develop job skills and may face a lifetime of lower wages.

Most of the jobs, 162,000 were in the private sector. State and local governments have been doing a bit of hiring, adding 19,000 jobs last month, while the federal government continues layoffs, cutting 6,000 jobs. Private sector payroll employment has now posted gains for 48 consecutive months and with businesses adding about 8.7 million jobs over that time, private sector payroll is almost back to the previous peak back in January 2008; just another 130,000 more to go; although that does not account for population growth. So, there’s a good chance private employment will be at a new high next month. And total employment will probably be at a new high before the end of summer.

State, local, and federal government had 32,000 fewer jobs than one year ago. This marks the 56th consecutive month, going back to July 2009, that government employment was down on a year-over-year basis, excluding the temporary jobs added for the 2010 census. If you count them, the string is 43 months, going back to August 2010. Still, by a wide margin, this is the longest string of government job cuts since the end of World War II. Governments now employ 15.9 percent of all Americans who have jobs. That is the lowest proportion since 2001.

The one area of improvement in government jobs seems to be coming from state governments because their finances are improving. While local government payrolls are holding steady, state-level payrolls have increased for seven consecutive months, pulling the number of jobs back up to 2011 levels. The main sources of new jobs have been education and healthcare.

An alternate measure of employment, the U-6, includes underutilized workers; the U-6 came in at 12.6%, down from 12.7%, and the lowest level since November 2008. There are still 7.2 million people working part-time for economic reasons; because they can’t find full-time employment or their hours have been cut back.

Once again the report highlighted the deeply uneven nature of the recovery in the jobs market. The unemployment rate for white people was 5.8%, for African Americans it was 12%, and Hispanics 8.1%, and unemployment for teenagers was 21.4%. Of the 175,000 new jobs last month, 99,000 went to women. Over the 12 months through February, women’s nonfarm employment rose by 1.07 million jobs, half of the total US gain of 2.16 million. A couple of years ago, women accounted for just 37% of annual job gains.

Here is the full breakdown of "young vs old" jobs since December 2007: those 55 and older have gained 4.9 million jobs. Those under 55 are still some 3.1 million jobs below their December 2007 level.

The quality of jobs has been a big concern for some time, however in February, white-collar professions including accounting, bookkeeping and consulting led the gains, as the professional and business service sector gained 79,000 jobs. Here’s the catch; one-third of the professional jobs were temporary jobs.  Blue-collar hiring was more muted with the manufacturing sector adding 6,000 positions and construction gaining 15,000. Retailers cut 4,100 jobs as a 12,000 gain in food and beverage stores was offset by a 12,000 decline in electronics and appliance stores. The leisure and hospitality sector added 25,000 jobs.

Average hourly earnings rose 0.4%, or 9 cents to $24.31 per hour; bringing the year-over-year gain to 2.2%; not much but a gain. The average workweek fell to the lowest level since January 2011, which might be due to the bad winter weather, but the weather-sensitive construction sector added 15,000 jobs last month. We know that the household survey took place during a week of storms in the northeast. The Labor Department also reported that 601,000 people in the household survey said they could not get to work because of the weather last month, nearly double the number who typically said that in February on a historical basis. So, weather had an effect, but at some point we just move beyond the weather excuse.

One interesting point about hours worked and hourly wages is that we can try to normalize this data by looking at average weekly earnings. In February, this number dropped slightly to $682.65 from $683.74. So, hourly wages were up  very slightly and hours worked were down a little, and it might be easy to explain this as weather related, but then we look  at average weekly earnings over  the past year, which would not be weather related, and earnings grew just 1.3%, which is the weakest earnings growth in 5 years.

The 175,000 net jobs added in February extrapolates to a pace of 2.1 million jobs a year, squarely within the long-term range. So we have a tepid jobs recovery; just enough to call it a recovery, not enough to call it a good recovery, not enough to instigate action to make it better, and not enough to see the virtuous cycle of job growth that feeds on its own strength.

It will likely be good enough for the Federal Reserve to put taper on auto-pilot. They will continue to trim back monthly bond purchases by $10 billion at their next FOMC meeting later this month. Yesterday, William Dudley, president of the Federal Reserve Bank of New York, suggested that it would take either a recession or an economic miracle to shift the Fed from its course.

Back in December, then-Fed head Ben Bernanke justified the taper as a program that was intended to foster job growth and that job growth was on track, so the work of QE bond buying was accomplished. Many Fed policymakers are still concerned about inflation, even though we’ve had more disinflation of late; and their thinking is they need to be properly positioned to raise rates if they need to battle inflation; before they could raise rates, they want to be out of the bond buying business.

Since the last quarter of 2012, nominal hourly wage growth has increased from 1.5% to the current 2.2%, while inflation has decreased from just under 3% to about half that pace now. That means that most regular workers were losing ground as price growth exceeded hourly wage growth; that seems to be changing now; wage growth is just a little more than inflation. That’s good but then we consider weekly earnings growth, which is around 1.3% annualized, workers are still losing ground to inflation, or at best – flat. So, this is not a reason to fear inflation, nor is it a reason for the Fed to raise interest rates.

The Fed’s target for unemployment is 6.5%, which doesn’t really sound like full employment. It wouldn’t be bad to do better; to get the unemployment rate below 6.5%; we really shouldn’t worry about the inflationary pressures of a tighter job market, in part because we haven’t seen any inflationary pressures, even though we are getting close to the target. Of course, the Fed may have limited ability to help on the jobs front. It would be nice to see more fiscal policy aimed at creating jobs. Inflation has not been an issue at all. The public debt has also not been an issue at all, and attempts to cut spending have been completely counterproductive and damaging to the short and long-term health of the economy.

Real wage gains for low and middle income workers would be a good thing. If people can start to get ahead, just a little, from their hard work, they are likely to take a more active role in the economy and that might mean we could eventually see some momentum in the economy. In other words, we still need to aim higher. 

Thursday, January 09, 2014 - A World Of Central Bankers

A World Of Central Bankers

by Sinclair Noe

DOW – 17 = 16,444
SPX + 0.64 = 1838
NAS – 9 = 4156
10 YR YLD - .03 = 2.96%
OIL - .67 = 91.66
GOLD + 1.80 = 1228.70
SILV + .02 = 19.65

If it's not one central bank, it's another. Today the European Central Bank and the Bank of England met to determine monetary policy. Back in November, the ECB cut interest rates to 0.25%, so there were no expectations of further rate cuts in today's meeting. In Britain, which is outside the euro zone, the Bank of England left its benchmark interest rate unchanged at a record low of 0.5 percent.

As the US Federal Reserve has been creating new dollars at the rate of $85 billion a month under Quantitative Easing, the Fed's balance sheet has been growing, even as the ECB's balance sheet has been shrinking. And even though the Fed announced it would scale back those purchases by $10 billion a month, that just means the Fed balance sheet will continue growing, just not as fast. Or the bottom line; the Fed is creating money and the ECB is not.

Today, Mario Draghi, the president of the ECB said he wanted to “strongly emphasize” his earlier promise to keep monetary policy easy for as long as necessary. And Draghi said the ECB was “ready to consider all available instruments” to address either further weakness in consumer prices or increases in short-term money market rates that could put stress on banks. He did not, though, specify what tools he would use. The fear in Europe is that a nascent recovery could sputter and that low inflation (0.8% in December) could turn into deflation.

When asked if the euro crisis was over, Draghi said, “The recovery is there, but it’s fragile,” and it was too soon to declare victory. Even that might be a stretch. The unemployment problem for much of the euro-zone remains lousy; stuck at 12.1% for the past 9 months, and in some areas, youth unemployment is still around 50%, very dangerous levels. The problem for the ECB is essentially the same problem the Fed faces – how to improve aggregate demand. The ECB has been offering cheap money to the euro banks but the credit isn't getting through to companies and households. Lending to small businesses in the euro zone shrank 3.9% in November from a year ago, the biggest decline recorded by the ECB.

And with the Fed taper ready to kick in, the hope is that other countries and other central banks will pick up some slack in the world economy. Draghi has promised to do whatever it takes, and today he reiterated that promise, but that has been the promise for the past couple of years, and a couple of years can easily turn into a lost decade.

Here in the US, Ben Bernanke's farewell tour included a luncheon on Capitol Hill with Congress-folk, where he received a standing ovation and some of his past critics seemed to go soft. Bernanke offered an optimistic view of the economy, listing the country’s booming energy sector, stronger financial institutions and modest federal budget deficit reductions as positive signs.  Bernanke indicated he is more worried about the economic fate of middle-class families than the federal budget deficit going forward.

Meanwhile, the newly confirmed Federal Reserve Chairwoman, Janet Yellen has granted an interview to Time magazine and here's what she says about the economy: "I think we'll see stronger growth this year. Most of my colleagues on the Fed's policymaking committee and I are hopeful that the first digit [of GDP growth] could be 3 rather than 2... The recovery has been frustratingly slow, but were making progress in getting people back to work, and I anticipate that inflation will move back toward our longer-run goal of 2 percent." On the housing market, which had a brief lull this fall: "I expect it to pick back up and I do expect a further recovery."

Talking about the Fed's QE program, Yellen seems to believe that higher home prices and stock market stimulation is helping the average family. She is clearly a believer in the wealth effect, even though I have to question what data she might be looking at. RealtyTrac just released its Home Equity and Underwater Report for December 2013, which shows that 9.3 million US residential properties were deeply underwater, or about 1 in 5 of every property with a mortgage. "Deeply underwater" is defined as worth at least 25% less than the combined loans secured by the property. There are fewer homeowners who are deeply underwater, but there are still millions who are in serious trouble, and the longer these homeowners remain in a negative equity position without relief in the form of a principal loan balance reduction, the more likely that foreclosure will become the path of least resistance for them.

And on the jobs front, recent data from the Economic Policy Institute shows we're still about 1.3 million jobs below the pre-crisis peak – that's just to get back to break even, and then we would need about 6.6 million more jobs to get to where we need to be, in other words, how many jobs would be needed to employ all the people who would be actively looking for work if the economy were running at full steam.

The 7% unemployment rate is misleading because it is based partly on people dropping out of the work force and no longer being counted as unemployed. The economy is not strong enough to create jobs, so labor-force growth is not living up to its potential. If people who have dropped temporarily out of the labor force were still looking for jobs, the real unemployment rate would be 10.3%, not 7%. In other words, Dr. Yellen's confidence in the wealth effect never filtered down to the actual labor force.

If labor force participation drops, if for whatever reason, millions of people are no longer counted as part of the labor force, as is the case in the US, it’s a troublesome indicator for the economy and the real employment picture. It also makes the unemployment rate, now 7%, look a lot less awful: if you’re not counted in the labor force, and you don’t have a job, you’re not counted as unemployed. There are millions of people in that category. And their numbers are growing, not diminishing. The irony of the U-3 unemployment statistic is the fact that while unemployment has gone down 30% since its 2009 peak, we have the lowest labor force participation rate in over 3 decades.

People 55 to 64 years old, the first forget-about-retirement generation, are staying in the labor force to an ever greater degree. In 1992, only 56.2% were still in the labor force, in 2012, 64.5% were. Similar for older folks. The participation rate for people 65 to 74 years old jumped from 16.3% to 26.8%. Reality is this: fewer people can afford to retire. And the further reality is that the older workers are getting paid less.

The pattern among employers in a downturn in managing the non-executive/senior managerial workforce was to push out higher-cost older workers in favor of cheap, high energy, less set-in-their-ways new hires. Lots of people over 40 were given the heave-ho. Some eventually found work at much lower pay, some became self-employed (it’s a lot harder than the business press lets on; 9 out of every 10 new businesses fail in the first three years), and some retired, living more modestly than they had wanted to.

But who is not making it into the labor force? Young folks. The participation rate for those 16 to 19 has plunged from 51.3% in 1992 to 34.3% in 2012. OK, the BLS explains that by an increase in school attendance, and that would be a good thing. But the 25 to 54 year olds? Even among them, participation rates dropped from 83.3% in 2002 to 81.4% a decade later.

Among the 18 to 34 year old “Millennials,” those lucky ones who’re official counted in the labor force, unemployment has been a nightmare, with double digit unemployment rates, still, nearly 6 years after the financial crisis. It’s even worse for the 16 to 24 year olds, whose official unemployment rate is still 15%. In prior downturns, the employment rate for young adults nearly reached pre-recession levels within 5 years.

In the Great Recession, young adult employment had not even recovered halfway by the same point. A quarter of all job losses for young adults came after the Great Recession was officially over. The lack of jobs had driven many discouraged young people from the labor force altogether. A recent report by Opportunity Nation estimates that 5.8 million young adults are neither working nor in school.

And on the issue of banking reform Yellen says Dodd-Frank is a good road map but there may be a need for further steps. Which may be the biggest understatement of the new year. The Dodd-Frank reform legislation has been moving forward at a snail's pace, and the bank lobbyists are still in the process of re-writing bits and pieces and generally eviscerating key components. And even complete fulfillment of Dodd-Frank along current lines will not end the problem of “too big to fail.” 

Still, it's nice to see an incoming Fed head act like she'll pay attention to the Fed's role as a regulator. Under Alan Greenspan, the Fed was more of a deregulator than a regulator. Under Ben Bernanke, the Fed seemed to be more concerned with crisis control, and any thoughts of regulation were subservient to not letting the banking system implode, even if the bankers had lit the fuse. Now that there is some level of equilibrium, Yellen may actually feel emboldened to … ah hell, let's not get carried away; nothing will change.

Wednesday, December 18, 2013 - According to Plan

According to Plan

by Sinclair Noe

Don't worry. Everything is going exactly according to plan. The Fed will taper just a little; cutting back to $75 billion a month in Treasury bond and mortgage backed securities; the cuts will trim back equally from both categories. You'll hardly notice.

The Fed said: "In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions, the committee decided to modestly reduce the pace of its asset purchases.” Great news for people in the hunt for a job; everything is good. And for those of you with two jobs, well your doubled efforts have not gone unnoticed. The Fed expects unemployment to dip to 6.3% to 6.6% by the end of the year, what with more people dropping out of the workforce and the participation rate shrinking. Besides, the current 7% unemployment is apparently just good enough to avoid civil unrest, or as the Fed calls it “progress toward maximum employment.”

The central bank also said it "likely will be appropriate" to keep rates near zero "well past the time" that the jobless rate falls below 6.5 percent. Again, this confirms that everything is going exactly according to plan..., for the bankers; for the rest of us – not so much. But if you are a banker, you have to love free money from the Fed.

It's not like they could continue QE forever; they were running out of stuff to buy. The federal deficit has been shrinking and that means fewer Treasuries. Mortgage rates have increased and that means fewer MBS. And as the Fed dried up supply, that would potentially lead to increased costs in executing QE. The Fed has already dumped $4 trillion on their balance sheet, and even with taper they'll purchase up to $900 billion over the next 12 months.

Inflation has not been a problem; disinflation has. QE couldn't get the prices up on just about anything but stocks and other financial assets. In the press conference, Bernanke said: “If inflation does not show signs of returning to target, we will take appropriate action.” Not sure what that is, but clearly $85 billion a month in QE wasn't the answer. Toss in the idea that our emerging market friends were getting miffed; the Brazilian finance minister sent a letter to the Fed before the FOMC meeting asking them to taper; something to the effect of just do it already!

And so the Fed just ripped the band-aid off the cut. I was a little surprised; it seems Grinch-like heading into the holidays and the Fed's big birthday bash. Goldman Sachs described it as “slightly more hawkish than expectations.” I thought they would wait until January or March, but in the long run it really won't matter. QE has not done the job intended because the money never went where it was most needed. Bernanke's helicopter hovered over Wall Street, the bags of money were tossed out, and sucked into a black hole, also known as the banks. The money never moved. 

The Fed created debt-free money and bought government debt with it, returning the interest to the Treasury. The result was interest free credit for the government; which was great for reducing the debt load, but the government never took the extra step of deploying super cheap money into the economy. And then the fatal flaw was that QE delivered money to the accounts of the creditors while doing nothing for the accounts of the debtors. There is still plenty of bad debt floating around, and there is still a debt problem. The Fed never extended its largesse to Main Street, and Congress is just contrary to economic growth.

In his final press conference after the FOMC meeting, Bernanke said “the recovery remains incomplete,” and he repeated the idea that tapering is data dependent, suggesting the Fed could always come back in and increase securities purchases on an as needed basis.

So Bernanke will leave the Fed in January and this wraps up, sort of, lingering loose ends; he'll hand over control to Janet Yellen and not leave her with the task of explaining taper. He leaves with one final short squeeze for the market bears. I'm not sure why the markets soared to new highs on this news, since it would seem to portend higher interest rates and higher interest rates tend to portend lower corporate profits and lower stock prices. But then rates have been going up anyway. Ah well, you know the old saying: don't fight the Fed, at least not today.

The Fed will taper; you'll hardly notice, because it was never meant for you and me, just whatever scraps might fall our way; what they call the “wealth effect”. Ben is leaving and maybe his legacy will be that everything went according to plan, it's just that the plan was all about Wall Street and not about Main Street. 

Wednesday, November 20, 2013 - Fed Minutes, Fed Conundrum

Fed Minutes, Fed Conundrum

by Sinclair Noe

DOW – 66 = 15,900
SPX – 6 = 1781
NAS – 10 = 3921
10 YR YLD + .09 = 2.79%
OIL - .01 = 93.33
GOLD – 32.40 = 1243.80
SILV - .49 = 19.95

The Federal Open Market Committee, Federal Reserve policy makers, met October 29-30, and to no one's surprise they did not change monetary policy. Today, minutes of that meeting were released. The policy makers “generally expected that the data would prove consistent with the Committee’s outlook for ongoing improvement in labor market conditions and would thus warrant trimming the pace of purchases in coming months.”

They think the economy is improving, despite the government shutdown and ongoing political dysfunction, the economy is getting better and the FOMC is considering how and when they can exit Quantitative Easing; they would like to scale back $85 billion per month in purchases of Treasuries and mortgage backed securities without triggering a rise in interest rates that could slow economic growth and wipe out gains in the labor market. That is not to say they are ready to raise their Fed Funds target for interest rates. That target has been right at zero and will likely remain at zero for at least a year or more.

They want to get out of the bond buying business without the market noticing, and independently pushing interest rates higher. It'll be a fine trick if they can pull it off.

In a speech to the National Economists Club, Ben Bernanke said: "I agree with the sentiment, expressed by my colleague Janet Yellen at her testimony last week, that the surest path to a more normal approach to monetary policy is to do all we can today to promote a more robust recovery," and he says, "The FOMC remains committed to maintaining highly accommodative policies for as long as they are needed."

Exactly how long the accommodative policies will remain in place is the $85 billion dollar question; the market is now guesstimating the Fed won't taper till March or maybe January. The idea is that they will wait for signs that the economy is strong enough to finally reach escape velocity. We're not there yet.

The National Association of Realtors reported that home re-sales fell 3.2 percent last month from September to a seasonally adjusted annual pace of 5.12 million. That's down from a 5.29 million pace in September and the slowest since June. A healthy pace is around 5.5 million. Sales of single family homes declined 4.1 percent, while condominium sales rose 3.3 percent. The median sales price of an existing home was $199,500 in October, up 12.8 percent from a year earlier and the 11th straight month of double-digit annual increases.

The 16-day partial government shutdown pinched home sales last month by creating uncertainty about the economy and slowing loan approvals: 13 percent of real-estate agents reported that transactions had been delayed. Now, that might just mean that sales were postponed, and they'll pick up in the next report, or it might signal a plain old slowdown.

The Fed's bond purchases have kept long-term interest rates low. Mortgage rates are still low by historical standards, but interest rates began to rise in late May on speculation the Fed would slow its bond purchase program. Add to that the idea that many younger potential home buyers, or first time buyers saw the carnage of 2006 and 2007 and they just aren't interested. In this past month's report, first time buyers accounted for 28% of sales, down from around 40% in healthier housing markets.

Cash purchases made up 31 percent of October's sales. This might indicate that the Fed's easy monetary policy has only been easy between the Fed and the banks. So, this gets right to the Fed policy makers' conundrum; how can they withdraw easy money from the markets without creating a slowdown; if the Fed stops buying mortgage backed securities, that would almost certainly make it even tougher to get a mortgage and the housing market would surely suffer.

One idea is to counter any taper of asset purchases by reducing the interest rate on funds that banks keep on deposit with the Fed. That's right, the Fed not only buys mortgage backed securities from the banks, but then they pay the banks to keep funds on deposit with the Fed, essentially discouraging the banks from taking the money and lending it out in the community and into the economy. This is something that might be a small step, worth considering, but the reality is that any Fed taper from QE will be met with a taper tantrum, and for now the Fed doesn't want to rile the markets.

This is not to suggest the economy is horrible; the Fed's assessment of a growing economy was reinforced with a report this morning that consumer spending rose in October, despite the shutdown, and suggesting upside momentum heading into the fourth quarter. Retail sales excluding automobiles, gasoline and building materials increased 0.5 % last month after advancing 0.3% in September. Overall retail sales rose 0.4% after being flat in September. Core retail sales last month were bolstered by gains in receipts at clothing, furniture, electronics and sporting goods shops, among others. Sales at electronics and appliance stores rose by the most since April.

Meanwhile, the Labor Department reported that inflation is a bit less than optimal; the Consumer Price index dipped 0.1% last month as gas prices dropped, after rising 0.2% in September; this was the first decline in 6 months. In the 12 months through October, the CPI increased 1.0%, the smallest gain since October 2009.

Stripping out the volatile energy and food components, the core CPI edged up 0.1%, rising by the same margin for a third consecutive month. Over the past 12 months, the core CPI increased 1.7%, matching the previous month's rise. A reminder that the Fed targets inflation at 2%; that's the level they want; less than 2% indicates a greater concern that disinflation could lead to deflationary pressures. All the more reason for the Fed to continue with its easy money policies.

The other target, or guidance, offered by the Fed is that they will stick with easy money until the unemployment rate hits a target of 6.5%; in last night's speech, Fed Chair Ben Bernanke, indicated that it is still a target but it doesn't mean that if the target is hit, it will automatically change anything. Bernake said:

“In the judgment of the Committee, the unemployment rate--which, despite some drawbacks in this regard, is probably the best single summary indicator of the state of the labor market--is sufficient for defining the threshold given by the guidance. However, after the unemployment threshold is crossed, many other indicators become relevant to a comprehensive judgment of the health of the labor market, including such measures as payroll employment, labor force participation, and the rates of hiring and separation. In particular, even after unemployment drops below 6-1/2 percent, and so long as inflation remains well behaved, the Committee can be patient in seeking assurance that the labor market is sufficiently strong before considering any increase in its target for the federal funds rate.”

Bernanke went on to say:

“When, ultimately, asset purchases do slow, it will likely be because the economy has progressed sufficiently for the Committee to rely more heavily on its rate policies, the associated forward guidance, and its substantial continued holdings of securities to maintain progress toward maximum employment and to achieve price stability. In particular, the target for the federal funds rate is likely to remain near zero for a considerable time after the asset purchases end, perhaps well after the unemployment threshold is crossed and at least until the preponderance of the data supports the beginning of the removal of policy accommodation.”

The Dow just skirted 16K and virtually the entire run-up of the stock market is based on one thing, and one thing only, the Fed pumping money into the markets.  That is it, that is all.  Since the market bottom the market has more than doubled, but jobs aren’t even close to recovering as a percentage of the population, Europe is still in crisis, and oil prices are still ludicrously high. You cannot have profits higher than actual productivity increases plus inflation plus population increase.  Anything more than that is not profit, it is fraud, underinvestment in real capital or it is diverting future profits to the present.

 The problems the economy has cannot be fixed by giving more money to banks and rich people and attempting to turn the housing market into a cash cow again. The economy requires targeted spending, to get off oil, to break up the big banks and other oligopolies, to open up the economy to actual competition, and to increase the pricing power of labor and reduce the pricing power of employers while making sure they don't run up against supply bottlenecks.  It does not require giving money to people who will simply use that money for more leveraged financial plays or to bury bad assets on balance sheets at mark to make believe.

To the extent a market works it must be regulated to be competitive, and assets must not be allowed to pile up in a few hands.  Financial profits cannot be allowed to be higher than non-financial profits, and the labor market must be tight, so that people are free to move away from jobs they hate (if your employees hate their jobs they should either be very well paid because the job is absolutely necessary, or it shouldn’t exist at all.) And the employees who are actually working need enough to actually live on. Did you hear about the Wal-Mart in Ohio that held a Thanksgiving food drive – for their own employees?

Whatever the Fed is doing or thinking about doing, the first step should be acknowledgment that the trickle down wealth effect from the housing market and the stock market is limited, very limited. As for the stock market, it is in fantasy land, entirely a creature of the Federal Reserve, almost completely divorced from the actual economy. Of course, the stock market can remain irrational longer than you can remain solvent.