The year began like the prior few with Wall Street pronouncing that the economy could finally stand on its own two feet. Riskier assets have rallied strongly once again. But a funny thing has happened on the way to this self-sustaining recovery. Much like the prior years, it has not arrived. Real final sales as reported in the recently released first quarter GDP report came in at avery weak 1.5% rate. We have endured the longest stretched of low growth since the 1920’s. To counter this fact, the government will soon be issuing a newly minted calculation of the GDP report to artificially concoct more growth.
We could not make this up if we tried.
The savings rate for consumers hit 2.6%, the lowest since 2007. Business investment in equipment slowed to 3% growth from 11.8% in the 4th quarter. Once again the talking heads had touted the strong growth of early 2013, but these numbers are troublesome in themselves because the inventory build within the GDP report suggests that second quarter growth is going to be hard to achieve. April’s just released ISM softened and many regional manufacturing surveys paint a picture of weakness. Last week, in a sign of frustration, the Fed blamed the pols in D.C. for the lack of monetary policy effectiveness.
April’s employment report was taken by the market as strong. Here is the take of Briefing.com:
“The underlying details point toward weaker consumption levels. The average workweek dropped to 34.4 hours in April from 34.6 and average hourly earnings increased 0.2%. The decline in workweek more than offset the increase in payrolls and earnings. Altogether, aggregate wages declined 0.3% in April. That would be the first decline in wages since January. We are working under the assumption that consumers will gradually raise their savings rate back toward the 3.5% that it averaged during most of 2012. If households increase their savings amid declining wages, there is no chance that consumption levels can remain positive. It would not be surprising, given these figures, if retail sales decline for a second consecutive month in April.”
In the first place, the total number of jobs added is not what we would have considered strong in the past. Secondly, aggregate wages do not shrink in a healthy economy. Thirdly, the big jump in part-time workers of 278,000 is another red flag. Finally, the broader measure known as U-6 total unemployment was up 0.1% to 13.9%.
Revenue growth has become a major concern in looking at earnings reports from a large list of companies like IBM, 3M, Procter and Gamble, Nestle, Apple, Amazon, and Caterpillar to name a handful. Bank lending rolled over in the first quarter as well and has been stuck at paltry growth rates since 2008, in essence explaining why Fed policies here are not helping the real economy (“you can lead a horse to water…”). The Fed’s new money just sits idle in bankreserves as money velocity craters. The S&P may be at record highs but most decision makers do not have the confidence this would typically reflect.
Just wait for the full impact of Obamacare later in the year!
We have seen some improvements in housing particularly in the cities that were the hardest hit, but much of that is the result of hedge funds rushing in to buy distressed properties. This is just the sort of speculative activity that currently reckless Fed policy evokes and it should be unsettling to us all because hedge funds are not natural owners. Look out below when they can’t rent their houses at the levels in their models.
Outside of the U.S., unemployment in Spain just hit 27.2% and incomes across the rest of Europe are imploding at an alarming rate. Slovenia appears to be the nation most likely to follow Cyprus into a bailout. France’s economy is a “basket case.” Perhaps most importantly, the Bundesbank just issued a scathing denunciation of the ECB’s bond rescue program as the German court reviews these policies. That court decision alone could derail efforts put in place to conceal the debt problems in the EU, which are only growing. Industrial profits in Chinaslowed to 5.3% for March from 17.2% growth earlier in the year and broader growth has been a negative surprise.
We could go on forever, but suffice it to say that the news has continued to worsen, emboldening those whose entire investment thesis is buy equities because the central bankers will magically levitate markets no matter what the news. Suddenly, discussion has changed from the Fed will ease up on QE because things are so good (let’s buy stocks) to the Fed will do more QE because things are so bad (let’s buy stocks). The common thread is “let’s buy stocks.” Japan is conducting QE and the ECB has mentioned giving a negative deposit rate a try after just lowering rates.
It matters not that valuations sit near the richest 15% or so of historical observations based on normalized earnings. Would you buy a business at a high multiples of peak earnings at peak profit margins when the economy is being sustained by extraordinary fiscal and monetary intervention and turning softer?
The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.