The deciders at the central banks have told us things were getting better when deep down most of us have known otherwise. Reality is a relentless master and it intervenes at inconvenient moments. Sustainable growth cannot be created out of thin air from a printing press in the Eccles Building, the home of the Fed. It looks like the final GDP numbers will show that the economy shrank in the first quarter as we suspected it might. The inventory build in that report is a cause for concern going forward. Retail sales for April were flat, so the second quarter is starting soft as well.
The average consumer is sitting out of the Fed’s fictional recovery. Their incomes are simply not growing. Most of the pundits wonder why “Joe six-pack” cannot be goaded into taking on just one more dollar of debt. That added debt might keep the party going for the markets, but that is the last thing already strapped borrowers need. Total consumer borrowing is going nowhere in spite of a subprime lending bubble in autos and another bubble in student lending.
When all the cheerleaders can point to in recent years is one small part of the monthly employment report and ignore everything else we have a problem. They disregard the seasonal adjustments and other statistical gyrations that go into the employment numbers and the overall message of that report by just looking at the total number of jobs created in the establishment survey. However, even that number is beginning to show that job growth has moved into a slower gear this year. In addition, people not in the labor force hit a record at over 93 million people in April. In a continuation of the trend, the jobs that were created last month were heavily biased toward the part-time variety and went disproportionally to those 55 and over who cannot even think about retiring. We also strongly suspect that the numbers still do not reflect that the fact that net new business formations are not as robust as assumed in the employment models, so jobs from small businesses are being overstated. To top it off, we have added a grand total of 1,000 manufacturing jobs across the U.S. in the last two months. Wow! That is a stunner you will not hear from many talking heads. Finally, the Fed’s own Labor Market Conditions Index has fallen by the most since 2012.
Even at these very low levels of economic activity, though, equity markets are cheering the weakness because participants believe it keeps the Fed at bay and may lead to more QE. That is their only hope. One day it will dawn on investors that they need growth to justify stock prices because markets already reflect low discount rates and peak margins as far as the eye can see. Without real growth, the number of companies whose cash flows shrink enough to alarm their stockholders will continue to build. We speak from firsthand experience. When one of our positions disappoints, it is the “same as it ever was.” QE does not insure against 10-20% hits on the day of a bad earnings report.
Corporate earnings numbers have joined commodities prices in implying the cycle has turned lower. Given soft economic growth, it is no wonder that expected “operating” or “fudged” non-GAAP earnings estimates for the S&P 500 for 2015 have dropped from a number around $137 a year ago to closer to $117 now. That is a 15% hit to expectations, yet that index remains close to all-time highs. Holy Fed bubble, Batman! In essence, the equity market rallied powerfully for two years into a meaningful decline in expectations.
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