Category Archives: Jobs Report

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Signs of Fragility in the Economy Point to an Impending Bear Market. What To Do Now To Protect Yourself.


  • The last jobs report was good news but it also indicates higher costs and full employment.
  • An “easy to hire, easy to fire” mentality is in the air.
  • Healthcare, cash or short term trades should be the best options in this situation.

Introduction

Last week the Nasdaq and S&P 500 reached yet another record high. Aggressive central bank stimulation pushes investors to disregard risks and look for any kind of yield or growth. Not looking at risk is the worst thing an investor can do, but they also shouldn’t fight the trend.

Even from a long term perspective the market is irrationally valued, and no one can know how long it will stay that way. Being in cash might seem logical but a 0.1% return looks much worse than the S&P 500’s 8.9% year-to-date return.

Today, we are going to analyze earnings as 86% of S&P 500 companies have reported them, but first take a look at Friday’s jobs report which sent mixed signals.

The Jobs Report

On Friday, the U.S. Bureau of Labor Statistics reported an increase in total non-farm payroll employment of 255,000 in July. The unemployment rate was unchanged at 4.9 percent which is great news for the economy but not so much for investors because it indicates that we are close to full employment. The unemployment rate has stabilized at 4.9% and wages have started to increase (2.6% over the year). Higher wages mean higher costs which have a negative effect on margins and earnings.

figure 1 unemployment rate
Figure 1: Unemployment rate. Source: Bureau of Labor Statistics.

Apart from the reach of full employment and higher wages, the fact that businesses prefer to hire more than to invest in equipment signals that corporations are not so optimistic about the future. They easily hire but know that they can fire with the same ease, if necessary. If you buy equipment, you are stuck with it in most cases.

figure 2 employment equipment
Figure 2: Lower equipment spending in favor of labor. Source: Bloomberg.

The “easy to hire and fire” effect is even more pronounced by the increase in the number of people forced to work part-time for economic reasons, which rose from 5.84 million to 5.94 million.

All of the above means that job numbers are fragile and can quickly shift in the opposite direction. This, along with slow GDP growth, will probably keep the FED on hold or result in minimally increased rates to hold off inflation.

S&P 500 Earnings

The second quarter of 2016 is the fifth consecutive quarter with a decline in earnings.

figure 3 earnings growth
Figure 3: S&P 500 earnings growth rate. Source: FACTSET.

The S&P 500 reported sales were flat in comparison to Q2 2015 which means that the increased hiring does not create growth but is necessary to merely keep up with the competition.

Analysts have postponed expected earnings growth to Q4 2016, which doesn’t mean much as they had expected earnings growth for this and for the next quarter. So, as always, analysts’ expectations have to be taken with a grain of salt.

From a sector perspective, consumer discretionary was the best performer with earnings growth of 10.7% which is logical seeing that consumer spending is the only growth segment of the U.S. GDP. But as consumer discretionary is not essential, any kind of bad news or tightening credit might quickly turn this trend around.

For investors interested in not taking on much risk if a bear market hits us, the healthcare sector continued its good news. Healthcare earnings grew 4.9% and revenue grew 9%. As we know that the global population is getting older, especially in the developed world we can expect demand for healthcare to stay stable, or fall the least in a recession or bear market. Therefore, finding good healthcare investments is essential for a defensive portfolio that is still open to growth in this bull market but limits the potential downside if things take a turn for the worse.

figure 4 sector
Figure 4: S&P 500 Earnings growth by sector. Source: FACTSET.

All other sectors are exposed to negative volatility because consumers are going to save on all things except for food and healthcare. With oil prices around $40 we cannot expect an earnings pickup in the energy sector.

The most important factor for long term investors is valuation. Lower earnings and higher prices have brought the current S&P 500 PE ratio to 25.25. If the FED is forced to increase rates due to high employment rates, corporate earnings will be further pressured downwards by the high debt levels and tightening credit will lower consumer spending.

figure 5 multpl
Figure 5: S&P 500 PE ratio continues to grow. Source: Multpl.

Conclusion

We are in a situation where the S&P 500 is consistently breaking new highs while there have been 5 consecutive quarters of declining earnings, slow GDP growth, lower productivity and where bank credit, the main factor for GDP growth, is about to tighten due to increased interest rates and full consumer indebtedness.

We cannot know for how long such a surreal situation will last, but as smart investors we have to be prepared for the worst and still try to grasp the benefits of the upside. As Warren Buffett has $66 billion in cash on his balance sheet, we might to also want think about having cash on hand just in case a bear market comes that will enable us to buy the bargains. As earnings yields are at 4%, that would be the opportunity cost for holding cash but we can hold cash for 5 years and still break even if a bear market comes along. It is difficult to mentally accept such a strategy as we are in the 7th year of this bull market, but some returns have to be sacrificed in order to lower risks.

Another option for diversification is to use a part of your portfolio for well-placed short term trades. The S&P grew minimally in the last two years but in the meantime it gave great trading opportunities. With stop losses and by knowing what you are doing, you can limit the time you are invested, thus lower the risk of being caught in a bear market while still creating healthy returns on the liquid part of your portfolio.

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Major Indicators Are All Positive, But Is It Time To Get Fearful?


  • Economic data is strong and positive.
  • Neither jobless claims nor consumer spending show signs of weakness.
  • The issues remain in valuations, optimism and low yields.

Introduction

In the post-BREXIT world, there is a lot of speculation but no one knows what will happen. This article is going to provide a general outlook on how the economy is doing and try to extrapolate trends while ignoring the noise provided by the media.

Unemployment

As initial unemployment claims are reported on a weekly basis, the number can be used to forecast the monthly job report. On Friday the Bureau of Labor Statistics will release its job report for June. The previous report was scary with 38,000 jobs were added, but the number of initial unemployment insurance claims still remains at multi-year lows as well as the current unemployment rate, which sits at 4.7%.

figure 1 jobless claims
Figure 1: Initial unemployment insurance claims. Source: FRED.

 

 

figure 2 unemploment rate and claims
Figure 2: Unemployment rate and claims since 1990. Source: FRED.

 

By plotting the unemployment rate and claims we can see that the unemployment claims precede changes in the unemployment rate. Any increases in jobless claims are clues that there may be trouble brewing though the market may not recognize it yet. What’s most alarming about the above data is the impossibility for the unemployment rate to stay stable. As it is coming close to the natural unemployment rate, we should expect a trend shift in the coming years, though what we cannot know is if the unemployment rate will drop lower or if it will go up next month.

Consumer Spending

Consumer spending is growing and shows no indications of slowing down. A slowdown in consumer spending is also a leading indicator, and only after it begins to drop does it indicate trouble in the economy.

figure 3 consumer spending
Figure 3: Consumer spending and GDP. Source: FRED.

 

Similar to consumer spending, the consumer sentiment index is a great signal for forecasting a recession. The index hit its lows in the midst of 2008 while the deepest part of the recession was half a year later. It is now at its pre-recession highs, which would indicate there is no trouble for now.

Since consumer spending is still strong and consumer sentiment sits at its pre-recession highs, neither of these indicators point to trouble in the short term.

4 figure consumer sentiment index
Figure 4: Consumer Sentiment Index. Source: University of Michigan.

 

Inflation

Inflation is tame compared to the 1980s, but it has picked up somewhat since the Great Recession indicating the economy is healthier.

Over the last 12 months, overall prices increased by 1%. Energy prices are at multi-year lows and favorable weather conditions have brought high crop yields which lowered food prices, therefore 1% inflation rate should be considered very good.

figure 4 consumer price index
Figure 5: Consumer price index (1984 = 100). Source: FRED.

 

Issues With The Above Data

With all of the favorable data, it might be tempting to pay higher prices for riskier assets, but that is exactly the biggest trap such economic indicators create.

A closer look at the above data shows that current indicator levels are similar to those from 2007, so even though they are all positive it might not be the best time to be heavily invested. Keeping in mind the essential investing quote of “being greedy when other are fearful and being fearful when others are greedy,” this might be the time to be fearful and wait for a future recession to be greedy.

figure 6 sandp gdp
Figure 6: S&P 500 and GDP since 2007. Source: Yahoo.

 

The market is far more volatile than the economy because investors tend to be overoptimistic in good economic times—as is the case now—and overly pessimistic in a recession. As all indicators are at their best levels, it is time to be fearful.

The issue here is that this is contrary to human nature as we are social creatures. Doing things differently than the rest of the pack makes us very emotional, but investors have to learn how to set emotions aside as markets and money have no emotions.

Valuations

Except for the fact that the market is finding it very difficult to grow and all economic indicators are more likely to worsen than improve in the next few years, another important indicator—which is the result of the positive economic developments—are valuations. Simply put, relatively high valuations increase the risk of holding stocks and minimize long term returns.

With 7 years of positive economic developments, investors should carefully analyze growth and clearly separate the growth coming from the general high liquidity artificially created by the FED, and real business qualities. A good way to do that is to look at debt levels. If revenues increase slower than a company’s debt level it means that the return on capital is lower than the cost of capital. Such a situation can be sustainable in an economic growth cycle but comes to an abrupt end at the first signs of a recession.

Conclusion

One has the be foolish to look only at the positive economic indicators and assume that everything is good and being long stocks is the best option. Stocks will be the first to react if any of the forecasting economic indicators turn negative, so careful stock selection is the only option to preserve capital in these uncertain times. Other risks come from exuberant optimism which inflates asset prices as well as low yields, which pushes investors toward stocks in search of higher yield, but which also comes with higher risk.

As we do not know when the economic winds will change, the current market volatility gives great opportunities to increase portfolio returns with well placed trades and a more active investing strategy.

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How the Jobs Report Affects Stocks


  • The April jobs report shows two sides: slower hiring and increased working times and wages.
  • The long term outlook is pessimistic due to the constant decline in the labor participation rate.

Introduction

On May 6, the Bureau of Labor and Statistics (BLS) released its monthly employment situation summary.

The report is released on the first Friday of the month for the previous month. It consists of two parts: one presents non-farm payrolls, hours worked and hourly earnings, and the other is created by surveying more than 60,000 households in order to extract the unemployment rate.

It is an economic indicator that investors and analysts anxiously look at as it is considered one of the best indicators in predicting business cycles. A rule of thumb is that an increase of 150,000 jobs indicates economic growth while any number lower than that indicates a weak job market and rough times for the economy.

Current Report and Long Term Trends

For April 2016, the jobs report showed slowed hiring and a slight increase in pay. Slower hiring could refrain the FED from raising interest rates. The non-farm payrolls rose by 160,000 and unemployment remained stable at 5%. This still does not mean much as those numbers are known to be volatile, but it is good to keep an eye on long term trends.

figure 2 us payrolls
Figure 1: US non-farm payrolls from 2006. Source: Trading Economics.

The interesting part of the above figure is the 2006-2008 period where the first periods of no payroll growth had already happened in 2006 and only later resulted in the 2008-2009 recession. Fortunately, the current situation is still far from the 2006 declines. FED Chairwoman Yellen targets 100,000 monthly job additions as a healthy measure for a stable and slowly growing economy with full employment.

Something to worry about in the long term is the US labor participation rate. Pre-recession levels were at 66% while they are currently a 62.8%. The long term decrease of 320 basis points lowers the productivity of the US economy and makes the low unemployment rate of 5% questionable as 3.2% of the population decided not to return to the job market. The main factor influencing such a state is an aging population and the Congressional Budget Office (CBO) projects the labor participation rate to fall to 60% in 2025.

figure 2 participation rate expectations
Figure 2: US labor participation rate outlook. Source: CBO.

 

A not so inspiring example of a declining labor participation rate is Japan. Its labor participation rate has been steadily falling since the nineties and resulted in prolonged economic stagnation.

figure 3 japan participation rate
Figure 3: Japan labor participation rate. Source: Trading Economics.

 

Fewer people working means less productivity and less productivity takes a big chuck off of economic growth. The above negatively influences the stock market in the long term.

figure 4 japan nikkei index
Figure 4: Japanese Nikkei index. Source: Yahoo Finance.

 

The Japanese stock index Nikkei is currently at the same point where it was in 1986.

Current Market Repercussions

In the short term, the constant publication of new economic indicators makes it difficult to assess the impact of the monthly jobs data on financial markets. The disappointment of the last job report that missed the consensus forecast of 200,000 by 40,000 did at first influence a decline in the markets but nevertheless the markets finished on a higher note as investors expect the FED not to raise interest rates due to the weaker job market.

figure 5 S&P 500 trading on jobs day
Figure 5: S&P 500 index on day of jobs data publication. Source: Yahoo Finance.

 

With Yellen targeting a 100,000 monthly payroll increase, the 160,000 for April does not look bad, but combined with the Q1 2016 GDP growth of only 0.5% it might indicate further procrastination in interest rate increases.

Hours Worked and Earnings

As companies are always reluctant to hire new employees, the hours worked can indicate where the economy is going. In April, the average workweek increased by 0.1 hour to 34.5 hours which means that companies are asking employees to work a little bit longer. Hourly earnings also increased by 8 cents to $25.53 bringing the year-over-year increase to 2.5%. Both increases indicate that there is more work and that the economy is doing fine. Also, these increases might push the FED to increase interest rates as the economy is reaching full employment and a 2.5% increase in wages is a good sign for the 2% target inflation.

Conclusion

This reports indicates one certainty: the US economy is not in any kind of stellar growth mode and such a scenario should not be expected anytime soon. The mixed results do not indicate a specific short term trend and thus imply stability, but stability is never the case in an economic environment. The long term outlook indicates slow growth as the quantitative easing and low interest rates keep the economy stable. Investors should be aware that there are increased risks attached to investing in the US economy, hopefully and probably they will not materialize but it is good to keep an eye on them.