Pouting Pundits of Pessimism

On June 12th, 2012, posted in: Economic News, Newsletter by

The Pouting Pundits of Pessimism hyperventilated over the weaker-than-expected 69,000 increase in May payrolls. There was also a downward revision in first quarter real GDP growth to 1.9%, the 10-year Treasury yields dropped to 1.5% and a stock market went back to zero for the year. Here come the bears, the predictions of doom and gloom and repeated prophecies of the end times upon us. So with all of this staring investors in the face, what happens? The markets advanced while Ben Bernanke, the Fed Chairman, testified before Congress. And even though he didn’t give any specific plans to implement QE3 to stimulate the economy, just the prospect of it, may have been enough? Who knows? These Pouting Pundits failed to note the Fed’s “Beige Book” noted moderate growth overall, highlighting unexpected strength in auto manufacturing and steel. With the continuing shedding of jobs in the public sector, this growth is not likely to boost the labor market enough to offset the pessimism. Unemployment is predicted to remain high through the end of the year, an election issue for the current Administration. With the Triple Crown no longer in the headlines, we can call this the Plow Horse Economy. It is not a race horse, but it’s not going to roll over and die either. There is nothing in the latest data or market action pointing to a precipitous decline or disaster in the economy looming on the horizon. Even with the European noise, our economy is not in recession and there is no evidence of one coming anytime soon.   You may remember the optimism these pouting pundits had during the winter months, when the payroll numbers were relatively robust. The pessimists complained then about a declining labor force. But now they ignore the fact the labor force rose by 642,000, while the participation rate rose to 63.8% from 63.6% in April. But good news does not sell media.   Unfortunately for the PPs, the jobs report is not the only area that defied their ardency. The most recent household survey (which also captures small business) reported 422,000 new jobs. This was not enough to overcome the shrinkage in the public sector, so the unemployment rate ticked up to 8.2%. But this acceleration in the household numbers suggests the job market is not as bad as some think. Much is made of those who have given up. And while this is true, the actual jobs are increasing in the private sector.   Recent news has promoted the idea that when an economy slows to below 2% real GDP growth 70% of the time, a recession follows. What is that supposed to mean? It is common sense an economy will decline if it is going into recession. Duh! Regardless, the government’s recent revision to construction data revised the real GDP rate above 2% for Q1.   So why a Plow Horse economy and not a Race Horse economy? The answer is not the one politicians are looking for – look at Europe and the impact high government spending, high taxes, and high regulation have had on their growth and employment for the past three decades. This is the Europe the current Administration so admires and wants us to emulate. If a race horse carries a 250 lb. jockey or you make a plow horse drag the plow through stumps and roots in a field, what is going to happen? When government becomes a burden it slows growth and reduces jobs. It is that simple. The only way to get a permanent acceleration – in real GDP, incomes, and job growth – is to lighten the load. There is some good news. The US has a four step plan to make this happen and all of them are coming to the fore this year.   First is the Wisconsin recall election where Scott Walker retained his position as Governor with a resounding victory. This was good NEWS for Wisconsin. A Walker victory should cause more reforms in other states.   Second will be the late June Supreme Court ruling on Obamacare. All admit Health insurance is an important issue. But reasonable people disagree about the solution. A government takeover signals increased growth in government spending and regulation which impacts the entrepreneurial spirit and increases uncertainty. If the court declares Obamacare unconstitutional, there will be a new enthusiasm in the market.   The third is the November 7th presidential election. Voters will get the chance to tell our legislators what they think about the size and scope of government. “Core” government spending – outside of defense, TARP, interest and entitlements – has hit a record high in recent years. Voters have the chance to greatly reduce the amount of GDP controlled by Washington. Finally, the fourth opportunity is the end of the Bush Tax Cuts. Effective January 1, there are scheduled tax hikes on income, capital gains, and dividends and this has become a wall of uncertainty for business. If the first three steps happen, then it is likely, the tax cuts will be extended. These four steps bring us to a cross roads. Will the US continue to head toward a European existence or will it remain the bastion of free market enterprise and capitalism for the entire world to emulate? As each step and the consequences continue to unfold, the importance and momentum of these decisions will also become more visible to each of us. I remain confident America is a predominately conservative, “center-right” country that respects its Constitution and laws. If that is true, we may discover our Plow Horse is really a thoroughbred in disguise. A look at the past few events shows the Plow Horse nature of our economy:

  • Consumer credit, especially credit card debt continued to slow. Analysts at Vanguard (www.vanguard.com), the large financial institution said, “… consumers seem reluctant to assume more credit card debt because of the job market and slow income growth.”

For an economy based on consumer confidence and spending, this is NOT good news. But then again, too much credit and spending isn’t either. Can’t win either way. The U. S. trade deficit held steady, with both imports and exports down about 1.5%.  Slower growth in China and the looming recession in Europe all point to a reduction in the trade sector. The trade deficit in goods and services came in at $50.1 billion in April. This was slightly larger than the consensus expected deficit of $49.5 billion. Exports declined $1.5 billion in April, while imports declined $4.1 billion. The changes in both exports and imports were led by capital goods, such as aircraft. By comparison, last year, exports were up 4.1% while imports increased more, by 6.3%. Implications: Imports and exports both declined in April, but, a larger trade deficit in the last quarter of 2011 could mean real GDP growth declined in that quarter, below the 3% level now shown. By the same token, it might also mean a large upward revision for Q1 when that “final” report comes out. Given the upward revision to construction and trade, real GDP growth might have been in the 2.5% to 3% range in Q1instead of the current official estimate of 1.9%. Factory orders slipped lower, another negative for the jobs market. Nonfarm productivity (output per hour) declined at a 0.9% annual rate in the first quarter   revised down from last month’s estimate of -0.5%. Nonfarm productivity is up 0.4% versus last year. Real (inflation-adjusted) compensation per hour in the nonfarm sector declined at a 2.0% annual rate in Q1 and is down 1.5% versus last year. Unit labor costs rose at a 1.3% rate in Q1 and are up 0.9% versus a year ago. In the manufacturing sector, the Q1 growth rate for productivity (5.2%) was substantially higher than among nonfarm businesses as a whole. The faster pace in productivity growth was due to output rising much faster than hours. Real compensation per hour was down in the manufacturing sector (-2.4%), and due to the increase in productivity growth, unit labor costs fell at a 4.9% annual rate. Implications: Productivity was revised down slightly for the first quarter, consistent with last week’s slight downward revision for real GDP growth. Output was revised down while the number of hours worked were revised up, which means less output per hour. Productivity is up only 0.4% in the past year, versus an average annual growth rate of about 2% over the past couple of decades. However, we do not think this means the productivity revolution has come to an end. It is not unusual for productivity to surge at the very beginning of a recovery (productivity grew 6.1% in the year ending in Q1 2010) and then temporarily slow down as hours worked increase more sharply. Nonfarm productivity declined -0.9%, and unit labor costs increasing +1.3% – this poses a trend worth watching as a predictor of inflation. Only our high unemployment rate keeps these two from adding more inflationary pressure to the economy. The ISM non-manufacturing index rose to 53.7 in May, coming in slightly above the consensus expected 53.4. (Remember, levels above 50 signal expansion; levels below 50 signal contraction. This is a indicator of which direction the economy is going. ) The key sub-indexes were mostly higher in May and all remained above 50, signaling expansion. The new orders index rose to 55.5 from 53.5 and the business activity index gained to 55.6 in May from 54.6. The supplier deliveries index rose to 53.0 from 51.5. The employment index fell to 50.8 from 54.2. Implications: The service sector accelerated slightly in May, narrowly beating consensus expectations. A small increase in the index is usually not much to get excited about. But, given the awful financial news coming out of Europe, which is creating dour sentiment holding down the index, it’s great news that it beat the consensus. The ISM services index has now remained above 50 for 29 straight months signaling continued growth. The business activity index, which has an even stronger correlation with real GDP growth than the overall index, rose to a solid 55.6, nowhere close to recession territory. Initial jobless claims remained high at 377,000. Bottom Line:  Overall, the U. S. economy is a plow horse working at 15 mph in a 25 mph zone.  This is not likely to change much until after the election. Besides the damper this puts on the US economy,  there is the entire global economy to consider. For Europe to mend its banking and sovereign debt woes and right their ship, is going to take courage rarely seen in that part of the world in recent years. Get ready for a long, slow ride, but remember, there is a thoroughbred in there somewhere. WHAT IS HAPPENING IN THE MARKETS With all this doom and gloom, the markets surprised most everyone last week by advancing sharply after a precipitous fall. After almost giving back all of the gains for the year, the Dow [+3.59%; +2.76%], the S&P 500 [+3.73%; +5.41%], and the NASDAQ Composite [+4.06%; +9.72%] all posted gains.  The Dow even regained positive territory for the year. Past performance is no guarantee of future results. Indexes are not available for direct investment. There are lots of reasons why this may have happened. Here are just a few factors impacting the world economy:

  1. Spain is no longer in denial. The country finally admitted the banks need about $125 billion to keep them afloat.
  2. European unemployment hit 11%. This is the highest level since the Eurozone began keeping records in the mid-1990s.
  3. Greek elections are scheduled for June 17 and there is no discernible outcome that is predictable. This may or may not be confirmed by the audits which are due near the end of June.
  4. There is significant labor unrest Italy and there are potential riots brewing in both Greece and Spain.
  5. There is a significant flight of capital occurring in the Eurozone, $2 billion per day. Investors are looking for safety. The money is flowing to both Germany and the USA.
  6. German Chancellor Angela Merkel seems ready to participate in the salvation of Europe. She may agree to support a fiscal union along with Eurobonds.

A fiscal union in Europe is the equivalent to the “third rail” of European politics.  Nobody is anxious to implement it.  In a recent report, it was speculated eleven different governments have fallen around the Eurozone in the past year. This is the US future if we don’t turn back. If this roller coaster continues, which it likely will, the U. S. stock market will continue to reflect the uncertainty and be volatile.  Looking ahead to the election, it is likely to be very close. Much closer than the McCain / Obama blowout. This is too much uncertainty for the market. As a result, we may see a lot of two steps forward (or back) and then one step in the other direction until it sorts out. Treasury yields jumped sharply this week, gaining back what they had lost the previous week.  That is a repeatable pattern as well. It is unfortunate that every hiccup in Europe cause indigestion in the US and sends investors clamoring for Treasury bonds.  But equally likely, every calm reverses the flow of money. Makes no sense, but that is what happens. The Fed appears to be riding this out. So don’t look for much help here. This may have a lot to do with the fact that there is not much they can do. For consumers, the oil price of $84.10 has caused gasoline prices to fall. FINANCIAL FACT OF THE WEEK The most recent GDP report shows government spending in the U. S., both federal and state combined, at about 20% of GDP.  In Europe, the governments are spending 40-50% of their GDP.  The combined tax rates in the U. S. are around 30%. In Europe, the combined rates are closer to 50%. There is a message in there for us.


This information is compiled by Guy Baker from an assortment of news feeds including First Trust, Yahoo Finance, Bloomburg and others. This information is intended to be informational only. This newsletter contains forward-looking statements about various economic trends and strategies. You are cautioned that such forward-looking statements are subject to significant business, economic and competitive uncertainties and actual results could be materially different. There are no guarantees associated with any forecast and the opinions stated here are subject to change at any time and are the opinion of the individual strategist. Investing involves risk including the potential for loss of principal. Data comes from the following sources: Census Bureau, Bureau of Labor Statistics, Bureau of Economic Analysis, the Federal Reserve Board, and Haver Analytics. Data is taken from sources generally believed to be reliable but no guarantee is given to its accuracy.


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