Another Spin of the Wheel


“We must take the current when it serves, or lose our ventures.” – William Shakespeare, Julius Caesar

The first week of November ushered in some important events – depending on your point of view, disappointments and/or victories. At the top of the list is the mid-term election, which in the end failed to deviate in any entertaining way from its preceding polls. The Republican party took uncontested control of the Senate, increased its hold on the House and come January, has dominance on Capitol Hill. Book-ending that result was the October jobs report, which was good but not great, disappointing my prediction of a stronger number (the unadjusted data was however stronger, as you can see below in the Economic Beat).

The full importance of the election result will not be known for many months, and there is an abundance of material elsewhere on the subject. For myself, I would echo economist Austin Goolsbee’s remarks, who observed rather smartly that the chances of getting any deal done before the election had been zero, but would now be cut in half.

There was the usual political show after the election of the two sides pledging to listen to any reasonable request to pass reasonable legislation – with barely disguised sotto voce observations that each side was perfectly willing to let the other agree to its own program and not much else.

I will sum up my own small mosaic of observations in this way – though the balance of power has shifted from the election, the nature of Washington politics is unmoved. No doubt there will be a flurry of symbolic votes and proposals shortly after the new Congress is seated, but the essential calculus will be business as usual: The Republicans do not have the White House, and would like to get it back. In pursuit of this aim, the chances of President Obama getting to sign a bill and even indirectly take credit for any major legislation, regardless of which side of the aisle it originated from, are zero.

The GOP’s tactical goal will be a focus on only passing legislation that can be seen as a clear victory for the party. It’s natural self-interest. Far from wanting to negotiate with the President and risk the chance of handing him some symbolic victory, the party will prefer attempts to craft bills in the Senate that can attract the half-dozen or so Democratic votes necessary to reach the magic sixty necessary to override presidential opposition. To get those votes will probably use a carrot-and-stick approach, with the carrot being appeals to moderate, at-risk Democrats with some kind of mollifying gesture thrown in.

The stick approach will be to soften up at-risk Democrats, most likely by launching a series of investigations (including the threat of impeachment proceedings) to weaken the President’s public standing and thereby encourage desertions predicated on self-interest. Such tactics do run the risk of turning public opinion back on the accusers, true, but the prospect of putting the President on the hot seat is pure political heroin for the junkies on Capitol Hill – for most, far too hard to resist. While the two chamber leaders, Speaker Boehner and soon-to-be majority leader McConnell, are probably less keen on launching any high-profile witch hunts that might backfire, as happened during the Clinton administration, their more vocal (and less experienced) members may leave them no choice.

As for the jobs report, it left unchanged the market’s perception of a rate rise in the middle of 2015. The jobs totals showed definitely enough underlying strength to worry the market, but the headline numbers are what get attention and set public opinion. The blowout number that I thought might spook the market (i.e., rates could rise sooner) did not come to pass, but the net additions were much better than you might guess from the adjusted total.

All of the above suggests that we are living in the calm before the storm, though it may not seem that way in the next week or two. With 50 companies left in the S&P 500 index to report, the blended growth rate for earnings in the third quarter is now 7.6%, the same as the second quarter (the heavy mix of retail companies this month could push this figure down a bit). The main difference from the second quarter is that estimates were cut even lower just before the outset (in June, Q3 earnings growth was estimated at 8.9%; by early October, 4.5%).

The market behaved well enough last week in consolidation terms that I would ordinarily think it ready for another move up. However, stocks are short-term overbought, the post-election victory lap seems to be ending, and the bull-bear ratio is flashing quite red, leaving markets more than usually susceptible to a jolt of discord. The pre-Thanksgiving period is often a rough one for stocks, despite the November-to-May period’s deserved reputation as one of outperformance – November performance itself usually lives off the first few and last few trading days. With Japan’s central bank now all-in and the Fed headed in the other way, that leaves only the ECB and China’s central bank as potential white knights for any (more than likely) further signs of economic weakness – and the ECB doesn’t look ready act until next month.

In the meantime, the return of the dreaded polar vortex is going to blast the central and eastern parts of the country in the back half of next week. Most of the scare stories from earlier in the fall – Ebola, the Middle East, global growth, Russia-Ukraine – have been quiescent the last couple of weeks. Combined with the steepness of the V-shaped rebound rally and the newly-reborn, backward-looking conviction of momentum traders that everyone must be fully invested at all times, it’s just the kind of situation that Mr. Market loves for sticking out a leg and tripping the unwary. The wheel so often spins right back to the same spot, doesn’t it?

The Economic Beat

The October jobs report showing 214,000 non-farm payroll additions was modestly below the consensus guess for 225,000. It was both more of the same – in line with the three-month average of 224,000 – and something of a puzzle. I suspect a heavy dose of data-fitting, but the Bureau of Labor Statistics is not about to confide in me. The salient point is that the underlying, unadjusted data points for October were well above the recent average and well above the average gain for the month of October, leaving me to wonder why the adjusted prints came in below. I suspect an upward revision is in store.

Last week I wrote that weekly claims data were pointing to a blowout number of 300K or more. When the 214K print crossed the tape, my first thought was that it was cosmic justice for my temerity it trying to predict such a notoriously difficult to predict number. However, although wage growth remained stuck on minimal, when looking at the unadjusted data on additions, the weekly claims data were indeed more or less on target.

The initial October estimate (unadjusted) has the year-over-year increase in non-farm payrolls at 2.03%, the best October annual increase since 1999. Net additions in calendar 2014 (unadjusted) are up by 1.84%, also the best year-to-date increase for the first ten months since 1999. What’s more, the September-October monthly change in unadjusted payrolls was 0.76%, the best showing since – 1987! It’s puzzling that last year’s smaller increase in unadjusted jobs – more than 10% smaller – resulted in a larger adjusted number – 237K instead of the current 214K. Had similar methods been used, the headline number would have been 251,000, above the nine-month average of 238,000. Still not 300K, but a lot closer.

The household survey also had some unusual data – to start with, an outsized increase in employment of 683,000. That number does fit better with the claims data, but comes with large caveats: based on a softer survey and using a much smaller sample, the household number is far more volatile. Over time the payroll and household series do converge, but in any given month the household number can be quite an outlier. Another oddity in the October data was the big jump in the labor force of 416,000. The average over the last year is only a little north of 100K and the September number showed a decline. It isn’t completely out of character, as similar jumps occurred in October 2012, 2008, and 2006. Maybe the even number is a factor, or maybe the school calendar can play havoc with the process.

Alas for wage growth, there is nothing new there either, nor any hidden clues that reveal something better. Average hourly earnings remain stuck at 2% year-on-year nominal growth, where they have lived for the last five years. Average weekly earnings are scarcely better, at 2.6% over the same period, the difference being entirely attributable in the last year to the 0.6% increase in hours worked. Wages are stagnant.

For the last 100 basis points or so of decline in the unemployment rate, optimists have been predicting that tightness in the labor market would lead to upward pressure in the labor market. These predictions usually come with anecdotes about tightness in certain trades and the odd story about companies having trouble filling skilled positions. But apart from actual recessions and the months immediately following, there are always spot shortages of some kind of labor somewhere - it isn’t as if you can simply FedEx families of skilled labor overnight, the way you can with goods. Teleportation being still unavailable as a method of commuter travel, the shortages don’t signal anything but the fact that the economic structure isn’t completely frozen in time.

Nominal GDP growth has been stuck at about 4% for the last four or five years. In the face of stagnant demand growth, companies are going to remain extremely sensitive to anything that might raise their cost structures. Nearly every corporate conference call I listen to (granted, Facebook (FB) isn’t one of them) contains at least one managerial boast about its cost-savings programs, and on the rare occasions I do hear plans about increased staffing, management usually sounds defensive, even embarrassed about it. That’s not the case with the go-go companies priced at ten or twenty times sales, true, but they are relatively few in number and unrepresentative of the economy at large.

Reports from chain stores showed softening during the last week, implying a modest number for the October retail sales report this coming Friday – another national category where year-on-year growth has been slowly but steadily descending. There was some pickup in September import purchases, but that has the effect, along with a lower export book, of putting downward pressure on the next estimate of third-quarter GDP.

The two ISM surveys both put up robust October numbers, 59 for manufacturing and 57.1 for services. They seem to have less and less correlation with actual output in our “new normal” economy, as factory orders fell -0.6%. Still, the latter number was a bit better than it looked, with the year-on-year rate in business cap-ex spending holding steady at 5%.

Construction spending may have fallen 0.4% in September – I say “may” because the number is subject to such large revisions. If the estimate broadly holds up, it might end up as another negative for third-quarter GDP – but the August decline was revised upwards. Private residential spending was reported as up, but mortgage-purchase applications are back near their lows on the year and trending at double-digit declines compared with 2013.

In general, the global economy seems to be on a path of gradual softening, as China, Japan and Europe struggle with their various issues. A great deal of hope resides in central banking, too much hope as I have often pointed out. Monetary policy can only cushion, not rebuild, and all the governments involved – including our own – have wasted the opportunity to address fundamental problems. It’s only human nature, after all – except during the worst periods, trying to make fundamental changes is nearly impossible and always politically suicidal. It took the Great Depression and the prolonged misery of the 1970s to bring about the last waves of change – perhaps the next downturn will make the public really want genuine reform, instead of the usual retreat to outdated slogans.

Next week will start quietly, with US bond markets, banks and government offices closed Tuesday in observance of Veteran’s Day (it was a stock exchange holiday for about 50 years, but you know, leaving all that money on the table was just so un-stock market…). The chief report of interest will be Friday’s retail sales report, followed in order of interest by the labor turnover report (JOLTS) on Thursday. China reports retail sales and industrial production on Wednesday night.

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