Fri, MAR 4th, 2016
Things are not as bad as financial markets have led investors to believe. Year-to-date, the Dow Transports and junk bonds – pockets that led the market lower since the second-half of 2014 – have performed much better than the broader indices. And since the February 11th low in the stock market these same pockets continue their fresh market leadership higher. Small caps are now beginning to participate, as is high-beta. Indeed, risk appetites have improved.
But why? What has changed over the past few weeks? Fundamentally, not much. Perceptions, a lot. Allow me to explain.
First, everyone became too bearish. It’s that simple. At this year’s market bottom over 90% of utility stocks – the most defensive group in equities – were trading above their 50-day moving averages and yet only ~18% of all S&P 500 stocks could boast the same feat. In the bond market the 10-year US Treasury – an exemplar proxy for safe haven demand – fell to ~1.63% back on February 8th, fear-driven lows not seen since January 2015; early 2013; mid-2012; and late-summer 2011. Meanwhile, key sentiment surveys like the highly followed AAII were showing bearish moods two standard deviations above the long-run mean; bullishness, two standard deviations below. Historically this type of hyper over-extension has meant that stock returns 6- and 12-months out have high odds of being above average. At some point markets inflect. Nobody can perfectly time nor pick the exact pivot points. It just happens. And in hindsight the mounting evidence as to why the turn happened becomes apparent.
Second, recession fears became overblown. Those of us paying attention to the economic data were never quite able to make the connection between the recessionistas’ message, the screwy behavior of the financial markets, and the healthy fundamental information underpinning the US economy. Households are doing fine, sporting record high net worth while debt servicing costs are at 25-year lows. The consumer continues to spend. Inflation is modest, with low energy costs that’ll ultimately be a net benefit to the economy. Banks are healthy, and we’re seeing sensible credit growth. Confidence is buoyant. Housing is on the mend. The auto market is strong. And the business cycle, excluding adjustments to cratered oil & gas earnings and the strong dollar, is growing at a +6 to +8% annual pace. Despite these facts the term “recession” had seen a +46% jump in Google searches since the beginning of the year, a clear disconnect between the evidence and the emotion.
And then there’s jobs.
This morning we received our monthly peek under the hood to see how the engine of the US economy is doing. The assessment: the mechanics are looking very good. Consensus estimates among economists for February job growth was +190K; we picked up +242K. Prior months revisions amounted to an additional +30K jobs. In an economy with approximately 150.5M folks currently employed (a record level), February’s 7.8M still unemployed, the same number as in January but down 831K year-over-year, embodies a pretty solid labor economy. For additional color, in February there were 599K discouraged workers — people not currently looking for work because they don’t believe jobs are available for them and therefore are not considered unemployed — which is down by 133K from a year earlier. What’s clear is that jobs continue to be created in this country and new hiring is strong. Monthly net job gains over the past three months have averaged +228K, and +222K over the past year. The unemployment rate (U3) remained steady at 4.9%, while the much maligned under-employment rate (U6) dropped to 9.7% from 9.9%. (Note: the spread between U3 and U6 has continued to drop as I predicted it would, and is now down to 4.8%, which is equal to pre-2008 levels and in line with the longer-run trend).
Wages in the February report were slightly down on a month-over-month basis. But this isn’t too surprising when you consider that January levels hit highs for this cycle with a growth rate versus December logging the second quickest pace on record. On a year-over-year basis wages grew +2.2%. Given that the Yellen Fed implicitly shifted their primary focus from the “full employment” part (box checked!) of their Congressional decree (the dual mandate) to “price stability” (managing moderate inflation), February’s temperate wage pace probably gives the Fed more cover to hold off on hiking rates further while providing enough economic thrust for stable aggregate consumption. A nice balance for financial markets.
Finally, in what may be the most surprising labor market trend of all these days, labor force participation continued its slow upswing hitting 62.9% in February. This marks four straight months of rising labor force participation. Have we finally seen cycle lows in this metric? Maybe. OK … I’ll say it, yes. But the secular dynamics at play – primarily an aging US population, a point I have long argued – will continue to keep participation a few percentage points below its all-time highs (~67.5%) set 15 years ago when baby boomers hadn’t yet begun to retire. Indeed, full cyclical adjustments by my math would place the “new normal” level for this labor figure around 64% for the foreseeable future.
This economy has made extraordinary progress on many fronts, and especially in terms of job growth. We have added +14.3M new jobs in this expansion in what has been the longest and strongest run of job growth since the boom of the 1990s. In fact, we’ve now added jobs every single month, uninterrupted, for 72 months in a row – the longest recorded streak since record-keeping began in 1939. And we’re not done just yet. At the current level of job openings, pace of initial claims (i.e., job losses), new hires, and labor force growth, the unemployment rate (U3) should be around 4.1% by the end of 2016 – the lowest rate since the year 2000.
The one thing we’re really missing in this recovery, in this labor economy, is healthy productivity growth. Its curious absence has restrained efficiency, output, and above all real incomes making it difficult for the economy to truly take off above a +2.0% to +2.5% real GDP pace. But this topic is deserving of an entire blog of its own, and is not in the scope of this editorial.
So … was the stock market too negative in January and the early part of February when recession was purportedly just around the corner (and here, here, here, here, here, and here … I could go on)? Or ghast! worse yet, perhaps we were already in one! I think the answer is clear, and stocks are now attempting to “reprice” this more constructive view. A view we’ve consistently held throughout this volatility (and here, here, and here). As far as the global economy is concerned, expect a +3% trajectory for 2016. A far cry from a global recession.
Jason L. Ware, MBA / Chief Investment Officer
Albion Financial Group