This time just might be different

“This time is different” has come to be known as the kiss of death phrase when regarding the future prospects of a particular asset or economic situation. Rightfully so, as we’ve seen bubbles like tech stocks and real estate blow up and burst while the majority of investors try to figure out where it all went wrong. Well, here we are today with the U.S. economy at a point that has many financial pundits warning of a recession or some type of crash. While I would not be so brash as to say such warnings have no basis, I would say that we need to look at what has happened to the economy that could actually make things different this time.

This past week we got several data points covering the services and manufacturing sides of the economy along with some employment data. It’s the employment data which I believe holds the key to understanding what is different this time around. While recessions can be triggered by many different things, what they all have in common is a rise in unemployment. The most recent weekly initial unemployment claims print came in at 265,000 which is a historically low number.

claims 3.27.16

As I have stated before, until this number starts to rise consistently over 300,000 the labor market is strong which translates to a strong economy. That said, let’s take a look at what has changed in labor market dynamics.

According to the NBER, whose data begins in 1854, the economy has had 33 cycles (recessions). During that time, the economy has evolved from being manufacturing / export based to services / consumption based. This evolution has allowed the economy to be more self-sustaining as it is driven by domestic consumption versus being dependent on foreign demand. This evolution has in turn led to an extension of the average length of economic expansions. If we adjust the NBER business cycles to reflect the evolution of the economy, we get a good metric for average expansion lengths.

Biz Cycles 3.26.16

The current cycle stands at 81 months and can arguably go on considerably longer when we factor in the changes to the labor market. It’s been the shift from manufacturing based labor force to one of services that makes all the difference.

Services based jobs have a much more sustainable quality to them than export based ones. For example, healthcare and education services in the U.S. and most developed markets are nearly perpetual in nature. Then we have Professional and business services which includes computer code writers and other dynamic technology oriented professionals. Essentially, industries for which there is always demand. In the charts below, I have drawn a comparison between Manufacturing, Professional and business services (PBS) and Total private employment. All three categories are titled and defined by The Bureau of Labor Statistics which is the source of all data used in the charts. I chose PBS because it best represents a broad range of service industries. The below charts are based on every recession that has occurred since 1945 as defined by the NBER. 1945 is the earliest starting point for which data was available for all three series.

The first chart shows the average number of jobs lost on a monthly basis as a percentage of its total industry. For example, in the recession of 2001, manufacturing lost an average of .81% of its workforce on a monthly basis while PBS lost just .43%. Then in the Great Recession, they lost .83% and .47% respectively.

recession 3.27.16

As you can see, throughout history, PBS has always been more resilient to downturns than manufacturing.

The second chart shows the monthly average number of jobs recovered (or decline in job loss) in the first six months after a recession has ended.

postrecession 3.27.16

The takeaway from these charts is that PBS has outperformed manufacturing in terms of losing fewer jobs during a recession and then recovering them more quickly after a recession. This outperformance is a function of the self-sustaining nature of services labor and suggests that a longer than average expansionary cycle is possible. Furthermore, as the workforce becomes more services based, future recessions should be shorter lived as employment is able to recover more quickly. The great news here is that not only are we building a more sustainable workforce, but we are also building a workforce that earns more as PBS earns 18.6% more than manufacturing on an hourly basis. The table below puts the earnings significance of services in perspective. The top three service sectors account for 58% of total earnings and employs 57% of total private payrolls.

total earnings 3.27.16

As for the actual manufacturing and services data received this past week, it was a fairly mixed bag. On the one hand, we actually got some strong manufacturing data from the Richmond Fed which goes along with other solid regional Fed data from New York and Philadelphia. Even the Kansas City Fed report, which had been abysmal, managed to come in less negative. Along with the regional Fed data, we got the Markit Flash Manufacturing PMI which came in at 51.4, up literally a tic from the previous month’s 51.3. A gain is a gain though. The Markit report also showed that employers increased their hiring.

Then, on the other hand, we got a very weak durable goods report on Thursday that took some of the steam out of the manufacturing recovery narrative. It’s still too early to tell what is going on in manufacturing, but it does look like activity is picking up overall. This is a welcome improvement from 2015 when manufacturing was basically missing in action all year.

On the services side of things, we got the Markit Flash U.S. Services PMI which moved back into expansionary territory at 51 from last month’s 49.7. While the Markit report had a pretty downbeat commentary, it did say “service providers signaled another solid increase in payroll numbers during March.” I look at employment as a leading indicator, so comments like that tell me business must be picking up. We also got a very favorable services report from the Richmond Fed which unfortunately went essentially unmentioned in the media. The report cited rising activity, wages and employment. So between general employment data and the various manufacturing and services reports, we have an economy that keeps chugging along.

To sum it all up, the economy remains on solid ground and is positioned to continue to grow. We have a significant amount of economic data due out this week which ends with the ever important nonfarm payroll report on Friday. A payroll report with both strong job creation and wage growth could be enough to push the Fed’s hand to raise in April. While such a move would most likely be rough for equities at the onset, a healthy economy will take them higher in the long run. While I would be surprised to see a rate hike next month, it is still possible. All this said, don’t be surprised if this expansion keeps on going and equities get to new highs. As history has proven, things change…It’s called evolution.

This bull market has plenty of room to run

There was a lot of talk in financial media last week about the seventh birthday of the current bull market and if we may be approaching the end of it this year or next. While I was glad to hear people acknowledge that we are in a bull market, I don’t so much agree with the age and certainly not the proposed longevity of it.

While you can call March 2009 a bottom and start the meter running from there, I think that gives too much credit to the early years when the economy was still struggling and then discounts the later years. For instance, S&P 500 operating earnings didn’t regain pre-crisis (2006) levels until 2011. Also, we were still having negative nonfarm payroll prints through September 2010 when we lost 52,000 jobs. Looking at the chart of the S&P 500 below, we didn’t really start a sustained upward move until 2012, which would be a more fitting starting point since the turbulence of late 2011 is excluded.

All that being said, I find it tough to associate 2009-10 with a period like 2013-14 when companies had much stronger earnings and the economy was creating jobs. Saying this bull market is seven years old seems to make it easier for people to say it’s about to end. For me, a bull market encompasses not only rising stock prices but also a positive economic backdrop.

Now, for the longevity of this bull market, it really depends on one’s view of the U.S. economy and the global macro situation. Based on that view, a person can look at the chart above and say the S&P is either at a top or a bottom. (For the record, it’s a bottom to me.) In terms of the U.S. economy, we know for a fact that the labor market is strong and arguably at full employment. The most recent weekly initial claims data showed a drop down to 259,000, which is so low, you’d actually have to go back to the week of Aug. 18, 1973, to find a lower print. The reason why the initial claims series is so important is because it’s as close to a real-time indicator of job losses in high turnover/cyclical industries as is possible. Then, when we look at claims data in comparison to job openings, we see there is still room for claims to go even lower. (In the chart below, weekly claims data have been aggregated to monthly periods to match the job openings data.)

The point here is that the labor market is strong and still has room to tighten. Hence, consumption is set up to be strong.

As a result of a strong labor market, and not to mention cheap gas, we’ve gotten some great news on the retail front. On Wednesday, Darden Restaurants (DRI) raised its third-quarter earnings estimates because of stronger-than-anticipated sales. The DRI news really ties in well with the data on increased gasoline demand and record driving amounts that we have gotten recently. Literally, people are going out to eat more often.

Then on Thursday, we got reports from a couple of true consumer discretionary names. Ulta Salon (ULTA) posted 11.8% year-over-year comparable sales (stores open 14 months including online sales), which helped send the stock up 17% the next day. Then we had the parent company of Zara (global fashion retailer Inditex) report 15.4% year-over-year growth in sales and 15% year-over-year growth in net profits for 2015, with Zara being a strong performer for the group. So we can add these names to the likes of Under Armour (UA), Foot Locker (FL) and Home Depot (HD) to see that strong consumer demand is there. In the case of the retailers that are missing earnings, it’s more from offering the wrong products and not from weak overall demand. (Under Armour is part of TheStreet’s Growth Seeker portfolio. Foot Locker is part of the Trifecta Stocks portfolio.)

On the global macro front, we’ve gotten some very encouraging news over the last few weeks. It pretty much all starts with oil and then finishes with the ECB seeming to have finally come up with the correct combination of QE tools to get things going in Europe. In the last month, oil has gone from roughly $26 to just over $38 a barrel, which has allowed U.S. and emerging markets as represented by the iShares MSCI Emerging Markets ETF (EEM) to rally along with it. Reasons abound for the rally in oil, but I suspect that the producers, namely Saudi Arabia, looked into the abyss that $26 oil was bringing and didn’t like what they saw.

Along with oil, there has also been a nice rally in the metals complex ranging from iron ore to copper. This has taken pressure off emerging markets and then, by default, the U.S. Even though the rallies are mostly being driven by an expected reduction in supply and not increases in demand, whatever gets the global deflationary death spiral off the table works.

As for Europe, it’s still very early to tell how all the policy tweaks announced by the ECB on Thursday will work out, but markets have reacted positively so far. Having read various sell-side reports and other private investor opinions, it seems the ECB’s shift to focus on credit growth vs. negative rates is the right approach. The reaction to the ECB so far in F/X could become a major tailwind for U.S. companies doing business in Europe. Since the announcement, the euro has rallied significantly vs. the U.S. dollar. If this trend holds up, we can hopefully eliminate the strong dollar roadblock to better corporate sales and earnings.

Coming up this week, we have several major data points along with the Fed meeting. The only thing really missing from the lineup is nonfarm payrolls. As for the Fed, I’m not expecting it to raise rates. Given the turbulence we just got over and the near-zero expectations in the fed funds market, it will hold for now. However, I would expect some hawkish language given the strength in labor and recent inflation readings.

As for the economic data, there are several interesting items. Retail sales on Tuesday could show a large gain. The only issue here is if the extra volatility we had in February somehow spills over into the sampling data. Considering the company reports I have listed in this article and the others we’ve gotten, we should get a strong print. That said, if we don’t get a strong number now, I would expect next month’s to be that much better, assuming we don’t go back down the oil rabbit hole.

Then we have industrial production (IP) and the Philly Fed Manufacturing Survey, which go somewhat hand in hand. IP was up nicely in its last report and Philly Fed came in less negative. If manufacturing is showing some reversion to the mean, then maybe we get some reasonably OK prints here. Again, I don’t expect much out of manufacturing in general.

On Thursday we get the JOLT survey, which measures job openings and quit rates. This is one of Janet Yellen’s favorite indicators about the health of the labor market. The last report had openings near an all-time high, and it would be great to see them go up again. However, it would be discouraging if the rise is from a lack of skilled workers. What we would really like to see in the report is an increase in the quits rate, which is indicative of workers’ confidence in moving between jobs for what we hope are better opportunities.

It’s going to be an action-packed week for sure, but all in all, I’d say this bull market has plenty of room to run and the legs to do it.

Fortunately for the Economy, Consumers Are on the Road Again

The past week was one of those weeks where people who casually follow markets might say, ”Oh that’s nice, stocks were up a little bit this week.” However, for those of us that work in them daily, this was a week where both bulls and bears went from feelings of rage to those of elation. Wednesday was the turnaround point for the week when the S&P 500 broke below 1900 in the morning only to go on a monumental, if not miraculous (for some) rally running 38 points off the lows to close at 1929. Considering all the recession talk lately, 1929 is a rather fitting number to have closed on since that’s the year the U.S. entered the Great Depression. Also playing into the recession narrative on Wednesday was the Markit Flash Services PMI that dropped into contractionary territory going from 53.2 to 49.8 (more on that later). The Markit release was at 9:45 am when things were looking rather bleak. Then at 10:30am, we got an EIA report that showed stronger than expected gasoline demand which turned everything around. As we’ve seen time and time again, this market takes its orders from oil, and when oil turned around and ran higher, it took stocks right along with it. Hey, a rally is still a rally.

The EIA report is especially interesting because it lends itself to the fact that Americans have been driving record amounts. In fact, the Federal Highway Association just released a report showing that December alone set a record for the most miles traveled in a month while 2015 was the highest driving mileage year on record (going back to 1990). Clearly, that’s a manifestation of consumers taking advantage of lower gas prices. Unless you think people are just driving around in circles the whole time, all those miles are being driven for a reason. Whether it’s work, for a trip to an out of the way restaurant or to go see some relatives, it’s all a form of consumption. Which brings me to my next topic, the excellent PCE data we got.

On Friday, we got January PCE readings which showed a very healthy .5% monthly gain in both income and consumption. The prior six months had run at just .3% and .2% average monthly gains respectively for the two series. Also in the report was the Feds preferred inflation gauge, core PCE, which rose .2% to 1.7% year over year. This jump in inflation is just another reflection of strong demand across goods and services. The main story driving this data is that a strong labor market coupled with the extra disposable income from low gas prices is giving people additional means to consume. Just this past week, we saw fantastic earnings from the likes of Home Depot, Target, TJX and Foot Locker. Clearly HD is benefiting from the strength in housing as evidenced by the strong existing home sales (EHS) print we got on Tuesday. EHS, which account for roughly 90% of total home sales, are also running at a six month high. Then we have TGT, TJX, and FL all showing that consumption is strong outside of the housing market as well.

Unfortunately, we did get some weak readings this week from the Markit Flash Services PMI and the Conference Board Consumer Confidence Index . These two reports are also known as “soft” data points. “Soft” means that they are metrics derived from participant responses to questionnaires rather than “hard” metrics that are derived from actual quantifiable inputs. From reading both reports, you can see the impact that February’s stock market sell off had on people’s temperaments. The equity selloff from Asia to Europe to here had respondents doubting current and future financial stability. This doubt also fed through into business decisions as presented by the Markit PMI report. However, it is interesting to note that even in the decline of the Markit PMI, the employment component in the index still picked up, highlighting the strong labor market narrative that has been in place the last few months. So clearly all is not bad. In terms of hard data, we got the January Durable Goods report that showed a very strong 3.9% gain for the month in core goods. This report verifies the nice pick-up we saw in another hard data point we got for January, Industrial Production. In 2015, the trend was hard data coming in on the weak side while soft data was running strong. Perhaps that was a reflection of the relatively stable stock market (ex-Grexit part of summer) we had for 2015 and that manufacturing was indeed struggling. Now, assuming equities stabilize from this point, we could be entering a period where both hard and soft data show strength and that would be quite remarkable.

Now we are heading into my favorite week of the month, which is jobs week. On Wednesday we get the ADP employment report as a warmup to the most important labor indicator we have, the nonfarm payrolls report on Friday morning. Also this week, we have both ISM manufacturing and services reports along with a smattering of other manufacturing and housing related data. I’m expecting the ISM services report to show softness for February given the other “soft” data results we’ve seen so far. That being said, in times of uncertainty, it helps to take a step back and look at what the economy really is. The economy is the people who go to work every day in this country and consume goods and services. As long as employment remains healthy, the rest takes care of itself. Based on the latest JOLT survey which showed job openings being near an all-time high, it certainly seems like the labor market will be healthy for the near future.

jolts 2.28.16

So remember, when you go out to dinner, take a road trip, or even buy flowers for that special someone, you are strengthening the economy because you are the economy!