Here’s what happened last week:
- April U.S. payroll growth of 160,000 worse than expected; wage growth higher; Fed probably less likely to raise rates in June
- April global manufacturing PMI 50.1 second weakest in 40 months, “growth rate at near standstill”1
- Trump is now the presumptive GOP nominee; despite his trade deal rhetoric, the 40-plus year downtrend in employee compensation as percent of GDP is unlikely to significantly reverse upward
- China’s April exports and imports fell more than expected; its reflating real estate and manufacturing bubbles likely to end badly but timing uncertain; Institute of International Finance warns on global corporate debt
- The S&P 500 closed at 2057 with the broad market ETF [SPY] down 0.3 percent for the week and up 1.4 percent year to date. International stocks, by way of the ETF [VEU], had a worse week, down 2.3 and 0.5 percent year-to-date.
This week looks like a light one for possible market moving news:
- Thursday initial unemployment claims
- Friday retail sales, consumer sentiment, producer price index
U.S. stock market in longest sideway stretch since 2009 bull market began
Even with the current rally, four of the major international stock indexes, in Japan, Germany, Hong Kong, and China, remain more than 20 percent below their previous peak, compared with the S&P 500, which is only 3.5 percent below its previous peak.2 This would seem to make the U.S. stock market “the cleanest dirty shirt” among global markets, to use the phrase former bond king Bill Gross coined long ago.
The broad market ETF [SPY] has tested the top end of its trading range near its all-time high 11 of the last 14 months but has been unable to breakout to the upside, marking the longest sideways stretch since the bull market began in March 2009. Negative earnings growth, high valuation, and ongoing uncertainty about key issues continue to constrain SPY.
What will the Fed do in June? That’s what makes markets
While Friday’s jobs report showed a weaker-than-expected 160,000 increase in payrolls, private-sector workers saw a stronger-than-expected 2.5 percent increase in their hourly earnings. Fed-watching journalists disagreed on how Friday’s job report would influence the Fed at its June 14-15 meeting.
Jon Hilsenrath of the WSJ, currently the most influential Fed journalist, said Friday’s jobs report would keep the Fed in “standby mode” and diminish the chances of a June rate hike. Gary Cameron at Reuters saw it differently saying the weak jobs report along with higher wages “dovetails with what the Federal Reserve expected” so its interest rate hike expectations should remain intact.
Following the jobs report, Wall Street’s top banks appear to have “all but abandoned any expectation” that the U.S. central bank would raise rates in June, according to a Reuters survey. Most now expect the Fed’s next rate hike to land in September. In addition, the Brexit vote on June 23 also makes it makes it more difficult for the Fed to move in June.
As the saying goes about disagreements, that’s what makes markets. And frankly maybe it just doesn’t matter that much, at least to the real economy, if and when the Fed lifts rates another mere 25 basis points.
If the specter of legions of highly paid investment professionals being focused on this long, drawn-out Fed rate hike soap opera is starting to look silly, financial markets indeed seem to be suffering from Fed fatigue at this point, and hoping for real economic and earnings growth to start to kick in without delay.
Global manufacturing near stall speed
A metaphor that is often employed by economists these days is that of an airplane near stall speed trying to gain altitude shortly after takeoff, when it is heavily loaded with highly inflammable jet fuel (global debt) and very close to the ground.
That metaphor is indeed very appropriate for interpreting the state of global manufacturing. The J.P. Morgan/Markit Global Manufacturing PMI (purchasing manager index) released on Tuesday was 50.1, the second weakest during the last forty months.
The growth rate of the global manufacturing sector came to a “near-standstill” at the start of the second quarter,” according to Markit’s press release. Rates of expansion in outputs and new orders also slowed, mirroring the stagnating results seen in February. Conditions stayed “muted in many domestic markets, while international trade flows continued to deteriorate.”
The silver lining in all of this is that the PMI finished goods inventory index fell sharply suggesting that manufacturers are slowing production until sales catch up. At that point, production gains should accelerate. At least that’s the market’s hope right now.
Yesterday it was reported that “China’s exports and imports fell more than expected in April, underlining weak demand at home and abroad and cooling hopes of a recovery in the world’s second-largest economy,” exacerbating the concerns over China discussed in the last section below.
If this is the best the global economy can do after more than seven years of historically unprecedented global monetary easing, by an extremely wide margin, then something could be much more fundamentally wrong, as fund managers and others doubled down on their dire warnings last week.3
What will be impact of Trump’s nomination on financial markets?
The Republican nominee seemed to become a lot less uncertain on Tuesday when Cruz and Kasich withdrew from the race following Trump’s resounding primary win in Indiana. What is still highly uncertain is what Trump’s now highly probable victory as GOP nominee in July will mean for financial markets.
Weighing in on that on at a hedge fund conference on Thursday was Jeff Gundlach of DoubleLine Capital, often considered the new bond king. “Trump is going to win, and Trump is going to increase the deficit,” which would help the U.S. economy recover,” he said. “First, I think you’re going to get a global growth scare, trade-based. That could cause a market rollover which to me looks like it’s already under way.”
Unlikely to change if Trump is elected president is the long secular downtrend in employee compensation as a percent of U.S. GDP since the late 1960, shown in this below chart. This downtrend has contributed to high profit margins and has been a key factor in several very strong bull markets that first began in 1982 under Reagan. The only significant increase during that long downtrend was in the second half of the 1990s during the tech boom and Clinton presidency, still lingering memories of which are helping his wife’s candidacy this year.
Click to enlarge
While market bears think very high corporate profit margins will revert to their long-term historical mean, and thus already high stock valuations would seem even higher as already weakening corporate earnings would actually be forecast lower, there seems to have been a major shift upward in margins due to American workers’ inability to demand higher wages and benefits in the globalized economy. But for financial markets, the down side is that low wage growth is constraining consumer demand and economic growth.
American workers today simply do not have the economic and political clout that they had during the heyday of industrial labor unions in the 1950s and 1960s. A data point that underscores this is that in 1974, the percentage of workdays lost to significant work stoppages was at least 58 times as great as it was in 2015, when the number was so small that the BLS data simply shows it as less than 0.005, 1/200 of one percent, which works out to roughly 6 minutes per worker per year, basically a short restroom break on a temporary, part-time, no benefits job.4
For this, we have corporate downsizing and outsourcing to thank, made possible by various technologies such as containerization and the Internet, and to some degree, the trade agreements of which Trump has made a significant issue in his campaign. Those U.S. factories are not coming back, as you can’t unscramble a broken egg, no matter what any presidential candidate says this year.5
China stimulus policies to try to avoid massive social unrest
If there is going to be significant political and social unrest of the magnitude that might get financial markets worried, it is much more likely to be in China, increasingly the home of the world’s factories and where an extremely difficult economic transition is underway to a more sustainable model based less on exports and physical investments and more on services and internal consumption.
China’s leaders are reprising what the Fed did in the 2000s following the busting of the tech bubble that destroyed hopes of continuing American middle and lower class income gains of the previous decade. Following the 2007-09 global crisis, China has inflated a massive real estate bubble that benefits the more prosperous, property-owning members of the country’s rapidly growing middle class, just as the U.S had prior to the crisis.
If and when that real estate bubble bursts, especially if combined with the bursting of the massive industrial and infrastructure over-investment bubble (which did not occur in the U.S.), it could lead to huge social unrest. And the wrath would not only be felt by angry property owners, as in the U.S. during the 2007-09 financial crisis, but also by tens of millions of displaced factory and construction workers with very little social safety nets.6
That prospect of massive unrest is one reason why so much money from prosperous Chinese has been fleeing to real estate in the U.S., Canada, Australia, driving up property prices in Vancouver, Sydney, and the San Francisco Bay area, whose commercial real estate market now seems to have peaked, along with valuations of unicorns, private companies valued at north of a billion dollars. 7
To try to prevent social unrest and capital flight, China’s leaders have this year once again reflated their economy, putting social stability ahead of economic transformation, as they almost always do. It’s no different than what our government – and governments everywhere – seem to do: kick the can down the road to try to postpone the day of reckoning, the European Union being the poster child for that in this decade. So now the Chinese communist leaders are trying to clamp down on the resulting bubbles8 and perhaps preparing for major bank bailouts.9
We can’t say we haven’t been warned
The Chinese are repeating the Fed cycle in the U.S., where at the first whiff of a “taper tantrum” from financial markets, the U.S. central bank backs off from even a small baby step toward “normalizing” interest rates.
With no major government willing to take it head on, rising global debt continues to be worrisome, not only in China, where according to one China based brokerage last week bad bank loans may be at least nine times greater than official data show. The latest debt warnings came this past week from the IMF on Asian debt and from the Institute of International Finance on global corporate debt: “Corporate debt has reached extreme levels across much of the world and now far exceeds the pre-Lehman financial bubble by a host of measures…The body flagged a double threat: a five-fold rise in company debt to $25 trillion in emerging markets over the past decade; and record junk bond issuance in US and Europe, along with shockingly-irresponsible levels of US borrowing to buy back shares and pay dividends.”
This weekend The Economist magazine weighed in with an entire special section on finance in China and a lead article titled “The coming debt bust” which starts “it is a question of when, not if, real trouble will hit in China.”10
We can’t say we haven’t been warned.
http://www.bloomberg.com/news/articles/2016-05-04/bass-says-investors-would-avoid-china-if-they-knew-banking-risk ; http://www.bloomberg.com/news/articles/2016-05-03/citi-five-trends-keeping-us-worried-about-a-global-recession
- http://www.theatlantic.com/business/archive/2016/04/the-impossibility-of-reviving-american-manufacturing/479661/; http://www.theatlantic.com/business/archive/2015/10/onshoring-jobs/412201/
- http://www.businessinsider.com/boston-properties-warns-of-sf-real-estate-downturn-2016-4; http://www.bloomberg.com/news/articles/2016-05-06/china-seen-churning-out-most-steel-ever-after-price-surge-chart