Value versus Trend
06/30/10
For two months now the markets act as if the world is coming to an end. At first I thought it was all about Europe and therefore salvageable for the US. The markets continued to lose ground though and I grew more concerned and now - finally - I see what they saw. The labor market is not improving! This is not good. We are about one year into this recovery and we can barely create any jobs. The employment report was bad, as private payroll employment only rose 83,000. Moreover, the household survey showed a drop in employment of 350,000. The unemployment rate fell. But that is because the - 350,000 fall in household survey was offset by a - 652,000 drop in the labor force. A labor force contraction is bad news as it implies public confidence in the availability of jobs has deteriorated. Moreover, the average workweek on private nonfarm payrolls fell 0.1 to 34.1 hours. As a consequence of modest employment gains and a drop in the workweek the index of aggregate hours worked only rose 0.1%I still think we'll see some employment growth on average over the next 6-months. But it will be anemic. The news has turned decidedly negative. Everybody is negative and the attitude in Washington is dominated by party bickering instead of a more productive "we are all in this together" mindset. The President made BP an offer it could not refuse, taxes are going up sooner rather than later and the lapse of the government stimulus program will act as a further form of tightening. By the second half, any uplift from inventory rebuilding will also have passed. Like I said, the news is bad and it seems everybody loves to hate stocks. For this reason, I set out today, to find us some good news in all this gloominess. Let’s see what I can come up with. But first, allow me to show you some of the reasons, why everybody is so down:
The ECRI Leading Economic Indicator turned down in late April. The indicator anticipates economic conditions about six months out and tells us that something happened in April that threw the economy off track. If we do not pick up steam by September, we may be looking at a double dip recession. Double dip recessions are not impossible but rare and so far the evidence points towards continued expansion. Bond-market yields -- the two-year at 0.6% and the 10-year below 3% -- are troubling and aren't predicting a whole lot of growth. I did not want to believe it but it looks like Mohamed El-Erian was right, when he talked about the sugar high coming off. The second chart above shows us one more reason, why this recovery feels anemic. The structural headwinds that everybody is talking about are the various forms of indebtedness in our society. While the financial sector has done a good job of deleveraging, businesses and households are not quite as far along but are proceeding apace, whereas the state, local and federal governments are the sectors that have leveraged up during this recession. The debate in Washington and many capitals around the world is, whether government expansion is necessary to counterbalance the contraction of the private sector until it has reached some kind of equilibrium or whether government debt is the cause of all evil and therefore should be reduced as quickly as possible. Europe introduced austerity measures in the wake of Greece’s borrowing problems, which are not necessarily the quickest path to economic recovery, just ask any Irishman. On the other hand, capital markets demanded action and seem happy with the promises of austerity and probity coming out of Europe - for now. So now the debate rages on in Washington, austerity or government stimulus - which is required? Maybe neither - as far as the US is concerned. Let us look at some positive data in all this doom and gloom. For example have you noticed that gas prices have fallen right before the peak driving season? Reformulated Gasoline Blendstock for Oxygen Blending (wholesale RBOB September delivery) prices have fallen from $2.45 at the end of April to $1.95 now. This 50 cent swing saves US consumers about $1 billion per day in fuel expense, amounts to an annualized $365 billion tax cut and comes absolutely free of any interest and amortization charges.
The index of aggregate hours worked, a key summary of the employment situation that tallies all of the hours worked in the economy and is thus a solid gauge of income and hence, the growth rate of the economy, continued to rise. Average weekly earnings in constant dollars reached $298.10/week and a new 20 year high.
Real average weekly earnings also continued to rise. These are calculated by tallying earnings of fulltime and part time workers, which consist of average hourly earnings multiplied by the average hours worked per week and adjusted for inflation. Production of durable consumer goods rose by $2 billion to $83.89 billion. New orders for all durable goods (not only consumer durables) came in at $192.8 billion dollars, which was slightly lower than April’s number but still solid.
The Port of Los Angeles is counting the number of containers leaving and arriving and whether they are full or empty. Take a look. Since the US is importing more than we export, the number of full containers arriving will always be greater than the number of full containers leaving (unless we become an export nation like Germany, China or Japan). Nevertheless, in May we shipped 160,621 full containers to Asia, slowly approaching the peak of 175,262 which was reached in August 2008. To be sure, this is a lagging indicator, but I can not help but wonder, whether Asia’s growth is not exerting a beneficial influence on our economy in the West. I also wonder if this is the reason why West Coast real estate has been performing much better than the rest of the country. Take a look at the Case-Shiller comparison of select cities. The three West Coast cities have definitely outperformed the rest of the country since March 2009. Most cities have mde new lows since then, whereas the three West Coast cities in blue have continued to advance.
So there you have my list of positives. Let us hope that they are not imaginings of a desperate soul but rather little pillars of stability in a swamp of ugly, crawling headlines. Naturally, I am tempted to go on and on. There is - for example - the fact that it took 21 months after the last recession of 2001 before the economy generated positive jobs growth. In this regard, we are definitely ahead of schedule. Or I could add that the stock market has the lowest price-earnings ratio (trailing or leading) in a decade. Or I could add that 38 of the 100 largest companies in the US have raised their dividends in the last 12 months. If a company has the confidence, balance-sheet and cash-flow strength to raise a dividend during a very uncertain time, then perhaps things are not that bad? Let us also not forget that 22 of those 38 companies have a dividend yield that is greater than the yield on 10 year treasury bonds. In short, there are many positives for the interested investor, but these matter when they matter - and not one day earlier. The market is a voting mechanism in the short run and a weighing mechanism only in the long run.
Hermann Vohs
"The plans differ; the planners are all alike ... "
Bastiat
Hermann Vohs is president of Cales Investments, Inc., a registered Broker-Dealer. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions. Opinions expressed in these reports may change without prior notice. Hermann Vohs and/or the staff at Cales Investments, inc. may or may not have investments in any of the markets cited above. Hermann Vohs can be reached at 303-765-5600.
This information is not to be construed as an offer to sell or the solicitation of an offer to buy any securities.
