The Days Ahead: Short week and jobs numbers.
One-Minute Summary: Market took on a lot. Again. The U.K. suspended Parliament pending the last round of Brexit negotiations. And if that sounds extreme and constitutionally questionable, it is. There was another attack on Fed independence. We think the Fed will weather it all but it's unsettling. Treasuries rallied again but this is very much part of a global trend. Stocks are up on the week but we’re writing this on Wednesday so time for more action.
Meanwhile, before heading out of the office for a break, this is a summary of all the stuff that’s gone on
1. Is the U.S. economy weakening? Yes, partly through slowing manufacturing (because of trade uncertainty). Lower net exports (same). Durable goods (same). Business confidence (same). Housing and consumer spending are sideways. Consumer confidence good. The latest report yesterday showed a solid recovery from the government shutdown days:
That’s all good but consumer confidence is a flighty metric. It can turn quickly and remains well below pre-crisis levels. Neither does confidence always lead to action. So we don't expect retail, auto or other sales to take off.
Another sign the economy is in the not-great phase was the announcement that there were 510,000 fewer jobs in the 12 months to March 2019. Such revisions are normally in the plus or minus 20bp range. This one is 30bp. It means the BLS overstated growth by around 41,000 jobs a month. In 2017-18, monthly job growth was 203,000. In 2018-19 it was 209,000. The revisions put them at 168,000.
Bottom line: the job market was not as strong as the Fed thought. So another reason to ease up next month.
2. Should we worry about Japanification? Not yet. This goes back to the property and stock market crash in Japan in the early 1990s from which Japan has never fully recovered.
From then to now, employment has grown from 62m to 67m, an average of 14,000 new jobs a month. Unemployment peaked at 5% and is now 2.3%. GDP growth averaged 1.2%. There have been seven recessions and numerous periods of negative GDP growth. Inflation has averaged around 0.6% and only occasionally jumped when the government raised VAT. Government debt has grown from around 100% to 225% of GDP. Bond yields are negative. The Japanese 10-Year Treasury bond hasn’t been above 2% in 28 years.
So Japanification is a constant battle against deflation and low growth. The Bank of Japan (BoJ) has given new meaning to loose monetary policy. They've targeted 0% for the Ten-Year and bought bonds for the last 20 years. The BoJ’s balance sheet is over 100% of GDP. The Fed is at 16%. They also bought real estate, stocks and ETFs. The Bank of Japan owns 70% of the ETF market and is the largest shareholder in Japan’s listed companies.
Could it happen here? Well, the demographics are better because we don't have Japan’s aging problem. The economy is certainly more dynamic. The credit and bond markets are deeper and highly competitive. The stock market is broader and with a wide range of investors.
Bottom line: So, no. But we’re facing slower growth and lower rates are not a panacea. As investors, it means we still see value in bonds, especially as the Fed loosens, and would expect stocks to maintain decent margins and growth.
3. Are bonds expensive and stocks cheap? Not yet but it’s beginning to look that way. When bond yields fall it’s meant to help kick start the economy. You know, get all those borrowers on the sidelines moving. The trouble is that a drop from, say, a 3.25% to a 3.0% loan makes precious little difference to the IRR of an investment project. For a house buyer thinking of a $200,000 30-year mortgage, it’s a difference of $28 a month. Hardly an attractive margin.
Lower rates make equities look attractive. First, the discount rate applied against future earnings is lower, which raise the present value (price of the stock) without anything else needing to change. Second, dividend yields now exceed 10-Year Treasuries by about 40bp. The green line here shows the difference between the two. When it’s below 0%, stocks yield more than bonds.
In the past, that seems like a reasonable entry level. Another measure is the earnings yield (explained here), which also suggests stocks are not expensive.
But the reality is the last four weeks have caused tremendous strain with plummeting bond yields, incoherence on trade and economic policy, a Renminbi fixing, a Fed under pressure and political crisis (looking at you U.K. and Italy) all to the fore.
Bottom line: U.S. stocks not overvalued.
Bottom Bottom Line: As we mentioned last week, markets are becoming numb on the trade wars. We have a month before the Fed (almost certainly) reduces rates. Bonds are rich, for sure, but likely to stay that way.
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