Volume 58, Number 9 | March 4, 2011
Thinking about the US jobs report while traveling in China reminded me of an Indian story – go figure. Anyway, it is the story of four blind men who come upon an elephant and each tries to determine what it is. The man who got the trunk thought that it was a great python, while the man who got the tail thought that it was a rope. The man who got a leg thought it was a tree trunk and the man who got the body thought it was a great wall. Bottom line, all analysis depends on perspective. My father – an MIT chemical engineer who started in nukes in the 1950s – taught me at a young age the key equation in life: P + R = A or part of it plus the rest of it is all of it.
With respect to the jobs report, the big picture is that this coincident indicator still suggests moderate expansion at barely above the potential GDP growth rate and little if any acceleration. True, payroll jobs jumped 192,000 (after the weather depressed job growth in January) and there were upward revisions of 58,000 to the two previous months. However, when the top line adjustments were all in, private sector job growth over the past two months averaged 145,000, almost precisely the 146, 000 average for the for the fourth quarter. Indeed, this pace is just slightly ahead of the 140,000 jobs added on average in March, April and May of 2010 – so recent job growth must remain steady or we will be losing ground year on year! The more volatile household report confirms the recent pace of private sector growth for wage and salary earners. Typically a leading indicator of employment, it has gone from signaling strength in early 2010, to weakness in late 2010, to neutral right now. Real GDP growth was steady at about 2.8% throughout 2010, and looks to remain in that range in 2011 so far – bottom line 3% real GDP growth plus 1% inflation gives 4% nominal growth – barely keeping the recovery away from the edge of a slowdown.
Within the payroll report we see two different worlds – success for big business and continuing attrition for small business. The most profound shift within the industry data in recent months is the significant pickup in permanent manufacturing employment – specifically durable goods factory jobs, which rose from an average 10,000 in the fourth quarter to 46,000 on average in January and February. This trend is confirmed by the ISM and a wide array of factory oriented data. We believe this reflects the bump in stimulus from the 100% expensing option – especially for motor vehicles, heavy trucks, and computer equipment which have significant pent up demand. However, some of these jobs replaced temporary positions (which are now growing more moderately) and job growth slowed modestly in many other sectors leaving the top line for payroll employment gains steady.
The recent decline in initial claims for unemployment points to strong job growth, but the decline in the labor force tells a different story. Those that are receiving unemployment benefits are more likely to have worked for large firms where turnover is lower, thus it was easier to make the six month threshold to qualify. As large firms are doing well, there are fewer new filings for unemployment – but the vast majority of the reduction in the number of beneficiaries in the first 27 weeks of unemployment is from movement into the extended benefits program, not to a job. Less new filings are a good sign, but it takes real hiring to generate income and growth. Meanwhile, long term unemployment has become a stigma that makes it harder to get hired today, so many are leaving the workforce – to return to school, to retire, to move into the black market, or just to sit home. Just as the ISM confirms the manufacturing job gains, the NFIB index confirms the lack of a recovery in construction and services where the majority of small business owners operate.
The combination of these two trends results in a private sector that is grinding along at barely above potential GDP – while the public sector remains a drag. Private sector wage and salary growth, estimated from average hourly earnings times aggregate hours, is 4.2% for the past three months compared to a year ago – leveling off after a climb during the recovery, like in 1994, 1997, or 2006. In those three cases the peak was closer to 8%, only in part due to higher inflation. There may be a reacceleration of growth from the current 4% plateau as in 2005, but the lead indicators point to a mature economic cycle. The yield curve is already quite steep, stimulus is exhausted and now a drag on the expansion, profits are moderating at an already elevated level of GDP, and most importantly – monetary and fiscal policies are being tightened around the world. To us, the headwinds are at least as strong as any remaining tailwinds. This does not assure a downturn in 2012, indeed the risks may still be just one in five, but the consequences of such a downturn – occurring with a 9% unemployment rate and a 9% of GDP federal budget deficit during an election year — point to a profound market reaction. A collapse in the dollar, a shift to protectionism and extreme fiscal austerity, and a final shakeout in the housing and banking sectors all seem reasonable consequences of a 2012 slump – after that it could get real interesting. Bottom line, insurance is warranted.
The Chinese Juggernaut Rolls On
The most interesting observation from this trip to China is that there seems to be very little concern about inflation. Everyone talked about it – especially in high end housing and vegetables – but no one seemed overly concerned. It was widely seen as temporary and not as bad as in 2008. There seemed to be little hoarding or buying ahead, at least by the consumer (it’s tough to hoard vegetables.) Businesses appeared to be holding higher inventories of inputs and filling orders faster for those trying to beat price hikes. The government is responding with tax breaks for the farmer and low income households and pay hikes for those on minimum wage or fixed pensions. Bottom line, no one likes inflation, but everyone appears to have sufficient income growth to deal with the current spate of price increases. They may not be gaining ground as fast as in the past, but they are not falling behind.
Meanwhile, the government announces almost daily a new long term investment project. Hundreds of billions for a decade long investment in water conservation and redirection. Hundreds of billions more for 100 million units of low cost housing – with Vice-Premier Li Keqiang leading the charge for 10 million units this year. Another couple hundred billion for 45 new airports. A hundred billion here, a hundred billion there and pretty soon it adds up to real money. Bottom line, the Chinese still have a significant budget deficit and a trade surplus – so these may be mal-investment projects, but they are going to go forward and are internally self-financed. With such high and sustained investment, it is hard to see the Chinese economic expansion ending any time soon – well at least in the two year time horizon that we generally employ in our analysis. More likely, the Chinese juggernaut will continue to crowd other investment and expansion out of the world by demanding and receiving first call on virtually all natural resources via the power of good old cash.
From our point of view, the Chinese juggernaut lies at the root of world’s volatile movement from crisis to crisis over the past two decades. The yuan devaluation in 1993 was the proximate cause for Mexico’s woes in 1994 as they rapidly lost market share to a new cheaper competitor. The Asian crisis three years later started in Thailand before spreading around the world, as smaller Asian production bases lost ground to China. Following the Asian crisis, most stopped competing with the Mainland and became their suppliers. During this post-Asian crisis period, the vast loan book built up to fund Asia’s trade deficits returned home to the developed world to fund the tech bubble, which popped in 2001. No one tightened to sop up the funds, because Chinese generated deflation kept global inflation low. A lack of developed market growth from 2001 through 2004 allowed China’s resource demand to grow unfettered by competition, but when recovery started prices escalated into the 2007 oil shock, the 2008 recession and ultimately the Lehman crisis. Again, China gained ground rapidly during the rest of the world’s economic depression, and now after a few brief quarters of recovery we are again faced by spiking resource prices (this time food, energy, cotton, minerals and metals) as too much demand chases too little supply. With a budget surplus, trade surplus, low debt levels and an appreciating currency, China will get the resources it needs. That inflicts the process of adjustment on others – say Tunisia, Egypt, and Libya this time as the North African crisis expands.
Not only does China drive the resource price volatility that is so basic to world cycles – it also leaves the risk of funding this volatility up to others exacerbating the depth of the crises to the rest of the world. China’s trade surpluses have, until very recently, been invested in the safest senior debt securities, leaving other surplus nations and their financial agents around the world as the risk takers. The consequences of the Mexican and Asian crisis were moderate, not causing recession. The NASDAQ’s pop caused a mild GDP recession and a profound asset price correction. The 2008 slump escalated from Bear Stearns to Lehman, ultimately crushing the global financial system and setting of near depression – with barely a scratch on China. Remaining debt imbalances still threaten the PIGS, the US housing sector and US small banks, and Japanese pension funding is increasingly suspect. New exposure in the Middle East is being revealed daily as oil rich nations draw down their surpluses to buy peace. The primary consequence of this financial instability is that China can now buy in-the-ground resources previously unavailable at bargain prices.
Bottom line, we do not see China’s growth slowing anytime soon and global resource production is already behind their voracious needs. Prices will go up until someone – not China – is crowded out, and then the broader consequences to their financiers will be felt. Trouble has cropped up every four or so years since 1994 with ever greater effect. We are three years past the 2008 calamity, and 2012 looks a bit dodgy to us. Unless a supply miracle occurs soon, we would guess the Chinese get next year’s supply of resources by driving the weakest sister out of the market for food, energy, cotton, minerals, metals or whatever else is in shortest supply. Then, after a sharp economic break, we will play again – mostly to the benefit of resource producers — as the Chinese juggernaut rolls on.
Also a happy birthday to my mother, 83 years young, born on March fourth – the most progressive day of the year.