Is the Glass Half Full or Half Empty? Experts Agree to Disagree for Now.

Tom Cleveland

The much-anticipated Non-Farm Payroll data release has come and gone for another month, and, to use a common term in today’s vernacular, it was a “buzz-killer”. For the analyst community at large, it was difficult to put a positive spin on the numbers. Yes, the unemployment rate declined a tad to 4.3%, but net new jobs of 138,000 were a great deal below the expected figure of 184,000, no matter how one chose to sugarcoat it. The downward trend that began two years back was noticeably visible and continuing. If these job figures are ever to take off north, there has to be a solid bottom formation at some point, but none seems to be in the offing.

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The general themes were that the economy is losing momentum, wage growth was abysmal, and that wages may soon start to decline in the near term. Per one analyst: “Today’s jobs report is an unmitigated disaster, and it has nothing to do with missing the consensus estimate. A pitiful 138,000 jobs were created in May, while the prior two months’ estimates were revised lower. The already weak figure of 79,000 jobs for March was revised lower by 29,000 to just 50,000, and the estimate of 211,000 jobs for April was lowered to 174,000. This brings the average over the past three months to just 121,000 new jobs.”

nonfarm payrolls

What is going on behind the numbers that portends that things may be worse?

One can slice and dice the published data from the DOL to arrive at a few worthy insights, but, unless you are familiar with how the data is gathered or reported on surveys, the real nuances of what lies in the shadows may escape you. Fortunately, there are several analysts with this knowledge that help to explain the drivers of the final results.

The first fact that emerges is that new businesses are not being created as rapidly as in the past. The DOL uses a “Birth/Death” model to estimate how many jobs are being created by new businesses that have yet to reach the stage where the labor survey might incorporate their contribution. One of the reasons for such large downward and backward revisions of late has been that statisticians have erred on the up side, an error that will eventually catch up with you.

The drop in the unemployment rate may seem like a positive, but it was not due to a rise in new jobs. The Participation Rate declined, meaning that fewer people were looking for work. The quality of new jobs is also suspect, primarily comprised of part-time, below minimum wage jobs in “bars and restaurants”. Employers are still complaining that they cannot find employees with the right skill sets, and, with tighter immigration rules imminent, you may begin to hear corporate leaders step up the volume.

Following Friday’s release, a flurry of both pessimistic, as well as optimistic, articles flooded the Internet, each proclaiming that either the sky was about to fall or that the Sun was shining through like no other day before it. Here are six brief synopses from the pack – I will start with the two optimistic slants, followed by four “half-empty” reviews:

  • A new unemployment model portends that a recession is not imminent.

Recession model with unemployment

This analyst actually back-tested his data back to 1945 to validate the indications of his newly released economic model. The visual depiction on this diagram may be overly taxing to the eye, but the author has merely taken published core data to generate a mix of exponential moving averages, rolling eight-month annual averages, and a single rate-of-change indicator. The various colored lines (Red, Blue, Green, and Black) then act like trending indicator lines that one might set up on a typical chart, i.e., using RSI and MACD in tandem to predict key event points when specific lines cross one another.

The conclusion drawn here was that the 4.3% for May did not cause the Blue line to cross the Red line, an event that signaled an imminent recession in 2001 and 2008. The Black rate-of-change line has also dipped, another confirmation that a recession in 2017 may not be in the cards. While optimists may jump upon this prognostication with glee, the general consensus has been that 2018 will not be fun. Are you prepared for that eventuality or if future data releases become more abysmal?

  • Earnings reports continue to astound, so why do we have a stock bubble?

This particular analyst likens himself to being “rationally exuberant”. He writes, “Among market watchers, it’s common to lament that everything seems overvalued. Whether it’s price-earnings ratios or index funds garnering two billion dollars a day or the market reaching record levels, folks are worried that if they buy now, we could be replaying 1999 or 2007 – the boom before the bust. But what if the market deserves its high valuation? What if it lives up to the inflated expectations analysts have placed on it?”

Corporate earnings for S&P 500 participants for the first quarter came in at 14% higher, year-over-year, more than twice the long-term average of 6%, quite an achievement by any measure. These same corporate leaders are the same ones pleading for less regulation and more tax cuts, because they just cannot seem to make it. Per the analyst again: “The economy appears to be strengthening around the world – not just in the U.S. – and corporations are seeing this in sales and it’s lifting their earnings. So throw out that wet blanket and enjoy the summer sun.” Keep an eye on your investment account, while you are at it.

  • Does the current S&P 500 stock bubble resemble the early 2000 balloon?

It is always fun when you read two different articles where the opinions of the two authors are 180 degrees apart. Each provides a convincing argument, but you know that one of them has to be wrong, if not in substance, then in timing. As vehemently as the previous author argued that stock valuations are right where they should be, his opposing debate partner was just as cool and calm in his delivery of the facts.

This analyst acknowledges that human nature can factor into the equation, but he stakes his reputation on what he calls a “P/S Ratio”: “Speculative bubbles are nothing new, nor likely to pass into history. Our technology changes but human weaknesses persist. Hubris, gullibility, greed, fear… all remain firmly on parade. Perhaps counter-intuitively, one of the best indicators of future stock market returns is the price-to-sales ratio (P/S).”

You may have heard of several well-known attempts to analyze price and earnings, i.e., Schiller’s CAPE index for an example, and then draw conclusions that markets are overvalued. The proposition with the ratio between price and revenue speaks to the issue that if the ratio gets too high, then valuations are obviously stealing from future revenue streams, which can only change so much in the overall scheme of things. The argument here is that the ratio has ascended to values that mirror those “irrationally exuberant” times in early 2000. See below:

P vs Sales Ratio

Both trend lines are worrisome. But today’s times are different, just as in 2000?

    • A disconnect between stocks, the USD, and treasuries is disconcerting.

Our current Bull market recently hit its eighth anniversary, making it the second longest and weakest recovery in history. The recent run up has been called the “Trump Trade”, a bet that the policies of the new U.S. administration would jumpstart its domestic and thereby the global economy into higher gears. This author finds the “disconnect” in the following diagram of concern:

USD 10Ys Ts and SnP

The Dollar and U.S. Treasuries went south in March. Why? Per this analyst: “Say what you will about historical relationships, there is no question that post-election, the reflation narrative was in charge, which explains the steeper curve, the stronger dollar, and rising stocks. At this point, Treasuries and the Dollar are signaling that they think the Trump agenda is DOA. That’s not a political statement. It’s just what that chart shows.” How long can the gap continue? Time will tell.

      • Does this Bull Market already have two strikes? Is a third coming?

The reason we are seeing so many articles along this similar vein is that investors are tying up the switchboards of their respective brokers, demanding to know if now is the time to get out of the market. For the record, a 10% fall in prices is usually dubbed a “correction”. On the other hand, a 20% decline is the definition of the beginning of a Bear Market. Lastly, anything over 30% is deemed a crash, and no one wants to live through another crash.

As you might expect, analysts have reviewed the history of major crashes to find that they typically followed very high stock prices, rising interest rates, and a recession. The average of four of these was 49%. The first two conditions have been met, unless the Fed pulls back or real interest rates in the marketplace fall. As for a recession, models profess later rather than sooner, but brokers are advising caution and a reduced exposure to stocks for the time being.

      • One analyst purports that a recession is 100% guaranteed!

It is always interesting to observe the lengths that an analyst will go to ferret out a special historical relationship that no one else has ever discovered. This particular analyst claims a recession is 100% guaranteed, based upon the amazing correlation he gleaned from U.S. Presidential data.

Two Term Pres plus Recession

According to this author, “Every two-term president in history – EVERY! – has left his predecessor dealing with a recession or depression early in the predecessor’s first term. History doesn’t play favorites, so it will be no different this time for Donald Trump.” “Every” can be a very convincing term. Do not hold your breath for some exception to the rule to come running to the rescue. As this author opines, “Though history is only a guide, it’s a guide that, in this instance, tells us that Trump and his team absolutely will not escape unscathed. Prepare while you can”

Concluding Remarks

The May jobs report was anything but stellar, a disaster by most accounts. When the data heads south, investors start calling their brokers, demanding answers to questions that cannot be truthfully answered. It is a cascading effect, which can snowball down a hill and cause real destruction, if not halted. There is still good data out there, but pessimists are beginning to outnumber optimists by two to one, and growing.

Make your choices wisely! Stay cautious!

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Tom Cleveland
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