This note was originally published at 8am on January 13, 2014 for Hedgeye subscribers.
“You can’t win a horse race with mules.”
This was a weekend of winners and losers. On the athletic front, I was excited that Yale’s hockey team beat Harvard hockey like a rented mule by a score of 5 – 1 in the inaugural Rivalry on Ice at Madison Square Garden. (Admittedly, Yale did lose by a wider margin in the alumni game!) And no doubt my colleague Darius Dale was excited that his hometown Seahawks went into full on beast mode and beat New Orleans 23 – 10.
As it relates to losing, the nation of Israel suffered a major loss with the passing of former Prime Minister Ariel Sharon. A loss like this of course is on a much greater scale than how any sports team did this weekend. I’m far from an expert on Israeli politics, but it’s hard not to respect a man who gave everything for his proverbial team. As a soldier, defense minister and finally prime minister, Sharon fought in or commanded every one of Israel’s major conflicts starting with its 1948 independence war.
Whether it be winning in politics or winning on the field or ice, victory is rarely an event that happens in isolation. My former college hockey coach, Tim Taylor, used the quote at the start of the note to describe our team when we were doing more losing than winning. His point is spot on that any great victory, in any field, takes hours of practice, repetition, and preparation. Nothing in life comes easy and the investment management business is no different.
Back to the global macro grind . . .
One of the big winners in the global asset class race over the past twelve months has been European sovereign debt. Specifically, both Spain and Italian 10-year yields have come in meaningfully. This morning the Spanish 10-year yield is at 3.83% and the Italian 10-year yield is at 3.91%. Both are effectively Euro era lows.
The healing of European credit markets, and the improvement has been meaningful, is part of what is underscoring our relatively bullish view on European equities in 2014. Ironically, the Financial Times still has a tab called, “Euro-in-Crisis”, despite a marked improvement in the outlook for the Euro. Also ironically, the five headlines in this section are as follows:
- Portugal Plans Post Bail-Out Cash Cushion;
- Investors Warm to Spanish Banks;
- Too Early To Declare Crisis Over Says Draghi;
- Draghi Can’t Keep Euro Down For Long; and
- Portugal Enjoys Huge Demand in Debt Sale
The conclusion from those headlines, and much our analysis, is that if the Euro-crats can actually get out of the way we might have a meaningful recovery in Europe.
Speaking of winners and losers, the employment report on Friday threw many U.S. focused economists for a loop and also reinforces our Q1 2014 macro theme of #GrowthDivergences. Friday’s employment report, which showed non-farm payrolls increasing +74K month-over-month to close 2013, was a disappointment versus prevailing expectations and an outlier verses the balance of higher frequency labor market data.
Indeed, in the context of the broader labor market data, where the preponderance of evidence remains positive with the ADP private employment estimate, initial jobless claims, and the ISM Manufacturing and Non-manufacturing employment indices all reflecting moderate, ongoing improvement, the BLS data sits as a single negative outlier.
With 273,000 people out of work due to bad weather (vs. an average of 166K over the prior five December’s) weather was held out as the biggest distortive factor and a favorite pundit talking point post the December release.
Our retail and restaurant analysts have highlighted weather as a drag on traffic over the last month as well, so we’re inclined to accept that unusually inclement weather did, indeed, have some negative drag – with the largest impact across hours worked and construction/transports/trade employment.
The other favorite talking point was the continued retreat in Labor Force Participation Rate (LFPR) which dropped another 19bps sequentially to 62.79% from 62.98%, driven by a net drop in the total labor force of -347K (-490K unemployed plus +143K increase in employed). The continued drop in the LFPR remains in excess of that implied by demographic trends (which we’ve written about previously) and should remain an intermediate term issue as the labor market continues to grapple with higher structural unemployment driven primarily by the stubbornly, persistent elevation in long-term unemployment. This point is highlighted in the Chart of the Day.
Further, the LFPR may seen another step function lower over the next couple months if congress fails to renew jobless benefits for the ~1.3M individuals who lost unemployment benefits at 2013 year end. Perversely, perhaps, if those individuals drop out of the labor force, the unemployment rate will show improvement at the expense of a further depression in the participation rate.
The other, somewhat disappointing metric in the release was average hourly earnings – which slowed 20bps sequentially to 1.80% year-over-year. You can’t spend it if you don’t got it and if the savings rate holds little upside and the current iteration of the wealth effect is muted compared to historical precedent, then middling, sub 2% growth in income (ie. capacity for consumption) isn’t the path to winning for a domestic economy still beholden to consumption for 70% of GDP.
Our immediate-term Risk Ranges are now:
10yr UST Yield 2.85-2.98%
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research