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Jobs Report: ‘The Better These Numbers Get, The Closer You Are to a Recession’

 

 

In this excerpt from The Macro Show this morning, Hedgeye CEO Keith McCullough and Macro analyst Darius Dale break down the October jobs report and explain what it means for investors.

 

Subscribe to The Macro Show today for access to this and all other episodes. 

 

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When "Bad Is Good" Goes Bad? | October Employment

Takeaway: Good Domestic Data Perpetuates Global Deflation Risk. The Last Domino Is Still A Domino.

I contextualized a lot of the current labor market dynamics in this morning’s Early Look (HERE), I touch on the incremental below.

 

The payroll data for October was strong across the board:   Headline NFP & Private Payroll gains, Hourly Earnings, Unemployment/Underemployment Rate (with healthy internals), Positive Sector Hiring Breadth, Employment mix were all better sequentially. 

 

The Fundamental Read-Through | Here’s what the prevailing narrative will be in the wake of the October data: 

 

At 5% Unemployment, the domestic labor market is now at or flirting with full employment and, with wage growth making a new cycle high at +2.5%, has finally reached some critical threshold whereby that tightness is beginning to manifest in higher earnings growth

 

Conventionally, wages are viewed as a lagging indicator, with wage inflationary pressure building as the labor supply declines and the economy moves towards constrained capacity.

 

The intuition is straightforward:  ↓ Supply + ↑/Stable demand = ↑Prices ….  as the labor market tightens (supply goes down) and job openings and hires remain solid (demand), the price of labor rises. 

 

That line of thinking is commonsensical and the core of the slack debate has centered on the magnitude of the shift in labor supply-demand dynamics and whether policy should move ahead of or behind any emergent inflationary curve in service of their dual mandate.  

 

The problem of the last 3 decades, however, has been that, by and large, there has been no inflation curve.  The conventional output-inflation loop in which rising wage growth drives demand pull inflation which drives an acceleration in broader inflation has been almost non-existent over the last 3 cycles.

 

Even with the inflationary cocktail of peak demographics, peak productivity growth, peaking leverage, asset price bubbles and positive interest rate cycle dynamics coming in-phase in the late 90’s and mid-2000’s core PCE inflation failed to rise much above 2%.     

 

The bearish/dovish re-joinder to the above is that on a Trending basis payroll growth is slowing, a growing list of lead indicators have moved past peak, the preponderance of domestic and global macro data has slowed in recent months, inflation is not an emergent threat, the Aug/Sept Employment figures were more reflective of the underlying reality and October was the outlier.  Time will be the arbiter. 

 

 

On Wage Growth:  Wage growth for production and nonsupervisory employees (~80% of the labor force) was +2.3%, below the private sector average of +2.5% so the improvement was broad based but still disproportionately going to the top quintile.  

 

Is a return to a halcyonic 4-4.5% level of nominal wage growth of prior cycles (see chart below)  in the face of persistently lower inflation, an aging workforce, top heavy demographics, lower productivity and lower credit growth a reasonable expectation?

 

Probably not.  Could we accelerate to +3.0%?  … sure, I suppose, but know that you’re (maybe) playing for something like ~50 bps and wage growth peaks at the very tail end of the expansion.   

 

Income & Consumption Read-through:  Consensus growth expectations continue to rely almost singularly on consumption expenditures and income growth anchors the capacity for consumption growth.  The acceleration in aggregate hours worked + acceleration in hourly earnings will = re-acceleration in aggregate income in Oct (reported 11/25). 

 

The slope of household spending growth will hold modestly negative (off the 1Q15 peak) but will remain “good” on an absolute basis to start 4Q, particularly if the savings rates stays static at current levels. 

 

 

The Market Read-Through:  #DeflationRisk

 

The Dollar, Yields, and Fed Fund futures which had already been discounting the rhetorically hawkish FOMC commentary all appear to be pricing-in the final price-in of a December hike.  And there's a month of data and another employment report to digest before that policy trigger pull.

 

A correction in equities alongside an attempt at policy normalization would not be surprising.  After all, if QE = ↓ Yields = ↓ Discount Rate = ↑ Present values, the converse should hold in some measure as well.  

 

Notably, if you look at the Shadow Fed Funds Rate – which attempts to translate unconventional policy initiatives into Fed Fund equivalents – we have been in a rising rate environment since April, 2014 and the effective Fed Funds rate has risen ~225 bps to -0.75% from -3%.  From a rate of change perspective, the macro data has slowed concomitantly.

 

Strong $USD:  A policy induced strong dollar only perpetuates global deflation risk.  Global Inflation expectations are priced in dollars (as are the Trillions in $USD denominated EM debt) and further dollar strength will only exacerbate the OUS growth and inflation challenges faced by foreign central banks.  The U.S. will continue to import that deflation on the back end and the industrial and earnings recessions we’ve witnessed the last two quarters domestically will persist.

 

Sustained domestic de-coupling is a sirenic concept but deflation's dominoes follow a winding path.  The last domino is still a domino.  

 

A visual tour of the Employment data is below.  

 

When "Bad Is Good" Goes Bad? | October Employment - NFP YoY

 

When "Bad Is Good" Goes Bad? | October Employment - Paryoll growth vs earnings growth

 

When "Bad Is Good" Goes Bad? | October Employment - Goods vs Services

 

When "Bad Is Good" Goes Bad? | October Employment - Wage Growth Nonsupervisory

 

When "Bad Is Good" Goes Bad? | October Employment - PCE inflaiton vs Unemployment

 

When "Bad Is Good" Goes Bad? | October Employment - Available Workers per job opening

 

When "Bad Is Good" Goes Bad? | October Employment - 20 34 YOA

 

When "Bad Is Good" Goes Bad? | October Employment - Employment by Age

 

When "Bad Is Good" Goes Bad? | October Employment - Empl Summary

 

 

Christian B. Drake

@HedgeyeUSA

 


We Were Wrong On Jobs

Why? Because the U.S. labor market is even later cycle than we thought.

 

With the advent of today’s gangbusters jobs report – specifically the sharp accelerations in the growth rates of nonfarm payrolls and wages (see: summary table below) – this U.S. economic expansion is now closer than ever to its termination.

 

  • The balance of the seven proprietary indicators we track to pinpoint our location in the domestic economic cycle suggests a recession has the highest probability of commencing in 10 months-time (i.e. in 3Q16).
  • With a slight majority of those indicators signaling a recession perhaps sooner than that, we continue to point out the risk to the economy and the financial markets that underpin it that are the Fed’s forecasts.
  • The FOMC dot plot and recent hawkish guidance from various Fed heads suggests policymakers are in line with macro consensus that the domestic earnings and industrial recessions are transitory and not a harbinger of a broader economic downturn. We remain on the other side of this view.

 

Click on the following link to download the presentation (13 slides): http://docs3.hedgeye.com/macroria/Hedgeye_U.S._Economic_Cycle_Indicators.pdf

 

From an asset allocation perspective:

 

  • We continue to raise cash.
  • We are buyers of Treasury bonds Muni bonds, Utilities and REITS on weakness. From a style factor perspective, we anticipate large-cap liquidity will continue to outperform over the intermediate-term.
  • We remain short sellers of Financials, Retailers and High-Yield Credit on strength. From a style factor perspective, we anticipate small-cap illiquidity and highly leveraged companies will continue to underperform over the intermediate-term.
  • Our ongoing G4 policy divergence theme lends us the confidence to remain bullish on the U.S. dollar in spite of our dour outlook for the U.S. economy – especially given that the Fed appears set to embark on a grave policy error by tightening monetary policy into the teeth of a #LateCycle Slowdown.
  • As a result, we remain the bears on reflation assets broadly – including commodities, commodity-linked equities, commodity currencies and EM.

 

Deflation’s Dominoes are coming home to roost.

 

Have a great weekend,

 

DD

 

Darius Dale

Director

 

We Were Wrong On Jobs - Employment Summary


Early Look

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VRX | MORE QUESTIONS...

OVERVIEW

It was announced this morning that Goldman Sachs sold 1.3 million shares of Valeant stock that was pledged by CEO, J. Michael Pearson in exchange for a $100 mill loan.  Pearson owns ~10 mill shares, of which ~2 mill are pledged as collateral in exchange for loans "to fund tax and other equity incentive awards and purchases of Company shares".  There are also 1.2 million shares in addition to the 10 million that belong to Pearson's grantor retained trust (GRAT), but are not included in the total as Pearson has "no pecuniary interest".  The proxy filing does not explicitly state whether the 1.2 million GRAT shares were used as collateral for the loan.

 

VRX | MORE QUESTIONS... - 2015 11 06 2015

 

According to Valeant's press release, the $100 mill in loan proceeds was used for "among other things, financing charitable contributions, including to Duke University, and helping to fund a community swimming pool, purchasing Valeant shares, and meeting certain tax obligations related to the vesting and payment of Valeant compensatory equity awards".  

 

VRX | MORE QUESTIONS... - Valeant Issues Statement

 

This is a problem if the 1.3 million in pledged shares were unrelated to Pearson's GRAT, because the proxy filing explicitly states that the proceeds of those loans were used only "to fund tax and other equity incentive awards and purchases of Company shares".  There is no mention of charitable donations, and brings into question what else Pearson may have used the proceeds of the loan for? 

 

VRX | MORE QUESTIONS... - 2015 11 06 Tax

 

Michael Pearson's large stake in the company and compensation tied to TSR has been a cornerstone of the bull thesis, providing assurance that incentives are properly aligned.  Therefore, it is clearly a problem if Michael Pearson used the loan proceeds for anything other than what is stated in the proxy filing.... even if it is for "charitable" purposes.  It is possible that the charitable contributions were made through the GRAT, although a GRAT is usually established as a way to transfer wealth to relatives to avoid paying a gift tax.

 

We have no problem with the practice of pledging stock as collateral in exchange for a loan.  What we do have a problem with is if Pearson used the proceeds of the loan for purposes other than what was disclosed to shareholders.  Given the falling stock price and heightened scrutiny, we would welcome an audit of the loan proceeds.

pearson allowed to sell stock

The 2014 proxy filing states that Michael Pearson is not permitted to sell "net shares until 2017".  However, the proxy filing in 2015 "permits Mr. Pearson to sell 3,000,000 net shares.... plus transfer an additional 1,000,000 net shares in charitable contributions".  This represents 50% of his stake (net of the 2 mill shares pledged as collateral), compared to 0% in 2014.  

 

"Valeant has adopted a policy generally disallowing future pledges and is permitting Mr. Pearson to sell shares, which may reduce the level of pledging"

 

VRX | MORE QUESTIONS... - 2015 11 06 VRX

 

This is a big change from the policy of prior years.  Pearson has touted that he has "not sold any shares provided to [him] as compensation" since joining Valeant.  However, we don't see any difference between selling stock and pledging shares as collateral for a loan, and based on the commentary in the latest proxy filing, neither does the board.

 

Please call or e-mail with any questions.

 

Thomas Tobin
Managing Director 

@HedgeyeHC   

 

Andrew Freedman

Analyst

@HedgeyeHIT  

 

 

 


The 'Where’s Waldo' Jobs Report: Head Fake Before Slowdown?

On Fox Business’ Mornings With Maria, Hedgeye CEO Keith McCullough, Barrons.com Editor Jack Otter and FBN’s Trish Regan analyze the October jobs report.

Click The Image Below to watch.

The 'Where’s Waldo' Jobs Report: Head Fake Before Slowdown? - fox bus  jobs

 

 


RTA LIVE: November 6, 2015

 

 


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