“I think Bigfoot is blurry, that's the problem. It's not the photographer's fault. Bigfoot is blurry, and that's extra scary to me. There's a large, out-of-focus monster roaming the countryside.”
I took last week off to build my deck.
My “vacation” kicked off with the shoveling of 100,000 lbs. of fill and process in order to grade the area.
If you’re unfamiliar with the soil/aggregate business, it’s a great legal racket. Here’s how it works:
A construction company has a piece of raw land that they want to develop but they need to do large-scale engineering and site prep work to ready the land.
Typically this will involve the reshaping and removal of a ton of earth …. literally thousands of tons of dirt and rock that, for development purposes, is waste that they somehow need to get rid of.
This is the good part ….
As they ponder how, and at what cost, to get rid of the earthen waste, people like me call them up and offer to buy it from them.
So, not only do they not have to pay to dispose of it, they actually make money by selling me their developmental ‘garbage’.
Selling people what you don’t want anyway is a paragon of operating efficiency. Find your industry equivalent and you have yourself a sustainable model.
Personally, I’ve always wanted to do something with leaves. Collect them => emulsify => add resin or some other compositing agent => use for some building product purpose (mdf type trim, plywood, etc).
Have people pay you to take their leaves away and then pay you again to buy it back in its reincarnated form. Repeat annually. Profitable, sustainable, marketable.
If anyone can think of a viable application and wants to partner on development, feel free to ping me.
Back to the Global Macro Grind …..
Selling someone the equity exposure you no longer want near the cycle peak is a close cousin to the golden goose of retailing refuse topsoil.
Across most domestic macro metrics, those peaks occurred between 2H14 and 3Q15. As we profiled in our 2Q Macro Themes presentation, the procession of economic fundamentals is not a mystery, it’s a cycle - our media team did a great job of simplifying the complex in this short clip on the topic (Sequencing the Cycle).
On the labor side, employment growth peaked in February 2015 at +2.28% year-over-year and has slowed consistently to the +1.99% YoY growth recorded last month.
We’ll get the April update in about 45 minutes and despite the manic “Jobs Day” agitations of social and financial media, we already know most of what matters relative to the trend in employment.
Unless we get something >256K (consensus is at 200K vs 215K prior) then employment growth will register another sequential deceleration. And unless we get something >675K – which is not going to happen – then the peak rate of change recorded in February last year will remain safely rearview.
In other words, the most probable scenario is that the labor market continues to slow on both a TRADE & TREND basis.
The flow through implications of slowing employment growth are important and relatively straightforward:
- With job growth slowing, earnings growth flat and weekly hours flat-to-down, aggregate income growth is also slowing.
- If income growth is slowing then so is the capacity for consumption growth. With external demand in the doghouse and investment and corporate capex in recession, consumption spending has buttressed aggregate expenditure.
- In income growth is slowing and the savings rate is flat-to-higher year-over-year as is the case presently then the drag on consumption growth is amplified- which is what we observed in the latest Household spending figures.
There also exists some equally relavant but less direct associations to the deceleration in employment growth.
- As the Chart of the Day below illustrates, while employment growth is slowing it is still rising at a premium to output growth …
- Employment Growth > Output Growth: Employment growing faster than output is a different way of saying that productivity is declining and unit labor costs are rising which, in turn, serves as a drag on Profitability …
- Input Costs > Output Prices: If the price to produce something (unit labor costs) is growing faster than the price at which that something can be sold (implied by the GDP deflator) then margin pressure will remain ongoing. In a situation of slack demand and declining productivity, employment gains are somewhat bittersweet. A rising employment-to-population ratio is largely paid for via margin compression … which then (unsurprisingly) manifests in the much discussed crescendo of companies reporting adjusted, non-GAAP earnings in an attempt to mask the more dour underlying reality.
- Productivity ↓ = Real Earnings ↓: Over the longer-term the trend in productivity drives the trend in real earnings growth. Recall, real earnings are earnings measured in units of goods and services and the more goods and services each person can produce (i.e. productivity) the more each person can consume. Declining profitability and productivity can function in a negative self-reinforcing fashion. Declining profitability disincentivizes business from both hiring and investing and protracted underinvestment will curtail gains in productivity.
To balance this out a bit before closing, let me highlight some bullish developments:
- 1Q GDP Revision: The final Construction Spending, Trade Balance and Factory Order data for March (which saw positive revisions) will support a positive revision to 1Q GDP. +1% is better than +0.5%, I suppose.
- Retail Sales Rebound: The rebound in auto sales in April will support sequential improvement in reported April Retail Sales (reported next Friday) and help backstop durables consumption to start 2Q16
These revisions and month-to-month shifts represent a kind of Forest vs Tree situation, however.
The current cycle is past peak and is now traversing its downslope but a continuous series of smaller cycles oscillates above and below the larger “Trend” cycle. Dalio’s description of this (HERE) is right on.
We’re well aware that we sound like a broken record on the #CycleSlowing theme. Big developed market fundamentals don’t shift measurably hour-to-hour or day-to-day. Just because we’re charged with generating high-frequency, daily commentary doesn’t change the slower, temporal reality of the macro cycle.
But while fundamentals trudge, markets and asset prices move enough on small time scales to present the profit and/or risk management opportunities that we attempt to highlight daily.
Bond markets have accurately reflected the cycle slowdown and, if you think about it, equities probably have on a net basis as well. Indeed, the S&P500 hasn’t done much (net) of anything in two years having finished 2015 down -0.73% and sitting just +0.32% in 2016 YTD.
To close, as the mania around jobs Friday surrounds you, the message for this morning is #Patience.
The economy is a vast interconnected and interdependent network with labor serving as a primary linchpin. Employment remains “okay” on an absolute basis but the trend remains one towards “less good” as payroll growth, income growth and confidence all continue to slow.
Breath and let the cycle play out, it takes time. Remember that things always look best before the crest. Aggressively risk-manage climbing the late-cycle wall of worry if you’re so inclined but don’t get caught riding the slope of hope (much) lower.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 1.70-1.85%
Oil (WTI) 42.40-46.51
Best of luck out there today,
Christian B. Drake
U.S. Macro Analyst