Omne Trium Perfuctum

“Omne Trium Perfuctum.  [Everything that comes in threes is perfect]”
- The Rule of Three

Month end. Quarter end. Cycle end?

While the number may be sacrosanct in the hearts of fractal fans and Sierpinski enthusiasts, the inherent elegance and natural, pleasurable balance for things that come in 3’s has been observed and ruminated on for centuries.  

The holy trinity, 3 strikes in an out, 3 outs in an inning, 3 talking points to every persuasive argument, 3 dimensions, 3 atomic components in every atom, 3 verses in a song, 3 primary colors, 3 little pigs, 3 Stooges/Bears/Muskateers ….

 ….. 3 components in the GIP model and 3 Themes in every quarterly Macro Themes presentation!

While equities again indulged in a late-cycle, low-volume, bad-data-is-hopefully-good-for-stahks FOMO spasm …. the true jedi, alpha FOMO was concentrated in our 4Q Macro Themes call where attendance, I’m proud to profess, printed a fresh ATH. 

Again, and like always, as active participants in our attempt to iterate and evolve the process of Risk Managing and Trendcasting macro and markets, we thank you for your continued engagement and trust. 

Back to the Global Macro Grind …

Not a particularly auspicious start to 4Q here.  

As we highlighted in contextualizing yesterday’s ISM Services convulsion:

It's getting worse by the day, literally.  The high-frequency data continues to deteriorate, globally and ubiquitously, as Quad 4 continues to metastasize and black hole risk crescendo’s.

This morning’s data pushes the domestic economy further towards the recessionary event horizon as ISM Services fell for 4^th straight month, dropping to a fresh 37-month low as Current Activity tanked -6.3pts while New Orders fell the most in 3 years – also good the worst print in 37-months.  With Demand falling and Prices rising +1.8pts to a one year high, the September data also carries a stagflationary undercurrent.

The larger narrative arc here continues to progress:  Global Divergences (positive domestic Growth/Policy Divergence vs RoW Slowdown) --> U.S. Cycle Peaks --> Global Mfg Slump worsens and begins to spill over into Services …. (“But the U.S. is still an insular island of strength”) --> U.S. manufacturing begins to catch down to the global cyclical deceleration …(“But U.S. Services and the consumer/labor market remain strong”)--> Global/Domestic Industrial contraction deepens --> U.S. Services post discrete deceleration amidst a Trending slowdown …. (“but the domestic labor market is still good, maybe, right?”) --> synchronized Black Hole.

“But the domestic labor market is still good, right?”

ISM Manufacturing miss.  ISM Services miss.  NFP miss?

Let’s review the latest as it relates to the final lynchpin of American Economic Exceptionalism:

1. In the latest benchmark revision to the Employment data, Payrolls for the April 2018-March 2019 period were revised down by -500K (an avg of -43K a month.  Note that the revision won’t get incorporated into the official data  until the final revision estimate in Feb 2020.)
2. The Employment and Average workweek series in the Fed Regional Surveys continue to sink to multi-year lows in the latest data.
3. ADP employment for September missed estimates with August revised lower.
4. Small Business Hiring Plans and Consumer Sentiment around the labor market both fell in the latest month.
5. The ISM Services Employment Series printed a 67-month low in September while the ISM Mfg Employment series fell to 44-month low.  Last time those series were this weak on a combined basis, we got a sub 100K print on headline NFP.
6. August marked the slowest pace of payroll growth of the cycle and the 3M, 6M and 12M moving averages for employment have all step functioned lower in 2019. 
7. *Idiosyncrasies: Temporary Census hiring will continue to act as a positive distortion to the headline (either back it out directly or use the Total Private Payroll figure as your read).  The GM Strike started just after the September Survey period so it shouldn’t be reflected in this month’s data … although it will show up in next month’s reading if it continues through the 2^nd week of October).

Now, regardless of what we get this morning a few key realities will remain ongoing:

1. Goods Services employment growth is slowing markedly.  Goods employment is comparably more cyclical and always leads the slowdown in both Services employment and the broader labor cycle.
2. Total Payroll Growth will continue to decelerate.  That’s a function of the first point (broader economic slowdown) but it’s also just an invariable late-cycle reality as the labor pool shrinks and the denominator (total people working) increases as the expansion endures.
3. Average weekly hours growth is slowing.  It’s most pronounced within the manufacturing sector but weekly hours growth across the total private sector in aggregate is now trending negative also.

As we’ve highlighted, those 3 realities carry some straightforward but significant implications:

1. If growth in the number of people working is slowing and growth in how much they are working is slowing then (assuming largely stable productivity) growth in “how much stuff” is created will be slowing … and “how much stuff they create” is real GDP.
2. Accelerating late-cycle wage inflation is occurring and a higher share of National Income for Labor is ostensibly positive for household consumption capacity.  However,  …
3. To the extent employers are curtailing total hours worked, it serves as an offset to improving hourly earnings growth.  In other words, if you are earning more per hour but are working less hours such that growth in average weekly income is flat to down (which it is), it’s not a boon to consumption capacity.

To tie this back to the Profit Cycle: 

Labor isn’t an entirely variable cost. If employers can’t, collectively, cut hours as much or as fast as demand is slowing then, simply, costs and revenue are going in opposite directions which is obviously margin/EPS negative. 

Rather than try to micro-parse the extent to which this is happening at the company or industry level, it’s relatively straightforward to monitor from a macro perspective.  If nominal wage growth is rising faster than nominal gdp, then labor’s share of national income will generally be rising .. which is the same as saying that corporates share of national income is falling which is also the same as saying that margins are declining.  You can see this plotted in the Chart of the Day below. 

So, to review the 3Q19 #EPS Slowing setup:

1. Demand is slowing
2. Labor costs are rising
3. Strong dollar is pinching via lower external demand and Fx translation.
4. We are going against the hardest comps of the cycle

One could argue that it can’t get much worse and base effects imply a Bad --> less bad transition for the forward outlook. 

That’s true, but the chop is decidedly heavy right now as we still have another month of #Quad 4 in Q3 data to be reported, none of the latest high frequency data is supportive of that transition yet and there’s no discrete catalyst for a durable RoC inflection to carry us from Less Bad --> Good.

Is more central bank easing your catalyst?

Remember, (good) rate cuts generally do not come in 3’s … 2 is a “mid-cycle adjustment”, 3 has been a harbinger of further weakness.  And the probability of a 3^rd rate cut in October popped (again) after the ISM data yesterday and sits at 84% as of this morning.

That’s not to say policy doesn’t matter:

If the Fed isn’t dovish enough, fast enough currently prevailing dynamics are likely to simply propagate further.  A relatively hawkish (or under-dovish) Fed will perpetuate a stronger dollar which will further perpetuate global and local disinflationary conditions, further tighten financial conditions, further exacerbate already acute dollar liquidity dynamic and further hamstring the capacity of other Central Banks (China) to initiate more meaningful stimulus measures. 

It will also continue to drag on earnings via both Fx translation and directly via lower external demand – a condition set that will feedback negatively on the domestic economy as businesses further curtail investment and hiring – all of which serve to undercut confidence and risk catalyzing a negative, self-reinforcing spiral. 

Lastly, and most importantly for Friday, everyone knows weekends should come in 3’s. 

Want to join the 2020 political fray? .. here’s your platform:  extoll the character and work ethic of the populous then make the 3 day weekend an official thing.  Hook. Line. Sinker!

Prepare. Perform. Prevail.

Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND signals in brackets) are now:

UST 10yr Yield 1.49-1.75% (bearish)
UST 2yr Yield 1.35-1.61% (bearish)
SPX 2 (bearish)
RUT 1 (bearish)
NASDAQ 7 (bearish)
Utilities (XLU) 63.23-65.30 (bullish)
REITS (VNQ) 91.63-93.75 (bullish)
Energy (XLE) 55.57-59.20 (neutral)
VIX 14.92-21.68 (bullish)
USD 97.95-99.42 (bullish)
Oil (WTI) 51.18-56.49 (bearish)
Nat Gas 2.21-2.44 (bearish)
Gold 1 (bullish)
Copper 2.51-2.62 (bearish)

Have a great weekend,

Christian B. Drake
Macro Analyst