Will Job Numbers Make The Fed Hit The Brakes?

Reprinted from: The Globe and Mail
June 6, 2013
By, David Parkinson

The Fed | Jobs Numbers

The latest monthly U.S. employment numbers, set for release Friday, provide a fresh gauge on the U.S. march toward 6.5-per-cent unemployment – the level at which the Federal Reserve Board has said it would start considering raising its near-zero policy interest rate. With the markets hyper-sensitive to the question of when the Fed will start reversing its unprecedentedly accommodative monetary policies (starting with an anticipated “tapering” of quantitative easing, a precursor to eventual rate hikes), any above-estimate job growth or below-estimate unemployment rate would kick off hand-wringing that the Fed is on a fast track to monetary tightening.

Don’t count on it. The Fed’s stated mandate on the labour front is to “maximize employment” – and even if the U.S. is closing in on the magic 6.5-per-cent unemployment number, employment is a long, long way from maximized. The improving numbers mask a troubling near-total lack of recovery in labour-force participation. A lot of people left the U.S. labour force outright in the Great Recession – not even trying to find a job any more – and they haven’t come back.

In a report this week, Montreal-based independent economic research firm BCA Research noted that despite unemployment having fallen from 10 per cent at its 2009 peak to 7.5 per cent as of April, the employment-to-population ratio for adults age 25 to 54 is still 4.5 percentage points less than its pre-recession average. What’s more, these participation levels have shown little improvement since the end of the recession.

It should be noted that the Fed never said it would raise rates once unemployment fell to 6.5 per cent (which is on pace to happen some time next year). It only said it would keep its key Fed funds rate at current lows “at least as long as the unemployment rate remains above 6.5 per cent.” Which means it would only consider starting to raise rates once that criterion has been met. BCA believes that upon such consideration, the Fed will reject rate hikes as premature – because hikes could kill any chance of a full recovery in labour participation.

“Recent research by the Fed suggests that the participation rate tends to react quite slowly to improvements in labour market conditions, and that the longer the participation rate remains depressed, the greater the risk that a worker will permanently drop out of the labour force,” it wrote.

We continue to believe the odds are low of premature easing at the Fed, especially since core inflation is so low. – BCA Research

“This provides the Fed justification for taking measures to ‘overheat’ the labour market – that is, to bring down the unemployment rate below where it was before the recession – in order to draw more people into the workforce, and by so doing, to maximize the long-term level of employment, as the Fed’s mandate requires.”

Indeed, BCA noted, this approach is implied by the “optimal control” approach to rate policy laid out in a speech last year by Fed vice-chairman Janet Yellen – who is considered the front-runner to succeed Ben Bernanke as chairman when his term ends about eight months from now. Under this approach, the Fed funds rate wouldn’t start to rise until late 2015, by which time unemployment would be well below 6 per cent. (Inflation under this scenario would creep above the Fed’s favoured 2-per-cent target, but not dramatically.)

“We continue to believe the odds are low of premature easing at the Fed, especially since core inflation is so low,” BCA concluded.

Still, the financial markets may not agree – creating the possibility of a dramatic reaction to Friday’s job numbers, as the debate over the timing of QE tapering remains a major preoccupation. In fact, Merrill Lynch chief investment strategist Michael Hartnett noted in a report Thursday, it’s being seen in some quarters as “the most important payroll release in years,” coming after a month in which QE worries wreaked havoc on the bond market.

Mr. Hartnett believes that a job-growth number north of 250,000 (versus the consensus estimate of 165,000) would be needed to send the market’s into a new tizzy, as that kind of number would imply an “imminent” unwinding of QE. On the other hand, he said, a figure below 90,000 would suggest to the markets that QE will be around longer than expected, reversing the recent bond sell-off.

[...read the article at The Globe and Mail]

Berezin Gives Even Odds On Recession In Canada

Reprinted From:  The Montreal Gazette
By, Peter Hadekal

Most forecasters expect that growth in Canada will accelerate during the next few quarters. But a more sobering view comes from Montreal-based economist Peter Berezin at BCA Research.

Canadian Dollar - Recession

A slowdown is on the way and there’s a 50-50 chance of recession in Canada by the middle of next year, argues Berezin, managing editor of the monthly newsletter The Bank Credit Analyst.

Growth is likely to falter as the housing bubble deflates and as investment spending slows, especially in the natural resource sector.

If that happens, the Bank of Canada would have limited recourse to stimulate the economy with easier monetary policy since interest rates are already near historic lows.

In these circumstances, the Canadian dollar is likely to weaken during the next year while Canadian stocks are likely to underperform.

Canada, he says, shares many of the same characteristics as other medium-sized resource economies such as Australia and Norway. All three have overvalued housing markets, high levels of household debt and overvalued currencies.

Canada may simply be at the leading edge of a broader story that will play out over the coming years, in which smaller economies begin to suffer the ill effects of global financial conditions that, from their perspective, have been too loose for too long. – Peter Berezin 

This would represent a sharp reversal of the trend in recent years in which Canada has outperformed many other economies. Our banking system was stronger after the financial crisis of 2008 and our governments were in better fiscal shape.

Most forecasters have continued to be reasonably optimistic about Canada in the short term, pegging growth at more than 2 per cent in 2014. The consensus view is that Canada will benefit from the recovery underway south of the border.

That’s wrong, argues Berezin. Canada has a 50 per cent chance of slipping into recession, even if U.S. growth does accelerate.

The main culprit will be a weakening housing market in this country, which until now has attracted new construction investment and helped to sustain consumer spending.

Recent declines in home sales are just the start of a likely slide in prices that could be painful. “Relative to disposable income, house prices stand nearly 40 per cent above their long-term average,” he notes.

And Canadians are dangerously exposed to household debt. By one estimate, 30 per cent of mortgage holders would encounter serious problems in making their monthly payments if rates were to rise by two percentage points.

A housing bust in Canada wouldn’t be as dramatic for our banking system as what we saw in the U.S., but it would have a severe impact on consumption, because of the willingness of Canadian households to take on more debt by using their homes as collateral.

So, if Canadian home prices were to decline by 20 per cent over three years, household wealth would take a $400-billion hit and leave Canadian consumers far less willing to spend.

Along with a slowdown in natural resource prices, Canada won’t benefit so much from a recovery in the U.S. One reason is that the Canadian economy is much less leveraged to the U.S. than it used to be.

In the past, U.S. and Canadian GDP have tended to move in lockstep, but now there are signs of decoupling. Canadian exports of manufactured goods to the U.S. have been on a downtrend for more than a decade.

In 2000, exports to the U.S. of manufactured goods, machinery and transportation equipment accounted for nearly 20 per cent of Canada’s GDP, but today, that has slipped to 8 per cent.

If you want more proof, consider that employment in Canada’s auto industry — usually a bellwether for trade to the U.S. — has shrunk by 30 per cent since 2000.

“In any case,” says Berezin, “it is not clear that Canadian manufacturing firms could easily increase production, even if they wanted to.” Manufacturing capacity has declined during the past decade in line with falling output.

And there will be no manufacturing renaissance north of the border until this country does something to reverse its long slide in competitiveness.

[...read the article at The Montreal Gazette]

Photo Credit: Johanna Goodyear / Shutterstock.com

Dividend Stocks, The New Nifty Fifty?

Reprinted from: Barron’s
By, Randall W. Forsyth

While central banks’ policies inflate a bubble in income equities, a nervous bull says the greater risk is not to buy them.

The New Nifty Fifty

Nifty Fifty. It’s a phrase out of stock-market history, one familiar to most of today’s investors only from history books, but an indelible memory to those who were active in the markets back in the 1960s and 1970s.

They were so-called one-decision stocks you were supposed to buy and put away forever because these supposedly elite growth companies would continue to grow no matter what. As a result, no price-earnings multiple was too great to pay given their unlimited and certain future growth prospects. Of course, it didn’t turn out that way in the devastating bear market of 1973-74.

Yet there was a kernel of truth in buying the Nifty 50, whose members included the likes of Coca-Cola (ticker: KO), International Business Machines (IBM), McDonald’s (MCD), Johnson & Johnson (JNJ) and Walt Disney (DIS), just to mention a few of the great Dow Jones Industrial Average members whose stocks have gone on to record highs in subsequent decades.

But this group also includes companies that have become footnotes to history, especially in technology, such as Digital Equipment and Burroughs. There also are companies such as Polaroid and Eastman Kodak, which became quintessential buggy-whip companies with the advent of digital photography. And then-dominant retailers, Sears, Roebuck and K-Mart’s predecessor, Kresge, now are part of Sears Holdings (SHLD) and are fighting against a then-unknown chain, Wal-Mart (WMT.) Microsoft (MSFT), Intel (INTC) and Apple (AAPL) not only didn’t exist but weren’t even conceived. Sic transit gloria.

Despite this example of history, a new Nifty 50 could be in the making, according to Chen Zhao, managing editor of the BCA Global Investment Strategy advisory from the organization that publishes the highly regarded Bank Credit Analyst.

This elite group of stocks would consist of reliable, high-dividend payers, which have become ever more sought-after in a market parched of income. He notes the Standard & Poor’s Dividend Aristocrats have returned half-again that of the Standard & Poor’s 500, a pattern that closely parallels the original Nifty 50 at the beginning of their run in the 1960s.

And while the original Nifty 50 became “massively inflated” during their heyday, the current bubble in dividend payers could continue to be pumped up for some time. To spoil the ending of the story, Zhao thinks the end-point won’t be reached until interest-rate expectations turn decisively to the upside; that’s a worry for next year or the year after.

Every decade or so, Zhao posits, there is a new, can’t-miss investment concept. After the original Nifty 50, it was gold and other real assets during the inflation of the 1970s; then came the Japan bubble of the 1980s; the dot-com bubble followed in the 1990s; and then there was the bull market in China and other emerging markets, which also resulted in a commodities boom.

The conditions spurring income-producing stocks now are similar to those that boosted the original Nifty 50 — artificially low interest rates held down by government actions (Regulation Q rate ceilings then, central-bank quantitative easing now.) In the 1950s, stocks routinely yielded more than bonds because of investors’ risk aversion, just as they do now for many Blue Chip companies.

“What should investors do? For me, I am afraid to be in it, but I am equally, if not more, afraid to be out of it,” Zhao pointedly concludes.

Zhao expects the Federal Reserve and other central banks to maintain interest rates at or near zero given the large slack in the world economy. Government bond yields under 2% make equities the highest-yielding asset class. But after the repeated financial traumas of the past decade and continuing uncertainties, “most investors are longing for stable portfolios that generate steady income streams. Naturally, stocks with fixed-income characteristics have become the favorite target of investors,” he writes.

The resulting asset rotation could be “incredibly strong,” according to Zhao, and has “the potential become the next mania.” But income stocks aren’t in a bubble, yet, which is a condition built on unrealistic expectations.

“Some say defensive stocks behave like fixed-income products and hence could weather weaker market corrections or shakeouts. In reality, they rarely can. My feeling is that the dividend party will not stop until interest-rate expectations begin to rise. That could be one or two years away.”

“What should investors do? For me, I am afraid to be in it, but I am equally, if not more, afraid to be out of it,” Zhao pointedly concludes.

That speaks volumes of how the Fed and other central banks have inflated asset values. Still, that is the world in which we live, whether we like it or not.

[..read the full article at Barron's Online]

New Daily Insights – Power On!

We are pleased to announce the official release of New Daily Insights – BCA’s first interactive service.

macroeconomic researchLaunched today, May 13, 2013 – New Daily Insights is now available as a completely online and interactive experience: research content will be delivered via emails that include hyperlinked titles and no static PDFs. In addition – through the power of responsive design – the service can be viewed across all platforms, including desktops, tablets and smart phones.

Our move to digital delivery coincides with the release of several new features:

Insights: Now with greater breadth and depth, in four categories:

  • Featured Insights: Focused and brief analysis of global financial market trends
  • Morning Meetings: A same-day snapshot into the ideas and debates of our strategists
  • Key Releases: Detailed analysis of the day’s economic data
  • The Week Ahead: Published Fridays, find out what BCA expects will move markets in the week ahead

Ask A Strategist: Interact with BCA strategists online. Ask your questions and access all QA to uncover what is relevant to the BCA community.

Inside BCA: Learn what our strategists are reading, view their comments on controversial themes and views, read interviews with members of the financial community, and discover suggested research from the BCA vault.

Polls: Share your opinion and search previous polls for insights on key topics. Suggest a poll – we’re listening.

We look forward to having our New Daily Insights clients engage with us through comments, questions and polls.

Nanci K. Murdock, CFA
Editor, Inside BCA
New Daily Insights

Another Disconnect

Reprinted from: The Economist
By, Buttonwood

If it seems odd that gold and Treasury bond yields are both falling when U.S. equities have recently been reaching new highs, Dhaval Joshi of BCA Research points to another disconnect – that between U.S. and European equities. Since the end of Janaury, the Eurostoxx had dropped 5.5% while the S&P 500 had risen by 4% (at the time his research note was published). Lest you think that is all down to the euro zone’s problems, emerging markets have also been weak this year.

Another Disconnect Graph

I s it all down to the relative strength of the U.S. economy? Surely not. For a start, recent data such as the non-farm payrolls have been weak. Secondly, as previous posts have pointed out, there is very little connection between an equity market and domestic economic growth. Many of the companies in the S&P 500 and Eurostoxx are multinationals and thus are affected by global factors.

Indeed, most of the time, the two indices move in tandem. According to Mr. Joshi, since the launch of the euro, the indices have moved in opposite directions for only 7 out of 57 quarters.

So what’s going on?

Mr. Joshi has pointed to the disconnect between equities and commodities before and he thinks the latter are clearly signalling a slowdown in global growth.  With U.S. companies reporting some disappointing earnings numbers, it may be that the recent falls in the S&P 500 have further to go.

[Read the full article at: The Economist]