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Our House: Is the United States the Best House in a Bad Neighborhood?
Liz Ann Sonders
Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc. June 4, 2012
Key points
The June 1 employment report was a dud, but other economic reports were a bit rosier.
The eurozone debt crisis and slowing global growth remain the greatest risks.
A muddle-through economy continues to be the most likely path.
I won't try to put lipstick on the pig that was last Friday's May jobs report, but I will try a little lip gloss. Somewhat lost in the mire of the dire reaction to the report were several other more-positive readings on the economy. That's testament to the likelihood that there are many more drivers to today's malaise than just jobs growth, or lack thereof. It seems clear we're in the midst of the third consecutive mid-year economic slowdown, driven by similar forces, most dominantly the eurozone debt crisis.
Questions about recession risk are as rampant now as they were last fall, but I remain in the camp that believes we will avoid one in the short-term. Part of the reason is not rosy: as the saying goes, if the plane never got off the runway, a crash is much less likely. It's the "blessing" and the curse of a muddle-through economy. I wouldn't bet the farm on a recession being avoided and I have as cloudy as crystal ball as anyone, but that remains my view.
First, the lip gloss
The weakness in the employment report was largely across the board. Payroll employment was up a meager 69,000, about half the consensus expectation, while the unemployment rate ticked up a tenth to 8.2%. The weakness was largely concentrated in three areas: business services, leisure and hospitality, and construction.
The weakness in construction probably reflects a "give-back" from the exceptionally strong, warm-winter-weather period in the beginning of the year. The other two segments tend to see their hiring lag movements in energy prices, and given their surge during the first four months of this year, the weakness is not terribly surprising. The good news is that energy prices have plunged since then.
There are some other caveats, too. The household measure of employment, from which the unemployment rate is derived, showed an increase of 422,000 and an increase in the number of participants in the labor force. The latter explains why the unemployment rate ticked up, but may also show some increased confidence about landing a job. However, it also points to expiring unemployment insurance benefits, which is forcing some participants back into the labor pool.
It's not all bad We also know that many of the leading indicators for job growth remain healthy, including:
Employment components of the Federal Reserve's regional manufacturing surveys
Hiring plans, sales, profits and jobs-hard-to-fill at multi-year highs
Jobs-hard-to-get at multi-year lows
Job openings (JOLTS survey) at a four-year high
Average hours worked at a 20-year high
National Federation of Independent Business plans to hire at a cycle-high
Friday also brought the latest Institute for Supply Management (ISM) manufacturing index, which registered a reading of 53.5—still well above the 50 reading that separates an expansion from a contraction, and consistent with economic growth remaining comfortably above recession territory. On top of that, the new-orders component of the ISM index (both the index overall and the new orders component are key leading indicators) is not only at a cycle-high, but the "prices paid" component, measuring inflation, has collapsed in the past month. As noted by Wolfe Trahan, the best US gross domestic product (GDP) readings have generally come in the wake of large declines in inflation. And stocks generally do well when leading indicators of growth (new orders) are stronger than inflation pressures (prices paid).
Wall of worry is back Sentiment has also improved markedly over the past month, thanks to May's weakness. When I last wrote about sentiment in early April we highlighted the market's elevated risk of a correction due to overly-optimistic sentiment (a contrarian indicator). As you can see below, that sentiment has reversed and is approaching territory that's usually supportive for stocks. But frankly, I'd feel better if sentiment got even more pessimistic. We may need to see a little more capitulation before the market can find its legs.
Manufacturing renaissance Longer term, we remain optimistic about the prospects for both the US economy and stock market relative to the rest of the globe. As I've noted consistently, we have a "renaissance" story unfolding here in the United States; particularly within manufacturing and domestic energy. Housing is also becoming a major tailwind (more to come on that in future reports.)
I got back from a trip to China 10 days ago and my conversations in Hong Kong and Shanghai largely supported my view that even in the face of a "muddle through" economic-growth environment, from which this country is unlikely to exit any time soon, there are bright spots worthy of attention. In fact, maybe tellingly, nearly everyone with whom I had a conversation was more pessimistic than the consensus about China's growth prospects but more optimistic than consensus about US growth prospects. And this was the sentiment of both local Chinese as well as US ex-patriots with business in China.
Part of this is the wage-gap story, as you can see highlighted in the chart below. Within the next few years, the "total landed cost" (definition below the chart) will have fallen to only 16%, explaining why many businesses are bringing work, equipment and plants back to the United States or are preparing to do so in the future.
Labor and Other Cost Spreads Narrowing Source: Supply Chain Optimization Study, The Hackett Group 2012. Landed Cost=total cost of a product once it has arrived at buyer's door and includes original cost of the item, all brokerage and logistics fees, complete shipping costs, customs duties, tariffs, taxes, insurance, currency conversion, crating costs and handling fees. Not all components are present in every shipment, but all must be considered part of the landed cost.
I won't go as far as suggesting full-on "decoupling" is underway, but do notice the sharp difference between the PMIs for the United States over the past six months versus other key regions around the globe. But key in the next month or two is to see whether US growth can hold up in the face of likely continued deterioration in Europe and some emerging markets. The June 4 factory orders report was weak for the second month in a row, so the environment remains rocky.
US PMIs Outperforming Source: Bloomberg, FactSet, as of May 31, 2012.
Of course manufacturing is nowhere near the primary driver of our economy, and its momentum has waned recently. The consumer still represents 70% of US GDP, but manufacturing is a major re-up-and-comer and suggests better things to come for jobs—at least of the manufacturing variety.
Take a look at the table below, which highlights the employment multiplier of many of the industries right in the heart of the renaissance. Top on the list is petroleum refining. By the way, the United States, for the first time in the modern era, is now exporting more refined petroleum products than it's importing. For every 100 jobs created in refining, nearly 1,200 related jobs are created elsewhere. Even for manufacturing more broadly, the multiplier is nearly 300.
Source: ISI Group, "Updated Employment Multipliers for the US Economy (2003)," by Josh Bivens. Economic Policy Institute Working Paper No. 268, August 2003.
These numbers swamp the industries that were the some of the big drivers of the last economic expansion's leaders, including investment banking, retail and construction.
The near-term risk for manufacturing is of course global growth. Much of peripheral Europe is already in recession and China, among other emerging economies, is experiencing a sharp slowdown. This remains the greatest risk to the muddle-through story that has kept US growth in the black and the stock market from moving into bear territory.
Important Disclosures The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
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