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Jobs are growing at a modest 1% rate



If you subtract government employment from the July jobs numbers (to correct for the distortion of census hiring and firing), then you find that the private sector of the U.S. economy has created jobs at about a 1% annual rate in the past six months. This is the same answer you get regardless of whether you look at the household survey or the establishment survey of jobs, so I think this is a number you can have confidence in. With average hourly earnings and weekly hours coming in somewhat above expectations, I think the jobs news was somewhat positive on balance, but it did fall short of anything impressive.

This rate of growth is unlikely to bring down the unemployment rate from its current 9.5%, because the U.S. labor force tends to grow about 1% per year just due to population growth. So unemployment is almost guaranteed to be quite high come November, and this is going to be bad news for the Democrats.

But if jobs continue to grow at 1% and productivity going forward equals its long-term historic average of about 2%, then these numbers added together give you real economic growth of 3%. I think we can do a bit better than that, so I'm sticking with my expectation that growth will be 3-4%. This is not much to cheer about, but it's better than the 2% or so that the "new-normal" crowd is expecting.

Still, numbers like these mean that politicians are going to be desperate to "do something" to make things better. Unfortunately for the party in power, it's very late in the game to make changes that will show up convincingly in the next three months. A modestly growing economy and high unemployment are essentially baked in the cake for the rest of the year no matter what kind of legislation gets passed between now and the elections.

So the important changes on the margin to look for are in the policy area. If Congress decides to only do more of the same (e.g., more transfer payments, more handouts for special interests), then the market is going to be disappointed because the economic fundamentals are unlikely to improve. The $1 trillion that was spent last year on "stimulus" was never likely to help the economy, and I actually think it has been a major factor in retarding growth. Taking money from those that are working and giving it to those that aren't working simply can't make the economy bigger. You have to do things that encourage people to work and invest more.

If policy discussions instead turn (as they appear to be doing) to things that can positively impact incentives (e.g., extending the Bush tax cuts, cutting spending programs, cutting corporate taxes, and not raising tax rates on capital significantly), then there is reason to be optimistic. I still hold out hope for the latter, and in the meantime I think the economy is doing somewhat better than most observers give it credit for, so I remain optimistic.

Emerging market update



In the past 8 years, the Brazilian stock market, when measured in dollars, has risen almost 20-fold. This is simply breathtaking. Of course, a lot of that rise was a recovery from the collapse in the early 2000s (which in turn was precipitated by a super-strong dollar, collapsing commodity prices, and Argentina abandoning its dollar peg), but still, you'd have to say that Brazil is on fire. Its currency has been steadily appreciating vs. the dollar since late 2002, which has to be an all-time record for any Latin currency to my knowledge.

And since I'm in S. Africa at the moment, I'll mention that the rand has been strong against the dollar since late 2001, rising from 12 to 7.25 today. The press here says the rand is "overvalued," but I would note that wine and food are a terrific bargain. We had lunch at a scenic winery restaurant in the Stellenbosch region (S. Africa's Napa/Sonoma), and most of the wine on the list costs a mere $3 per glass, and it can hold its own against most of its California counterparts. S. African restaurants offer tremendous wine bargains for American tourists, since it appears to me that they mark up the wine no more than 50% above what you would pay at the winery (which is about as cheap as it comes).

Emerging market economies have been the direct beneficiaries in recent years of the Fed's decision to move from very tight to very easy monetary policy, which in turn has helped bring down the value of the dollar and has helped boost commodity prices across the board. Emerging economies have also benefited from very positive structural reforms of their own as well as generally tight monetary policy (with the notable exception being Argentina). I've seen tremendous progress here in S. Africa, and Brazil's accomplishments in recent years would have been almost unthinkable a decade ago (I used to be very bearish on Brazil).

The progress in emerging economies has been reflected in stronger currencies, lower inflation, stronger equity markets, and lower interest rates. From a supply-side perspective, this is fabulous news, since all of these improvements reflect and encourage rising investor confidence and thus more investment and more growth. I don't see an immediate threat to a continuation of strong returns for emerging market investments. Let the good times roll, these countries need it.

ISM service sector indices a bit on the weak side



This measure of the ISM service sector index that I have been following has dipped in the past two months, and that is somewhat discouraging. But it's hard to read much into the monthly change in any index like this, since it is chronically volatile, rising and falling almost every other month. What I do see is a strong gain in the index over the past 18 months, and the fact that the index is still in positive territory (i.e., above 50). So on balance I think this is modestly positive.


On the other hand, I would note that the employment index has been relatively strong and firm with a slight upward trend over the past several months. Manufacturing employment also looks relatively strong. Both are very positive signs, since they show that businesses are hiring and that is the only way the economy is going to post growth of more than the ±2% that the "new-normal" folks are talking about. Rising employment is also a sign that businesses are willing to invest in the future. As a supply-sider, I think that signs of investment are much more important than whatever we see in the personal income and spending data, which so far have not been very impressive. A dollar invested today in new plant and equipment, new jobs, or a new venture represents a new future stream of dollars and higher living standards on average. Demand doesn't drive the economy, supply (i.e., work, investment and risk-taking) does.

Corporate layoffs are low and stable



The fact that corporations haven't been laying off people en masse for most of this year is good news, but it is no longer new news, so in that sense I can't say that this chart is a reason to be optimistic. But it does solidly refute the notion that the economy is slowing and/or we are approaching another recession. By failing to support the bearish case, the chart and the news are a positive, given how bearish sentiment is.

10-30 spread hits record high



The spread between 10 and 30-yr Treasury bonds has hit an all-time record high of 114 bps, according to my quick review of history. This record curve steepening is not showing up in other areas of the curve, however, and the spread has widened sharply in the past week or so. This could be a signal that 10-yr bonds are benefiting from unusually strong demand, perhaps because the Fed has presumably leaked its intention to reinvest income and principal on its MBS holdings, rather than allow them to reduce its balance sheet. That's a tempting conclusion, but I think there are other things at work as well. 

The curve has been steep for some time now, and that is a classic sign of accommodative monetary policy and, and as such the curve presages a) an economic acceleration and/or b) rising inflation. Either one of those would be consistent with a widening of the 10-30 spread. 

It might also mean that those who were speculating on rising 10-yr yields have had to buy back their short positions, for fear that this presumed change in Fed policy will delay the rise in 10-yr yields. 

Whatever the case, a much steeper curve at the long end almost surely is a vote of no-confidence in the deflation scenario. If deflation were really a strong possibility, then investors would be buying the 30-yr and selling the 10-yr, betting on a flatter yield curve and locking in 4% yields on 30-yr Treasuries.

As I've said many times in the past, anything that diminishes the risk of deflation is automatically bullish from an equity investor's viewpoint. So the bottom line here is that the steepening of the long end of the yield curve is a positive, especially considering how bearish market sentiment appears to be, and how pervasive deflation fears appear to be.

Car sales continue to be very strong


July auto sales were up at a 21% annualized rate from last year's low. That's very strong no matter how you look at it. Another V-shaped recovery for an important sector of the economy.

Inflation update



The personal consumption deflators have been fairly tame of late (the headline rate was slightly negative in June), but on a year-over-year basis, both the core and the headline version are registering 1.4%. That's less than I would have expected a year ago, and both are within the Fed's desired 1-2% range, so while I'm disappointed about being wrong, I'm happy that inflation so far has not been problematic.

I still think the risks are skewed to rising inflation in the future, and I still take issue with those who worry about deflation. Just as a reminder that there are a lot of prices out there that are rising, I offer the next chart, which is the CRB Spot Commodity Index; it contains no energy and many of its components are very basic items that don't have futures contracts associated with them, so speculative pressures most likely don't have a lot of influence on this index. As you can see, it has bounced nicely in the past week or so, and is very close to its recent highs. It's only 8% below its mid-2008 all-time high.


I would also note that the dollar has dropped about 9% in the past two months, which means that the average price of anything that you buy overseas has risen by 9%.

Cape Town is magnificent



The skyline of Cape Town is dominated by Table Mountain, shown in this photo.


You take an aerial tram up to the top (about 3,300 ft. above sea level), and look back down on the city, as shown in this next photo. I happened to capture some kids preparing to abseil down the sheer rock face, and I thought it gave a good idea of just how high we were and how close the city is to this gorgeous hunk of rock.


Looking south (the picture above was sort of facing north), you can see how this massive rock formation extends into the distance. At the end of the peninsula, you find the Cape of Good Hope, shown in this next photo. The incredibly scenic drive from the city to the Cape takes a little less than two hours.


This next photo shows the Cape from above and from the other side as shown in the above photo. This Cape has been the bane of mariners for over 500 years, as it marks the confluence of two ocean currents which help generate unpredictable and terribly fierce weather. It's very close to being the most southern portion of the African Continent (but I would note that almost half of Argentina and Chile lie even further south).


Finally, a shot of some of the hundreds of African penguins you can see about halfway from the city to the Cape of Good Hope, on the eastern side of the peninsula. The government has done a great job of preserving their habitat right in the middle of an upscale community on the waterfront. Really worth a visit.


All of this majestic scenery right next to and within a short drive of Cape Town really sets it apart. It's really a world-class city in every sense.

fear subsides, prices rise



I haven't posted this chart in a while, but I think it is significant that the story it is telling hasn't changed for the past two years: the ups and downs in the equity market are strongly correlated with the market's level of fear, uncertainty, and doubt (as expressed by the Vix index). The market went into a mini-panic last May, but fear is slowly dissipating, and prices are beginning to move back up. Why? Europe didn't melt down; commodities didn't collapse (in fact they are rising nicely); the U.S. economy hasn't double-dipped (in fact it is doing better than expected); and policy errors that could really threaten growth—like cap and trade—aren't happening.

The one cloud that remains on the horizon is the expiration of the Bush tax cuts at the end of this year, but the political winds continue to blow in a favorable direction on that score (i.e., the growing likelihood of big Democrat losses this November), and if more people can apply common sense, facts, and logic to make the case for not increasing taxes and instead for cutting spending, like Art Laffer does in his WSJ op-ed today, then investor confidence in the future could really start to improve.

The market is suffering from the "once burned, twice shy" syndrome. The majority of people are still terribly afraid that something else is going to go wrong with the economy. All it takes for prices to move higher is the realization that the market's worst fears aren't materializing. Now, if we could actually get some really positive news, imagine the upside potential!

Construction spending holds steady



Construction spending in June was somewhat stronger than expected, just as the ISM index for July was stronger than expected. It's not that construction spending is growing, however, it's that it is not declining further. Total construction spending has been flat so far this year, and residential construction has managed to post some enduring gains over the past 12 months. That is much better than the fear-mongers have been expecting.

I like the fact that construction has stopped declining. This is a good sign that the bulk of the adjustments in the sector (e.g., declining real estate prices) have been made, and that the ground is being prepared for future gains. Lenders are beginning to be more willing to lend, and builders and developers more confident about committing to new projects. Things aren't great by any stretch, but on the margin they are no longer deteriorating, and that's good.

ISM indices say the "new normal" economy is a no-show


Just came back from touring fabulous Cape Town. Really a gorgeous city that reminds me of the best of San Francisco, San Diego, and even Hong Kong. I'll post some photos in a bit. Anyway, I am happy to see that the market is up, and it would appear that once again it's because the news on the economy has proven stronger than expected. The ISM manufacturing index (above) was stronger than expected, and as my chart suggests, this is fully consistent with the 3-4% economic growth rate (if not more) that I've been expecting to see for the past year. It's a bit weaker than the fabulously strong levels that were showing up recently, but it is not supporting the popular "new normal" economy theory, in which growth registers a feeble 2-3%.


Most encouraging was the employment index (above) which is still at very strong levels that have been seen only rarely in the past several decades. This is very good news, since the weakest part of the recovery so far has been jobs and business investment, and the ISM index suggests that the manufacturing sector has shrugged off this malaise quite nicely.

My thesis is still in place: this economy is growing at a 3-4% pace, which is not very impressive given the extent of the recent recession, but it is stronger than the market has been expecting, and that is enough to drive equity prices higher and corporate spreads lower. It is also serving to weaken the dollar, since a moderately growing economy reduces the need for the world to seek shelter in the dollar for fear of a double-dip recession or worse.

Since 10-yr Treasury yields are still hovering just under 3% (a level that is only consistent with a market that is fundamentally bearish on the economy and very concerned about deflationary pressures that presumably arise from sustained economic weakness), I believe I am still correct in saying that the equity market is cheap and the Treasury market is very expensive.

Victoria Falls



Yesterday we took a helicopter flight to see Victoria Falls from the air (see photo above). It's really quite spectacular. Victoria Falls is considered by many to be one of the seven natural wonders of the world. It's much wider than Niagara, and a bit taller as I recall. But Iguazu falls (claimed in part by both Argentina and Brazil) is much wider and much more visible. As this photo shows, the water that pours over Vic Falls dumps into a narrow ravine, so that the falls themselves are only visible from the air or from the opposite side of the ravine. But the latter view is obscured tremendously by all the water vapor that comes rushing up from the bottom. It gave us the impression of being in the midst of a huge rainstorm.

Iguazu, on the other hand, is very visible from far away, and more easily accessible. It doesn't dump into a ravine, but is horseshoe-shaped so that you can see it from far away and from many interior angles. I would urge that waterfall lovers visit both falls, since they each have unique and very impressive characteristics.

If you do visit Iguazu, I would suggest flying to Buenos Aires and taking a flight from there to Iguazu. The best place to stay is the Sheraton Hotel on the Argentine side of the falls. But be sure to see the Brazilian side as well.