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Misery Index update



The top chart is an update of the Misery Index as of June (assuming the CPI will be reported as up by 3.7% in the 12 months ended June). At 12.9, the index is now higher than at any time since May 1983. The components of the Misery Index are included in the second chart for informational purposes.

Some observations worth noting: Every significant rise in inflation has preceded a rise in the unemployment rate. Why? Because the Fed starts fighting the rise in inflation by tightening monetary policy, and a scarcity of money (and high real interest rates that it entails) slows and eventually crushes the economy. Similarly, every significant decline in inflation has preceded and/or accompanied a decline in the unemployment rate. Since the unemployment rate moves inversely to the health and strength of the economy, we can say that, based on the experience of the U.S. economy over the past 50 years, high and rising inflation is bad for growth, and low and falling inflation is good for growth.

June jobs report so bad it's difficult to believe

According to the June Establishment Survey, only 18K jobs were added, far below expectations of 105K. Private sector jobs rose only 57K, against an expected 132K, and were very far below the 157K that was predicted by the ADP survey yesterday. Worse still, according to the June Household Survey, jobs fell by more than 500K! A weak employment report might be understandable given that the economy was still suffering from its "soft patch" in June, but bad news of this magnitude—and especially considering the huge variance between the household, establishment, and ADP surveys—must be considered suspect. Sometimes these surveys just go buggy. When they all line up in the same direction, then one can be reasonably confident that the data is somewhat sound. But when they vary by almost 600K, then it's time to take a deep breath and avoid jumping to extreme conclusions.


This first chart helps put things in perspective. Note first that the household survey can be extremely volatile at times, and June's big employment decline has plenty of precedents. More often than not, a big move up or down in one month is followed by a reversal in the next month or two. Second, both surveys still appear to be in an uptrend, and both are saying that about 2 million private sector jobs have been added since early 2010. Taking an average of the six-month growth rate of the two surveys (next chart) yields an annualized growth rate of 1.3%. So it's reasonable to think that the economy is still growing, and that private sector jobs are probably increasing on average at a 1.3% annual rate, or about 120K per month.  That's a very weak number, to be sure, but it is consistent with the fact that the unemployment rate has risen in the past two months and weekly claims for unemployment have been hovering at just over 400K per week (there has been no indication in the claims data to suggest a sudden and massive loss of 500K jobs in June). Conclusion: the economy is still growing, but slowly.

For the past year or two, one consistent theme in the jobs data has been a steady—and perhaps even an accelerating—decline in the number of public sector jobs, and June was no exception. As the chart below shows, public sector jobs have declined by a little more than 500K on net since their peak in 2009 (abstracting from the temporary census jobs). This is welcome news, since bloated public sector spending and public sector payrolls (and their attendant and generous benefits) have been a drag on growth for some time.


It's also of note that the decline in public sector payrolls to date was matched only by the 500K decline (bigger in percentage terms) in public sector payrolls that occurred from 1980 through 1983. This is a nasty shakeout for the public sector, but not without precedent. Happily, the economy enjoyed very strong growth from 1983 through 1989 after suffering through wrenching adjustments. I would like to think that all the bad news we are seeing these days (e.g., a painfully slow recovery, very high rates of unemployment) is setting us up for a shift to more growth-friendly fiscal policies, and it may come sooner rather than later given the looming issue of the debt ceiling.

UPDATE: reader "brodero" suggests that seasonal adjustment factors could have played a significant role in the June jobs weakness, just as seasonal factors have sent false signals with the weekly unemployment claims data. This would be one more justification for my decision to focus on the six-month trends in the data. Note this quote from High Frequency Economics:

In trying to explain the very weak June jobs report, Ian Shepherdson of High Frequency Economics examines the June seasonal factors. Because of summer jobs, the unadjusted number of June payrolls is always higher than the adjusted number. Shepherdson says the SA-NSA spread in private payrolls was -920K in June 2010; this year it was -1084K. The swing in the seasonal factor, -164K, was the biggest ever recorded (the data go back to 1947). He concludes: "Had last June's seasonal been used again, private payrolls would have been +221K."

Money supply growth alert


As the above chart of the M2 measure of money supply shows, recently there has been a very unusual pickup in the amount of money in the economy: $76 billion, to be precise, in just the last week. Over the past several years and since 1995, M2 has grown about 6% per year on average, which would equate to about $10 billion per week currently; the latest surge thus stands out as a huge aberration, and one that warrants close attention. About 80% of the growth in M2 in the past week came from increased savings deposits at commercial banks and thrift institutions (mostly commercial banks).


This next chart shows the year over year and 3-mo. annualized growth rates of M2, in order to highlight just how significant the recent increase in M2 has been. A one week outsized jump in M2 has resulted in a 3-mo. annualized growth rate that is very high by historical standards. A few more weeks like this and we would have M2 growth that was only equaled during the panic of late 2009, when the world was desperate to hold as much liquid money as possible. This latest growth might be panic-related, but there is no other sign of panic that I am aware of.


Over a very long period, M2 growth is still averaging only 6% a year, as the chart above shows, and that is quite unremarkable. Indeed, the persistence of 6% annual M2 growth in recent years has been a significant argument against the likelihood of a meaningful rise in inflation. We may now be seeing a significant change in that important fundamental, but of course with only one outsized-growth week, it is premature to jump to conclusions.


Nonetheless, I add this last chart to the mix, since it shows that there has been a significant pickup in Required Reserves of late: in fact, required reserves have grown at a 32% annualized rate so far this year. Why is this important? Because the Fed has flooded the banking system with $1.6 trillion of reserves in the past few years, and until recently, the vast majority of those additional reserves were being held by banks as Excess Reserves. Banks were using only a very small portion of their additional reserves to create new deposits, which explained why the broad money supply was growing at only 6%, and leaving the rest on deposit at the Fed as excess reserves. That is now changing, as banks are putting more and more of their reserves to work, and thus expanding the money supply.

Strong growth in the broad money supply doesn't necessarily signal higher inflation, since the extra growth could be due to stronger money demand. But if the extra growth we are now beginning to see corresponds to an increased willingness on the part of banks to lend and borrowers to borrow, then it easily could lead to higher inflation down the road. I will be paying very close attention to M2 in the weeks to come, and I'll wager that others will too.

Dr. Copper agrees: the "soft patch" is over


This chart of nearby copper futures shows how prices have jumped in the past week, confirming that the recent rally in equities and the selloff in Treasuries have been driven by improving growth fundamentals. Dr. Copper (so-called for its ability to detect and reflect the changing dynamics of economic growth and monetary policy) has been on a tear since early 2009, with a few pauses along the way which coincided with periods during which the market had deep concerns about the risks of a double-dip recession.


Markets are feeling better about the prospects for growth even as yields on 2-yr Greek debt and the prices of Greek credit default swaps continue to show a very high likelihood of a significant Greek restructuring/default. So the Greek debt tail is not likely to wag the global economic dog. Economic activity is likely to continue to expand, albeit at a relatively slow pace.

ADP jobs survey encouraging


In addition to the excitement over weekly claims, the market today is also impressed with the strength of the ADP jobs survey, which rose more than twice as much as expected (+157K vs +70K). This naturally increases the chance that the official private sector jobs number released tomorrow will be stronger than expected, perhaps on the order of +160K or more. Both numbers will reinforce the notion that the much-ballyhooed economic slowdown of recent months wasn't much more than a temporary thing that had more to do with supply-chain disruptions in the wake of the Japanese tsunami and a spike in energy prices, than with the beginnings of a double-dip recession.

Claims: much ado about nothing (cont.)



As I predicted last week, and a few weeks ago, today's reported decline in weekly claims for unemployment has got the market excited. Claims fell by more than expected, and bonds and stocks are reacting predictably to a positive growth shock. In reality, though, nothing has really changed as far as claims go—the past few months of claims gyrations have been all about seasonal adjustment factors.

The top chart shows seasonally adjusted claims, while the bottom chart shows the raw data. Claims actually rose a bit last week, but the rise wasn't as much as the seasonal factors expected (because not as many auto workers were laid off as is usually the case), so the adjusted number fell. This same pattern should be repeated over the next two weeks I believe, so stay tuned for more (seasonally adjusted) excitement.

No double-dip risk, just more of the slow recovery blues


The message of this chart of announced corporate layoffs is that there is no sign of any deterioration in the job market. Indeed, layoff activity remains unusually low. Large corporations long ago finished their restructuring activities. We've already seen a pickup in new hiring activity, but to date it has been fairly modest.


Although new hiring activity has increased only modestly, conditions today are still far better than they were one and two years ago. In the very large service sector, businesses' new hiring intentions are in positive territory (second chart), but far from what might be termed robust. So while bad news has slowed to a trickle, we are still waiting for the really good news.

In my view, we aren't likely to see any real strength in the U.S. economy until such time as the federal government makes a determined effort to cut back on its spending addiction, simplify the tax code, reduce and flatten tax rates, and ease up on the regulatory pressure. Massive federal borrowing leaves no room for private sector initiative, corporate tax rates are the highest in the industrialized world, and the tax code's complexity is beyond comprehension. As I've mentioned before, the federal budget deficit has absorbed every dime of corporate profits since the recovery began two years ago.

I still think this is possible, and mainly because there really is no alternative. We've had our great experiment with Big Government and it has failed. Time now to give the private sector a chance.

Equities are not overvalued



I've been pushing this theme for a long time, and the point is to show that the market is still gripped more by pessimism than by optimism. This is a market that is very reluctant to accept that things have improved and very quick to believe that conditions are going to deteriorate. For investors who believe that there will be no deterioration, rather just a continuation of the (unimpressive) status quo or perhaps some modest improvement in the future, this makes today's valuations attractive.

The top chart shows that PE ratios remain below their long-term average, using data as of June 30. The bottom chart compares the earnings yield (the ratio of per-share profits to share price) on equities to the yield on BAA corporate bonds (which is representative of a significant share of the large cap corporate universe). For the past year, earnings yields have been higher than corporate bond yields, a condition that is a relatively rare occurrence. Ordinarily, investors are willing to accept a lower yield on equity ownership than they could receive by buying a corporate bond, because equity ownership can deliver capital gains in addition to the earnings yield. That investors today seem largely indifferent to these two valuation metrics is a sign that the market doesn't see much chance, if any, of future capital gains.


To be fair, I should note that the growth of earnings has slowed considerably this year, as evidenced by the chart above. Over the past six months, profits growth has slowed to an 8.1% annualized pace. But I would also note that an earnings growth slowdown does not necessarily foreshadow a recession (e.g., 1986-87), nor does relatively slow earnings growth preclude an ongoing rise in equity prices (e.g., 1996-1999). So while the market may be correct to suspect that earnings growth could be well below the double-digit range for the foreseeable future, this is not a death knell for the economy or the stock market. After all, earnings growth has averaged 6% per year over the past 50 years.

Happy Freedom Day


Here's how hundreds of people are spending the 4th of July on Calafia Beach in So. California. It's almost a perfect day. Warm weather, no clouds, a light breeze, and not much surf (good for the little kids). In fact, it's the best beach day of the summer so far.

One thing marred our experience this year, however. Calafia Beach was taken over by the State Park system a few years ago, and this year, for the first time, the park rangers were out in force, even though we've never had problems before. Four burly rangers with billy clubs, pistols, and beer bellies were scrutinizing everyone as they crossed the railroad tracks to go down to the beach. They weren't looking for terrorists or bombs, though. They were looking for that most fearsome of all substances, alcohol. It reminded me of TSA and airport searches, as pretty young moms with their kids in tow had to open up their bags and coolers and any can or bottle they were carrying was subject to inspection.

Woe to those who were looking forward to relaxing on the sand and drinking a beer. The mere possession of alcohol turns you into a criminal, since even if only one person in a few hundred can't handle their beers every now and then, why then everyone must go without. Possession of alcohol is treated the same as reckless and illegal behavior.

The Nanny State can quickly become the Police State if we aren't careful, and I'm agin' it.

Changing the subject, I should add that former President Nixon's Western White House is nestled among the trees at the end of point at the upper left hand corner of the picture. It's now owned by a friend of the Nixon family who is also the owner of the famed Roger's Gardens nursery in Newport Beach. The trail at the bottom left of the picture was paid for in large part by the California Coastal Conservancy, and extends from Calafia Beach to the San Clemente train station, about 2.25 miles northwest. It's probably the best use of taxpayer funds in this area that I'm aware of, and we take plenty of its advantage.