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Claims continue to decline

Weekly claims for unemployment continue to show no sign of any unusual weakness in the labor market, as they continue their multi-year decline. Meanwhile, the number of people receiving unemployment insurance has fallen by 1.2 million, or 19% in the past year. These are significant facts that all but rule out a recession. 


This chart shows unadjusted claims since the beginning of 2011 and their 52-week moving average, which remains on a slowly declining trend.


The number of persons receiving unemployment insurance has fallen by more than 5 million in the past three years. It was boosted far beyond what was typical in prior recessions by Congress' decision in mid-2008 to grant "emergency claims" benefits which greatly extended the time that an individual could collect benefits. Emergency claims have now fallen from a high of almost 6 million to 1.8 million today, and the number is still declining. Politicians think of emergency claims as a way to help those who lost a job, but economists think of them as headwinds to recovery, since they reduce individuals' incentives to return to work and thus act like a headwind to growth. Emergency claims have good intentions, but in the end probably do more harm than good; so it is good that they have declined by almost two-thirds from their early 2010 high.

On the margin, the perverse influence of policymakers on the economy is diminishing, and that allows the natural forces of recovery more breathing room. I've learned to never underestimate the U.S. economy's ability to overcome adversity, and there is more reason every day to continue to follow that advice. The economy is very likely to continue to grow, and that's all that matters for investors in today's zero-interest-rate-cash environment.

Truck tonnage up 4% in the past year

In March, the nation's trucks hauled almost 4% more tonnage around the country than they did a year ago. This is good evidence of the increased physical size of the economy and its continued overall growth. 



The top chart shows the long-term trend in truck tonnage and how it correlates to the level of the S&P 500. If anything, it lends credibility to the rise in equity prices, since it shows that equities have risen pretty much in line with the expansion of the economy in the past four years. The second chart shows just the truck tonnage index, and how—with the exception of a burst of activity in late 2011 and a weather-related drop in October of last year—the recovery has been relatively steady and constant for the past four years, increasing at a 5% annualized pace since March 2009.

Capital goods orders disappoint

New orders for capital goods in March were substantially less than expected, thanks mainly to a large downward revision to February orders. As a result, capex orders have not increased at all for over a year, although they did rebound significantly from a first-half slump. This is disappointing, since it points to weaker productivity growth in the future (capex is the seed corn of productivity), and a lack of business confidence. This is the core of the economy's biggest problem: a lack of job creation which in turn is the result of business' lack of confidence in the future and reluctance to invest in new jobs, plant and equipment. We'll need to see some real improvement in capex before we can expect a significant improvement in the economy.


The question for investors, however, is whether this disappointing news runs counter to expectations. I've long argued that the market has been priced to gloomy expectations, and that can be seen in such things as the extremely low level of Treasury yields; the strong demand for cash, cash equivalents, savings deposits, and safe assets like T-bills and bank reserves; and the below-average level of PE ratios despite record corporate profits. Weak capital goods orders are just another side of what is basically a lack of confidence and a lack of risk-taking.

So today's capex news is not "new" news and thus is not disappointing to the market. Indeed, I think the market has been quite pessimistic about the economy's prospects for a long time, to the extent that the market is probably priced to a recession. Thus, anything less than a recession is better than what the market is braced for. As I said in a post back in January, avoiding recession is all that matters. There is nothing in the capex data to suggest we're headed for another recession, and there are quite a few areas of the economy (e.g., housing, auto sales, unemployment claims, industrial production, factory orders, the ISM indices) that are obviously improving, and some by impressive rates. On balance, we're left with what we've known for the past several years: this is a disappointing, sub-par economic recovery. But it is nevertheless a recovery, and that's what matters.

Credit spreads point to continued growth

Swap and credit spreads have typically been good coincident and forward-looking indicators of systemic risk and the health of the economy. Currently they are showing no signs of any deterioration, and remain about as low as they have been at any time since the last recession. This strongly suggests that the U.S. economy is likely to continue to grow.


Swap spreads both here and in the Eurozone are relatively low. They were much higher in the runup to the last recession, and in the past few years they have increased from time to time due to concerns about the threat of sovereign default risk in the Eurozone. Currently, however, they show no signs of any unusual sources of risk to the economy.


Credit default swap spreads are still elevated relative to where they were in early 2007, but they are as low as they have been at any time since the last recession. There is no sign here of any impending economic weakness or threats to the future cash flows of large corporations.

What do commodity prices tell us?

Commodity prices on average are down about 15-20% from their all-time highs two years ago, but they remain very high relative to their 2001 lows. The recent weakness in commodity prices could be explained by slower economic growth here and in places like China, but commodity prices are not weak enough to point to any monetary policy errors (i.e., deflationary risk).  


The above chart shows the CRB Raw Industrials Index going back to 1981. This index is composed of basic industrial commodities, many of which do not have associated futures contracts. It's arguably the best index to follow for clues as to the health of global manufacturing activity. Prices today are down 15-20% from their recent all-time highs, but remain very high relative to their 2001 lows—130-150% higher. While this is consistent with the observation that economic growth in recent years has been disappointingly slow, prices are still at lofty levels compared to a decade ago, and much higher than what we saw in late 2008 when global manufacturing suffered a major decline.


This next chart shows inflation-adjusted value of the broader Spot Commodity Index, which adds foodstuffs to the Raw Industrials Index. One thing that stands out is that, despite huge gains since 2001, most commodity prices today are lower in real terms than they were in 1970—on average, commodity prices have risen by less than the rate of inflation for over 40 years. Commodities rose in real terms in the 1970s (after being largely flat throughout the 1960s), a period during which monetary policy was generally accommodative, inflation was rising, and there was lots of speculative purchasing of commodities and other physical assets for their inflation-hedging properties. 

Commodities fell significantly in the 1980s and 1990s, when monetary policy was generally tight and inflation was falling. The Fed began to ease in 2001, and commodity prices have risen significantly since then, suggesting that—as was the case in the 1970s—monetary policy has played a significant role in driving prices higher in the past decade. From this perspective, it would appear that the Fed's policy accommodation over the past decade has been enough to remove the deflationary impact that monetary policy had on commodity prices in the 1980s and 1990s, but not enough to create new inflationary pressures.


The chart above compares the price of gold with the CRB Spot Commodity Index. Note that gold tracked the ups and downs of other commodity prices fairly well from the early 1980s until 2011, when commodity prices fell but gold continued to rise and remained elevated. The latest decline in gold could be the market's attempt to realign gold and commodity prices. I don't see evidence of deflationary pressures here, but rather a decline in gold prices from what were arguably very high levels that in turn were likely driven by speculative activity and geopolitical risk concerns.


The first of these two charts shows the nominal level of crude oil prices (using the futures contract tied to domestic light crude), while the second chart shows the inflation-adjusted level of Arab Light Crude. Crude oil is unique among commodity prices, since it peaked in 2008 and is higher in real terms today than it was in 1970 or 1980. In general, with the brief exception of the spike in prices in 2008, it can be said that crude oil today is almost as expensive, relative to other things, as it has ever been.


Because energy has become so expensive in real terms, we have found ways to use it more efficiently, with the result that energy consumes a much smaller portion of personal consumption today than it did in 1980 despite being more expensive. Expensive crude prices have also helped bring us the miracle of modern fracking technology, which in turn has given us very cheap natural gas.



Industrial metals prices tell roughly the same story: prices have been volatile but range-bound for the past 6-7 years, and they are still much higher today than they were at their 2008 and 2001 lows. Copper is five times more expensive today than it was in late 2001, while industrial metals prices on average are 3 and a half times more expensive. The thing to note here is not that prices have broken down of late, but that they are still very high from a long-term historical perspective.


The chart above shows prices for a small basket of relatively obscure commodities (hides, rubber, tallow, plywood, red oak). It is now at an all-time high. No evidence here of any economic weakness.

To sum up, I don't see much to worry about in the prices of commodities. They have weakened of late, but on average they remain at levels that just a decade ago would have seemed exceedingly high.