Lock and Load, Disengage Safety and Prepare to Commence Firing!
According to the recent Wall Street Journal survey, economists don’t think the Federal Reserve (Fed) will begin the long anticipated rate hike trend in September, however all the economic data they will gather to make their decision has now been collected as of the favorable September 4th jobs report. We would lean against the consensus by expecting the Fed to begin a secular trend of Fed Funds interest rate hikes starting on September 17th, assuming stocks remain range bound until then. We favor stocks continuing their dead cat bounce in September before retesting or reaching new lows by October.
The Fed may not commence firing, but all the western economies led by the US are witnessing stable economies, strong jobs growth and surging service sectors which account for the majority of our GDP. US “official” unemployment is down to 5.1% and the long term cycle uptrend in jobs from 2010 is accelerating at or above the pace of previous expansion cycles. Adjusted for population growth, the ratio of employed is historically low yet it continues to reach new highs for this cycle. The darkest clouds over the labor market surround wage growth and real unemployment rates (U6).
Wage growth has been hovering around a dismal 2% rate for most of this 6 year recovery, easily the lowest pace of wage growth in modern history. As you can see here when Unemployment falls, earnings growth rates accelerate. When Unemployment reaches a rate of FULL employment it means the economy has peaked and wage inflation is topping out above 4%. Clearly this is NOT the case during this cycle which supports what we have been saying for years that true unemployment rates are not low and the labor market is not hot – “es caliente”. You may notice that during the most similar economic contraction comparison back in the early 1980’s we also had over 4 years of sharply falling unemployment before earnings growth rates stopped falling and finally confirmed a surge back toward the historical 4% wage inflation plateau when the job market was red hot and interest rates were rising rapidly to cool an overheating economy. Our forecast is for a 3 year acceleration in earnings to begin over the next 6 months – as commodities bottom.
Job openings are at record levels thanks to a booming service sector concentrated in the low wage sectors of hospitality and healthcare. The courage to leave a job to look for better wages, as measured by the Quit rate, is still moderate and indicative of the sluggish pay for new hires in the workforce. The true measure of Unemployment (U6) used by economists adds workers unable to switch from part time to full time employment. It’s not the 5.1% that the media naively printed Friday, but 10.3% that economists and our Central Bank are more focused upon. This is getting better and somewhere under 10% (maybe next spring) we are likely to start talking about a better jobs market and inflation. For now its political fodder for both parties to complain about Obama’s weak economy from the Right and the need to financially punish stingy employers from the Left. Of course mandating higher wages and forcing higher taxes on capital formation and the job creators will not help the economy, nor will blaming Obama for something he has little ability to influence. This is not unique to the US. It’s a global low wage phenomenon ever more reliant upon costly welfare and entitlements where no amount of tax cuts and monetary stimulus have been able to bring economic growth back toward “normal” rates of expansion and prosperity for all. Demographics of age, debt, entitlement and long term cycles of atrophy have always been our primary explanations for this sluggish US and Global environment. Japan, Russia and Euro countries are rapidly losing their workforces due to demographics and the financial burdens continue to grow as the shrinking earners have to support the growing retirees. Immigration ironically may one of the ,long term solutions. Fortunately, if we can avoid a global panic and recession in the months ahead, we should see 2016 as the start of a 3 year uptrend in wages and economic growth. The downward demographic and entitlement burden will continue into the next decade, but if we can hurdle the obstacles from decelerating export countries over the next 5 months or so then we should have the wind at our back for a change.
As Oil Bottoms an Investment Boom Begins – in Iran!
The commodity deflation and resulting China deceleration wave led by the crash in Oil prices have been the main impediments to Fed rate hikes beginning this year. Saudi Arabia has had almost nothing to do with this Oil deflation. The US and Canada had everything to do with the global over capacity Oil crescendo of 2014. With the international sanctions on Iran essentially removed, the oil markets have to digest additional new supplies as Iranian Oil production could reach 4.2 Million barrels per day (mbd) in 2016 and 5 mbd by the end of the decade. Oil companies from around the world are begging to spend Billions to revive an energy infrastructure that is in dire need of retooling. The Iranian economy may begin booming in 2016 and beyond despite the estimated $100/barrel break even cost to produce Oil in that antiquated environment. Bad news for terror funding by Iran, but good for global oil prices that are likely to have bottomed out in the $30’s and stabilize in the $50 to $70 per barrel range longer term. Above we again explode the myth that the Saudis caused the Oil price collapse as portrayed in the media. Clearly the US has unintentionally sent OPEC and Russia into a contraction due to our new fracking technology wave. Eventually US/Canadian fracking will boost many more oil producers currently in steep decline.
Below we discredit the myth that US and European sanctions caused a recession in Russia and for their Ruble to depreciate. As Oil goes so goes the Russian currency and their economy. Despite the severe pain being felt by Russia, OPEC and commodity sensitive economies around the globe, the current odds still favor the Fed Funds rate being hiked for the first time since the Bush era as of September 17th.
The other week we framed the global economic debate with the tug of war between a demand pull acceleration from western economies being opposed by a supply side slump in China and emerging export nations. The risk of a panic remains and is impossible to predict with certainty, but we continue to favor the traditional pattern of consuming nations creating enough demand to help China and emerging markets to begin a new cycle of export growth in 2016. The earnings cycle with or without the energy sector should bottom with commodities in late 2015 to early 2016 from which stock market valuations will begin to price in future growth. The time to lock in mortgage rates and possibly stock portfolio allocations is the Autumn and Winter seasons coming up. The global economic outlook is still a mixed bag with considerable risk, but the jobs picture and consumption tea leaves hint that the Fed will want to remove the destructive anxiety over when the Fed Funds will begin their long awaited journey higher. The Fed is Locked and Loaded!