Over the past 4 months the US stock market is essentially unchanged while economic data has deteriorated. Forward earnings, retail sales, service and manufacturing indices weakened and the energy sector accelerated its contraction. While the 1st quarter GDP will show further slowing of US economic data, let’s blame it on the weather and get ready for renewed growth in the 2nd quarter.
The Citi Economic Surprise Index reflects inflation, earnings, employment, confidence and various service and manufacturing indices all cobbled together to portray the underlying strength and weakness of economy beyond the usual GDP metric. The above chart reveals that (blue line) Europe’s 2nd recession in 6 years ended a few months prior to the March 2015 launch of monetary stimulus. We expect this Eurozone uptrend to continue along with a rising money supply which should lead to the highest Eurozone GDP since 2011 – north of 2%.
We expect the US economic data to rebound with some inventory build as consumer confidence, wages and spending turn up in the 2nd quarter and throughout the remainder of 2015. Company surveys confirm the uptrends we talked of in 2014 will manifest in real growth acceleration in 2015 . Wage growth should approach 7 year highs near 3% by the end of 2015. Rising incomes and savings rates (4.9%) along with record low debt service cost should boost consumption in 2015. The survey below of companies planning to raise compensation with a 9 month lead time shows an amazingly accurate correlation – thus accelerating wages and incomes should be expected throughout the remainder of 2015.
The past year has revealed a rising wage trend that the media has ignored while the past 4 months have seen a sharp acceleration in income. No more blaming hamburger flippers and entry level job gains for depressed wages. Clearly the improving employment trends are spreading to higher skilled and compensated industries. Too often we hear about the less meaningful U3 official unemployment. With U3 at 5.5% and wages remaining low the blame shifts to the greedy companies failing to compensate their workers. Fed Chair Yellen even placates the narrow minded politicians and media audience by constantly readjusting where U3 official unemployment has to reach before the economy and inflation accelerate – now she says beneath 5% is the magic number. Trust us, Bankers watch U6 much closer than the Government reported U3 these days. U3 under 5% will be a strong sign for higher wage inflation, but U6 under 10% will be more meaningful. Another way to show how much better the job market is and what to expect this year is a look at Job Openings. The current level from January was testing the highest levels ever. Despite energy sector jobs being lost we expect even higher job opening numbers in the months ahead, as hard as that may be to comprehend.
While Job Openings may be exaggerating expected wage trends vs potential, the Quit rate below continues to highlight the improving job quality toward skilled labor and the confidence in workers to leave their job for one offering better compensation.
Historically income growth rates during the heart of an economic recovery average around 3 to 4% with spikes into the 5 to 7% zone. After averaging a sub par ~2% since the current recovery began in 2009 we can see that the 4th quarter 2014 income acceleration provides hope that businesses are increasingly able to pay more as the need for skilled labor is reaching a positive threshold. It’s rare that income growth can sustain for long above 4% with occasional spikes over 6%, but we suspect that the enormous pent up demand for capital goods and labor will lead to historically above average income growth sustainability. Capex may need a Fed that is reducing reserve balances and raising rates to shift US companies priority from share buy back to equipment investment.
The self sustaining economic model without Central Bank stimulus has eluded the US and all industrialized nations thus far, but higher consumption rates will be another sign that the Fed can start Selling its Bonds back into the private market. Personal consumption expenditures move very much in sync with inverted unemployment and disposable personal income and should rise as well.
After strong consumption during the 4 month July to November period in 2014 combined with an historic snow-mageddon out east, it was not a surprise to have consumer spending falter the past few months. In fact yearly numbers (red line above) may drop further when the March data comes out due to seasonality. However, low energy costs, rising jobs and income growth rates during a period of high savings rate (~5%) and extremely low debt service costs mean pent up consumption trends will rebound to a strong 3.5 to 4% rate later this year with even higher spikes down the road.
How this fits in with our concerns of a stock market correction > than 20 to 25% starting from higher levels is paper vs plastic. The paper stock market and other financial assets are likely to have a rising interest rate realization adjustment lower while the underlying more durable economy continues to advance. The panics of 1987 and 1998 come to mind as examples.
Summary: Deteriorating US earnings and economic data as well as better European and Japanese data will all improve further in 2015. US unemployment, income and consumption will continue to improve which will lead to stronger wage inflation and the almost inevitable Fed announcement that zero bound interest rates are over and a new secular trend of rising rates has begun. 3rd quarter is the most likely period when Central Bank controlled short term rates will start rising. Longer term maturities will start rising much earlier in anticipation. It’s this rate transition period in the 2nd and 3rd quarter that is a concern for the stock market medium term. Should the stock market correction exceed 20% then it will begin to impact the economy short term with a more positive long term picture staying in tact for a few more years from the current perspective.
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