Nonfarm Payrolls came in much worse than expected, but much of that was due to government job cuts, including census workers. The revision was even uglier and only half of the downward revision was government workers. The remainder came from the private sector. The Unemployment rate remained at 9.5%, but that was because over 100,000 discouraged unemployed workers answered the survey by stating they were not seeking employment at this time. The real unemployment rate is believed to be much higher.
I have a theory that the best private sector jobs data will be reflected in today's report and the report due out on September 3rd. My reasoning is that employment data is a lagging indicator and today's data reflects hiring during the height of the recovery and inventory replacement. The increase in manufacturing payrolls bears this out.
What is troubling for me are the increase of discouraged workers (over 389,000 additional displaced workers who have become discouraged and have ceased seeking employment since last ) year and the reliance on manufacturing data for private sector job growth. Not only is manufacturing a small part of the U.S. economy, but most of the manufacturing jobs were in the automotive sector. The was due to government assistance to automakers and increases demand from the "Cash for Clunkers" program. This is not the way to drive the economy forward.
The way to drive the economy moving forward is to create a friendly environment for small business. Forthcoming economic and tax polices do the exact opposite. Critics of small businesses have pointed to lower wages and fewer benefits than union jobs found at larger companies. However, those higher wages and greater benefits have made many large firms uncompetitive and many (unless you are a Detroit automaker) have closed their doors. Asset values and, in some instances, wages became inflated. America needs to be repriced. However, the administration and and Congress are trying to prevent a price correction. In fact, what they are proposing in the way of higher taxes and health care would cause prices to rise.... if consumers could afford to spend.
What is the DC solution? Demonize the banks for not lending. Think about it. They are bashing the banks for focusing on risk management after bashing them for poor risk management. What would be the reaction from Capitol Hill and the White House if banks gave loans to those who were higher risks and these people went delinquent or defaulted. The first reaction would be to call ban CEOs before Congress to lambaste them for creating systemic risks. A few months later, after the delinquencies and defaults piled up, the same CEOs would be hauled in front of Congress and be harshly criticized for predatory lending, forcing loans upon people who could not afford them. Please tell me again why banks should lend?
Although it is true that bank lending is somewhat tight and lending standards are high, they are closer to historical norms than what we have seen during the past 20-years. This gives us some insight to what the economy may be like during the next several years. Higher taxes, government mandates and stricter regulations, combined with less-than-free-flowing credit will keep growth, employment and inflation low.
Inflation has been a hot topic in the investor community. The equity arena and the small investor world (the two are closely related) are concerned with higher inflation and runaway interest rates. They theory is that because the U.S. is printing large amounts of money and issuing large quantities of debt, inflation and higher rates must result. Such opinions are only looking at one side of the problem.
For years, investors and financial professionals were taught to look at debt issuance as resulting in a weaker currency. A weaker currency would result in inflation as a dollar loses purchasing power. It would also result in higher long-term interest rates as investors desire higher rates of return to assume greater downside currency risk. These fears would be valid if the economy in question was unique in its difficulties and the economy was not global in nature. This is what happened in the 1970s, but the dynamics are much different today. The economy is global, other large economies are in trouble (Europe) and even booming economies are having brakes applied (China). In the current environment, deflation may be the bigger concern.
Deflation is a growing concern in the bond market. Fixed income traders and strategists are of the opinion that there is no escaping the economic down turn. The most robust economies in Asia and other emerging markets exist under the control of some of the most restrictive governments. Try to buy Chinese bonds and one would find it difficult. Try to deliver these bonds outside of Asia and one could find it impossible. What to own the renminbi? One might find it easier to acquire a unicorn. Therefore the U.S. dollar will remain the world's reserve currency. The currency which could have posed the biggest threat to the dollar, the euro, exists in an economy which is in worse shape than the U.S. economy. The EU also does not have a unified economic policy. This is evidenced by the PIIGS being able to thumb their noses at EU deficit limits.
Currently the U.S. treasury market is pricing in a flat-lining U.S. economy, if not worse. That in my view may be a little extreme, but it has a greater possibility of occurrence than a booming v-shaped recover. Pimco's Bill Gross hit the nail on the head when he stated in his investor letter that the problems facing the U.S. economy are structural and not cyclical. Until recently I was of the opinion that the Fed would begin its gradual tightening early in the third quarter of 2011. I am not of the opinion that the earliest we will see Fed tightening is the second half of 2011 if not 2012.
The treasury market has historically been among the better predictors of future economic conditions (more so than the equity market). However, this is being lost on many financial advisers. They continue to plow investors into LIBOR and inflation floating rate notes in anticipation of higher rates and inflation. Their thinking is that at sometime we will have higher rates and inflation and then they will be prepared. However, besides not understanding how said floaters work (LIBOR floaters work when the yield curve flattens, not when rates rise and CPI floaters work best when the RATE of inflation increases not just because inflation is high or even positive. Their coupons can actually fall if inflation was positive and high, but that rate falls from say 5% to 4%) they fail to correctly assess the opportunity cost of waiting at very low rates for extended period of time versus investing in higher fixed-coupon instruments.
This reminds me of 2003 when famous fixed income strategist forecast a 6.00% 10-year treasury within a year. By 2005 he was saying that his prediction was not incorrect, but his timing was off. If one took his advice they are still waiting for the 6.00% 10-year. A broken clock is correct twice a day, but one would be ill advised not to repair it. Buying LIBOR and CPI floaters is a broken clock strategy. They will be right at some point, but they are not worth the wait.
Until next time: Duck and cover!
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