There will be no Weekly Commentary for the week of XXXXXX. Scott’s most recent commentary is available below.
Market participants got ahead of themselves last week. There were a number of calls for a positive gain in nonfarm payrolls, which failed to materialize. The economy is in recovery mode, to be sure. However, that doesn’t mean that we’re off to the races. The labor market was expected to lag in the recovery process. This is not going to be a V-shaped recovery, but growth should improve gradually over time. There are a number of headwinds and the list of second half worries is long.
The December Employment report was disappointing, but hardly a disaster. Nonfarm payrolls fell by 85,000 instead of rising as many anticipated. The broad range of evidence suggests that the pace of job losses slowed dramatically toward the end of last year. Initial claims for unemployment benefits have trended lower, nearing a level (about 400,000) that would be consistent with net job growth. Announced corporate layoff intentions for the last three months were the lowest fourth quarter total since 1999. However, new hiring has yet to pick up. That should happen soon. Hiring for the 2010 census should lead to gains in nonfarm payrolls in 1Q10 and 2Q10.
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The unemployment rate held steady at 10.0% in December. However, it would have risen to 10.3% if not for a decrease in labor force participation (which fell from 64.9% to 64.6%). That could reflect people exhausting their unemployment insurance benefits. Annual benchmark revisions showed little change from previous estimates of the unemployment rate. The government’s broadest measure of unemployment, which includes discouraged workers (those that have given up looking for a job and are no longer officially counted as “unemployment”) and those working part time but preferring full-time employment, rose to 17.3%, vs. 17.2% in November and 13.7% a year ago. The unemployment rate for teenagers remained elevated (27.1%) and the rate for young adults (those aged 20-24) edged somewhat lower (15.6%).
In the recession, negative feedback loops took over. Fearful of recession, firms curtailed capital expenditures and trimmed payrolls – which was a self-fulfilling prophesy. Bad news fed on itself. These negative feedback loops appear to have been broken and we seem to be on the brink of some positive feedback loops. If consumers spend a little more, if business invest a little more, if banks lend a little more, that will create a snowball effect. That’s how recoveries progress. Yet, there are still serious headwinds. Problems in the residential and commercial real estate markets will continue for some time. We need to see job growth to ensure a recovery in the housing sector. That should come, but it will take some time.
There is still room for more policy efforts – this time more specifically directed at increasing the flow of credit to small businesses and to increasing new hiring.
Support for the housing market is less certain. The Fed is scheduled to end its purchases of mortgage-backed securities in March. While the Fed cannot support the mortgage market indefinitely, its efforts have reduced mortgage rates significantly. Mortgage rates are expected to pop higher as the Fed stops buying, and long-term interest rates could be higher in general, putting a damper on the traditional spring selling season. Additionally, homebuyer incentives will end in April (the initial transaction must occur by the end of April, closing by the end of June). Will this program be extended? Most likely.
Last week’s reports showed a further increase in inventories through November. These figures are not inflation adjusted and were boosted partly by higher oil prices. Remember, inventories don’t have to rise to add to GDP growth in the fourth quarter. They only have to fall at a slower rate. Depending on what the Bureau of Economic Analysis assumes for December, the estimate of real GDP growth for 4Q09 could be as high as a 5% or 6% annual rate. Don’t get excited. Ex-inventories, growth appears to have been relatively lackluster (1% to 2%) – positive, but aided by fiscal stimulus. Real GDP growth is likely to be in the 3.0% to 3.5% range in 2010 (4Q-over-4Q), but inventories are likely to be choppy, generating relatively large swings in GDP growth quarter-to-quarter.
The economic outlook is cautiously optimistic, not ecstatic. The bigger concerns arrive toward the end of the year. The fiscal stimulus begins to ramp down in the second half of the year and into 2011, effectively acting like a drag on GDP growth. More importantly, the Bush tax cuts are scheduled to sunset at the end of this year. Most likely, there will be some sort of compromise, either extending the tax cuts or phasing them out over time. However, there is a groundswell of public opinion wanting to reduce the budget deficit. The uncertainty may work against consumer and business sentiment later this year.
The economy appeared to end 2009 about as expected. A few analysts were anticipating a sharper rebound last year and some felt that the financial difficulties would be a bigger drag. However, the consensus view was that the recovery would be gradual, with continued job losses for some time. The good news is that the pace of job destruction slowed dramatically in late 2009 – although new hiring does not appear to have picked up much. Labor market improvement will be a key factor in the 2010 economic outlook. However, there are plenty of other questions regarding bank lending, financial regulatory reform, taxes, and Fed policy. The outlook is likely to become more optimistic, but still a bit guarded in the near term.
The consumer fared poorly in 2009. Private-sector wage income fell 4.9% y/y in the first 11 months of the year, although disposable income rose 1.3% – thanks to the economy’s automatic stabilizers (tax payments fall and transfer payments, such as unemployment insurance, rise during recessions). Weakness in wage income was largely the result of job losses. A sustainable economic recovery will eventually require job gains.
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Job losses were extremely high at the start of 2009, but the pace of layoffs slowed over the course of the year. In December, initial claims for unemployment insurance dropped toward a level consistent with relatively minor net job losses. Anecdotal evidence suggests that new hiring has not begun to pick up much, but that should change. Firms typically increase their hiring in the spring (unadjusted payrolls usually rise from February to June). This year will see some boost from hiring for the 2010 census (The Census Bureau will have more than 700,000 additional workers at the peak in April). These are temporary jobs and many of them are part-time, but this could serve as a sort of pump-priming, especially if it helps to improve business sentiment and consumer confidence.
Banks tightened credit considerably for consumers and small businesses during the financial crisis. However, bank lending should loosen up over time, helping to reinforce the economic recovery. Fed policy should remain supportive for bank lending. Small businesses accounted for a third of net job growth in the two previous expansions, so improved credit flow is crucial.
Longer-term, financial regulatory reforms will be important in ensuring that the causes of the financial crisis are not repeated. A large part of the problem was that there was no systemic regulator, someone in charge of overseeing the whole financial system. Currently, there is a turf battle being played out in Congress. The Federal Reserve would seem to have a good case for being the systemic regulator. The information gleaned from more comprehensive monitoring of the financial system would also help the Fed in setting monetary policy. However, there is significant opposition to the Fed being the systemic regulator. Turf battles could lead to a less desirable outcome.
The Bush tax cuts are set to sunset at the end of this year. This creates a political dilemma for both Democrats and Republicans. The GOP has made a lot of noise about the budget deficit, but tax increases are not likely to be advocated. As the mid-term election approaches, the Democrats may fear the loss of Congressional seats if taxes are set to be raised (which they are if nothing happens). A tax increase in a fragile economic recovery is the last thing you would want to do. Additionally, all tax cuts are not equal – it’s unclear what priority will be given to capital gains taxes vs. marginal tax rates and so on. Given the animosity between the two political parties, there’s a good chance that a compromise may not be reached.
Federal Reserve policy is perhaps the biggest question mark for 2010. In the December 16 policy statement, the Federal Open Market Committee repeated that conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period (conditional on elevated unemployment, low core inflation, and well-anchored inflation expectations). Most likely, the Fed will remain on hold well into the second half of the year and probably into 2011. Remember that Chairman Bernanke is an expert on the Great Depression and is well aware of the danger of removing stimulus to soon. With the fiscal stimulus package ramping down in the second half of this year and taxes likely to rise in 2011, Bernanke should be unwilling to saddle the recovery with another burden – but that depends on whether inflation is expected to remain low. Most likely, it will.
Real GDP growth in 4Q09 is likely to have been well above a 4% annual rate (possibly 5% or more), but that’s largely an inventory story. Growth should average about 3.0% to 3.5% over the next four quarters – a good recovery, but somewhat lackluster given the depth of the recession.
The end of the year is a natural time for reflection, and the current period is no exception. However, this year also marks the end of a decade, one that many investors would like to forget. It is also a season for looking ahead, with some degree of hope and optimism.
The S&P 500 ended 1999 at 1469.25 and is currently trading at about three-quarters of that. The -25% return reflects the fact that we were in an equity bubble at the start of the decade and in the Great Recession at the end of the decade. The NASDAQ composite ended 1999 at 4069.32, about 85% higher than it is now. The 10-year Treasury note yield was 6.44% at the end of the last decade, which was not a bad return in comparison (also illustrating the advantage of having a diversified portfolio). The dollar lost 30% of its value against the euro, but only 11.5% against a broad basket of currencies – down 23% against the major currencies (which account for about half of U.S. trade) and up 3.5% against the other currencies (which account for the other half of U.S. trade).
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Private-sector nonfarm payrolls in November were 1.5 million lower than in December 1999 (overall payrolls rose by about 460,000, thanks to increases in government jobs – which rose 9.5% a little less than the growth in the population).
Manufacturing payrolls fell by 5.6 million, or 32.6% over the last ten years (while manufacturing output, which is adjusted for quality changes, such as faster processor speeds, fell just 2.3%). Between the mid-1960s and the year 2000, the level of U.S. manufacturing jobs was more or less steady, falling in recessions, but rebounding in recoveries. In the 1980s, the rule of thumb was that one out of 10 factory jobs was lost each year, but was replaced by a new factory job. That changed in the 2001 recession. There was no rebound in manufacturing jobs during the ensuing economic recovery. A large part of that was due to globalization. Increased foreign trade had been a factor for a long time. However, reductions in transportation costs (larger vessels and increased port capacity) and a relatively strong dollar (against the Asian currencies) likely accelerated the impact on U.S. manufacturing.
Even with the sharp downturn over the last several quarters, real GDP rose 17.9% from 4Q99 to 3Q09, or a 1.7% annual rate (the population has grown 10.6%, or 1.0% per year, over the same period – which means that real GDP per capita has average a 0.7% pace over the course of the decade). Nonfarm business productivity rose by 29.6%, or 2.7% per year. A large part of the boost in productivity growth has been through technology. Cell phones, networking equipment, and the use of the Internet exploded in the 1990s, but the impact on the economy was greater in the 2000s. There’s a dark side to these gains. Firms can do more with fewer workers.
Looking ahead, the economy faces a number of serious challenges. Roughly eight million jobs have been lost since the recession began. If nonfarm payrolls rose by 200,000 per month, it would take nearly three and a half years to regenerate that many jobs. However, from the start of the recession to that time, the growth in the working age population will have generated the need for nearly another eight million jobs. Clearly, this is a major mountain to climb. Substantially stronger job growth, on the order of 300,000 or more per month, would be a big help. That could be achieved with a couple of years of 5% to 6% GDP growth. Hence, as long as core inflation remains low and inflation expectations remain well-anchored, Federal Reserve policymakers should be willing to let ‘er rip.
This is not just the end of a decade, but also the end of an era. Nobel Laureate Paul Samuelson died last week. His contributions to economics were many. In his Ph.D. thesis, he brought higher mathematics to economics, bringing rigor and added clarity to economic analysis. In his popular textbook, written more than 50 year ago, he championed Keynesian economics as a tool to escape a depression or severe recession (particularly when interest rates are near 0%).
Negative feedback loops played a major part in the downturn. For example, job losses led to weaker consumer spending, which led to more job losses, and so on. Those negative loops appear to have ended for the most part, but we’ve not yet reached a point where positive feedback loops have taken over. That should come over time. It’s how recoveries build. A little bit of good news should lead to a little more consumer spending and a little more business investment. Tight credit will remain a restraint in the near term. However, bank lending should loosen up over the course of 2010.
Best wishes for the holiday season.
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All expressions of opinion reflect the judgment of the Research Department of Raymond James & Associates (RJA) at this date and are subject to change. Information has been obtained from sources considered reliable, but we do not guarantee that the foregoing report is accurate or complete. Other departments of RJA may have information which is not available to the Research Department about companies mentioned in this report. RJA or its affiliates may execute transactions in the securities mentioned in this report which may not be consistent with the report's conclusions. RJA may perform investment banking or other services for, or solicit investment banking business from, any company mentioned in this report. For institutional clients of the European Economic Area (EEA): This document (and any attachments or exhibits hereto) is intended only for EEA Institutional Clients or others to whom it may lawfully be submitted. There is no assurance that any of the trends mentioned will continue in the future. Past performance is not indicative of future results.
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