Lack Of Participation

It was open season on risk assets, especially stocks and commodities, during the third quarter. The major equity indices fell 7% or more during the period, so it was painful being long anything other than volatility. The latter was greatly in evidence, especially on August 24, when the Dow’s daily range was greater than 1000 points.

The selloff was the first correction of 10% or more (measured from the May highs to the August lows) since 2011. The market then spent most of September backing and filling after the August 24 rout that was precipitated by a debacle in Chinese stocks. Hence, the question is whether the correction was sufficient to dispel extreme bullish sentiment and avoid a bubble or was it merely a shot across the bow in advance of more trouble ahead. Stay tuned….

As bad as the period was for stocks, it was far worse for commodity prices, which fell almost 15% during the quarter based on indices of a variety of commodities. Most of the damage was done by crude oil, which fell over 20%, and industrial commodities such as copper. The weakness in said products reflects the worsening situation in the world’s largest consumer of industrial commodities, China, and is a better indication of the real condition of the Chinese economy than any of the statistics emanating from Beijing. Furthermore, commodity prices have long been an important leading economic indicator for all advanced economies and the only one that is available in real time and not subject to revision.

Speaking of which, we learned once again that the past isn’t what it used to be as GDP growth in 2013 and 2014 was revised downward to 1.5% from 2.2% and to 2.1% from 2.4%, respectively. Growth in the second quarter rebounded sharply from the first quarter’s decline but initial data from the third quarter suggest that there was only modest follow through.

The ISM survey has dropped near the key 50% level that demarcates growth (>50%) or decline (<50%) in the manufacturing sector. Industrial production was up 0.6% in July but fell 0.4% in August. Housing starts, which were strong in the spring, have leveled off of late. The composite index of leading economic indicators fell 0.2% in July and eked out a mere 0.1% gain in August.

One key leading indicator, however, initial claims for state unemployment benefits, fell to its lowest level in forty years during July, which is a positive as lower claims typically indicate stronger growth and a better jobs market. Curiously, however, recent employment gains have been lackluster. More on this anon.

It’s a shame that we can’t harvest all of the hot air created in the debate about what the next move by the Fed will be and put it to some useful purpose. Chairman Yellen adamantly maintains that a tightening will occur before the end of 2015 despite the fact that inflation, as measured by most of the various price indices, is still not near the central bank’s long-term target of 2%. The latest year-over-year changes for the PPI and the CPI are -0.8% and 0.2%, respectively. The same measure for the Personal Consumption Expenditure Price deflator is 0.3%. Verily, inflation is most notable by its absence.

In the sporting news, long-time readers of this missive must surely be wondering why there has been no mention of the recent success of a certain team in the NL Central Division. Given the history of that organization, complete with disgruntled billy goat owners, black cats and sundry other hexes, we choose not to jinx them by reporting on their astounding progress. They shall remain unmentioned until it is all over.

Meanwhile, we note with dismay the proliferation of exceedingly gaudy college football uniforms. Recruits apparently find them to be sick (sic). That’s pretty much how we feel about them but there is no doubt a huge dichotomy between our definition of the word “sick” versus that of the younger generation. Vanderbilt, for example, has four different uniforms (which is one more than the number of wins last season) all of which are adorned with likenesses of anchors (their nickname is the Commodores). One of these features pants that display the slogan, “Anchor Down.” We suppose that’s appropriate for a team with one of the worst offenses in Division I.

We noted earlier that low unemployment claims (they have been below 300,000 for seven consecutive months) should be followed by strong gains in jobs growth. Alas, the latest household survey indicates that only 47,000 jobs have been added since May - a paltry sum by any reckoning. Meanwhile, the latest payroll survey was disappointing and the data for prior months were revised downward. What gives?

No doubt the problem involves some complexity but a large part of it may be explained by the chart below. The lackluster nature of the current recovery has been widely discussed. Despite massive monetary stimulus on a scale never imagined heretofore, the “virtuous cycle” of economic growth has somehow been short circuited. Said cycle involves the sequence of higher employment leading to gains in disposable income, which, in turn, leads to growth in consumer spending. The greater spending leads to production gains that result in even more hiring. And the beat goes on.

In the current expansion, potential hirees have stopped seeking employment. Hence, a lower level of unemployment claims has not been followed by a surge in payroll growth because an increasing number of workforce participants are dropping out. Wage growth has also been lackluster, so the net result is that the virtuous cycle is not hitting on all cylinders. Now we have news that a profit squeeze in some areas is resulting in sizable layoffs. Should that trend develop further, the claims data may begin to climb back toward 300,000 and the threat of recession will grow. Hence, any move by the Fed to tighten may in retrospect prove to have been ill advised.