A bubble in complacency

May 28, 2014 13:24
Richard Yamarone, senior economist at Bloomberg Economics, reports unfavorable readings in four of five special data series that reflect the state of the economy: dining out, casino gambling, jewelry and watches, cosmetics and perfumes, and women’s dresse

In this week’s letter I want to recap some of what I learned from this month's Strategic Investment Conference but do so in a little different manner. I have come across several very good summaries and reviews that I am going to excerpt rather liberally, along with sharing some of my own thoughts.

Nearly everyone noted that there was somewhat of a divide in opinion as to whether things in the United States and global economies are getting better or worse. I think John Nicola of Nicola Wealth Management had it right. If we all examine a glass that is filled up to the mid-point, some of us will describe it as half-full and others will describe it as half-empty. And of course there is plenty of data to back up either position.

The simple fact is that we are in what I call a "muddle-through economy". Things aren’t terrible, but they aren't great either. We’ve come through a devastating Great Recession caused by a crisis in the financial sector. It is quite typical for the effects of such a crisis to linger for a decade or more. So compared with where we were at the bottom of the Great Recession, the glass is half-full. But compared to the expectations we have for economic recovery and the resumption of vibrant growth, half-full seems like an exaggeration. And for many people, the glass is simply empty, while for others it is spilling over.

According to the National Employment Law Project, the quality of the jobs that have been created since the end of the last recession does not match the quality of the jobs that were lost during that recession.

Lower-wage industries constituted 22 percent of recession losses, but 44 percent of recovery growth. Higher-wage industries constituted 41 percent of recession losses, and 30 percent of recovery growth.
Yes, unemployment is down, but so is labor participation, and outside of the petroleum sector new jobs are not being created to anyone’s satisfaction. We are losing businesses faster than we are creating new ones – an unprecedented statistic. This is a glass not only half-empty but leaking.

Richard Yamarone, senior economist at Bloomberg Economics, takes a less sanguine view on unemployment than David Rosenberg. He argues that the type of jobs being created makes a difference. Job creation now is skewed toward low-skill, low-income categories. To circumvent the Affordable Care Act’s requirement to provide healthcare to full-time employees, retailing, healthcare and food service employers are cutting workers’ hours. Consequently, new jobs are being created for people who now have to hold multiple part-time jobs. But that does not constitute a genuine increase in employment or GDP.

Yamarone’s view of the labor market leads to a comparatively bearish outlook on the economy. He also reports unfavorable readings in four of five special data series that he has found to be accurate indicators of the economy-- dining out, casino gambling, jewelry and watches, cosmetics and perfumes, and women’s dresses.

Lacy Hunt, executive vice president of Hoisington Investment Management, contends that the Fed’s strategy for boosting the economy is not working. Hunt explains that the monetary policy cannot influence the economy unless the market rate of interest (represented by the Baa corporate bond yield) is below the natural rate of interest (the nominal rate of GDP growth). Until it is, Hunt contends, consumers will have no incentive to take on debt to finance spending and economic growth will remain sluggish.

Ian Bremmer, a geopolitical analyst with the Eurasia Group, noted that the huge increase in US oil and gas production means much less dependence on Mideast oil and suggests that the US will eventually become a net energy exporter. As a result the US will not want to get entangled in the Middle East, and this reluctance will increase the risks in that region. Regarding the Ukraine situation, Ian feels the US made a mistake in trying to put sanctions on Russia that it couldn’t back up (a sentiment echoed by several speakers). He also expects Israel and the US to make a deal with Iran in the next 12 months – and if they do, Iran will bring 1.5 million extra barrels of oil to world markets. The big winner of the Ukraine crisis? Ian argued very cogently that it’s China.

Jeffrey Gundlach was quite negative on US housing but is positive on multifamily rental real estate, given that rentals increase as home ownership drops. Home ownership has dropped from 69 percent of households to 65 percent. One well-known US investor, Sam Zell, expects it to drop to 55 percent. A 1 percent drop means 1.2 million more households are looking for rental accommodation. Another speaker mentioned that more than 1 million millennials live with their parents, which is a major factor in the reduction of household formation.

Grant Williams made an excellent comment during a discussion about global markets. He asserted that there is a bubble in complacency. He is very concerned with shadow banking in China (now 60 percent of GDP) and with unaffordable housing. Many investors in wealth management products will lose a lot of money unless government bails them out. Overall there is a credit bubble in China. Japan is even worse at almost 250 percent of GDP for government debt alone. Grant feels Abenomics is not working and that little structural reform is occurring.

Notwithstanding that, Japanese 10-year bond rates dropped from almost 1 percent to 0.6 percent in the last year. Kyle Bass said he thinks Japanese 10-year rates will rise to 2.5 percent.

There was a very consistent theme in a number of presentations: no one is sanguine about China. The comments ranged from quite concerned to worried to very alarmed. There was not much that was positive to be said about Europe and Japan. Thoughts on the emerging markets varied a great deal and at the end of the day were very specific to particular markets.

John Nicola offered this summary to his clients. There are still many headwinds to getting inflation to rise. One of the main issues is considerable slack in global labor markets. With emerging markets looking to improve their own standards of living, this spare capacity will likely be with us for many years. Overall it should continue to provide deflationary pressure on wages.

For a large part of the 20th century the developed world experienced real growth of 3-plus percent per year. Many countries now have flat or declining populations, and all of them are aging. Looking forward, the developed world would be doing well if it were to realize real growth of 2 percent annually. Global growth will be driven by developing nations.

The impact of shale oil and gas is a game changer for the US both politically and economically. When this is combined with the US having the best demographic profile of any developed nation, it becomes an important part of any portfolio.

Long-term interest rates have been in a relatively narrow range for the last couple of years, and this may continue for some time even as quantitative easing is reduced or eliminated. Even when rates rise they may not get to the “real” return levels of the past when long-term government bonds earned between 2-3 percent after inflation. At some point rates will rise, and we need to design portfolios to prepare for that. But the increases may take longer than many forecasters expect and be more muted as well.

The writer is a financial celebrity, an author, a commentator and publisher of the Thoughts from the Frontline newsletter.

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The United States is losing businesses faster than it is creating new ones.

A noted financial expert, a New York Times best-selling author, an online commentator, and the publisher of investment newsletter Thoughts from the Frontline