Labor Market Looking More “Healed” Than “Healing”

Observations on the Capital Markets – Week Ended July 18, 2014

Federal Reserve Chairwoman Janet Yellen’s Congressional testimony this week, in my view, was not pointing to bubbles. In her testimony, she suggested that valuations of social media and biotech stocks and lower-rated corporate debt appear “stretched.”  Some observers suggested she was saying we are in a bubble.  But I have a different perspective: I think she was saying, in effect, “yes, prices are high in some niches, but not generally.” In any case, it’s doubtful Yellen is shifting her focus from less-than-full-employment to the question of possible market bubbles.

The latest unemployment numbers continued to show improvement. Initial unemployment claims dropped to 302k last week.  The 4-week average (309k) is at a recovery low and will fall further unless claims jump in the coming weeks.  To put this in perspective: during the last boom, the average was below 300 only in January-April 2006, bottoming at 287.

Yellen’s Humphrey-Hawkins testimony broke no new ground . . . Note: uncertainty does not equal dovishness

  • She reiterated that policy would be data-dependent.  (Read-through: there is no forward guidance.)
  • She explicitly highlighted upside risk to rates if the labor market continued to improve more quickly than anticipated by the FOMC.
  • Note: the Fed has consistently been too optimistic about GDP and too pessimistic about employment.
  • What’s next?  I expect the pattern to continue.

The Fed’s “Beige Book” was generally consistent with Goldilocks . . . but with a hint of coming wage inflation

  • Most districts reporting slight to modest inflation.
  • Manufacturing rose in all twelve Fed districts.
  • All twelve districts reported slight to moderate employment growth.
  • Five districts reported low or dwindling new home inventories…six cited shortages of construction workers.
  • Four districts cited a shortage of truck drivers.

Housing starts disappointed . . . apparently because of labor shortages!

  • Housing starts fell to a 0.89 million seasonally adjust rate, far below the 1mm+ level the consensus expected.
  • Permits also disappointed, falling to a 0.96 mm pace.
  • Almost all of the slowdown was in the South: other regions were fine.
  • Builders apparently generally cited a lack of ready-to-build-on lots (upstream labor) and a lack of workers, rather than a perception of weak demand, as the cause of weaker-than-expected activity.

Housing Starts Fall due to Labor ShortageOther U.S. economic data was strong across the board

  • June industrial production grew 0.2% m/m (month over month).  Overall, Q2 industrial production rose at a 6.7%, seasonally adjusted, accelerating nicely from Q1’s (weather-slowed) 1.4% rate.
  • Factory capacity utilization was stable at 79.1.  Moderate capex (capital expenditures) by companies is raising capacity in line with output: healthy.
  • Business inventory: sales ratios remain stable as both rise: healthy.
  • The NY (Empire State) Fed manufacturing survey rose from 19.3 to 25.6.  The Philly Fed index rose from 17.8 to 23.9.
  • Retail sales were better than they appeared…upward revisions to May made June’s rise look smaller.
  • The NAHB (homebuilders) index rose from 49 to 53 on stronger current and sales and sales expectations, although “traffic” remains well below the breakeven 50 level at 39.
  • The LEI (index of leading economic indicators) rose 0.3%; 7 of 10 components contributed; building permits were a drag.

The trailing data shows neither inflation nor deflation…just about right

  • PPI (Produce Price Index) was up 1.9% y/y (year over year); core (less food and energy) was up 1.7%.
  • Import prices are up 1.2% y/y; export prices are up 0.2%.
  • The Atlanta Fed’s most recent business year-ahead inflation expectations survey came in at 1.9%.

Last week in the capital markets: Airline Tragedy Center Stage . . . but Doesn’t Hold Down U.S. Market

The market shrugged off the shooting down of a civilian airliner by (we assume) Ukrainian separatists and an Israeli invasion of the Gaza Strip.

  • US Equities: The S&P 500 ended up 0.6% for the week as Thursday’s correction (the first daily move of more than 1% in over 3 months, accompanied by a 30% rise in Volatility (CBOE SPX Volatilty index, or “VIX”) was essentially erased by Friday’s gain.  Over the full week, Information Technology (+1.5%) led, powered by Intel (+8%) and Microsoft (+6%).  Next were Financials (1%), led by Citi and JPM.  The weakest sector was Health Care (-0.6%); biotech was weak in the wake of Yellen’s comments.
  • Bonds:  Treasury yields generally trended higher during the week, interrupted by a drop as news of the airliner spread.  The 10-year Treasury yield ended down 3 bps to 2.50% (near the bottom of its 15-month trading range.  European markets acted as if they expect further monetary easing from the ECB: German 10-year Bund yields hit all-time lows, ending 5 bps lower, at 1.15% and peripheral sovereign spreads generally tightened.  While European spreads may have tightened, U.S. spreads did not.  High yield spreads as measured by the BoAML High Yield Index widened 17 bps to 3.78%.  Spreads have now widened from their tightest levels of the year to about average for the year.
  • International Equities:  The MSCI AC World Index was up 0.5%.  With the exception of Russia, most markets moved roughly in line with the U.S.  The Russian ruble fell more than 2%, and MSCI Russia declined 6%: investors either expect tougher sanctions to hurt or don’t want to own such positions.
  • Commodities:  Oil rose 2%, to $103.  After rising almost 8% in four consecutive up weeks, gold fell back 2%.  The GSCI Agricultural and Livestock commodity price index, up almost 20% in early May, is now back to beginning-of-year levels.
  • Currencies:  The Yen and Yuan were little changed against the dollar; the Euro fell 0.6% to $1.35, at 2014 lows.

China update: reported GDP was OK; house prices are not

  • As promised, Chinese GDP came in at 7.5% y/y with the second quarter better than the first.  As always, there is no ability to verify the data: details are lacking and the release does not conform to global standards.
  • The government appears to be using a weaker currency, targeted fiscal stimulus and increased lending to support the economy.
  • Housing price appreciation has turned into a correction (at best): prices dropped in 55 of the 70 cities tracked by the government.  Six months ago, 65 of 70 showed higher prices.

A brief update on (the many) global hot spots

  • You’ve been following this story: the downing of a Malaysian airliner over the Ukraine has the potential to dramatically alter the trajectory of events there:  Putin is suddenly on the diplomatic (and, as the will to stiffen sanctions builds, economic) defensive.
  • Israel launched a ground invasion of the Gaza Strip.  Another wild card…
  • The Islamic Caliphate has (according to the WSJ) been giving Christians in its territory the choice of religious conversion, exile, or death…effectively religious genocide.  If the story is true these guys are seriously evil.  Still, other news from the region suggests a lull in the fighting.
  • Secretary of State Kerry appears to have negotiated a “political cease fire” in the disputed Afghanistan elections.
  • Asia was calmer, with China pulling its drilling rig back from disputed territory.

Earnings season: so far, so good

  • It’s early, but so far, so good . . . against low expectations, but beating expectations.


Data Sources: The Wall Street Journal, Financial Times, Bloomberg.

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About Sam Wardwell

Sam Wardwell, CFA, is Senior Vice President and Investment Strategist at Pioneer Investments. He joined Pioneer in 2003.
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