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Summary – Sinai’s Employment Conference Call – 6/1/12
[private][private]May Employment Report: Good Enough for Consumption for a Good Enough Economy?
Disappointing jobs report. The May Employment Report disappointed expectations, as Nonfarm Payrolls only increased by 69K (Consensus: +150K; Decision Economics: +160K). Revisions to March and April were also disheartening: -11K to +143K in March and -38K to +77K.
Some weather distortions. While the results may be weather-related, as stronger seasonal corrections kick in during Q2 and warmer Q1 weather may have pulled hiring activity forward, the recent trend of tapering employment gains looks like a repeat of 2010 and 2011.
Jobs, Jobs, Jobs…That Is the Question
Job creation is the key to economic growth. A healthier labor market means improved household incomes. Higher incomes make for more robust consumption, and consumption makes up 70% of U.S. growth. A better labor market would also promote consumer confidence measures as well as U.S. equity market performance—witness this morning’s selloff in response to the dreary May employment report.
External risks have increased over the past month. The Eurozone is in an accelerating downturn reducing demand for exports, particularly from China. This could intensify the slowdown in China—which DE is still forecasting as a “soft landing.” While U.S. exports may also suffer, exports only represent 14% of the U.S. economy.
The main question is whether job growth will continue to help consumer fundamentals fuel U.S. growth and be able to withstand external headwinds and a possible draconian fiscal cliff (beginning with $500 billion of cuts in 2013).
For now, consumer fundamentals look resilient enough to keep the U.S. economy on the expansion path. Both consumption and the housing market seem livelier of late. Jobs numbers will have to pick up for improvement to be sustained. The +69K in May shows a clear slowing of Q1 momentum, with the unemployment rate ticking up to 8.2%. Even accounting for seasonality factors causing job growth to be understated by 35-50K, recent data is lackluster. Income, sentiment, and equities will all take a hit. The two main bright spots were that labor force participation increased by two-tenths and that 422K found jobs last month.
GDP for Q1 was 1.9%. With today’s report Q2 growth is estimated in the 2 ¼ % to 2 ½ % range. For the second half of the year, DE is estimating growth between 2 ½% to 3%. However, the macro crises in the Eurozone cannot be underestimated.
Eurozone Crises Multifaceted in Nature
There is a clear banking crisis developing in the Eurozone. Banks in the periphery need to consolidate and be recapitalized. The downturn in activity results in more reluctance to lend and there is a credit crunch. While the ECB has helped with LTROs, expect more similar action to be necessary going forward.
A financial crisis is emerging as well. Debt servicing costs in periphery nations are rising as yields surge. Equity markets in Europe have tumbled, justifying the strategic DE underweight held over the past year. Capital flight has begun in Spain. Safe haven bids to Germany continue.
Nine political leaders have been replaced since the beginning of the debt crisis—and Merkel could be next as Draghi and Hollande, among others, support pro-growth measures instead of tough austerity. Austerity leads to a debt spiral—austerity measures harm growth and make it impossible for nations to meet targets, leading to further austerity measures, and so on. Policymakers are too sanguine and slow-moving.
Uncertainty remains on the path going forward. While the ECB has discussed a Eurobond, it will likely wait to see results from Greek elections on June 17. The two scenarios going forward would be a muddle-through or a complete break-apart of the Eurozone. The muddle-through scenario, which is the more likely case, involves the Eurozone adopting pro-growth austerity measures. The break-apart scenario involves multiple peripheral countries leaving the zone, perhaps eight in total. The remaining nine nations would have to bear the costs of a stronger euro.
DE More Bearish on Equities on Near-Term Headwinds and Risks
- Because markets will note the confluence of a soft employment report with rising Eurozone Crisis risks, in a tactical sense we would not get in the way of short-term equity market moves. The market has already corrected 10% from its previous peak.
- Earnings reports for Q2 will be watched for hints of the extent to which the Eurozone downturn is hurting U.S. equities.
- The report is positive for fixed income in the near-term as well, and leaves our outlook for long-term rates flat, perhaps even surprising to the downside as assets continue to move away from Europe.
- The #1 risk remains the economic, political, and financial market Eurozone Crises. Likely deeper Eurozone recession – now a 0.7% to 1% decline, but will problems spread to France and Germany? Austerity with growth-focused measures will be a tough trick to pull off, leaving open the possibility that global and U.S. growth prospects become seriously impacted.
Longer Run Investment Themes and Outlook Intact
DE is now tactically bearish on equities. Baseline is still 1400 for year end, with risks tilting towards the downside.
DE would not encourage bearish views on the 10yr Treasury. As Europe skirts from crisis to crisis, Treasury yields could go lower. Forecast range now 1 ¼% to 2% (from 1 ¾% to 2-5/8%). However inflation should also ease lower, meaning that safe havens likely will not enter negative real return territory.
Long-term rates, supported by the Fed, will remain low, and along a flat profile, even potentially surprising to the downside.
Fed policy shift? Maybe. Operation Twist will likely be extended, a new DE view (it was set to expire in June), and QE3 is back on the table.
The Fiscal Cliff and Election Uncertainty
If the $500 billion cuts for 2013 actually happen, there will be a 2% to 2 ½% drag on real GDP next year. While DE does not think the measures will actually be enacted in their entirety, a new alternative scenario of a recession caused by the fiscal cliff now has a 10% probability. The fiscal cliff tilts towards tax increases (or expirations of temporary tax cuts) instead of outlay decreases. It is not likely that a grand compromise on the fiscal cliff will happen prior to the election—due to the heat of the competition—even though Obama’s and Romney’s economic plans are broadly similar. The DE forecast is for some of the fiscal restraint to happen—although not $500 billion next year—resulting in a lower 2% real GDP growth forecast for next year.
The weak jobs numbers and Eurozone crises are a negative for Obama. The U.S. electorate does not view the economy as Obama’s strong suit, instead leaning towards Romney on that issue. Underperformance by the U.S.—even if caused by Eurozone recession—in Q3 and Q4 would hurt Obama.[/private][/private]