NFIB

Some prefer to see the 'employment' glass half-full, some half-empty, and others see the glass smashed into a million shards on the keynesian kitchen floor. The zealousness with which the 'number' has been dismissed and praised has generated more questions than answers. Goldman's Jan Hatzius addresses the question of the pace of progress in the labor market, the reasons for the contrast between GDP and employment, the amount of slack left, and the implications for Fed policy.

Since the release of the most recent BLS Employment Situation Report, which showed an astounding drop in the unemployment rate, we have spent a good bit of time dissecting the release and discussing why the real unemployment rate is really between 17% and 22% depending on how you calculate it.  (See Here and Here)  However, today's release of the September NFIB Small Business Survey shows the extent to which the current BLS employment calculation method may have detached from reality. No matter how you look at the data there is a clear disconnect between the BLS report and economic realities.  From the NFIB's point view it is "economic uncertainty" that weighs on business owners and keeps them on the defensive.  The actions by the Federal Reserve to buy bonds and inject liquidity into the financial system does not solve the problem of "poor sales", reduce regulations that strangle growth or solve the "fiscal cliff" issues that threaten business profitability by the end of the year.  

Nothing materially new here from David Rosenberg's latest letter, but it is useful to keep being reminded over and over how central planning has totally destroyed the primary function of capital markets: discounting, and replaced it with a dumb terminal which only responds to red flashing headlines reporting of neverending liquidity. "If the Fed really had its way, the economy would be booming. But it is sputtering. For all the talk of one month's employment report — look at the entire quarter for crying out loud. Looking at total labour input, aggregate hours worked, it eked out a tepid 0.8% annualized gain in Q3....That the stock market is up 16% this year (on track for the best year since 2009) with earnings contracting underscores the major success of Fed policy in 2012 — managing to deflect investor attention away from negative profit trends and towards its pregnant balance sheet. So welcome to the new normal: the Fed has managed to negotiate a divorce between the economy and equity market behaviour.

Indeed, it is now clear, via QE 3, that the Fed has gone “all in” in its commitment to money printing. QE 2 put food prices to record highs… what do you think QE 3 (which is unlimited) will do to the cost of living?

Against what seemed logical (given the assumption that Bernanke would save his limited ammo for a weaker market/economic environment), Bernanke launched an open ended mortgage backed securities bond buying program for $40 billion a month "until employment begins to show recovery."   That key statement is what this entire program hinges on.  The focus of the Fed has now shifted away from a concern on inflation to an all out war on employment and ultimately the economy.  However, will buying mortgage backed bonds promote real employment, and ultimately economic, growth.  Furthermore, will this program continue to support the nascent housing recovery? Clearly, the Fed's actions, and statement, signify that the economy is substantially weaker than previously thought. While Bernanke's latest program of bond buying was done under the guise of providing an additional support to the "recovery," the question now is becoming whether he has any ammo left to offset the next recession when it comes.

The Obama campaign has amplified its push on increasing taxes on the wealthy and has painted Mitt Romney as a Robin-hood in reverse saying that he wants to take from the poor and give to the rich.  The attack on Romney is incorrect as the real truth is that it is the current Administration that is failing, once again, to recognize that the problems facing the economy has nothing to do with the current tax rate structure.  It is election season, however, and the Obama campaign's "eat the rich" rhetoric will play well with the 22% of the population that is either unemployed, discouraged, working part-time for economic reasons or have just given up looking for work.  It will also play well with the rest of the country that are living paycheck to paycheck as real wages have been on the decline over the last couple of years while the cost of living has risen.  While the speeches, finger pointing and podium pounding will certainly tug at the heart strings of those living in a recessionary economy - it only serves to deflect attention from where it should be directed - employment.

For investors, the continued increases in profitability, at the expense of wages, is very finite.  It is revenue that matters in the long term - without subsequent increases at the top line; bottom line profitability is severely at risk.  The stock market is not cheap, especially in an environment where interest rates are artificially suppressed and earnings are inflated due to "accounting magic."  This increases the risk of a significant market correction particularly with a market driven by "hopes" of further central bank interventions.  This reeks of a risky environment, which can remain irrational longer than expected, that will eventually revert when expectations and reality collide.

Just because it is always amusing to watch the cognitive dissonance in the head of a permabull, here is Jim 'Soon to be head of the BOE... allegedly' O'Neill's latest missive to (what?) GSAM clients. Yes, the same O'Neill who week after week, letter after letter kept on saying that 2012 is nothing like 2011, finally being forced to admit that 2012 is, as we have been saying since January 1, nothing but 2011, as the central planners' script writers prove painfully worthless at coming up with anything original. That, of course, and that the lifelong ManU fan had to suffer the indignity of interCity rivals picking up the trophy this year after a miraculous come back win against QPR. Oh, the horror...

In this recovery consumer services bought/supplied have grown by 3.2 percent from their level at the end of recession as of the 33rd month of the expansion. It is the weakest performance we have seen by a long shot in the last eight recoveries that lasted this long. The previous low point at this point in the cycle was in the 2001 recovery at 6.5% before that it was the 9.2% rise in the 1990 recovery. In those comparisons you get the sense of structural change as it is in the most recent recoveries that growth has become progressively weaker. The average for this point of the expansion cycle would be an 11.4% gain in services output if we had normal service sector growth. IF we had that, we would have had 5.5 million MORE jobs even after discounting for productivity growth in the sector and the loss of goods sector jobs from that demand shift to services. That means about 165K more jobs per month than what we have had all recovery long. This not a trivial problem it is a huge problem. And no one seems to be thinking about it.

Much has been made of the apparent lack of demand for credit as well as apparent supply (especially well-collateralized and credit-worthy credit) during a period when the banks have been mouth-to-a-fire-hose gorged on money. Small businesses, as UBS notes, have been at the center of this debate - as the engine of the economy, politicians have been vociferous in the face of banks ignoring their suggestions to lend. This initial credit crunch, however, has led to a structural change among small businesses which may have a much larger slowing-impact on OECD growth than is currently understood. Small businesses horded cash and reduced their reliance on bank loans after the crisis as the fear of the credit crunch remains front-and-center (and therefore crushed a key transmission mechanism of monetary policy). This drop in demand is driven by the hidden credit crunch - a structural shift to more just-in-time inventory management regime. This in turn reduces the inventory:sales ratio (which is exactly what we have seen in an unusual divergence from large business and appearing like a structural decline). The worrying aspect of this, and indeed the other credit crunch is that the inventory management regime-change among small businesses exaggerate anaemic growth since restocking has traditionally helped to drive economic growth above trend in a recovery phase. As UBS' Paul Donovan concludes, "the traditional concept of inventory restocking may be a great deal more lacklustre in the current environment."

The Social Security Administration made an alarming announcement recently that they will exhaust their funding capability by 2033 which was several years earlier than originally projected. As millions of baby boomers approach retirement more strain is put on the fabric of the Social Security system.  The exact timing of this crunch is less important than its inevitability.  The problem that Social Security has is "real" employment.  I say "real" employment simply to sidestep the ongoing arguments about the validity of government employment survey's from the Bureau of Labor Statistics. The Federal Government receives income from the Social Security "contribution" from employee's paychecks. Social security "contributions" have decreased sharply by almost $70 billion from its peak. This is due to two factors.  The first is that the number of "real" employees, while growing, is in lower income producing and temporary jobs. The second factor is that a larger share of personal incomes is made up of government benefits which does not affect social security contributions. The entire social support framework faces an inevitable conclusion and no amount of wishful thinking will change that.

With S&P futures, and most notably financials, staging the second overnight opening surge in a row, we thought it perhaps worth reflecting on five quite concerning fundamental reasons why dip-buyers (as anesthetized as they have become thanks to central bank 'protection') could face a tougher time. As Mike Wilson of Morgan Stanley notes, for those looking for a cause or explanation of recent weakness, feel free to blame it on the more hawkish Fed minutes, Draghi’s comments that it was now “up to governments to do the right thing” or the soft US payroll numbers. After such an uninterrupted run, some kind of correction was inevitable and simply a matter of timing. The bigger question to resolve is whether this pull back will look like what we experienced in 2010 and 2011 or end up being more muted. Obviously, the key variables for this analysis remain growth and liquidity expectations. The 'payback' that we have been warned about for such an unseasonably warm winter is upon us (as macro data surprises increasingly to the downside) and that is the first flaw in BTFD logic. Wilson goes on to point out that NFIB small business hiring intentions have dropped precipitously, GDP growth is weak but earnings growth is now catching up (down) to that weakness and for many stocks is rapidly falling towards zero, we remain in a 'liquidity lull' as central banks stand on the sidelines and reflect, and perhaps most worrisome is the rapid deterioration in the Bloomberg financial conditions index. All-in-all, these sum up to suggest a greater-than-5% correction is more than likely.

Here is a number for you: 70%  That is roughly how many economic reports have missed their mark in the last month.  Why is this important?  Believe it or not - It has a lot to do with the weather.   We have written many times recently about the weather related effects skewing the seasonal adjustment figures in everything from the leading indicators and retail sales to employment numbers.  Now those weather related boosts are beginning to run in reverse as weather patterns return to normal and realign with the seasonal adjustments. This resurgence of economic weakness is only just beginning to appear in the fabric of the various manufacturing reports.  The Chicago Fed National Activity Index (a broad measure of 85 different data points) has declined from its recent peak in December of .54 to .33 in January and -.09 in February.   The ISM Composite index (an average of manufacturing and non-manufacturing data), Richmond, Dallas and Kansas Fed Manufacturing indexes all posted declines in March.

So far futures are broadly unchanged, following the release of a Chinese trade report which while showing a resumption in the trade surplus, on expectations of further trade deficit in March, showed it was primarily due to a slide in imports, not so much a rise up in exports, a fact which impacted the Aussie dollar subsequently. We already noted that in conjunction with the BOJ, this means that Asia's central banks will likely hold off on further easing, and defer to the Chairman, especially with food inflation in China still prevalent. Aside from that the traditional European weakness is back, where April Sentic Investors Confidence slid to -14.7 on expectations of -9.1: to be expected from a meaningless market-coincident indicator. Keep a close eye on PIIGS bonds where whack a mole is now firmly back as the LTRO benefit is long forgotten, 3 month half life and all that.

Have you wondered what really drives consumer confidence? The answer is simple. Jobs. If consumers are to be confident about their future, they need to feel secure in the present and future employment. The chart shows (gold bar) the confidence gap, which is the difference between the present situation index and the future expectations index. The red and blue lines are the number of individuals surveyed who feel that jobs are currently hard to get or plentiful. When confidence is high, so are the number of people who feel that jobs are plentiful. This is generally because they are currently employed and feel like they could get another job if they wanted one. The opposite is true today. This gap between jobs being hard to get and plentiful has closed slightly in the last couple of years; however, we are a long way from getting back to levels that are more normally associated with recoveries.