Submitted by Lance Roberts of STA Wealth Management,
The debt ceiling debate continues into its third week as the impasse between the Democrats and Republicans continues unabated. The latest proposal to lift the debt ceiling, fund the government and repeal a portion of the "sequester," in exchange for a 2-year delay of the economically damaging medical device tax, was soundly rejected by the White House on Friday. Furthermore, the House Republicans have sent up 14 separate funding resolutions to keep portions of the government operating which, likewise, have been rejected by the Senate. This leaves the House Republicans, at this point, held "hostage" by the administration for a funding bill that would be "political suicide" for the party as a whole.
However, like any good drama on television, we are now left waiting and watching for the next advancement in the ever evolving political showdown in Washington. In the meantime here are 5 things to ponder as the week progresses:
1) Corporate Earnings Continue To Stall
I recently discussed in analyzing Q2 earnings that:
"In order for profitability to surge, despite rather weak revenue growth, corporations have resorted to four primary weapons: wage reduction, productivity increases, labor suppression and stock buybacks. The problem is that each of these tools create a mirage of corporate profitability. The problem, however, is that each of these not only have a negative economic consequence but also suffer from diminishing rates of return over time."
That problem continues to impact forward expectations as hope meets the reality of a weak underlying economy. Barclay's recently noted that even with earnings expectations being ratcheted downwards heading into Q3 only 52% have topped revenue estimates while the number of companies beating expectations plunged to its lowest since Q1 2009.
This erosion in earnings and revenue continues to put a tremendous amount of pressure on the "markets are cheap based on forward estimates" argument as trailing reporting valuations now encroach on levels that are historically consistent with bull markets peaks rather than the beginnings of new bull markets.
2) The Truth Behind Employment
John Dorfman from Real Clear Markets recently discussed a topic near and dear to my heart which is the analytical approach of evaluating employment in the U.S. He stated:
"To begin, the civilian population of the U.S. aged sixteen and over has grown from 234.9 million people to 245.9 million. This is the universe of people that we need to follow to see what has happened in the labor market. That is, since the population of potential workers has grown by 11 million, the goal of this column is to determine where all 11 million of those people went.
Based on the national labor force participation rate, we would expect about 7.1 million of our 11 million people to join the labor force, either as employed or unemployed. Instead, the number of people in the labor force increased by only 1.3 million-from 154.2 to 155.5 million people. That is an enormous, unanticipated change in the proportion of people in the labor force. Whether the change is demographic, due to labor market conditions, or caused by government policies, something unusual is going on."
The point here is that employment growth is being driven by population growth rather than real aggregate demand from the economy. This is a topic I have discussed at length in the past in regards to "labor hoarding:"
"As you can see there have been very few months since the turn of the century where employment has exceeded population growth.
This explains two things:
1) Why the employment to population ratio has plunged along with the labor force participation rate; and
2) That employment gains, so far, have been a function of businesses hiring only to meet the demand increases caused by an increase in population rather than from a growing economy.
The latter point is very important and relates directly to an issue that has been lurking silently in the background called "labor hoarding."
3) "They're Back" - Consumer's Ramp Up Debt To Make Ends Meet
After a very brief and forced deleveraging, by default, bankruptcy and forgiveness, the consumer is back ramping up credit. In an attempt to make ends meet, as wages have remained stagnant while the cost of living has increased since the end of the financial crisis, consumers are quickly reverting to old habits.
According to a recent CNBC article:
"As Washington is struggling with debt and all its political ramifications, American companies and consumers are embracing it, running up record amounts in 2013.
Whether it's corporate loans, all quality levels of bonds or simple consumer credit, the debt party is back on in the U.S., whether it's in the boardroom or the living room."
- Consumer credit of $3.04 trillion as of Q2, +22% over past three years
- Student loans +66% over past three years
- Total household debt is $13 trillion, almost back to 2007 peak.
- Government debt almost $15 trillion
- Through September junk bond issuance is a record $372B, +27% y/y
- US loan volume is $1.53 trillion through Q3. +25% y/y
- Globally, syndicated marketed loans hit $2.93 trillion Q3, +15% annualized gain
- High-risk leveraged loans global volume hit $1.23 trillion, highest since 2007
4) Economic Growth At Risk Due To Shutdown
I have repeatedly warned since the beginning of this year that the economy was at risk of a recession due to extremely weak underpinnings, however, I have been clear that recessions don't just "occur" but are triggered by some sort of catalyst.
"However, it is also not an absolute certainty that the many individuals in the 'no recession' camp will be right either given the fact that the data revisions to much of the 2012 economic data, which will come later this year, will likely shown an economy that is much weaker than currently estimated. As stated above there is very little 'wiggle room' for the economy at this point to absorb much of a shock. With real final sales plugging along at 1.9% and the output gap above 6% the slack in the economy is huge. As a reminder these numbers are generally levels more associated with recessions and not four years into a recovery.
A recession will inevitably come it is simply part of the economic and business cycle. The Fed may be able to slow, or distort, economic cycles but they cannot repeal them entirely. Whether a recession comes this year, or next, is largely irrelevant the issue will be the damage caused to investors by the impending reversion as reality collides with fantasy."
As noted by Goldman Sachs (Via ZeroHedge) the risk to the economy currently is the government shutdown itself:
"From October 1-4, we believe the shutdown probably reduced federal compensation by roughly $400mn per day. We would expect the non-compensation aspects of the initial stage of the shutdown to have been very modest. Overall, the first four business days of the shutdown probably reduced growth by 0.16pp.
Going forward, the effect that the ongoing debate will have on growth will depend on whether the agreement reached over the coming days is limited to only a short-term extension, or if a longer-term (i.e., through 2014) resolution is achieved. It also of course depends on whether the shutdown is ended over the coming week. As noted earlier, at this stage the duration of the agreement is unclear, but it seems increasingly likely that the shutdown will be ended with the resolution of the debt limit. If a longer-term resolution can be reached over the coming days, we would expect the downside risk from the fiscal debate to be limited to about 0.5pp in Q4, compared to our current growth forecast of 2.5%"
5) Is The Market Reaching Extremes
John Hussman wrote an extremely good piece this week on the markets and the current extensions being driven by aggressive monetary policy. However, he notes that monetary policy is not what saved the markets from the financial crisis:
"Suffice it to say that I consider the stock market to be near the highs of a decidedly unfinished cycle.
The upshot is fairly simple. We presently observe both a hostile long-term outlook from a valuation standpoint, and a hostile intermediate-term outlook from an estimated return/risk standpoint.
I continue to believe that much of the impact of QE is based on superstition - the result of investors misattributing the 2009 market rebound to monetary policy. It's certainly true that replacing $3.6 trillion of interest-bearing securities with zero-interest cash encourages investors to reach for yield in riskier securities, but that's not what ended the crisis. In hindsight, the risk of widespread bank insolvency ended the instant the Financial Accounting Standards Board relieved banks of any need for balance-sheet transparency, deciding in early-2009 to abandon mark-to-market accounting. Of course, it seems more heroic to attribute the recovery to courageous monetary policy than to applaud a handful of bureaucrats with green eyeshades for caving in to Congressional pressure and moving the banking system that much closer to a Ponzi scheme."
The entire piece is worth reading but that single point is not something that should be readily dismissed and should answer the question as to why JP Morgan and Bank of America are still in business despite the fact they are continually in litigation for shafting consumers, homeowners and investors.
It's 8:30am And The Market Don't Care
Despite the ongoing antics in Washington the market remains less than 5 points (at the time of this writing) from its all-time closing high. If the markets were concerned about economics, fundamentals or potential default; stock prices would be significantly lower. The reality is that as long as the Federal Reserve remains convicted to its accommodative policies the argument for rationality is trumped by the delusions of Mo' Money.
We have seen these "Teflon" markets before - do I really need to remind you what happens to a Teflon pan when you finally scratch the surface?