Thursday, May 21, 2015

Claims keep falling, but risk aversion is still the problem

This continues to be the weakest recovery in modern times, but it has set a record for the lowest rate of layoffs.

Using a 4-week moving average, initial claims for unemployment last week fell to their lowest level in 15 years. 

Relative to the number of people working, claims are now at their lowest point in recorded history. The average worker has never been so little at risk of losing his or her job.

Meanwhile, after-tax corporate profits have never been so strong.

Nevertheless, despite record-setting profits, business investment has been quite weak. In real terms, capital goods orders, a good proxy for business investment, are at the same level today as they were 20 years ago, even though the economy has grown by over 60% in that time! 

The problem today is not layoffs and unemployment, it's a lack of investment. Animal spirits are lacking, and risk aversion is still high.

Sovereign yields in developed countries are very near their all-time lows. That is the best proof that animal spirits are lacking and risk aversion is still high. The world is willing to pay extraordinarily high prices for the safety and security of sovereign debt. Why? Because the world is very afraid of the alternatives, even though they yield substantially more.

As the chart above shows, the earnings yield on the S&P 500 has rarely been so high relative to the yield on 10-yr Treasuries.

Weak investment and tepid jobs growth have created a $2 trillion annual shortfall in GDP (by my calculations, the so-called output gap is about 10% of GDP).

Even a massive increase in government spending and transfer payments couldn't boost the economy. Indeed, it's quite likely that it was the big increase in government spending and transfer payments that weakened the economy.

The solution to this dilemma is straightforward. We don't need more attempts at government stimulus. What we desperately need is more incentives for private investment. We need lower marginal tax rates and we need reduced regulatory burdens.

Tuesday, May 19, 2015

Housing market still improving

April housing starts rose almost 12% more than expected (1135K vs. 1015K), reaching a new post-recession high. This shouldn't have been too surprising, given the relatively strong readings of builder sentiment, as the chart above suggests. Housing starts are still only half what they were at the height of the boom, so it's reasonable to think that the housing recovery is still a long way from exhausting itself. We're likely to see slow but steady growth for years to come.

The housing recovery is also reflected in home prices, which are still comfortably below their 2005-2006 highs, both in nominal and real terms.

Mortgage rates are still very low from an historical perspective, adding significantly to housing affordability. Higher rates seem almost inevitable at this point, and that is likely to fuel housing demand as buyers rush to catch the train before it leaves the station.

Real yields on 5-yr TIPS (blue line in the chart above) are one of my favorite indicators, since they speak volumes about the bond market's sense of how strong the economy is. They have jumped some 170 bps in just over two years, and they are comfortably above the real yield on Fed funds. This suggests that the economy's growth fundamentals have improved substantially even as Fed policy remains accommodative. Nothing scary about this picture; expect more of the same in the months to come.

Friday, May 15, 2015

Oil prices rise, consumer confidence drops

As the chart above shows, the price of regular gasoline at the pump has rebounded about 30% in the past 3 ½ months, after dropping by almost half since last summer.

As the chart above shows, this has dampened consumers' enthusiasm a bit. Nevertheless, consumer confidence is still fairly close to its post-recession highs.

As the chart above shows, active oil and gas drilling rigs in the U.S. have plunged in response to the collapse in oil prices. But the decline in the rig count is slowing down, and this means that supply and demand are coming back into balance. The bounce in oil and gas prices may be a bit overdone (markets have a way of over-reacting), but nevertheless it's quite likely that gasoline prices will be substantially lower going forward than they have been in the recent past, and that augurs well for things in general. Energy is what makes the world go 'round, so cheaper energy should eventually translate into healthier economic growth.