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Benchmark Blues: BLS to Cut 0.3%, or 501,000 jobs, from 2019 levels

The extrapolation methods used by the Bureau of Labor Statistics in producing their monthly estimates (their word) of NonFarm Payroll (NFP) growth can obscure the magnitude of cycle turns, which is why it is important to pay attention to the annual benchmark, derived from the Unemployment Insurance filings mandated by federal law that cover 97% of the NFP universe.

The rule of thumb at the BLS is that if the benchmark falls between +/-0.2%, the average of the last 10 years, everything is copacetic, but if it exceeds that there is real information there. This morning the BLS released the preliminary benchmark for 2019 and, unfortunately, there is information there. The overall employment level is slated to be taken down by -0.3% or 501,000 jobs when it is made formal in January 2020, and in the private sector -0.4%, or -514,000 of the jobs previously estimated will be benchmarked away.

Largest losses are in logging & mining, -2.2%, or a scant -16,000 jobs, leisure & hospitality -1.1%, a not-so scant -175,000 jobs, retail trade -0.9%, or -146,400 jobs, professional/business services, -0.8%, or -163,000 jobs, and wholesale trade, -0.6%. Transportation & warehousing will be revised up 1.4%, or about 80,000 jobs, information 1.2% or 33,000 jobs, and government 0.1%, or 13,000 jobs. That’s it for the plus signs.

As you can see on the table, this is both out of trend, and the largest negative benchmark since the 2010 decline in the aftermath of the great recession.

“Credit positive activities,” A Short-lived Phenomenon

According to a Moody’s analysis of 100 large companies, after an initial round of “credit positive activities,” notably debt reduction, following the corporate tax cuts in the 2017 overhaul, firms have shifted their attention to stock buybacks. The tax cuts increased corporate cash flow by almost $400 billion in 2018. Of that increment, 37% went to debt reduction in the first half; that fell to 14% in the second half. Just over a third, or 36% went to share repurchases in the first half; in the second half, that soared to 60%. Capital spending’s share went from 22% in H1 to 20% in H2.

The first half’s gross debt paydown exceeded gross borrowing, making for a net reduction in debt outstanding. In the second half, however, firms returned to net borrowing (though at a rate considerably below 2016 and 2017).

Shifting the focus from the uses of the tax cut gusher alone, firms devoted 49% of their total cash outflow to capex in 2016–2017; that fell to 41% in 2018. But the share devoted to buybacks went from 25% to 31%.

Moody’s report pairs nicely with a new NBER working paper by Daniel Greenwald of MIT, Martin Lettau of Berkeley, and Sydney Ludvigson of NYU, “How the Wealth Was Won: Factors Shares as Market Fundamentals.” They find that between 1989 and 2017, $23 trillion in real equity wealth was created by the nonfinancial corporate sector. More than half, 54%, of that increase “was attributable to a reallocation of rents to shareholders in a decelerating economy.” (To be specific, those rents were reallocated away from labor.) Economic growth accounted for 24% of those gains, lower interest rates for 11%, and a lower risk premium, also for 11%. By contrast, between 1952 and 1988, less than half as much wealth was created, but almost all of it, 92%, can be attributed to economic growth. Conventional estimates of the equity risk premium are, by their work, overstated by 50%.

Unlike many models of stock returns, rather than imagining a single representative agent, Greenwald et al. divide the population into shareholders and workers—in line with a world where the top 5% of stock wealth distribution owns 76% of total stock market value. Shareholders earn relatively little of their income from labor, and workers earn almost all of theirs that way. In this model, shifts in income from labor to capital, which play no role in the traditional valuation literature, have a significant explanatory power over stock market returns. A reminder that two of the three authors of the paper are business school professors and not freelancing Bolsheviks.

What about the low interest rates of recent years? The authors find they explain little of the stock market’s rise since the financial crisis. While real rates are low by the standards of the 1984–2000 period, they’re not by the standards of the 1950s through the 1970s.

Greenwald et al. do not address buybacks specifically, but they certainly fit in with the distributional shift towards shareholders in their model.

Philippa Dunne & Doug Henwood

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IPOs Underperforming the Broad Market

The unicorns are finally going public in size after a long delay. Lyft did its IPO at the end of March, and Uber will be coming any day now. And more as the year goes on, flooding the San Francisco Bay Area with billions, and separating techno-optimists from large quantities money. It’s almost like 1999 again, minus the productivity acceleration (and pervasive euphoria).

Perhaps we’re being spoilsports, but this is all looking rather frothy. We’ve been worrying for some time about stock market high valuations, but an exuberance has been missing. Wacky IPOs might be a sign that the long bull market is finally entering its blowoff phase (though these can take some time).

Here are some stats from the leading academic authority on IPOs, Jay Ritter of the University of Florida. As the top graph below shows, there’s been a long-term decline in the share of firms making their market debut that were profitable. In the 1980s, 81% of tech firms going public were profitable; that fell to 14% in 1999–2000 but rose back to 38% from 2001–2007 (though obviously many fewer floated stock in the early 2000s than the late 1990s). But we got back to 16% in 2018. The profitable share of firms classed as “other” has almost always been higher, but it follows a similar path. Biotech firms are the least profitable, but they’re often swinging for the fences with a single product rather than trying to build a broad business.

As the lower graph shows, today’s market debutantes are generally much older than those of the dot.com era—an average of twelve years in 2018 compared to less than eight at the end of the 1990s. Uber, which lost $3 billion on revenues of $11 billion last year, and which shows no signs of becoming profitable any time soon, is ten years old. (As the company confesses in its prospectus, “we may not be able to achieve or maintain profitability in the near term or at all.”) You might think a firm that’s not making money after a decade or more of life and survives only on constant infusions of cash from venture capitalists might not have the best prospects for the future. But, as conceded above, perhaps we’re being spoilsports.

But maybe not. Ritter shows that since 1980, using a three-year buy-and-hold strategy, IPOs have underperformed the broad market by over 18 percentage points. Which makes one want to ask a VC, if this firm is such a great investment, why are you selling it?

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Just around the Corner? Maybe Not.

A very smart analyst joked yesterday that the Consumer Price Index is the new Nonfarm Payroll. Since the FOMC has made it clear that they are waiting for 2% inflationor perhaps Godotall eyes are searching for signs we might be getting there, so all price indexes are good fodder, especially the PCE, the Fed’s favored index.

The FOMC’s models have continually demonstrated a “just around the corner,” feature where, despite currently weak PCE measures, the expectation is that higher inflation would occur in the near future.
Unfortunately, a historical look at the broad components of this inflation measure belies their optimistic projections:

pce-log

Above is a logarithmic graph of the three components of the PCE price index: durable goods prices (in blue), non-durable goods prices (in red) and service prices (in green). Two key visual elements are apparent: durable goods prices have been consistently declining since the mid-1990s. Non-durable goods prices have been stagnant to slightly lower for the last 5 years. That leaves services as the only PCE price index component that can exert upward pressure.

Let’s look at the same data from a Y/Y percentage change perspective:

pc-yy

Durable goods prices (in blue) have been subtracting from price growth for the last 20 years. Non-durable goods prices (in read) have been declining since 2011-2012; they subtracted from PCE price growth for most of 2015 and only recently turned positive. Only service prices (in green) have increased PCE price pressures on a consistent basis.

There are several important lessons to draw from this data. First, the PCE price index looks at prices from a business perspective. According to the Cleveland Fed, “the PCE is based on surveys of what businesses are selling.” The above charts indicate that neither durable goods nor non-durable goods companies have any pricing power. Second, the Y/Y percentage change in service prices has been declining. Third, price growth for 31% of PCEs are either negative or very weak. That means the remaining 70% of prices would have to increase at a faster Y/Y rate to hit the Fed’s 2% PCE Y/Y inflation target. This runs counter to the second conclusion regarding service prices, that the y/y rate of change is narrowing.

Those trends mean the Fed cannot hit its 2% y/y target under the current circumstances.

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