Checking the Boxes
GaveKal Capital
By Research Team
November 7, 2011
1 – Recent Developments & Impacts on the GaveKal Investment Scenario
Our regular readers will know that we have argued recently that the current rally is largely dependent on US economic performance, since Europe's crisis is not going to be solved anytime soon. On that basis, Friday's reports of mixed and lacklustre data for US employment may not seem overly confidence-boosting. The household survey showed the unemployment rate unexpectedly ticked down from 9.1% to a six-month low of 9.0% in October; but the establishment survey disappointed, showing total nonfarm payrolls grew +80K last month (vs an expected +95K). Beyond these headline figures, however, we found the report supportive of our major current themes:
1) The US economy will avoid recession after all: One should never look at just the initial estimates for the latest month of payrolls as these are famously prone to large revisions. On that note, August payroll growth was just revised up from +57K to +104K, and September was revised up from +103K to +158K. So, while the initial estimate for October disappointed by -15K payrolls, the prior two months were revised up by a combined +102K.?This is good news, as the direction of revisions is often a reliable indicator of the underlying job market. That being said, payroll growth is neither booming nor evident in all parts of the economy, which brings us to our next two themes...
2) The US economy is growing at two speeds-one for the deleveraging sectors and another for the rest: While total payrolls were up +95K in October, private payrolls were up +104K; and if we?strip out government, construction and finance, the rest of the economy was busy adding +120K jobs. While not great, this is still decent job growth. And this dichotomy is not just evident in the fickle initial estimates for October, but are a structural characteristic of this recovery. It now looks like an imminent recession has been avoided, but structural headwinds remain as the US is still working off its past excesses in real estate, finance, and government. We call this the deleveraging part of the economy, which has now lost all of the jobs added since 2000 and has yet to show any sign of recovery. Meanwhile, employment in the rest of the economy (what we call the non-deleveraging part) is also well below its 2007 peak and also roughly where it was in 2000, but at least here we are seeing significant growth rather than further contraction (see charts on page 2).
3) All in all, growth should be decent, but employment and wages will still take a long while to recover fully: The rebound of growth for payrolls and aggregate hours worked shows that demand for US production is recovering.?However, the downside for the unemployed, politicians, and consumption plays is that US companies have largely been meeting new demand with more hours worked and higher productivity, keeping new hires to a minimum. This could be in part due to the lack of confidence in the recovery, in part due to troublesome labor regulations (e.g., minimum wages, required healthcare benefits, etc...), and in part due to the structural evolution of growth dynamics (from the rise of the emerging market competition to the rise of robotics, OECD labor markets have been forced?to make some serious adjustments-and this is not likely to abate anytime soon).
Of course the avoidance of a US recession is broadly bullish-but then again this development did not go unnoticed by markets in October, which saw the biggest monthly jump since December 1991! Looking forward, the fundamentals for US labor and consumption remain mixed: while activity in parts of the economy continue to recover, consumers are themselves still deleveraging (particularly those with underwater mortgages) along with government and finance. Moreover, we still have oil prices well above trend (this could change but has not yet), and companies are still trying to squeeze the most out of the fewest workers, rather than risking new hires. As such, we believe investors should continue to bet on a US recovery, but should position themselves for a recovery led not by US consumers, but by a rebound in investment, manufacturing and net exports.
2 — The ―Non-Deleveraging‖ US Economy is Looking Strong
(c) GaveKal Capital
