1.2% Q1 GDP Growth But Strong Private Sector Jobs Growth?

In this article, I will continue the discussion about the indicators which are telling separate stories. Many hard data economic reports have been weak; the corporate debt level would seem to indicate the cycle should have ended already. Even with slow GDP growth last year and a debt cycle which appears to be near its end, the labor market remains strong. The stock market bulls can point to the strong labor market and re-emergence of profit growth as reasons to stay in the market. Valuations and productivity growth determine long-term performance, while these indicators along with low interest rates effect short-term performance; this allows bulls to justify paying high multiples for stocks.

Before I review the latest economic news, I will discuss the stock market’s lack of volatility. As I have mentioned previously, the streak of not having a 1% daily decline in the S&P 500 is the longest since the start of this bull market. The streak has reached 100 trading days which is the longest since 1994. As you can see from the chart below, the S&P 500’s 50-day average intraday trading range is the lowest since at least 1983. The longest streak without a 1% decline was in 1963 and lasted 184 trading days.

This lack of volatility doesn’t mean anything on its own, but when it’s combined with the market’s high multiple, it’s disconcerting. In 1994, the Shiller PE was between 19.91 and 21.41. In 1963, the Shiller PE was between 19.26 and 21.04. The current Shiller PE is 29.11, which makes me feel the market won’t follow the same positive performance it has historically had following these periods of low volatility. The idea that fiscal policy uncertainty and low earnings growth makes this market “resilient” is laughable. It’s not a positive to have stocks exceed their intrinsic value.

The trend of weakening GDP growth, increasing corporate debt, a strengthening labor market, and an increasing stock market has been in place for a couple years. The trend remains in-tact with the latest data points. You would think these trends would clash at some point bringing the economy higher or lower, but it hasn’t happened yet. I guess it’s not surprising to see a divergence of indicators because the economy is neither in a recession nor in a recovery.

The biggest economic report Wednesday was the ADP jobs report. The report showed acceleration in private sector hiring as there were 298,000 jobs created which is the highest in the past 12 months and 37,000 higher than last month. The report beat expectations for 190,000 jobs. Because of this beat, the rate hike in March became more of a lock because it’s a signal the BLS report on Friday will be great. The expectation for a rate hike went up from 81.9% to 90.8%.

The ADP report showed broad-based strength in every component. Goods producing jobs gained 106,000 and service jobs increased 193,000. The two strongest areas were construction and professional & business, with both adding 66,000 private sector jobs. The chart below shows the breakdown in job growth by business size. Small businesses added 104,000 jobs, mid-sized businesses added 122,000 jobs, and large businesses added 72,000 jobs. It’s not a surprise to see small businesses hiring as they are very optimistic because even though current business isn’t strong, they are hopeful tax cuts, infrastructure spending, and regulatory reform will boost the economy in the next 6-12 months. Very small businesses added 51,000 jobs which shows a continuation of strength after there was some stagnation in late 2016 as December saw very small businesses lose 3,000 jobs.

Usually employment is a late cycle indicator. I would argue the cycle has been near its end for over a year, yet employment keeps getting stronger. One indicator which hasn’t been strengthening is the GDP Now Forecast for Q1 growth. Growth is now only expected to be 1.2% which is much below the Trump admiration’s goal of 4% growth. The GOP’s fiscal plans haven’t been put in place yet, but one must wonder how the market can rally if the Q1 report does come in at 1.2%. The forecast ticked lower on Wednesday because the wholesale report caused a small inventory investment adjustment.

The main reason I was predicting a recession in 2016 was debt was rising and the credit market was seizing up. While the credit market conditions have improved, the debt is still rising. The gross leverage ratio for U.S. investment grade companies is 2.4X which meets the high in March 2002. In the last two cycles, the leverage ratio peaked after the economy went into a recession. If that same timeline played out in this cycle and the economy went into a recession in the middle of 2017, the leverage ratio would continue to move higher until at least 2018. There is no specific leverage limit, but it certainly looks ominous.

The final chart which is slightly less ominous is the proportion of cash to debt at investment grade companies. The rate fell in 2015 as profit growth stalled and firms borrowed money cheaply to buy back stock. The rate is closing in on what was seen prior to the 2008 recession. However, it may improve in the next few months because buybacks have been slowing and profit growth is accelerating.

Conclusion

The stock market has given up the entire post-Trump speech rally last Wednesday. Saying the market is resilient is a bad description. If the stock market is going up despite deteriorating fundamentals, I prefer to call it a bubble. I consider the lack of a 1% daily fall in the market for 100 days to be more negative than usual because of the high Shiller PE. The investment grade cash level is weakening and the leverage is rising. However, this has been ignored for over 12 months. The stock market prefers to look at the positives which are regulation cuts and jobs growth. If this trend continues, the market will rally on Friday after the BLS report shows the labor market continues to be strong.

Spread the love

Comments are closed.