The Role of Government

December 18, 2016

What role should government at many levels – Federal, state and local – play in our lives?  Some want a large role, some small.  Does the Constitution give the Federal government a diminished role in our lives? That is the viewpoint of those on the right side of the political divide in this country.  As Donald Trump gets ready to lead a Republican dominated Federal government, the debate burns white hot, as it did at the founding of this country.

Let’s turn the time dial back to 1936, the middle of the Great Depression, to appreciate just how much we depend on government today.  At that time, the unemployment rate had declined from a soul crushing 24%, but was still high at 17%.  The Roosevelt administration had ushered in many programs to alleviate joblessness.  In 1936, total government spending at all levels was $257 billion. (Dollar amounts don’t include what is called transfer payments like Social Security. and are in 2016 dollars.)

Eighty years later, it is $6 trillion, about 24 times the 1936 level.  Some might counter that the population has grown so, of course, government spending has grown.  The population has indeed increased, but only 2.7 times, far below the 24 times that government spending has multiplied.  In 1936, per person spending was $2,000.  Today it is $19,000.

During World War 2, government spending climbed six times to $1.6 trillion, about 25% of today’s level.  We are not currently engaged in a global war which occupies most of our economy as it did in the 1940s.  We do not have millions of young men in combat.  And remember, these figures don’t include Social Security, welfare and business subsidies.

Now let’s look at this from another viewpoint, one that might lead to a different conclusion.  Let’s look at government spending as it relates to family income.  According to the IRS and BLS, average family income was about $26,000 in 1936. (IRS and BLS See note below).  Remember, this was during the most severe Depression in our nation’s history.  So, per capita government spending was about 6% of this rather low family income.  Today, it is 33% of the $56,000 median family income.  So, we squint at these figures from two viewpoints and we are still left with the same conclusion.  As a percent of income and on a per capita basis, government spending has become a significant part of our lives.

When Republicans talk about smaller government, the “small” in that catch phrase should be kept in perspective.  At best, Republicans might want to lower spending growth to eight times, not ten times, the spending of 1936.  Those on the left might want to accelerate that growth to 12 times.  In either case, neither party advocates the frugal spending levels of 1936.  I should note that President Roosevelt himself was concerned that this low (to us) level of government spending – most of them his New Deal programs – was becoming too high.

The current fad is speaking in hyperbole.  Many daily experiences in our lives are awesome.  Our kids, our vacation, the latte we had yesterday – all awesome. It is no surprise, then, that we would  use hyperbole to describe those who don’t agree with our political views.  They are communists, or socialists, or capitalist anarchists, or [insert epithet here].  The voices of moderation are growing smaller by the year.

Half of the voters in this country want less government, half want more.  If each of us wants “our” views to prevail, we need to get up off our asses and pull on the rope in this political tug of war.  When “our” side gets into power, the other half has to suffer through it, and vice-versa.  This battle of ideas will continue throughout our lifetimes and – God Forbid! – we might even change sides.

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Endnotes

According to the IRS, only 4.3% of tax returns reported positive taxable income in 1936.  One out of 20 families footed the entire bill for Federal government spending. 95% of families had no federal taxable income. 

Real wage growth in the U.K. has turned negative for the first time since the 1860s.
(Bloomberg)

The most common job in a lot of states:  truck driver.  (NPR)

Pickup and Letdown

May 8, 2016

Based on ISM’s monthly survey of Purchasing Managers, the CWPI blends both service and manufacturing indexes and gives additional weight to a few components, new orders and employment.  Last month we were looking for an upward bend in the CWPI, to confirm a periodic U-shaped pattern that has marked this recovery. This month’s reading did swing up from the winter’s trough and we would expect to see further improvement in the coming few months to confirm the pattern. A break in this pattern would indicate some concern about a recession in the following six months. What is a break in the pattern? An extended trough or a continued decline toward the contraction zone below 50.

Since the services sectors constitutes most of the economy in the U.S., new orders and employment in services are key indicators of this survey.  A sluggish winter pulled down a composite of the two but a turn around in April has brought this back to the five year average.

Rising oil prices have certainly been a major contributor to the surge in the prices component of the manufacturing sector survey. The BLS monthly labor report (below) indicates some labor cost increases as well.  Each month the ISM publishes selected comments from their respondents.  An employer in the construction industry noted a severe shortage of non-skilled labor, a phenomenon we haven’t seen since 2006, at the height of the housing bubble.

Last week the BEA released a first estimate of almost zero growth in first quarter GDP, confirming expectations.  Oddly enough, the harsh winter of 2015 provided an even lower comparison point so that this year’s year over year growth, while still anemic, is almost 2%.

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Employment

April’s employment data from the BLS was a bit disheartening.  Earlier this week, the private payroll processor ADP reported job growth of 150,000 in April and lowered expectations for the BLS report released on Friday.  While the BLS estimate of private job growth was slightly better, the loss of about 10,000 government jobs, not included in the ADP estimate, left the total estimate of jobs gained at 160,000. The loss of government jobs is slight compared to the total of 22 million employed at all levels of government but this is the fourth time in the past eight months that government employment has declined.

A three month average of job growth is still above 200,000, a benchmark of labor market health that shows job growth that is more than the average 1% population growth  With a base of 145 million employees in the U.S, a similar 1% growth rate in employment would equal 1.5 million jobs gained each year, or about 125,000 per month.  To account for statistical sampling errors, the churn of businesses opening and closing, labor analysts add another 25,000 to get a total of 150,000 minimum monthly job gains just to keep up with population growth.  The 200,000 mark then shows real economic growth.  In March 2016, the growth of the work force minus the growth in population was 1.2%, indicating continued real labor market gains.

Job growth in the core work force aged 25 -54 remains above 1%, another good sign.  It last dipped briefly below 1% in October.  This core group of workers buys homes, cars, and other durable goods at a faster pace than other age groups; when this powerhouse of the economy weakens, the economy suffers. In the chart below, there is an almost seven year period, from June 2007 through January 2014 where growth in this core work force group was less than 1%.  From January 2008 through January 2012, growth was actually negative.  The official length of the recession was 17 months, from December 2007 through June 2009.  For the core work force, the heart of the economic engine, the recession lasted much longer.

In 2005, a BLS economist estimated that the core work force would number over 105 million in 2014.  In December 2014, the actual number was 96 million, a shortage of 9 million workers, or almost 10% of the workforce.  In April 2016, the number was almost 98 million, still far less than expectations.

Some economists and pundits mistakenly compare this recovery from a financial crisis with recoveries  from economic downturns in the late 20th century.  For an accurate comparison, we must look to a previous financial, not economic, crisis – the Great Depression of the 1930s.

The unemployment rate in April remained the same, but more than a half million people dropped out of the labor force, reversing a six month trend of declines.  It is puzzling that more people came back into the labor force during the winter even as GDP growth slowed.

Average hourly earnings increased for the second month in a row, upping the year over year increase above 2.5%.  For the past ten years, inflation-adjusted weekly earnings of production and non-supervisory workers have grown an anemic .75% per year.  In the sluggish winter of January and February 2015, earnings growth notched  a recovery high of 3%, leading some economists and market watchers to opine that lowered oil costs, on the decline since the summer of 2014, would finally spur worker’s pay growth in this long, subdued recovery.  A year later, earnings growth is about 1.2%, a historically kind of OK level, but one which causes much head scratching among economists at the Federal Reserve.  When will worker’s earnings begin to recover?

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Hungry

A reader sent me a link to a CNBC article  on food insecurity in the U.S. The problem is widespread and not always confined to those who fall below the poverty benchmark. Contrary to some perceptions, food insecurity is especially prevalent in rural areas, where food costs can be 50% higher than urban centers.  How does the government determine who is food insecure? The USDA publishes a guide with a history of the project, the guidelines and questions.  To point out the highlights, I’ll include the page links within the document. The guidelines have not been revised since this 1998 revision.

In surveys conducted by the Census Bureau, respondents are asked a series of questions.  The answers help determine the degree of household food insecurity.  The USDA repeatedly emphasizes that it is household, not individual, insecurity that they are measuring.  The ranking scale ranges from 0, no insecurity, to 10, severe insecurity and hunger. An informative graph of the scale, the categories and characteristics is helpful.

In 1995, a low .8 percent were ranked with severe food insecurity (page 14) . To be considered food insecure, a household must rank above 2.3 (household without children), or above 2 .8 (with children) on the scale.  Above that are varying degrees of insecurity and whether it is accompanied by hunger. (Table)

The USDA admits that measuring a complex issue like this one can provoke accusations that the measure either exaggerates or understates the number of households.  What are they measuring?  Page 6 contains a formal definition, while page 8 includes a list of conditions that the survey questions are trying to assess, and that a condition arose because of financial limitations like “toward the end of the month we don’t have enough money to eat well.”

Page 9 describes the rather ugly pattern of progressively worse food insecurity and hunger.  At first a household will buy cheaper foods that fill the belly.  Then the parents may cut back a little but spare the kids the sensation of hunger.  In its most severe stage, all the family members go hungry in a particular day.

Those of you wanting additional information or resources can click here.

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Earnings

Almost a month ago the giant aluminum manufacturer Alcoa kicked off the first quarter earnings season.  87% of companies in the SP500 have reported so far and FactSet calculates a 7% decline in earnings.  They note “the first quarter marks the first time the index has seen four consecutive quarters of year-over-year declines in earnings since Q4 2008 through Q3 2009.”  Automobile manufacturers have been particularly strong while the Energy, Materials and  Financial sectors declined.  Although the energy sector gets the headlines, there has also been a dramatic decrease in the mining sector.  The BLS reports almost 200,000 mining jobs lost since September 2014.

The bottom line for long term investors: the economic data supports an allocation that favors equities.  The continued decline in corporate earnings should caution an investor not to go too heavily toward the equity side of the stock/bond mix.

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(Edited May 11th in response to a reader’s request to clarify a few points.)

Pickup Purchasing Power

April 24, 2016

Relatively stagnant wages and income inequality have become a frequent theme on the campaign trail.  Let’s look at what I’ll call pickup purchasing power to understand the problem.  Sorry.  No graph from the Federal Reserve on this one.

A favorite vehicle among construction workers is the F-150 pickup, a reliable vehicle with room for a toolbox and a trip to the local lumberyard for supplies.  The MSRP of a standard bed 1998 model, available to the public in September 1997, was $14,835 (Source ) In 2016, the MSRP of that same model is $26,430 (Source), a 78% increase, about 3.2% per year.  There have certainly been improvements in that truck model in the past two decades but customers can not order the model without the improvements.  The basic model is the basic model.

Let’s look now at the wages needed to buy that pickup.  In May 1997, shortly before the 1998 F-150 was released to the public, the BLS survey reported average carpenters’ wages of $30,800.  At that time, wages and salaries were about 70.5% of total compensation, or about $43,700 (BLS report).  In the decade before that, wages as a percent of total compensation had declined from 73.3% in 1988 to 70.5% in 1997.  Rising insurance costs and other direct benefits to employees were slowly eating into the net compensation of the average carpenter.

In 2015, the average wage for carpenters was $43,530.  The BLS reported that wages were now 67.7% of the total employment cost, or about $64,300.  In that 18 year period, carpenters’ wages grew 41% but total compensation grew 47%, or 2.1% per year.  The price of that pickup truck, though, grew at 3.2% per year.  That seemingly small difference of 1% per year adds up to a big difference over the years.  That’s the sense of anger that underlies the current election season.  The growth in price of that pickup is only slightly above the average post WW2 inflation rate of 3%.  It is the wages that have fallen behind.

Trump blames the politicians who have given away American jobs with badly negotiated trade agreements that disadvantage Americans.  Trump’s promise to bring those manufacturing jobs back home wins him popular appeal in those communities impacted by the decline in manufacturing.  The loss of manufacturing jobs has left a larger pool of job applicants for construction jobs.  Some of those displaced workers did not have the carpentry skills needed but some were able to work in roles supervised by an experienced carpenter.  The more the supply of job applicants the less upward pressure on wages. If – a big if – some manufacturing jobs do come back to the U.S., it will help spur more growth in carpenter’s wages.

Bernie Sanders blames the fat cats and proposes taxing all but the poorest Americans to distribute income more evenly. His remedies to promote his programs of fairness are far ranging.  Employers who are currently providing health insurance for their employees will probably welcome a 6.2% payroll tax.  On a forty year old employee making $50,000 a year, the $3100 tax is far less cost than an HMO plan. Employers who do not provide such coverage will resent the imposition of more taxes but at least it will be across the board, affecting all competitors within an industry or local market.  Sanders’ healthcare plan also relies on 10% cuts in payments to doctors and hospitals, who are projected to save at least that much in reduced billing costs.

While Trump addresses a specific demographic, a particular segment of the labor market, Sanders proposes broad remedies to a number of problems.  Trump’s appeal will be to those who want a specific fix.  Bring back jobs to our community.  We’ll figure out the rest.  Sanders’ proposals will appeal to voters who have more confidence in government as a problem solver.

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Oil Stocks

Readers who put some money to work in oil stocks (XLE, VDE for example) in late February, when I noted the historical bargain pricing, might have noticed the almost 20% increase in prices since then.  There are a number of reasons for the surge in price but the buying opportunity has faded with that surge.  Inventories are still high relative to demand.  Recent comprehensive market reports from the IEA require a subscription but last year’s report is available to those interested in a historical snapshot of the supply and demand trends throughout the world.  Until 2014, total demand had slightly exceeded supply.  A glance at the chart shows just how tightly coordinated supply and demand are in this global market. A “glut”in supply may be less than 1% of daily worldwide consumption and it is why prices can shift rather dramatically as traders try to guess both short and long term trends in demand and supply.

Post War Productivity

July 26, 2015

Each year, the Council of Economic Advisors (CEA) submits the Economic Report of the President  to the Congress.  They compile a number of data series to show some long term trends in household income, wages, productivity and labor participation.  Readers should understand that the report, coming from a committee acting under a Democratic President, filters the data to express a political point of view that is skewed to the left.  When the President is from the Republican Party, the filters express a conservative viewpoint.  Has there ever been a neutral economic viewpoint?

In this year’s report the Council identifies three distinct periods since the end of WW2: 1948-1973, 1973-1995, and 1995-2013.  In hindsight, this last period may not be a single bloc, as the report acknowledges (p. 32).

The most common measure of productivity growth is Labor Productivity, which is the increase in output divided by the number of hours to get that increase.  Total Factor Productivity, sometimes called Multi-Factor Productivity (BLS page), measures all inputs to production – labor, material, and capital.  As we can see in the chart below (page source), total factor productivity has declined substantially since the two decade period following WW2.

In the first period 1948-1973, average household income grew at a rate that was 50% greater than total productivity growth, an unsustainable situation.  This post war period, when the factories of Europe had been destroyed and America was the workshop of the world, may have been a singular time never to be repeated.  What can’t go on forever, won’t.  In the period 1973-1995, real median household income that included employer benefits grew by .4% per year, the same growth rate as total productivity.

The decline in the growth rate of productivity hinders income growth which prompts voters to pressure politicians to “fix” the slower wage growth.  If households enjoyed almost 3% income growth in the 1950s and 1960s, they want the same in subsequent decades.  If the rest of the world has become more competitive, voters don’t care.  “Fix it,” they – er, we – tell politicians, who craft social benefit programs and tax programs which shift income gains so that households can once again enjoy an unsustainable situation: income growth that is greater than total productivity growth.

“Where Have All The Flowers Gone?” was a song written by legendary folk singer Pete Seeger in the 1950s. It was  a song about the folly of war but the sentiment applies just as well to politicians who think that they can overcome some of the fundamental forces of economics.  Seeger asked: “When will they ever learn?”

Wage Growth Rings

June 14, 2015

The broader stock market has been on a continuous upswing since November 2012 when the weekly close of the SP500 index briefly broke below the 48 week average.  The past six months is one of those periods when investors seem undecided.  Even though the market is above its 24 week average, a positive sign, it closed at the same level that it was just before Christmas.  Earlier this week came the news that Greece might avoid default on its June payment to the ECB and the market surged upwards. At the end of the week, news that talks had broken down caused a small wave of selling on Friday morning. Investor reaction to what, in perspective, is a relatively small event, indicates an underlying nervousness in the market.

As the SP500 began a broad upswing in late 2012, the bond market began a downswing.  A broad aggregate of bonds, AGG, fell about 5% over the following ten months before rising up again to those late 2012 levels this January.  In the past five months, this bond index has declined almost 4% as investors anticipate higher rates. A writer at Bloomberg notes a worrisome trend of concentrated ownership of corporate bonds.

Retail sales in May showed strong gains across many sectors in the economy. As the chart shows, growth below 2.5% is weak, indicating some pressures in household budgets that could be a precursor to recession.  Current year-over-year growth in retail sales excluding food and gas is up almost 5% – a healthy sign of a growing economy.

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Wage Growth

“Since 2009, when the great monetary experiment began, global bond markets have increased in value by about $17 trillion. Global equity markets have increased by about $40 trillion. The average worker has seen wages increase by about $722 billion, which means about 2% of the benefit of QE (quantitative easing) went to workers. The rest went to asset prices.” (Source)

A cross section of a tree shows a historical pattern of rainfall, temperature and volcanic activity.  Wage and salary income across a population can provide a similar historical picture of the economic climate of a people.  The recovery from the recent recession has been marked by slow growth in wage and salary income relative to the growth rates of previous recoveries.

Economists find it difficult to reach a consensus to explain the muted growth.  A WSJ blog summarized a number of explanations.  I have noted several of these in past blogs.  They include:

Slack in the job market.  However, the labor dept reports that the number of job openings is at a 15 year high. (BLS Report)

Some economists point to the large number of involuntary part timers, those who want a full time job but can’t find one, as an indication of slack in the labor market.

The number of people quitting their jobs for another job is improving but is still weak by historical standards.

Sluggish productivity growth. Multi-factorial productivity growth estimates by the labor dept show that productivity gains in the past 15 years are chiefly from capital investment, not labor productivity.  Capital productivity during the recovery has been slow but labor productivity has been terrible, according to multi-factorial productivity assessments by the BLS.  As the century turned, we applauded the transition toward a more service oriented economy.  Less pollution from manufacturing industries, we told ourselves.  “The service sector is less cyclic,” economists reminded us.  It is much more difficult to wrest productivity gains from many service sector jobs. The cutting of a lawn, the making of a latte – there is a minimum threshold of time to do these things.

The sticky wages theory: namely, that companies withhold raises during the recovery because they couldn’t cut wages during the recession.

Let’s compare income growth to retail sales growth, using the data for retail sales less  food and gas whose prices are more volatile.  Periods when both growth rates decline set the stage for recessions.  Periods when both rates increase mark recoveries.

Simultaneous declines in 2011 and 2012 prompted stock market corrections.  The upswing of the past two years has contributed to the rising stock market.

Winter Wanders

March 8, 2015

Labor Market

If you are reading this and have not set your clock forward, that’s OK.  March to your own drummer!

On Wednesday, payroll processor ADP released their data for February, showing private payroll gains of 212,000.  This confirmed estimates that total job gains from the BLS would be about 230,000.  The bothersome data point in the ADP report was the huge upward revision of job gains in January, bringing it close to the BLS estimate.  ADP is working with a lot of hard data – actual paychecks – so was this revision a discrepancy in seasonal adjustments?

On Thursday, the BLS issued revised figures for labor productivity in the 4th quarter of 2014. The report includes this: “The 4.9 percent increase in hours worked remains the largest increase in this series since a gain of 5.7 percent in the fourth quarter of 1998.” 4th quarter productivity sagged 2.2% from the 3rd quarter,  and was essentially unchanged from the 4th quarter of 2013.  Labor productivity is often a lagging indicator but it narrowed Thursday’s trading range as investors crossed bets on the Fed’s plans for raising interest rates later in the year.

The BLS report of 295,000 job gains in Febuary was so over the top that many traders punched the sell button.  Government employment increased 7,000, meaning that private job gains as reported by the BLS was almost 290,000, a difference of almost 70,000 between the BLS and ADP reports.  When in doubt, traders get out.

For mid to long-term investors, the continuing strength in the labor market is an optimistic sign.  Employees add to costs and commitments.  If businesses are adding jobs, it is because they anticipate higher revenues in the near future.  Some analysts pointed to the high number of jobs gained in the leisure and hospitality sectors as a sign of weakness in the labor market.  These are jobs that pay on average about 25% less than the average of all production and non-supervisory employees and a third less than the average for all employees.  However, higher paying jobs in professional services and construction also showed strong gains.

As I have mentioned before, the Federal Reserve compiles a Labor Market Conditions Index (LMCI) which summarizes 24 employment trends and one which chair Janet Yellen uses as her gauge for the fundamental strength or weakness of the labor market.  Next Wednesday, the Fed will release the LMCI updated for February but a chart of the past twenty years shows longer term trends.

While the index itself is still in negative territory, the momentum (red line) of the index is strong and consistent.  We can understand Yellen’s cautious optimism when recently testifying before the Senate Banking Committee.  This index was only developed a few years ago so this chart includes revised data and methodology that is backward looking.  If history is any guide, a long term investor would be ill advised to bet against the momentum of this index when it is positive.

A key indicator for Ms. Yellen is the Quit rate, the number of employees who quit their jobs to go to another job or who feel confident that they can find another job without much difficulty.  That confidence measure continues to rise and is currently in a sweet spot.  It is not overly confident as it was at the height of the housing boom in 2006 and the dot com boom of the late 1990s.  It is neither pessimistic as it was in the early 2000s or darkly apocalyptic as in the period from 2008 – 2012.

The number of new claims for unemployment as a percentage of the Civilian Labor Force is at historic lows.  One could argue that new claims are too low.

Wage growth in this month’s report was minimal.  However, wage growth since 2006 has not done too badly, growing more than 25% and outpacing the 16% growth in inflation during the period.

Benefits have grown more than 20% in the same period and showed no decline during this past recession.  Many employees are simply not aware of the costs of their benefits.  They may think that vacations and holidays and health care are the only benefits they get.  There are several mandated taxes and insurance that an employer is required to pay.

Because some benefit costs are “sticky,” and not responsive to changing business conditions, the continued strength in the labor market shows an increasing commitment on the part of employers, a growing confidence that economic conditions are fundamentally improving.  Several years ago, many employers were reluctant to take on new employees because positive news was regarded with a healthy skepticism.  “We won’t get fooled again,” as the Who song lyric goes.  Despite improving fundamentals, the market is likely to be somewhat volatile this year as investors and traders speculate on the timing and aggressiveness of any interest rate moves from the Fed.

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Purchasing Managers Index

Based on the monthly survey of purchasing managers, the Constant Weighted Purchasing Index (CWPI) declined slightly again this month as expected.  The manufacturing sector slid a bit this past month but employment in the service sectors popped up, keeping the composite index up above the benchmark of strong growth.  If the post-recession trend continues, we might see one more month of softening within this growth period.

New orders and employment in the service sectors are the key indicators that I highlight to get a more focused analysis of growth trends.  When this blend of the two factors stays above 55, the benchmark of strong growth, the economy is strong.  Except for a slight dip below that mark (54.4) last month, this blend has been above 55 for ten months now.

We can also see the brief periods of steady decline in these two components in 2011, 2012 and the beginning of 2013, causing the Federal Reserve to worry about a further decline into recession. The Federal Reserve enacted a series of bond buying programs called QE.  Continued economic strength may prompt a slow series of interest rate hikes.  The key word is “slow.”  Under former chairman Alan Greenspan, the Federal Reserve adjusted interest rates up and down too quickly, which produced small shock waves in the financial system.  Banks, businesses and investors may make unwise choices in response to rapid rate changes.  Live and learn is the lesson.

GDP, Unemployment, Wage Growth

Feb. 1st, 2015

GDP

The first estimate of 4th quarter GDP growth was 2.6%.  This figure is truly a guesstimate and is sometimes heavily revised in the following months. Last October, the first estimate of third quarter GDP growth was 3.5%.  As data continued to roll in, that estimate was revised upwards by a whopping 42% to 5.0%.

The year over year growth in inflation-adjusted, or real GDP was 2.5%, more or less following a trend that is four years old.

On a per capita basis, GDP growth is near 2%, the average rate of growth since World War 2.

Let’s get in the wayback machine and look at per capita GDP growth over the past four decades.  Reagan and Clinton groupies can leave the room now.  The adults are going to talk.  The 1970s and first half of the 1980s were a period of high inflation and erratic growth – up 5%, then down 3%.

Growth above 3% for any length of time leads to distortions in investment and the labor market which generates a subsequent downward correction lasting several years.  Above average growth in the late 1980s was followed by a three year period of below average growth in the early 1990s.  The strong growth of the late 1990s was fueled by a boom in dot-com investment and telecom coupled with ever rising house prices.  The above 3% growth of those years sparked an inevitable correction lasting three years, bringing us back to the 2% average.

The housing boom of the 2000s generated above average growth followed yet again by a three year correcting downturn. For those families who have struggled to recover from the recession, average growth may be too slow and too small.  On the other hand, average growth is less likely to lead to a rebalancing recession.

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Unemployment

Much ado this week when the Labor Dept announced that new claims for unemployment dropped more than 40,000 to 265,000.  The week after the Martin Luther holiday is typically volatile each year with little consensus on the reasons.  The somewhat erratic weekly numbers are smoothed by using the four week average of new claims.  That average has been just below 300,000 since September.

Low numbers for the newly unemployed is good, right?!  As with GDP, too much of a good thing for a period of time may be a precursor to an offsetting period of not so good.  Such is the law of averages.  As a percent of the labor force, new claims are at the same low level as in mid-2000 and late 2006.

As the demand for labor increases, employers make compromising decisions out of necessity.  They hold onto low productivity workers. Workers who are let go can more readily find new jobs.  The number of new claims remains low.  Re-entrants into the job market help to reduce the pressure for wage increases but eventually wages begin to move upward.  Employers may cut margins to pay workers more than their productivity is worth.  Real wage growth climbs as the percentage of new unemployment claims remains low.

In the graph above I have highlighted two previous periods where new unemployment claims were low as real wage growth climbed.  The graph below illustrates the point a bit clearer.  It is based on the Employment Cost Index, a relatively new series about ten years old, that tracks the total employment cost, including benefits and required employment taxes and insurance.

Historical data suggests that a growing divergence between these two factors may play some part in generating an imbalanced economic environment – one that, unfortunately, soon rights itself.

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Market Timing

The link to Doug Short’s blog is on the right side of this page but in case you might miss it, here is Doug’s monthly update of moving averages and the simple allocation model of the Ivy Portfolio.    The 10 month simple moving average crossover is similar to the 50/200 day crossover system I have mentioned numerous times: i.e. the Golden Cross and Death Cross.  Either system will help a person avoid the worst of a protracted downturn as we saw in the early 2000s and 2008 – 2011, and capture the majority of a long term upswing.

For those of you who have not read it, the Ivy Portfolio is a keep-it-simple allocation and timing model of domestic and foreign stocks, real estate, commodities and bonds using low cost ETFs.

Wage and Industrial Growth

July 6, 2014

This week I’ll take a look at the monthly employment report, update the CWPI and introduce a surprising medium term trading indicator.

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Employment

On Wednesday, the private payroll processor ADP gave an early forecast that this month’s labor report from the BLS would be robust, near the tippy-top of estimates of job gains that ranged from 200K to 290K.  The BLS reported $288K i net job gains, including 26K government jobs added. 17,000 of those jobs were in education at the local level.  Rising sales and property tax revenues have enabled many city and county governments to replace education jobs that were lost during the recession.

Job gains may be even better than the headline data shows.  ADP reports that the large majority of hiring is coming from small and medium sized firms.  The headline number of job gains each month comes from the BLS Establishment Survey, which underestimates job growth in really small firms.  The Household Survey estimated about 400K job gains this past month.  Usually, the Establishment Survey is thought to be the more reliable estimate but in this case, I would give a bit of a bump up toward the Household Survey estimate and guesstimate that job gains were closer to 330K this past month.  The BLS also revised April and May’s job gains upward.

The unemployment rate decreased .2% to 6.1% and the y-o-y decline in the rate has accelerated.

Excellent news, but let’s dig a bit deeper. The BLS tracks several unemployment rates.  The headline rate is the U-3 rate.  The U-4 rate includes both the unemployed who have looked for work in the past month, and those who have not, referred to as discouraged workers.  The trend in discouraged workers has been drifting down, although it is still above the normal range of .2 to .3% of the work force.

I would be a whole lot more optimistic about the labor market if the employment rate of the core work force aged 25 – 54 were higher.

Slowly and inexorably the employment level of this core has been rising in the past few years but the emphasis is on the word slowly.

The number of workers who usually work part time seems to have reached a high plateau, close to 18% of the Civilian Labor Force (CLF).  The CLF includes most people over the age of 16.  June’s Household Survey shows a historic jump of 800,000 additional part time jobs added in the past month.

A closer look at the BLS data makes me doubt that number. The unseasonally adjusted number of part timers shows only a 400,000 gain, leading me to question any seasonal adjustment that doubles that gain.  Secondly, the BLS did not seasonally adjust last month’s tally of part time workers, leading me to guess that June’s figure includes two months of seasonal adjustment.

That same survey shows a one month loss of more than 500,000 full time jobs lost (Table A-9 BLS Employment Situation).  The year-over-year percent change in full time workers is 1.8%.  As you can see in the graph below this is in the respectable range.  The unseasonally adjusted y-o-y gains is close to the seasonally adjusted gain, leading me to believe that the losses, if any, have been overstated due to month-to-month fluctuations in seasonal adjustments.

However, if you are selling a newsletter that says the stock market is grossly overvalued and the end is coming, then you would want to highlight the change in June’s seasonally adjusted numbers, to wit:  500,000 full time jobs lost;  800,000 part time jobs gained.

While the Civilian Participation Rate has steadied, it is rather low.  The Participation Rate is the number of people working or looking for work as a percent of most of the population above 16. Below is a chart showing the declining participation rate and the unemployment rate.

Now let’s divide the Participation Rate by the Unemployment Rate and we see that this ratio is still below the 34 year average.

                                                                                      
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Wage Growth

Each month the BLS reports average weekly earnings as part of the labor report. Year-over-year inflation adjusted wage growth is flat but has probably declined below zero.

An investor would have done very well for themselves if they had paid attention to this one indicator.  (There is a week lag between the end of the month price of SP500 and the release of the employment report for that month but it is close enough for this medium to long term analysis.)

The SP500 has gained almost 50% since the first quarter of 2006.  An investor going in and out of the market when inflation-adjusted wage growth crossed firmly above and below 0% would have made 134% during that same period.  “Ah, ha!  The crystal ball that will give me a glimpse into the future!” The problem with any one indicator is that it may work for a period of time.  This one has worked extremely well for the past eight years.  This series which includes all employees goes back only to March 2006.  The series that includes only Production and Non-Supervisory employees goes back to 1964.  The two series closely track each other.  I have left the CPI adjustment out of both series to show the comparison.

However, an investor using this strategy in the mid-1990s would have been out of the market during a 33% rise.  She would have been in the market during half of the 2000-2002 downturn and been mostly out of the market during an almost 50% rise from 2003-2005.  In approximately twenty years, she would have made half as much as simply staying in the market.

The ups and downs of wage growth may not be a reliable indicator of the market’s direction but it does indicate positive and negative economic pressures.  Poor wage growth in the mid-2000s probably fueled speculation in real estate and the stock market.

From the mid-1980s to the mid-1990s, a decade of negative inflation adjusted wage growth exerted downward pressure on labor income, which naturally led to a stratospheric increase in household debt.

The stock market quintupled as inflation adjusted wages stagnated.  During this period an investor would have been better to do the opposite: buy when wage growth fell below zero, sell when it crossed above.  As long as workers were willing and able to borrow to make up for the lack of wage growth, company profits could continue to grow and it is profits that ultimately drive stock market valuations.

Wage growth ultimately influences retail sales which impacts GDP growth.  The difference between the growth in retail sales and wage growth roughly tracks changes in GDP.

If retail sales growth is more than wage growth for a number of years, the imbalance has to eventually correct.  We are in a period of little wage growth and modest sales growth which means that GDP growth is likely to remain modest as well.

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Constant Weighted Purchasing Index (CWPI)

Purchasing Managers surveyed by the Institute for Supply Management continue to report strong growth.  The CWPI index, based on both the Manufacturing and Services surveys, continues to rise as expected.

A composite of new orders and employment in the services sector remains strong.  February’s dip below 50 was an anomaly caused by the severe winter weather which coincided with inventory adjustments.

We see that this is a cyclic indicator, responding to the push and tug of new orders, employment, deliveries and inventories.  If the pattern continues, we would expect a decline in activity in the several months before the Christmas shopping season, a cycle that we have not seen since 2006.

The CWPI generates buy and sell signals when the index crosses firmly above and below 50 and has generated only 8 trades, or 16 separate transactions, in the past 17 years.  It is suited more to the long term investor who simply wants to avoid a majority of the pain of a severe downturn in the market.  Because it charts a composite of economic activity, it will not generate a signal in response to political events like the budget disagreement in July 2011 that led to an almost 20% drop in the market.  A strategy based on the CWPI gained 180% over the past 17 years as the market gained about 110%.

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Takeaways

Strong employment report but wage growth is flat and declining on a year over year basis.  CWPI indicator continues to rise up from the winter doldrums and should peak in two months.

Employment and Government Shut Down

Earlier this past week there were rumors that, due to the government shut down,  the Bureau of Labor Statistics (BLS) might not release the monthly employment report on Friday.  The employment report is probably the foremost key indicator that guides stock and bond market action as well as a prime metric used by the Federal Reserve in the determination of future monetary policy. On Thursday, the BLS confirmed that they would not release the report, which prompted a drop in the stock market, followed by an almost equal rise over the next day.

On Wednesday, ADP released a tepid 166,000 estimate of net job gains for September accompanied by a downward revision of their August estimate.  On Thursday, the weekly report of new unemployment claims held no surprise.  Traders probably figured that they had enough information to guesstimate the BLS number of net job gains – tepid growth a bit above the 150,000 needed to keep up with population growth.  In short, there was less likelihood that the Federal Reserve would be tapering their QE program before the end of the year.

So this is a good opportunity to take a look at some historical employment trends.  Measuring wage growth and inflation adjustments to wages is a complex task, far more complex than the gentle reader wants to delve into.  Labor economists crunch a lot of regional employment data gathered by the BLS.  Whenever there is a wealth of data, there is also a wealth of ways to treat that data, which data to focus on, etc.  Some economists focus on median compensation.  The median represents the middle, i.e. 50% of workers make more than the median, 50% make less.

In a 2011 paper published by the Economic Policy Institute (EPI), author Lawrence Mishel states  “Between 1973 and 2011, the median worker’s real hourly compensation (which includes wages and benefits) rose just 10.7 percent.”

“Real” means inflation adjusted but there are different methods used to calculate inflation.  One method, the Consumer Price Index, or CPI, has been changed over the years, making it difficult to make comparisons of data.

For a longer term perspective into the controversy over measurement, let’s turn to a graph of real output and total compensation per hour worked for the business sector.  Here we see a narrowing between compensation and output until output crosses above compensation in the mid-2000s.

The flattening of compensation growth is shown when we focus on the past twenty years.

But the hourly data seemingly contradicts the claim that there has been only an 11% increase in real compensation over the past forty years.  Looks like the total compensation of all workers has risen about 40% or more in the past forty years.  How can the median growth be so far below the total?  To understand that, a reader would have to examine the data sources behind the claim.  We might find that median weekly, not hourly, compensation has risen only 11%.  This could be due to more part time workers, or the rising percentage of women in the labor force who generally work fewer hours than men. What we do know is that a competent economist can find or crunch the data to prove his or her point.

The ability to work empirical magic with data often leads to contradictory claims by noteworthy economists.  The contentiousness of the discussion among economists baffles the intelligent reader.

Let’s return to that bugaboo mentioned earlier: measuring inflation. Twenty years ago, economists Brian Bosworth and George Perry noted the trending gap between output and productivity: “In an economy where real wage growth has paralleled the rise in productivity over the long run, this apparent divergence implies that the benefits of increased productivity have not been distributed in the expected way over the past two decades.”  A chart from their paper illustrates the trend.

A notable trend in the numbers is the steep rise of employee taxes and benefits, or non-wage employer costs.  Economists or politicians sometimes point to the decline in the real hourly wage over the past forty years, without bothering to note the growing non-wage costs of employment, a convenient omission.

Bosworth and Perry document problems and changes in measuring inflation in both consumption and output but noted that “the prices that workers pay as consumers have been rising significantly more rapidly than the prices of the products they produce.”  Further analysis by the authors shows that the wage growth in that twenty year period 1973 – 1993 did not flatten till after 1983.  They conclude that the major reason for the divergence is the difference between how inflation was measured before and after 1983. The authors recommended the use of a Personal Consumption Expenditure (PCE) deflator instead of the CPI, which overstates inflation relative to output.

Let’s look at wage growth over the past twelve years using two methods to see the difference.  The BLS calculates real wage growth using the CPI-U inflation index (Source).  Here is a graph from their data.

Now let’s use the PCE deflator to get a slightly different picture of the same Employment Cost Index.

Now let’s compare the two.

They tell two different stories.  Using the CPI inflation adjustment, the blue line, I could tell a story that wage growth has stagnated over the past ten years.  Using the PCE inflation adjustment, I could tell a story that wage growth has stagnated since the financial crisis.

Now imagine a politician who wants to bash the policies of former President George Bush and exalt the policies of the current administration.  That politician would use the blue line to tell the story of how the Bush Administration undercut the wages of American workers and that this led to the worst recession since the Great Depression.

On the other hand, if a politician wanted to criticize the Obama administration, she would point to the red line.  Worker’s wages grew during the Bush years.  Since Obama took office, wages have stagnated, indicating that Obama’s policies are hurting American workers.

Thus a dense and complicated argument on how to measure inflation becomes a talking point for a politician.  Even worse, noteworthy and popular economists who understand the difficulties of measuring both employment and inflation choose one line or the other to tell a simple story based on their own bias.

During this ongoing government shut down, we will hear a lot of spin and invective.  The profusion of TV, radio and internet media sources ensures that anyone can choose exactly – to a ‘T’ – the version of reality that they want to hear.  Of course, our sources and opinions are unbiased and perfectly reasonable.  But can you believe what the other side is saying?  Boy, are they crazy!

Productivity

August 25th, 2013

(First a little housekeeping: an anonymous reader commented that when they clicked the “back” button after viewing a larger sized graph they were returned to the beginning of the blog post instead of where they had left off when they clicked on the smaller image within the text.  I suggest that, after viewing a graph, try clicking the ‘X’ button on the top right of the graph page to return to where you left off.   This works in the Chrome browser.)

Since the onset of the recession in late 2007, I have read many articles on the lack of wage growth despite big gains in productivity.  Ideas become popular when they have a narrative, one that I took for granted.  Each quarter, the Bureau of Labor Statistics (BLS) issues a report on productivity and labor costs that I have taken at face value.

The 2001 manual of the OECD manual states “Productivity is commonly defined as a ratio of a volume measure of output to a volume measure of input use.”  They frankly admit that “while there is no disagreement on this general notion, a look at the productivity literature and its various applications reveals very quickly that there is neither a unique purpose for, nor a single measure of, productivity.” (Source)

The authors of a recent paper at the Economics Policy Institute cite BLS data showing that productivity has grown “by nearly 25 percent” in the period 2000 – 2012 while the median real, that is inflation adjusted, earnings for all workers has essentially remained flat.   Company profits are at all time highs and workers are struggling.  The narrative is familiar but I wondered: how does the BLS calculate productivity growth?

What the “headline” productivity numbers describe is labor productivity, the output in dollars divided by the number of hours worked.  The BLS Handbook of Methods, page 92, gives a detailed description of its methodology.  As the BLS notes, this often cited productivity figure disregards capital investments in output like machinery and buildings.  For this reason, the BLS also calculates a less publicized multifactor  productivity measure using methodologies which do incorporate capital spending.  How does capital investment influence the productivity of a worker?

Consider the simple case of a man – I’ll call him Sam – with a handsaw who can make 20 cuts in a 2×4 piece of lumber in an hour.  His company charges customers a $1 for each cut, the going rate, so that the company can sell Sam’s labor for $20 per hour. Due to increased demand for wood cutting, the company invests $1000 to buy an electric chop saw.  The company calculates that Sam’s productivity will rise enough that they can undercut their competition and charge 75 cents a cut.  With the chop saw, Sam can now make 60 cuts per hour at .75 per cut = $45 dollars in revenue per hour to the company.  Sam’s labor productivity has now risen 150%.  In our simple case, this would be the headline labor productivity gain – 150%.

A more complete measure of productivity including capital investments is quite complex.  The latest edition of the OECD handbook notes that “there is a central practical problem to capital measurement that raises many empirical issues – how to value stocks and flows of capital in the absence of (observable) economic transactions.”  To illustrate the point further, the asset subgroup listed in the BLS handbook includes “28 types of equipment, 22 types of nonresidential structures, 9 types of residential structures (owner-occupied housing is excluded), 3 types of inventories (by stage of processing), and land.”

You want simple?  Let’s go back to our kindergarten example.  At this rate of production, let’s say that the saw’s useful life is only 10 months.  The company has an investment of $100 per month in the saw, plus additional costs like electricity, a bigger workbench, etc.  To round out the numbers, let’s say that equipment related costs are $150 a month.  If Sam’s output is 8 hours a day x $45 an hour, Sam is producing $360 per day in revenue for the company, or close to $8000 a month. The $150 a month in equipment costs is trivial and multi-factor productivity is very close to labor productivity.

Sam knows he is making much more money from the company and goes to his boss and says he wants a raise.  Not only is he producing more for the company but the electric saw is much more dangerous than a handsaw.  The company gives Sam a raise from $7 an hour to $8 an hour, an almost 15% increase that Sam is happy with.  In addition to the raise, the company has an additional $2 in mandated labor costs, bringing the total costs for Sam’s labor to $10 an hour.  Even with the higher labor costs, the company is raking in huge profits – $35 an hour – from Sam’s labor.

But now an inspector comes in and tells the company that, because an electric saw makes much more dust than a handsaw, the company will have to install a ventilation and filtering system so that the employees and neighbors won’t have to breathe sawdust.  The company gets bids that average $100,000 to install this system and the company estimates that the system will equal $1000 a month in additional capital costs.  Despite the additional costs, the company still continues to make substantial profits from Sam’s labor.  To the company, the capital costs for this new system represents about 60% of an additional worker’s labor costs, yet that additional cost is largely not included in measuring labor productivity because Sam’s hours and the revenue generated by Sam’s labor remain the same.

A multifactor productivity comparison of handsaw vs. chopsaw production would show a percentage growth of 40%, far below the 150% labor productivity growth.

All of us have our biases (except my readers who are perfectly rational beings) which cause us to look no further than the narrative that clearly supports our previous conceptions.  If we generally agree with the narrative of companies taking advantage of workers, we read of 25% productivity gains for companies and 0% gains for workers in the past twelve years, and we look no further – for the data has confirmed what we previously had concluded.  Big companies = bastards; workers = victims.

In June 2013, the BLS released revisions to their productivity figures for 2012 and included historical productivity gains for various periods since 1987.  During the past 25 years, multifactorial productivity, including capital investment, has averaged .9% per year – less than 1%.

While labor productivity has grown 25% since 2000, multifactorial productivity has been half that, at about 12%.   Dragging the 25 year average down is a meager .5% growth rate since 2007.  Even more striking is the growth rate of input into that recent tepid productivity growth; the BLS calculates 0% net input growth since 2007.  For the past 25 years, capital investment has grown at more than 3% but since the recession capital growth has slowed to 1.3% per year.  I wrote last week that there is an underlying caution among business owners and this further confirms that caution; companies have been cutting back on both labor and capital investment.

If multifactorial productivity rose by 12+ percent over the past 12 years, and the profits did not go to workers, where did the money go?  For a part of the puzzle, let’s look to inflation adjusted dividends of the SP500.

From the beginning of 2000 through 2007, when the recession began, inflation adjusted dividends grew at an annual rate of almost 3.8%, eating up most of the profits from productivity growth.  As bond yields continued to decline, I would guess that investors pressured companies for more of a share of the profits from productivity growth.

As workers lost manufacturing jobs during the 2000s, many were able to switch to construction jobs in the overheating real estate market and unemployment stayed low.  This should have pressured management to give into labor demands for an increased share of the productivity growth but it didn’t.  I suspect that the labor mix contributed to the lack of pressure on management.  Fewer manufacturing jobs meant fewer union jobs; a reduced labor union influence meant less demand on management.

Looking past the headline labor productivity gains, overall productivity is slow.  Capital and labor investment is slow, which means that future overall productivity is likely to remain slow.

While walking a trail in the Colorado Rockies years ago, my brothers and I complained about having to dodge moose poop on the trail.  Then we ran into the bull moose that made the poop.