Plugging Along Despite Weakness In Small Business and Labor Dynamism

We think most markets are fully priced waiting for a sense of direction on U.S. and global growth. Recent data has been moderate, beating our expectations. The ISM orders for November were strong, and today’s retail sales

showed November up 0.7 percent from October, in part due to heavy discounting. Initial jobless claims rose but the four week average is low by historical standards reflecting an improving labor environment but also a reduction in the turnover rate in U.S. labor markets. 

• Today’s data showed an ongoing increase in business inventories to $1.69 trillion, up at a 7.1 percent annualized rate over the last three months. Some interpret this as foresighted business confidence that will meet rising demand, but we note weak pricing in many sectors that may, with inventories high, encourage a delay in purchases rather than an acceleration. 
• We think the world will face disinflationary pressures in 2014, with the 2013 decline in many commodity prices spreading to other sectors and to weaker economies. We note plentiful global capacity, the lack of structural reforms in Europe, Japan and the U.S. and contractionary policies at the Federal Reserve and Bank of Japan. The Fed has borrowed trillions of dollars from banks to buy high-priced government bonds, and its ongoing monthly purchases are pushing U.S. bank cash above 20 percent of bank assets and U.S. bank reserves above 25 percent of bank deposits, signs of massive distortions in credit markets. 
• We disagree with the view that today’s increase in federal spending will add to 2014 growth. The claim is that fiscal drag from the January tax increase and the sequester slowed growth in 2013 GDP growth and will be relieved in 2014. We think the private sector’s reaction to government policy is forward-looking and overwhelms the direct effect of government spending, so the fiscal changes in early 2013 were constructive, not contractionary. Our view is that structural improvements are critical in the growth outlook and are largely missing in the current environment due to difficulties pushing ahead with tax, immigration and mortgage reforms and entitlement restraint.

While the government and larger companies are doing well, a key concern in the 2014 outlook is the continuing weakness in the rest of the economy that doesn’t benefit from near-zero interest rates. Data on small and new businesses, personal income and wages remain weak, showing a lack of broad participation in the upswing. 

• Data on real median incomes for U.S. households has continued to be weak. While near-zero interest rates help the financially sophisticated (e.g. those able to refinance large mortgages at lower rates), many U.S. households get little benefit. Monday’s flow of funds data from the Federal Reserve showed U.S. households holding $14.7 trillion in credit market instruments including $9.3 trillion in deposits, almost all of which earn near-zero in nominal interest rates, negative in real terms. 
• Tuesday’s NFIB indicator on November small business confidence remained low at 92.5, up from 91.6 in October, but still at the worst confidence readings in the 1990 and 2001 recessions. The Labor Department’s household employment survey showed only 25,000 net new jobs per month over the last four months. Data on new business formation, once a critical factor in job creation, has shown almost no recovery from the 2008 crisis. Through the first quarter of 2013, the latest data available, gross job gains at new companies outside the government-dominated education and health sectors are showing particular weakness, remaining at the trough levels set in 2009 and sharply below previous decades even though the population is larger.  
• The Labor Department’s JOLTS (Job Openings and Labor Turnover) report released Tuesday showed that gross new hires slowed to 4.50 million in October from 4.63 million in September while separations (quits and layoffs) fell to 4.29 million. The combination of lower hires and lower separations is consistent with data in the establishment survey showing moderate net job growth, but also reflects a reduction in U.S. labor mobility versus previous decades. In October, gross hires per total employment were only 3.3 percent, well below the 3.8 percent average hiring rate in the 2001-2007 expansion, the earliest available data. The reduction in labor dynamism reduces growth prospects and is consistent with the signals from weak gross and net capital expenditures.
• On the positive side, the JOLTS report showed a decline in layoffs to 1.47 million in October, the lowest month since the data started in 2001, helping explain the low level of initial jobless claims. The number of people quitting their job rose to 2.39 million in October, a new high for the recovery, in part based on optimism about job prospects. The number of job openings in the JOLTS report rose to 3.93 million, a new high for this cycle. The NFIB’s report on November job openings rose to 23 from 21 in October. And after a shut-down-related drop in October, the NFIB’s Planning to Hire index improved to 9 in November, suggesting further declines in the 7 percent unemployment rate. 

David Malpass is the President of Encima Global and a contributor to e21.