Running Through the Numbers

Each weekend I will take some time to review my very long term models. They are nothing revolutionary but do give me an idea of what is occurring in the "long term" for the markets as well as the economy. I learned a long time ago that in determining my economic viewpoint, I should stick to a limited amount of stats because the more stats I viewed, the more confused I became! So lets call this the first installment of the "economic view of the financial markets." 

Before delving into the numbers, one phrase can describe things at the moment - slowing down. If one looks across the variables which include some manufacturing surveys, some employment indicators and some retail metrics, the slowdown is in full force. Meanwhile, on the monetary side, it appears that a pickup is occurring with lending and credit both expanding. So to use an analogy, the runner is still moving along in the race but his pace is slowing. At the same time, his metabolism and his heart rate are pumping strong and improving. Does this imply then that the foundation for the economy is now building because it appears that the body is now finding support? Could be. Lets look at the stats.

• On the earnings side of the ledger, the current earnings yield of the S&P 500 is around 6.5% using trailing variables. This level is the highest that I can find since late 1994 right before the markets exploded to the upside and ended in a ball of flames in 2000. If you add in dividends, it is around 8.5%...a level last season in you guessed it, 1994. So on balance, the markets have not been this cheap in over 16 years. Perhaps, as I tweeted this past week, PE expansion is now in the cards with predictable falls in both of these yield levels to follow. In looking at corporate profit levels, while rise, those seem to be leveling a bit which argues that while PE expansion can occur, it might be limited to 13x (earnings plus dividends) or somewhere in the 1300 range. Overall I would argue though given the upward trend in corporate profits plus the relatively healthy levels for the yields, the stock market is in good shape and a positive leading indicator for the economy.
• In terms of the economic indicators I follow on the services and manufacturing side, the stock market crash in May through June definitely disrupted things in the economy as the surveys I follow all turned down following the may problems from a momentum standpoint. As of September, they have not changed this downward momentum. Now if the stock markets were to continue higher, perhaps sentiment would change. However, these shocks that we have had, in May as well as the fall of 2008, are not helping the economy. Also not helping things is the stagnation on the small business side - without small business expanding, innovation will not expand and this will be a pressure on profit margins and essentially growth for the economy. Overall, I would then argue that these measures are a negative for economic growth at the moment.
• On the employment side, this picture is ugly with some signs of improvement - offset by some signs of deterioration. First in terms of improvement, the labor force is again expanding which is bullish and the participation rate has leveled off around 64.7% and has basically remained here for 4 months. This argues that the conditions for employment are not worsening but since they are not rising meaningfully, this also argues that employment growth is stuck in a rut. Services employment is improving on balance while manufacturing employment is weakening though still above the growing line. Average hourly earnings are rising but the momentum has not been this low since 2004 and before that 1987. The median duration of employment bounced back upward this past month which is troublesome and generally leads to a shrinking of the workforce as people give up looking for jobs. On balance, these measures overall are weak and I would argue a negative growth factor working against the economy.
• On the retail spending side, the net consumption levels are rising indicating an improvement in momentum on that end. Retail sales ex auto is also continuing to rise which is a positive as well. If you taken into account the moribund wage growth as well as anemic employment growth, they are offsetting factors. In terms of the numbers on the market side, net revenue figures for the retail companies that I follow are in a rising trend with the discounters actually slowing (arguing people are moving back up the Leger). This is bullish and argues that confidence is returning to the consumer.  So outside of the anemic employment end of things, the consumer is spending again and this is a positive support for the economy
• The last variable, but not least, is my housing models and they remain weak with one major caveat. If housing demand rises, there is a very good possibility that there will not be enough housing supply out there in a few years based on the fact that permits remain weak and new home starts are just dire (with NAHB confidence lousy as well). When trying to find a happy medium for prices, one must balance supply and demand; if the future supply is not rising, then we only need to work off the current supply. The opposite side of this is simple though - is there enough demand to work through the current inventory problems at current price levels? I don't believe so and this as a result is a negative headwind for the economy.

So on balance, we are looking at a weakening industrial and services sector, an improving market perspective given high yields on earnings and dividends, a flat employment picture, retail spending that is rising and housing that is stalled out to lower. Overall, I would argue that the picture is weak and while I have argued against the merits of QE2 which is the rage these days, I would be very careful to argue the economy is growing at any sustainable rate at the moment, given the variables.