THE TRADE WAR, THE WALL STREET IMPERATIVE and THE EMPLOYMENT FIGURES
By Brian Green
Today’s employment figures surprised everyone on Wall Street, especially after the weak ADP figures earlier in the week confirmed by a number of soft surveys. It is perfectly obvious that the statistical imperative at a time when Wall Street is hanging on to the ledge with its fingertips,and,the US needs to strongarm China, is for statistics to paint a rosy picture of the economy. This is no Marxist sneering at the data because of wobbly predictions. Warren Buffett himself said that the letters BLS (for Bureau of Labour Statistics) were prominent in a longer word, making up the first, the third and fifth letter.
I have been a critic of the data coming out of the USA since the trade dispute. The employment figures simply do not stack up. Either capitalists employ workers to produce profits or they employ workers simply to pay out wages. The employment figures suggest the latter, that the capitalists have become humanitarians, that we reside in a post-capitalist world. Such a view is really BLS.
In the two graphs below I once again analyse hours against payrolls (number of jobs). I did so previously for October. I have attached the spreadsheet with the data taken from Table 6 produced by the BLS. Before proceeding, it is important to note that the average weekly hours between Nov 18 and Nov 19 have decreased by 0.3 hours or around twenty minutes. In percentage terms that is -0.8%. Not sufficient to meaningfully disturb the relation between aggregate hours and payrolls found in the graphs. It accounts for only a quarter of the difference between hours and payrolls of 3.2% .
We note that there are four industries where the number of hours worked actually fell,but nowhere do total payrolls fall. In fact,every industry registered at least a 2% rise in payrolls. This is brought out in Graph 2 on the next page.It shows the annual change in hours worked by the average worker in each industry. In every case the average hours fell. The blue line denotes no change. Anything below it is a reduction in average hours.
I have superimposed two months to show the movement between them. Each graph represents a yearly shift. Once again we note that mining and logging shows the biggest discrepancy in absolute values meaning that the average worker in that industry worked 6% fewer hours. The most striking industry is the one marked Professional and Business Services. This industry has been in the forefront of creating jobs, but it seems that the average worker or contractor there is working 4 hours less on average than they were in 2018.
To the more important bit
The robust data on employment was not unexpected as this was needed to sink the ADP data. It is also needed in case the trade deal is delayed beyond December 15th. What is more important is that it is highly inconsistent with the data on corporate profits.The consistent fall in corporate profits has affected spending on fixed assets, but it appears,not on employment. It seems employers are engaging in bizarre behaviours. This is capitalism but not as we know it, unless the data is wrong.
The data forming Graph 3 is taken from NIPA Table 1.14 released on the 27th November. The nominal figures have been deflated by the GDP Implicit Price Deflator. Chained figures would yield similar results over this short period of time. Thus the profit figures are real rather than nominal. In addition the profit figures are unadjusted and pre-tax. They can be found on line 37 of the Table. These are the figures that relate most closely to the net surplus data.
The annual nominal fall in profits between the third quarter of 2018 and the third quarter of 2019 is 6.9% while the inflation adjusted fall is 8.5%. More than likely there will be a further fall in annualised profits when the BEA releases its second estimate in late December. As the orange line shows, the fall has been systematic and has endured for an abnormally long 5 years. In total, profits are down by £341.3 billion or 24% compared to Q3 in 2014 and in real terms they are down 29.5%.
Graph 4 below represents the rate of profit for total corporate; both financial and non-financial. The reason for comparing total corporate is that it will be used to bring symmetry to the comparison between the rate of profit and that of P/E ratios later in the article. The rate of profit for 2019 is limited to the first nine months of the year unlike the other years which are full calendar years. We note that the rate has fallen relentlessly for the last five years, in total close to 30%, but this has not prevented the stock market surging. (Note 1)
In Graph 5 there are 3 individual graphs. The broken red line represents Graph 4, which is the normal ratio of profits over capital. On the other hand the blue graph represents an inverted rate, capital over profit to bring it into line with the Price to Earnings ratio which is the market cap of the shares over net earnings. It is important to note that net earnings, the denominator in the P/E is defined as pre-tax earnings so we are comparing like with like. (https://www.investopedia.com/terms/e/eps.asp)
[Graph 6] is the more interesting graph. It shows the absolute difference between the rate of profit and the P/E ratio.
It shows that the deviation is on par with the deviation found in 2000.We will see in the Hussman Report that this epic deviation is also equal to the one that took place in 1929. If the same collapse in share prices takes place, to that which occurred in 2000, then a fall in share values in excess of 50% is probable (Nasdaq fell 78% in total after its 2000 peak).
The crash of over 50% in share prices will be more significant because the period of globalisation is at an end. There are no driving forces in the world economy. The Dotcom crash occurred in the middle of the globalisation gallop, which because it was dynamic, was a different period altogether. A question of over exuberance when faced with ground-breaking technology.
What is also interesting is that the current overvaluation of shares is double that of the period preceding the financial crash in 2008.The reason for this is that the rise in the rate of profit prior to 2008(Graph 4) compensated for the rise in the P/E. Share prices rose faster prior to 2008, but because profits also rose faster it offset the deviation between the two ratios. Matters stand differently post 2014. Now the cause of the deviation is not so much rising share prices as a declining rate of profit. This is what makes this deviation the most dangerous in history. The outlook for profits has never been so gloomy.And this must in the end cause a destruction of capital and debt on a scale not seen before.
This gloom is also shared by a few insightful bourgeois analysists and investors such as John P. Hussman, Ph.D. whose December Report [– i.e., HUSSMAN FUNDS DEC 2019 PDF (attachment) –] is attached alongside this article on the site.
The Hussman Report
I consider the analytical skills of Mr Hussman to be best in class. Bourgeois [analysts, despite their diligent efforts,] are trying to crack a rock with a wooden hammer. That rock is the confusing edifice of capitalism. And while they may be able to score it and knock a few shards off it, their tools are not capable of penetrating to the centre, the condition needed to expose it. Despite these critiques, it is uncanny, if not embarrassing, how close his results are to mine.
Nowhere does Mr Hussman try and reconcile the valuation of shares to the underlying rate of profit. The metrics he uses are a discounted cash flow model, price to earnings ratios based on modified profit margins (a form of Schiller Cape model) and the comparison which he relies on; the ratio of non-financial capitalisation to corporate gross value added adjusted for foreign earnings. In all cases he uses longer term perspectives for decoding these ratios compared to the here and now mainstream [analysts]. One of the particular strengths of his commentaries is that he reaches back as far as 1929 in order to draw comparisons and fill out perspectives.
He provides various graphs based on these metrics in his various commentaries. A few are missing from the attached commentary such as his complex Schiller Cape ratios. What all his graphs have in common is they portray a market which is currently, as overvalued as that found in 1929, 2000 and 2007.As he points out, the problem is not investors sitting on an overvalued plateau, but investors who still have the speculative bit in their teeth despite the high plateau,driven by the fear or is it greed, of missing out on that final opportunity to make a buck.
The most significant graph in his commentary is the second one. This graph is based on the outlook for nominal S&P 500 total returns over the next 12 years. In his estimation, the outlook is worse than the one on the eve of the 1929 crash. “Last week, our estimate of prospective 12-year nominal annual total returns on a conventional portfolio mix (invested 60% in the S&P 500, 30% in Treasury bonds, and 10% in Treasury bills) fell to the lowest level in U.S. history, plunging below the level previously set at the peak of the 1929 market bubble.” I concur. Standing close to 0% it is hardly existent. The current overvaluation has to be repaid by future undervaluation. An adjustment to the mean always occurs.
But there is more to the picture than the one he presents. He confines himself to the pavements on either side of Wall Street. He does not consider the grand picture. The picture that includes the political impediments to opening up the world market in order to reboot globalisation, the costs of a fragmenting world economy, the rise in class struggle around the world, of neo-liberalism having exhausted capitalism, the cost of climate change. All this has to be factored in as well. Capitalism may be a primitive economic mode, but because it pits independent producer against independent producer with each seeking to gain an advantage, their combined and contradictory actions brings competition to the boil, a veritable cauldron generating mirages, illusions, facades and spectres, a haze that is difficult to penetrate.
Which leads me to the final point. Mr Hussman is wise enough and experienced enough to recognise that there are no mechanical levers joining preferred ratios to the behaviour of the market. The market is much more subtle. And while he recognises, compared to his previous report, that more supports have been kicked away making the market’s elevation more fragile, he does countenance the unexpected supporting the market.
He discusses one set of supports, market internals, towards the end of the report, that is the breadth or lack of it of advancing shares. He notes how few shares are leading the upward march in the S&P 500. Normally this would be a shrill warning sign, but this time around technical analysts seem to be ignoring it. I attribute this to the role ETFs are playing. ETF funds have to buy shares making up the index, and because a dozen or so shares dominate the index, they attract a disproportionate amount of purchases. Purchasing lower rated stocks would cause the index to rise but more slowly compared to focusing on the higher rated stocks like Apple, Microsoft, Google and so on. This is complimented by the share buy backs concentrated in these leading shares.
One of the strengths of the report is that he debunks low interest rates as providing a sustainable set of supports. He correctly identifies that low interest rates are a function of the overall weakness of the markets, meaning they can only delay the inevitable, because they are an effect not a cause.
The unexpected did happen today. The extraordinary increase in employment that drove the stock markets up by 1% erasing much of the falls this month. Will it be enough to prevent a collapse should the trade talks disappoint? Perhaps not, but additionally there are further emergency interest rate cuts and the ongoing FED REPO funding mechanism. This FED REPO facility is pumping money into the markets on a scale not seen since the early days of Quantitative Easing, which we may add, took place after the 2008 Crash, not before it as now. But in the end there is no substitute for profitability, and when the market fabric tears, despite all the extra stitching that has been added, it will be the rate of profit which determines the scale of the fall.
Note 1. The reader may notice a greater deviation, when comparing the graphs depicting the deviation between the rate of profit and that of the P/E ratio, compared to a previous posting. The reason is the previous posting used adjusted pre-tax corporate profits while this posting uses unadjusted pre-tax profits. In future I will only use unadjusted profits as I consider them more reliable.
Brian Green, 4th December 2019.