HOUSE_OVERSIGHT_024132.jpg

Eye on the Market | March 15, 2012
J.P.Morgan

Topics: Is US data as good as it looks? Is Chinese data as bad as it looks? Is European data as bizarre as it looks?

What a diff'rence a day makes. Ever since the ECB gift-wrapped 650 billion Euros for EU banks, the news has been pretty good, particularly in the US. Most of the market's focus is on the US consumer, for the simple reason that US households are the largest single economic force in the world (see table). Even after deconstructing the labor report for signs of false positives¹, the message is clear: US job markets are gradually getting better, and so is spending. The capital position of US banks is in good shape², so we expect access to credit to remain easy³. A US GDP growth rate of 2.25% is still below trend, but a long way from the unavoidable recession articulated by the ECRI last fall. I agree with those who think the US economy could not withstand a withdrawal of stimulus right now, but I also do not see the Fed actively withdrawing it. Whatever rain dance the Fed is doing to keep inflation low, they better keep doing it.

The importance of the US consumer
Billions of USD | Private Consumption | Investment | Gov. Spending | Net exports
US | 10,417 | 1,818 | 3,020 | (500)
Asia | 8,231 | 4,614 | 3,449 | 424
Asia ex. CN/JPN | 2,761 | 597 | 1,482 | 134
Japan | 3,501 | 1,185 | 1,175 | 58
China | 1,969 | 2,832 | 792 | 232
Europe | 9,670 | 3,148 | 3,662 | 130
EMU | 7,145 | 2,386 | 2,704 | 145
Latin America | 2,747 | 754 | 1,010 | 28
Source: Haver. Data as of Q4 2010.

A chart I saw on the history of jobless claims (below, left) was meant to show how good things may get. In the prior 3 business cycles, when continuing claims fell through 2.2% of the labor force (1982, 1993, 2003), it was a great time to add risk in portfolios. Improving claims signaled that the business cycle was picking up enough steam to be self-sustaining, and last week, the US crossed through this barrier again. But as Big Bird used to say, one of these things is not like the other: the US primary budget deficit which supports this recovery is a bigger now. So, the US economy better improve markedly in order to pay the freight. When will this chart on the primary deficit (below, right) matter to financial markets? Only when it becomes a binding constraint, either due to a lack of demand to finance the deficit at current yields, or due to the economic cost of closing it. The timing is uncertain, given Central Bank purchases of Treasury bonds, and a Congress which may leave the problem for another day (or generation). I lose a lot of sleep over this, but I don't know a lot of other people that do. As discussed last week, portfolio allocations given today's private and public sector realities vary substantially across wealth management firms. Ours rely on hedge funds, credit and real estate as complements to public and private equity.

[Chart Left]
In past cycles, claims were a great market signal
Continuing claims as a % of labor force
[Graph showing percentages from 1.0% to 5.0% over years 1967 to 2012]
Source: Department of Labor, BLS, Empirical Research Partners.

[Chart Right]
Paging Dick Cheney: Do Deficits Matter?
Deficit ex-interest, percent of GDP, seasonally adjusted
[Graph showing percentages from -12 to 8 over years 1954 to 2008]
Source: CBO, BEA, OMB, J.P. Morgan Private Bank.

¹ Our chief economist Michael Vaknin has analyzed the various seasonal adjustments that the Bureau of Labor Statistics uses when it reports payrolls. After adjusting for better weather, the Lehman shock and other factors, payroll growth does not look quite as good as reported, but is still positive. The trend is supported by the latest Manpower surveys, Institute for Supply Management surveys, JOLTS surveys, etc, all of which show growing demand for labor. Even state and local government firing has finally come to an end, which was a constant fixture of the last two years. So far, hourly earnings remain very weak, and typically do not grow until later in the cycle.

² The latest US bank stress tests were pretty stressful. Two-year loss assumptions applied by the Fed were higher than those experienced during 2008 and 2009, and comparable in almost every category to realized losses during the Great Depression. Almost every institution passed the test, and even the ones that didn't are expected to reach required capital levels in short order. US banks have sharply reduced reliance on "hot money" (time deposits, commercial paper and repo), relying instead on core retail deposits to finance their balance sheets. Comparing the rigor of US and European bank stress tests is like comparing the rigors of actual football to Wii football.

³ So far, net household borrowing other than student loans is weak; loan growth is almost exclusively from companies rather than households.
1
HOUSE_OVERSIGHT_024132