For the week, both the Dow and S&P500 declined 0.9%. Economically-sensitive issues were in retreat, with the Transports down 2.9% and the Morgan Stanley Cyclical index down 1.7%. The Utilities dipped 0.6%, and the Morgan Stanley Consumer index declined 0.5%. The small cap Russell 2000 dropped 1.7%, and the S&P400 Mid-cap index declined 1.4%. Technology stocks were mixed. The NASDAQ100 declined 0.8%, while the Morgan Stanley High Tech index added 0.2%. The Semiconductors declined 0.7%, while The Street.com Internet Index gained 0.3%. The NASDAQ Telecommunications index dipped 0.5%. The Biotechs slipped 0.4%. The highflying Broker/Dealers declined 1.4%, and the Banks fell 1.1%. With bullion up a noteworthy $27.25, the HUI Gold index jumped 5.4%.
For the week, two-year Treasury yields rose 7 bps to 4.82%. Five-year yields gained 6 bps, ending the week at 4.69%, and bellwether 10-year yields rose 4 bps to 4.715%. Long-bond yields added 1.5 bps to 4.81%. The 2yr/10yr spread ended the week inverted 10.5 bps. The implied yield on 3-month December ’07 Eurodollars spiked 10.5 bps higher to 4.93%. Benchmark Fannie Mae MBS yields rose 8 bps to 5.92%, this week underperforming Treasuries. The spread on Fannie’s 5 1/4% 2016 note was little changed at 34, and the spread on Freddie’s 5 1/2% 2016 note was also little changed at 34. The 10-year dollar swap spread increased one to 53.8. Corporate bonds generally gained a little bit more ground on Treasuries, although junk spreads widened slightly this week.
Investment grade issuers included Idearc $2.5 billion, JPMorganChase $2.0 billion, Bank of America $1.75 billion, Goldman Sachs $1.0 billion, 3M $400 million, Praxair $400 million, MetLife $400 million, Partnerre Finance $250 million, Principal Life $350 million, Wisconsin Electric Power $300 million, Bank of New York $250 million, Colgate-Palmolive $250 million, and Borg-Warner $150 million.
Junk issuers included Sabine Pass LNG $2.0 billion, Huntsman Intl $200 million, and Medimedia $150 million.
October 31 - Bloomberg (Belinda Cao): “Defaults on high-yield, high-risk bonds sold by U.S. and foreign companies fell to record low in September, Standard & Poor’s said. Junk-rated companies defaulted on their bonds at a 0.89 percent rate, down from 1 percent in August, the previous record low…”
November 1 – Financial Times (Paul J Davies and Gillian Tett): “The cost of buying credit protection in the derivatives market has pushed through its lowest ever levels as bullish views on debt markets mix with a heavy bout of protection selling related to the creation of new structured products. Spreads, or protection premiums, on the indices of credit default swaps, which provide a kind of insurance against the non-payment of corporate debt, have been shrinking steadily since the latest index series were launched at the end of September. Some traders attribute this tightening of spreads, which has accelerated in recent weeks, to a benign economic outlook and a widespread belief that Federal Reserve tightening has peaked. But others point to the sudden growth of a new type of complex derivative product.”
Convert issuers included Core Labs $300 million and MPT Operating $125 million.
International dollar debt issuers included Colombia $1.5 billion, Israel $1.0 billion, Greentown China $400 million, Pakistan Mobile $250 million, and Banco Credito Peru $120 million.
Japanese 10-year “JGB” yields dipped 2.5 bps this week to 1.71%. The Nikkei 225 index dropped 2.7% (y-t-d up 1.5%). German 10-year bund yields fell 3.5 bps to 3.77%. Emerging debt markets were resilient and equities mostly higher. Brazil’s benchmark dollar bond yields dipped 2 bps to 6.16%. Brazil’s Bovespa equities index jumped 2.0% this week (up 20.9% y-t-d). The Mexican Bolsa slipped 0.8%, reducing 2006 gains to 30.1%. Mexico’s 10-year $ yields rose 6 bps to 5.755%. The Russian RTS equities index added 0.9% (up 46% y-t-d). India’s Sensex equities index gained 1.7% to a new record high, increasing 2006 gains to 39.7%. China’s Shanghai Composite index surged 3.3%, increasing y-t-d gains to 60.7%.
This week, Freddie Mac posted 30-year fixed mortgage rates dropped 9 bps to 6.31%, unchanged from one year ago. Fifteen-year fixed mortgage rates fell 8 bps to 6.1% (up 17 bps y-o-y). One-year adjustable rates declined 7 bps to 5.53% (up 44 bps y-o-y). The Mortgage Bankers Association Purchase Applications Index dipped 1.8% this week. Purchase Applications were down 13.4% from one year ago, with dollar volume 13.7% lower. Refi applications declined 4.5%. The average new Purchase mortgage rose to $226,200, while the average ARM declined to $363,000.
Bank Credit added $1.1 billion last week to $8.136 TN. Year-to-date, Bank Credit has expanded $629 billion, or 10.1% annualized. Bank Credit inflated $722 billion, or 9.7%, over 52 weeks. For the week, Securities Credit declined $8.9 billion. Loans & Leases expanded $10.0 billion during the week, with a y-t-d gain of $492 billion (10.9% annualized). Commercial & Industrial (C&I) Loans have expanded at a 15.1% rate y-t-d and 14.5% over the past year. For the week, C&I loans increased $5.9 billion, and Real Estate loans gained $6.3 billion. Real Estate loans have expanded at a 15.7% rate y-t-d and were up 15.2% during the past 52 weeks. For the week, Consumer loans gained $3.5 billion, while Securities loans dropped $12.2 billion. Other loans gained $6.4 billion. On the liability side, (previous M3 component) Large Time Deposits fell $17.4 billion.
M2 (narrow) “money” supply jumped $18 billion to $6.948 TN (week of 10/23). Year-to-date, narrow “money” has expanded $262 billion, or 4.7% annualized. Over 52 weeks, M2 has inflated $313 billion, or 4.7%. For the week, Currency gained $2.1 billion, while Demand & Checkable Deposits increased $19.6 billion. Savings Deposits fell $7.2 billion, while Small Denominated Deposits gained $4.4 billion. Retail Money Fund assets dipped $1.0 billion.
Total Money Market Fund Assets, as reported by the Investment Company Institute, expanded $11.6 billion last week to a record $2.265 Trillion. Money Fund Assets have increased $208 billion y-t-d, or 12.0% annualized, with a one-year gain of $297 billion (15.1%).
Total Commercial Paper added $0.5 billion last week to $1.90 Trillion. Total CP is up $259 billion y-t-d, or 18.6% annualized, while having expanded $270 billion over the past 52 weeks (16.6%).
Asset-backed Securities (ABS) issuance this week slowed to $5.0 billion. Year-to-date total ABS issuance of $605 billion (tallied by JPMorgan) is running about 6% below 2005’s record pace, with 2006 Home Equity Loan ABS sales of $411 billion about 3% under comparable 2005. Also reported by JPMorgan, y-t-d US CDO (collateralized debt obligation) Issuance of $266 billion is running 71% ahead of 2005.
Fed Foreign Holdings of Treasury, Agency Debt rose $8.3 billion during the week at $1.694 Trillion (week of 11/1). “Custody” holdings were up $175 billion y-t-d, or 13.6% annualized, and $216 billion (14.6%) over the past 52 weeks. Federal Reserve Credit expanded $2.6 billion to $833.4 billion. Fed Credit is up $7.0 billion (1.0% annualized) y-t-d, while having expanded 3.9% ($31.5bn) over the past year.
International reserve assets (excluding gold) - as accumulated by Bloomberg’s Alex Tanzi – were up $636 billion y-t-d (18.6% annualized) and $697 billion (17.5%) in the past year to a record $4.682 Trillion.
October 30 - Bloomberg (Matthew Brown and Andy Critchlow): “The United Arab Emirates, the second largest Arab economy, may reduce its holdings of dollars by almost half in an effort to reduce its dependence on the weakening U.S. currency, the country’s central bank governor said.”
The dollar index added 0.2% to 85.54. On the upside, the South African rand gained 2.0%, the Norwegian krone 1.4%, the Taiwan dollar 0.9%, and the Polish zloty 0.9%. On the downside, the Ukraine hryvnia declined 0.9%, the Japanese yen 0.4%, the Swiss franc 0.4%, and the Canadian dollar 0.4%.
November 1 - Bloomberg (Tony C. Dreibus): “A two-month drought in wheat-growing regions of China, the world’s largest producer, has delayed planting and made it difficult for seeds to take root, Cropcast Ag Services said. Areas that normally get 5 inches of rain in September and October received none the past two months, and 90 percent of the soil is short of moisture needed before plants go dormant for winter late next month…”
November 3 - Bloomberg (Danielle Rossingh): “Platinum had the biggest gain since May in London on speculation that an exchange-traded fund linked to the price of the precious metal may be introduced… The metal had a weekly increase of almost 11 percent, the biggest jump since mid-May.”
October 31 - Bloomberg (Christopher Donville and Gavin Evans): “Uranium prices surged 7 percent to a record… Uranium, the raw material in reactor fuel, has risen more than sixfold since October 2001…”
November 3 - Bloomberg (Grant Smith): “Shipowners are turning down the highest offers from breakers’ yards in six years as freight rates encourage them to keep older oil tankers in service, shipbroker E.A. Gibson said. Prices for the scrap metal from…The largest vessels used to haul crude oil, have more than tripled since 2000 to more than $16 million a ship…”
Gold jumped 4.5% to $627.20, and Silver rose 4.6% to $12.635. Copper slipped 2.4%, reducing y-t-d gains to 72%. December crude declined $1.53 to end the week at $59.22. December Unleaded Gasoline fell 3.3%, while December Natural Gas added 0.4%. For the week, the CRB index declined 0.8% (down 6.6% y-t-d), and The Goldman Sachs Commodities Index (GSCI) fell 1.8% (up 0.5% y-t-d).
October 31 - Bloomberg (Jason Clenfield and Mayumi Otsuma): “Japan’s household spending fell the most in almost five years and wage growth stalled in September, undermining the Bank of Japan’s case for raising the lowest interest rates among major economies this year.”
November 1 - Bloomberg (Nerys Avery and Nipa Piboontanasawat): “Manufacturing activity in China expanded at a slower pace in October as growth in output and new orders eased…”
November 1 – Financial Times (Krishna Guha): “China’s growth this year is likely to exceed 10.5 per cent, the International Monetary Fund’s senior country official said…as he cast doubt on the effectiveness of Beijing’s efforts to cool the economy. Steve Dunaway, the IMF mission chief for China, said he had “considerable doubts” that the Chinese authorities were winning the battle to slow growth to a more sustainable level… Mr Dunaway suggested that the largely administrative measures being used to slow the economy would probably prove inadequate. He said Beijing would have to consider more market-based solutions, including tighter monetary policy and more rapid currency appreciation.”
October 31 - Bloomberg (Cherian Thomas): “India’s central bank raised its overnight lending rate for a fourth time this year, seeking to curb record borrowings and tame inflation without damping economic growth. Governor Yaga Venugopal Reddy increased the…repurchase rate…by a quarter-point to 7.25 percent.”
Asia Boom Watch:
November 1 - Bloomberg (Denise Kee and Wes Goodman): “The Asian bond market outside Japan will grow 10 percent to 15 percent a year to $10 trillion by 2015, said Heng Swee Keat, managing director of the Monetary Authority of Singapore. The market has grown to $2.7 trillion this year, making up 45 percent of Asia’s gross domestic product excluding Japan… That’s up from $600 billion in 1997, when the bond market made up 20 percent of GDP, he said.”
November 1 - Bloomberg (Seyoon Kim): “South Korea’s exports rose by the least in three months in October as the nation's thanksgiving holidays curbed shipments of computers and machinery. Exports gained 11.5 percent from a year earlier after
surging 21.3 percent in September…”
Unbalanced Global Economy Watch:
November 1 - Bloomberg (Richard Blackden): “Airline passenger-traffic growth slowed for a fifth month in September, the International Air Transport Association said. International traffic…rose 4.7 percent from a year earlier, less than the 5.9 percent average gain this year…”
October 30 – Financial Times (Clive Cookson): “Large companies are pouring money into research and development at an unprecedented rate, in response to growing global competition. The international R&D Scoreboard, published today, shows a 7 per cent increase in spending by the world’s top 1,250 companies. ‘In many sectors profits are growing strongly and companies can afford to spend more on R&D,’ says Norman Price, an industrialist at the UK Department of Trade and Industry, which publishes the annual scoreboard. ‘Where profits are weak, such as the automotive industry, the competition is so fierce that companies dare not cut their investment.’”
November 3 - Bloomberg (Theophilos Argitis): “Canadian employers added more than three times as many jobs as expected in October and the jobless rate unexpectedly fell… Employment rose by 50,500 jobs, the largest gain since May…lowering the unemployment rate to 6.2 percent from 6.4 percent in September. Average hourly wages rose 3.1 percent from a year earlier.”
October 30 - Bloomberg (Brian Swint): “U.K. mortgage approvals unexpectedly rose to a two-year high in September, suggesting the Bank of England will have to follow an August interest-rate increase with more to cool Europe’s second-largest economy.”
November 3 - Bloomberg (Craig Stirling): “Personal bankruptcies in Britain climbed to a record in the third quarter as surging house prices pushed consumers to take on more debt and rising interest rates reduced their ability to repay. Individual insolvencies rose 5.7 percent to 27,644 in the quarter, the highest since records began in 1960…”
October 31 - Bloomberg (Ben Sills): “Europeans’ confidence in the economy increased more than expected in October, underscoring the European Central Bank’s concern that inflation will accelerate again from a 2 1/2-year low. An index of sentiment among executives and consumers in the dozen nations sharing the euro rose to 110.3, the highest since February 2001…”
October 31 - Bloomberg (Jonas Bergman): “Norway’s domestic credit growth accelerated…as lending to companies rose and consumer borrowing kept pace amid falling unemployment and rising consumer wealth. Credit for households, companies and municipalities rose an annual 15 percent, the most since March 1988, up from 14.7 percent in August…”
October 30 - Bloomberg (Jonas Bergman and Robin Wigglesworth): “Norwegian retail sales rose 1.7 percent in September from the month before… On an annual basis sales rose at the fastest pace in six months, gaining 8.1 percent…”
October 31 - Bloomberg (Tasneem Brogger): “Denmark’s economy will expand 3.7 percent this year as household spending growth exceeds last year’s 11-year record, Danske Bank said, almost doubling its previous growth forecast.”
November 1 - Bloomberg (Tasneem Brogger): “Danish manufacturing grew at the fastest pace in 12 months in October, led by a surge in new orders and production. The purchasing managers’ index rose to 63.6 in October from 62.1 the previous month…”
October 30 - Bloomberg (Nasreen Seria): “South African credit growth accelerated to a record for the third consecutive month in September, adding to the case for more interest rate increases. Growth in borrowing by households and companies accelerated to 25.3 percent from 25 percent in August…”
October 30 - Bloomberg (Mike Cohen): “South African retail sales rose 14.8 percent in September from a year earlier as consumers continued to benefit from low interest rates, an industry group said.”
Latin American Boom Watch:
October 31 - Bloomberg (Valerie Rota and William Freebairn): “Mexican President Vicente Fox plans to hand over an economy growing at its fastest pace in six years, with the first budget surplus since 1996, after record oil prices boosted revenue.”
October 30 - Bloomberg (Eliana Raszewski): “Argentina’s Economy Ministry sent a proposal to Congress to increase spending by 11 percent this year to boost salaries and security payments, newspaper InfoBAE reported…”
November 1 - Bloomberg (Eliana Raszewski): “Argentina’s October tax revenue rose 35 percent from a year earlier, the country’s tax collection agency reported.”
October 30 - Bloomberg (Guillermo Parra-Bernal): “Venezuelan imports jumped in August to their highest level since at least January 1994 as shortages of foods, car parts and machinery equipment coupled with record oil income fueled demand for foreign-made goods. Imports rose 28 percent…”
Central Banker Watch:
October 30 – Market News International: “The People’s Bank of China said…that
adjusting global imbalances could cause volatility in the currency markets, with knock-on implications for US growth and, by extension, Chinese exports and GDP. The Chinese central bank reserved part of its latest, annual financial stability report for a rare discussion about the threat posed by global imbalances and what moves to address them could spell for growth in the US and China. ‘Global economic imbalances are a concern for every country in the world because it leads to worldwide excessive liquidity, low long-term interest rates as well as price hikes in resources and other assets… Adjustments to world economic imbalances (particularly disorderly adjustments) may increase the fluctuation in the world’s major currencies, which will cause a slowdown in US economic growth and price adjustment of US assets, and this in turn may impact China's export and economic growth.’”
Bubble Economy Watch:
November 3 - Bloomberg (Margot Habiby): “Third-quarter earnings of U.S. companies rose an average of 23 percent, led by investment banks including Goldman Sachs Group Inc. and insurer Allstate Corp. Profit for members of the Standard & Poor’s 500 Index climbed more than 10 percent for the 13th straight quarter, matching the longest streak since 1950… Profits also rose for 13 quarters from the fourth quarter of 1992 to the fourth quarter of 1995.”
October 30 - CNW Telbec: “Compensation packages in Canada - especially in Alberta - are rising to levels that could force more companies to put investments on hold, according to The Conference Board of Canada… Average wage gains of 5.1 per cent are projected for Alberta, while increases in British Columbia are expected to average four per cent.”
October 30 – Financial Times (Francesco Guerrera): “The pay packages of US chief executives are rising faster than corporate earnings and shareholder returns in a sign that US companies are failing to link executive compensation to performance, a Financial Times study has found… The median pay package of US chief executives, which consists of salary, bonuses, options exercised during the period and other long-term compensation, rose 20 per cent to about $5m in the past fiscal year. By contrast, net profits at their companies increased by an average of 15 per cent and total shareholder returns, calculated by combining share price movements and dividends, rose by only 9 per cent.”
October 31 – Seattle Times (Melissa Allison): “Those were the days, back in the spring when the flowers bloomed and the housing market sizzled. Washingtonians had such confidence last spring that they spent with abandon on computers, hotel rooms, jewelry and other items. They spent 10.5 percent more than they had a year earlier, the largest increase for taxable retail sales in Washington since 1990, according to April-to-June data…”
November 1 – The Wall Street Journal (Peter Sanders and Christina Binkley): “Casino giant Harrah’s Entertainment Inc. has spent nearly $1 billion over the past year buying up land on and around the Las Vegas Strip for an ambitious redevelopment of the gambling mecca’s tourist corridor. But the company hasn’t revealed exactly what it plans to do with the 350 acres it has amassed. One reason for the silence: mounting concerns about rising construction costs and a shortage of steel, concrete, window glass and other materials… MGM Mirage, Wynn Resorts Ltd. and Boyd Gaming Corp. have their own massive redevelopment projects in the works… The companies are vying to build self-contained empires with so many lodging, shopping and eating options that guests won’t be tempted to venture outside. But rising materials and construction costs are in almost every case either driving up the price tag substantially or prompting the developers to hedge their bets and scale back.”
Real Estate Bubble Watch:
November 1 - Dow Jones (Danielle Reed): “Despite higher mortgage rates, homeowners are still choosing to take cash out of their homes when they refinance, housing finance agency Freddie Mac said… In the third quarter of 2006, 89% of Freddie Mac-owned loans that were refinanced resulted in new mortgages with loan amounts that were at least 5% higher than the original loan balances, Freddie Mac said… That’s up from 88% in the second quarter, and is the highest share since the second quarter of 1990. Cash-out refinancings have increased even as mortgage rates have risen, bucking historical trends, Freddie Mac said…‘Mortgage borrowers continue to refinance their mortgages at a higher frequency than historically would have occurred given the rise in mortgage rates over this year,’ said Frank Nothaft, Freddie Mac vice president and chief economist… One difference in today’s refinance environment, he said, is that there are now large numbers of mortgage borrowers holding hybrid…(ARMs) whose fixed-rate terms are almost over, meaning those ARMs are due to shift to floating rates. This ‘provides borrowers an incentive to refinance into a lower-cost ARM or fixed-rate mortgage,’ Nothaft said… The cash-out refinance report also showed that prices of properties refinanced during the third quarter of 2006 had a median appreciation of 33% from the time the original loan was made…”
Financial Sphere Bubble Watch:
November 1 - Bloomberg (John Glover and Cecile Gutscher): “…Bondholders worldwide are suffering a double whammy this year because more than 80 companies controlled by LBO firms have borrowed at the expense of workers and debt investors just so they can pay themselves dividends… Firms such as New York-based Blackstone Group LP and Kohlberg Kravis Roberts & Co. completed $269 billion of LBOs this year by borrowing at least $166 billion in loans and bonds, according to Bloomberg and Lehman Brothers Holdings Inc. data… The debt of companies owned by buyout firms has risen to the equivalent to 5.4 times their cash flow, the most ever, S&P says…”
October 31 - Bloomberg (Julia Werdigier): “London’s investment bankers and hedge-fund managers may earn a record 8.8 billion pounds ($16.7 billion) in bonuses this year, more than Iceland’s gross domestic product, according to the Centre for Economics and Business Research Ltd… The payments may climb 18 percent from 7.4 billion pounds in 2005…”
October 30 - Bloomberg (Alex Morales): “Global warming may cost the world as much as $9.6 trillion by the next century because of the effects of famine, rising sea levels, storms and other environmental damage, a study for the U.K. government indicates. ‘Climate change will affect the basic elements of life for people around the world: access to water, food production, health, and the environment,’ Nicholas Stern, the government’s chief economist, said in a 600-page report published in London today. ‘Hundreds of millions of people could suffer hunger, water shortages and coastal flooding as the world warms.’”
November 1 – Financial Times (Stephanie Kirchgaessner): “A little-known contractor whose hedge-fund parent last month appointed John Snow, former US treasury secretary, as its chairman is leading a strong push to win a multi-billion dollar military contract currently held by Halliburton. IAP Worldwide Services – owned by Cerberus Capital Management…– is making what is being seen as a serious bid to win a chunk of a huge defence contract to provide logistical support to US troops in the field. If it succeeds, the bid would transform IAP – once a relatively small government contractor with 5,000 employees and never regarded as a significant player before its 2004 takeover by Cerberus – into one of the most powerful and politically connected groups in the booming industry of providing food, shelter and support to the US army. It would also increase the political attention on the role in the public sector of hedge funds such as Cerberus, which also counts Dan Quayle, former US vice-president, as chairman of its international business.”
October 31 - Bloomberg (Kevin Carmichael): “John Snow, the former U.S. Treasury secretary named chairman of Cerberus Capital…said investors, not policy makers, are the best regulators of hedge funds. Snow…said he came to favor a ‘lighter’ touch for hedge funds because the industry, which oversees $1.3 trillion in assets, was too big for the government to monitor effectively. ‘The real policing of these pools of capital are the investors,’ Snow said… Any government promise to increase scrutiny would create ‘a real risk of moral hazard that implies, ‘Don’t worry. Now the government is watching over you and there aren’t any problems.’”
November 3 - Bloomberg (Hui-yong Yu): “Morgan Stanley, the largest real-estate investor among U.S. securities firms, is raising as much as $8 billion for the biggest high-yield property fund.”
Prevailing Inflationary Biases:
There should now be no doubt that U.S. labor markets are tight. At 4.4% (down from September’s 4.6%), the Unemployment Rate has quietly dropped to the lowest level since May 2001. This is down from the 5.6% rate when the Fed commenced its “tightening” cycle back in June of 2004. Average Hourly Earnings were up a stronger-than-expected 0.4% last month, with this measure of earnings now having expanded at a 4.1% rate so far this year. Average Hourly Earnings have accelerated from 2005’s 3.2% increase, 2004’s 2.5%, and 2003’s 1.7%. Total Non-farm employment has increased 1.967 million over the past year.
And while October’s 92,000 jobs added were less than the 123,000 estimated, previous job growth continues to be revised significantly higher. September’s 51,000 jobs gained was revised up to 148,000. August payrolls were originally reported as a gain of 118,000. This number was revised last month to a rise of 188,000 and then again to today’s 230,000. Notably, August Service-Producing jobs gains were originally reported at 118,000, then revised to 170,000 and then again to 223,000.
Understandably, the bond market took no comfort from today’s much-stronger-than-expected 4.2 point jump in the ISM Non-Manufacturing index (to the highest level since May). Fueled by ultra-loose Financial Conditions, the economy’s enormous “services” boom runs unabated. It is worth noting that the Service-Producing sector has mustered average monthly job growth of 155,000 during the past five months. This is up from the 123,000 Services jobs created during the first five months of the year, as well as an increase from the monthly average 143,000 created during the 2005 Services boom.
Overall, the economy has created a monthly average of 135,565 jobs during the past five months, up slightly from the 134,860 created during the first five months of the year and the average 133,459 added monthly during 2005. Interestingly, even the Goods-Producing sector is showing signs of life. A monthly average 38,000 jobs have been created over the past five months, up from the 31,000 during the first five months of the year and the average 22,000 during 2005. But at only 16.6% of total US Non-Farm Payrolls, I've always found the keen attention paid by the market to the ISM Manufacturing data - and manufacturing/producing employment generally – rather curious. The much more important financial, economic, employment and compensation trends these days percolate throughout the expansive “services” arena. That’s the home of one of today’s Prevailing Inflationary Biases.
Construction jobs actually declined 26,000 during October, although six-month losses in this sector total only 14,000. Construction jobs are still up 144,000 over the past year. Retail Trade jobs have declined 65,000 over the past five months and were down 63,000 over the past year. On the upside, “Financial Activities” jobs increased 53,000 over the past six months and 160,000 over the past year. “Professional, Business Services” employment is up 248,000 in six months and 468,000 over the past year. “Health, Social Services” jobs have increased 181,000 over six months and 356,000 over 12 months. “Leisure & Hospitality” employment has increased 173,000 over six months and 322,000 over the past year. Government employment is up 164,000 in six months and 230,000 in 12 months.
It is not easy to reconcile tight and further tightening labor markets with the view of mounting recessionary pressures. Moreover, corporate profits remain exceptional, with S&P 500 earnings so far running 23% above Q3 2005. While most sectors are enjoying double-digit y-o-y earnings growth, financial sector profit growth is nothing short of spectacular. Booming financial profits – a Prevailing Inflationary Bias - are a consequence of ongoing strong lending growth and robust capital markets activities. Such exceptional profits also create a powerful incentive to prolong the boom – and, in the process, maintain loose Financial Conditions for all.
The bond market today suffered its worse one-day loss since July 21, 2005 (according to Bloomberg). Two-year Treasury yields surged 15 basis points to 4.82%. Two-year yields were 4.88% on September 18th, only to sink to 4.59% by October 4th, then to jump to 4.92% on October 24th, then to drop back to 4.65% Wednesday of this week, then to jump 17 basis points in two sessions. June ’07 Eurodollar yields surged 18 basis points today to 5.18%, with a two-day jump of 20.5 bps.
November 3 - Bloomberg (Belinda Cao): “America’s corporate bond sales hit a record $677 billion, with some of the biggest offerings still scheduled for the final two months of the year. Cheniere Energy Inc.’s sale this week of $2.15 billion of notes pushed the total for the year above the $675.7 billion companies raised in 2001, the previous record, (according to…Bloomberg)… The four-month rally in Treasuries and $1.29 trillion of mergers and acquisitions encouraged companies to borrow. The lowest default rates in more than a decade and earnings growth of more than 10 percent increased investor demand for riskier debt.”
November 3 - Market News International (Steven K. Beckner): “Although falling energy and other commodity prices have been reducing business costs and helping moderate inflation in a climate of slower economic growth, the Federal Reserve is still keeping a close eye on a much more important business input -- rising labor costs. Comments by Fed sources suggest that, while labor compensation pressures are not worrisome enough in the current economic context to force a resumption of policy firming anytime soon, they are enough of a concern, together with other considerations, to reduce chances of Fed easing. Although they continue to tell varying stories, all three major measures of labor cost increases, including the wage data contained in Friday morning’s employment report, have shown a fairly consistent pattern lately -- namely an accelerating trend.”
The interplay between the Credit Bubble and the Bubble Economy is something to behold. Massive Credit-induced Current Account Deficits are “recycled” back to purchase (at inflated prices) much of our top-rated securities issuance, in the process stoking unparalleled speculative demand for higher-yielding corporate debt (see last week’s Bulletin). Importantly, the reemergence of the corporate debt Bubble is a powerful force fostering strong job and income growth, despite the marked slowdown in U.S. housing and related sectors. Overall buoyant employment and income inflation sustain the Mortgage Finance and Credit Bubbles that ensure unrelenting Current Account Deficits and general liquidity over-abundance.
Barring some meaningful change in the Credit backdrop – in Financial Conditions – I don’t in the foreseeable future expect much abatement in the Prevailing Inflationary Bias that have transitioned to employment and compensation. A strong case can be made that Credit Availability and Marketplace Liquidity have never been as generally robust throughout the U.S. corporate sector as they are today. And the recent bond market rally has only fanned this inflationary bias.
It is helpful to differentiate today’s backdrop to the 1998-2000 corporate debt boom that chiefly financed the technology and telecom booms. The previous Credit Bubble dynamic was noteworthy for largely isolating the most acute inflationary wage pressures within the broader tech industry. More importantly, the historic boom in technology investment and spending fed the so-called “productivity miracle.” Throughout the technology Bubble, a runaway investment boom coupled with a relatively small number of workers could produce an extraordinary amount of output – GDP. This worked to keep average unit labor costs low, while the technology boom also had the extraordinary capacity to absorb – like a sponge - incredible amounts of finance. This ensured that broad swaths of the U.S. economy were only minimally impacted by the historic debt and equities Bubbles. Recall that y-o-y average-hourly earnings gains actually peaked in early 1998, with few workers outside of the bubbling tech sector enjoying much in the way of boom-time bargaining power.
Today’s corporate Credit boom is a much different animal. It is more general in nature, which creates some notable contrasts to the previous tech-centric Credit Bubble. For one, today’s corporate Credit Bubble is not financing a conspicuous stock market sector Bubble (Internet/technology), as it did during 1999/early-2000. It certainly garners little attention, with most analysts instead fixated on bursting housing Bubbles. The corporate debt boom's relatively diffuse and inconspicuous nature has allowed it to gather one heck of head of steam without spooking either the Fed or the markets. Or, should I say, without detracting bond bulls from notions of collapsing home prices, panicked consumers, and recession.
More importantly, the economic output (GDP contribution) associated with today’s corporate debt boom include a real estate construction boom, an energy boom, and general corporate spending that – when compared to the tech boom – offer significantly less GDP per worker hour. Additionally, with skilled worker shortages now prevalent throughout the economy, that extra (less “productive”) worker hour is costing employers more in wages and benefits. The nature of the current boom dictates that there is today less potential marginal GDP to expand without further heightening inflationary pressures. There will be no reemergence of the “productivity miracle,” and I do believe at least some at the Fed recognize this dynamic.
What I believe few at the Fed or elsewhere recognize is how this Bubble is seductively distorting “fundamentals.” Unlike the 30% to 40% annual earnings growth that many companies were enjoying during the previous tech-centric debt Bubble, today’s much more dispersed Credit boom fosters near double-digit revenue growth and greater earnings inflation virtually throughout the entire business sector. There is today little angst related to equities gross overvaluation that we saw in 1999/2000. In fact, the general nature of today’s profits inflation is taken as confirmation of the soundness of the underlying U.S. economy, while increasingly confident bullish analysts trumpet today's undervalued equities market.
The current dynamic recalls the revisionist debate with regard to the 1928/29 stock market backdrop. Some prominent economists have contended that - because many leading stocks were trading at multiple of only 10 to 12-times earnings - the marketplace in the late-twenties was not dangerously speculative. Amazingly, the revisionists can examine the historical data and see only “the golden age of Capitalism” that an incompetent Fed somehow failed to sustain. Yet the Bubble reality was that gross Credit and speculative excesses and resultant unsustainable financial flows had radically inflated profits, while creating acute vulnerabilities to any change to monetary conditions/financial flows. Underlying “fundamentals” had come to be completely distorted by Bubble effects. The bursting of speculative and Credit Bubbles would abruptly interrupt – and even curtail - the flow of finance to some key sectors of the economy. Monetary Processes that had come to be commanded by leveraged speculation would be especially susceptible to the unwinding of positions and de-leveraging. This process saw previously inflated corporate profits seemingly disappear overnight.
Following by a few days Otmar Issing’s warning about global liquidity excess, come pointed comments from the Bank of China: ‘Global economic imbalances are a concern for every country in the world because it leads to worldwide excessive liquidity, low long-term interest rates as well as price hikes in resources and other assets… Adjustments to world economic imbalances (particularly disorderly adjustments) may increase the fluctuation in the world’s major currencies, which will cause a slowdown in US economic growth and price adjustment of US assets, and this in turn may impact China’s export and economic growth.’