One of Pacific Investment Management Company’s (PIMCO) elite brain trust Mohamad El-Erian coined the phrase, “the new normal” six years ago when characterizing the future returns for equity investors. Basically after all his in-depth research, analysis, modeling and magic wand he stated equity investors would need to adjust to future returns of 5% or so. Mr. El-Erian is undeniably a very intelligent fellow witch, up to this point in time had a very solid record. Mr. El-Erian fell victim to his conviction. Meaning even as the markets raged forward he continued to dig in his heels stubbornly clinging to his “new normal” theory costing his investors and followers hundreds of billions of dollars and some years later his very own job. The underlying theme here is the markets are always right so, as investors we need to be humble, flexible and when called for quick.
The US economy is no longer a good house in a bad neighborhood. We are the Bentley in a used car lot. The US economy for the trailing two quarters is averaging better than a 4% expansion rate of growth with the current quarter estimated to be tracking at close to 3%. This would give us a three quarter average of better than 3 ½%. Take that when comparing the US vs. the Eurozone’s blistering pace of +.2%, Japan at -1.6% contraction, the United Kingdom’s +.7% and Russia at +.7%. The US economy, now after five years of repair from a bruising and painful recession, is now finally starting to fire on all gears. So, where are we. Let’s get to it.
Jobs- The Non-Farm Payroll figures were released this morning and they were stellar coming out at +321,000. There was strength across the board. Average hourly earnings registered a +.4%. The average workweek pushed higher to 34.6 hours. Importantly the jobs created were good paying solid jobs with Business and Services adding 81,000 to head count and Healthcare and Manufacturing added 28,000 and 29,000 respectively. No two ways about it a very strong number. We’ll wait for the January release to see if this was a one off number, if this November number is followed up with another very strong number we may need to rethink the timing of the first Fed rate hike.
Institute for Supply Management Manufacturing –The ISM Manufacturing figures released earlier this week came in a +58.7% which is solid but down slightly from the prior reading of +59.%. Looking inside the headline figure we continued to strength across the board. Aside from the positive Production and Employment components we saw an uptick in the New Orders an Exports indexes and a slowdown in inventory build outs which bodes well for future growth .
Institute for Supply Management Non-Manufacturing-The ISM Non-Manufacturing figures came out at +59.3 which was 2.2% higher from the prior month. There were some softness noted in the employment index but still registered growth along with a pickup in the Business Activity Index which leapt 4.4% to +64.4%. Also, importantly the New Orders posted a 2.3% increase to 61.4%. Respondents noted the following: Finance-“uptick in demand and spending”, Technology, “Business is good with new products”, Professional Scientific, “Business is strong with many accounts wishing to be implemented before year end”. Also very positive was from mining,’ we are experiencing downward pricing pressure on natural gas as a result of lower pricing from OPEC. There should be a smiley face inserted her but I’m prohibited from doing so.
Leading Economic Indicators-LEI. LEI released in late November showed a very strong jump of +.9% following September’s +.7%. This continued strength suggests a strong holiday season spilling over and into the first quarter of 2015. There was strength registered across the board.
Industrial Production-IP. IP ticked down a -.1% in October after having surged ahead +.8% in September. There was some strength seen in manufacturing up +.2% which was far outweighed by the decline in mining activity of -.9%. This overall indicator is still showing a 4% gain for the comparable year ago period. The Capacity Utilization rate declined -.3% to 78.9% which leaves ample cushion to absorb any future inflationary pressure when they arise.
Housing- Housing Starts for October registered a 1,009,000 annual run rate which was a bit softer than September release of 1,038,000 but is up +7.8% from the year ago period. Importantly Housing Permits came in at 1,080,000 this is a +4.8% improvement from the prior months reading.
Now to where we are going.
There is no getting around what is driving the US economy now. Front and center Jobs and energy. I’m not sure which is the cart and which is the horse and for me that’s another discussion. The jobs picture is finally starting to see acceleration with the three month average now at +263,000. We’ll hold off on our opinion regarding the latest Non-Farm figure until we get confirmation this wasn’t a onetime anomaly from the January release. The argument that there were no “quality” jobs being created should now be quieted. Clearly good quality high paying jobs in Manufacturing, Business and Healthcare are being created. I always had a problem with the term “good quality jobs” to begin with. When I was out of work, any job was a good job, up until the time I could find a better one. Looking to the other input part of the economy the correction going on in the energy sector is a boom for everyone, ex- Texas, North Dakota and most notable OPEC, Russia and Venezuela. But those players have partied on our dime for long enough. Foreign investment to take advantage of our cheap natural gas and natural gas liquids is booming. Over the course of the last 10 years we’ve debunked the “Peak Oil” theory as a paper funded by and for the oil industry. The Shale formations in the US have unleashed a tidal wave of cheap oil and gas that will forever change the pricing and security of America. No longer will we need to engage hostile forces to protect “US Interests “abroad. No longer will we be held hostage to rival religious fanatical factions to heat our home and fill our tanks. The Shale Revolution has changed all of that while producing tens of thousands of high paying US jobs. The argument now is where will oil find a bottom. I can remember back to the depths of the financial crisis when Institutional Investors and Hedge Fund managers were scrambling to raise cash for clients redemption requests. They were selling any and everything which meant the futures and options position being closed out in the energy pits as well. The bottom price of oil at that time when speculators were chased out of the market was right around the $36.00 barrel level. The Saudi’s say they can extract oil at $10 barrel. Some estimate the Bakken and Permian have similar extraction rates for break even. We’ll see. But to show just how powerful this move down in gasoline can be for consumers. US consumers spent close to $374 billion on fuel last year. If we simply hold the 30% correction at the pumps we’ve already experienced for the next year we’ll have put $110 billion back in to consumers’ pockets and pocketbooks. That doesn’t take into account the additional savings from heating ones homes. Potentially hugely stimulative to the consumer and better than any government program. So, let’s hope the government doesn’t try and figure a way to get ahold of those monies before it gets to the consumer. Back on point. The point here is the US is doing much better and about to take flight. This without much assistance from the Euro zone which is close to reentering a recession, Russia about to enter a recession, Japan which is fighting stagflation to a standstill at best along with China and India enduring a soft landing of +7.5% and +5.4% respectively. This drag the US is encountering from the global economy may actually work to our benefit as it prevents our economy from overheating forcing the Yellen Federal Reserve to hike interest rates thus choking off a continuation of the domestic expansion and market surge. Instead with more American’s being put back into “good jobs” with improving wages coupled with the drop in energy prices this scenario could provide us with years of this Goldilocks environment providing above average returns for investors. So, if this is Mohamad’s New, New Normal, I’m all aboard.
For now we remain aggressively committed to the market closely monitoring data along with any signs to change course in which case we’ll be in contact immediately.
Thank you again for your patience and confidence in this very challenging investing environment.
Yours in pursuit of the KWAN!
