Topic Tags: U.S Economy

Still Waiting for Wage Growth

On Friday, April’s unemployment rate was announced at 5.4%, the lowest reading since May 2008 and significantly down from its peak reading of 10% in the aftermath of the Great Recession. Despite the low participation rate (62.8%), the dramatic improvement in the unemployment rate should be viewed as a positive development for the United States economy.

On Friday, April’s unemployment rate was announced at 5.4%, the lowest reading since May 2008 and significantly down from its peak reading of 10% in the aftermath of the Great Recession. Despite the low participation rate (62.8%), the dramatic improvement in the unemployment rate should be viewed as a positive development for the United States economy.

Although the unemployment rate has recovered, wage growth continues to stagnate, as shown by our chart this week. In looking at the chart, a negative correlation between unemployment and wage growth is abundantly clear and makes sense intuitively: when unemployment is high, workers do not have pricing power to demand higher wages, but when unemployment is low and demand is high for employees, firms are forced to offer higher wages to entice workers. The most recent recovery in the unemployment rate, however, has not been accompanied by the ascension in wage growth that is to be expected. So while the lower unemployment rate is encouraging, it is difficult to label the labor market as fully recovered until we see more tangible growth in hourly earnings.

Will Student Debt Suffocate Economic Growth?

According to the National Center for Education Statistics, an estimated 1.8M students across the country will graduate this month with their undergraduate degrees. These graduates are entering an ever improving job market as shown by the latest unemployment figure of 5.5%, but they are also graduating with an increasing amount of debt as shown by this week’s chart.

According to the National Center for Education Statistics, an estimated 1.8M students across the country will graduate this month with their undergraduate degrees. These graduates are entering an ever-improving job market as shown by the latest unemployment figure of 5.5%, but they are also graduating with an increasing amount of debt as shown by this week’s chart.

Total student loan debt levels have grown by over 64% since the end of the recession in 2009. Wage growth, on the other hand, has been modest, increasing just over 10%. There are two major concerns about this disconnect between student debt and wage growth. The first is that there will be a widespread pattern of defaults on this outstanding debt, as students are unable to keep up with the loans after graduating. The second is a reduction in consumption from millennials who are spending a larger percentage of their incomes on debt service, rather than consuming goods and services. Together these two issues could be a significant drag on economic growth.

Has the Drop in Oil Prices Been a Drag on the U.S. Economy?

Over the past few quarters there has been much discussion about how the recent plunge in oil prices would impact the U.S. economy. While there were expectations of both positive and negative effects associated with lower oil prices, the general consensus amongst economists was that this would have a net positive impact on the U.S. economy.

Over the past few quarters, there has been much discussion about how the recent plunge in oil prices would impact the U.S. economy. While there were expectations of both positive and negative effects associated with lower oil prices, the general consensus amongst economists was that this would have a net positive impact on the U.S. economy. Cuts in capital expenditures from U.S. oil producers (which have been a significant contributor to GDP growth for the past several years) were expected to be a drag on economic growth. At the same time, lower energy costs for consumers were expected to result in increased disposable income and thus increased consumer spending, which would boost economic growth. Given that the U.S. is a net importer of oil, the benefit to consumers was expected to more than offset the decrease in capital spending from producers, resulting in a net positive impact.

Since low oil prices have persisted for several months now, we are starting to get an indication of the impact on the economy, and at this point it does not appear to be nearly as positive as expected. It appears as if the economic drag from decreased capital expenditures from oil producers has been greater than the benefit from lower oil prices. While the drop in capital expenditures from oil producers has more or less been in line with expectations, the increase in disposable income has not translated to the increase in consumer spending that was anticipated. Consumers appear to be saving, rather than spending, this increased disposable income. As the chart illustrates, from June 2014, when oil peaked at approximately $115 per barrel, to February 2015 (the most recent date data is available for), annualized household spending on energy has decreased from approximately $645 billion to approximately $533 billion, representing a decrease of approximately $112 billion. Over the same time frame, annualized household saving has increased from approximately $658 billion to $768 billion, an increase of approximately $110 billion.

Thus far, the negative consequences from lower oil prices (reduced capital spending and job cuts from the energy sector) have been a drag on the U.S. economy, while the benefits from lower oil prices (increased consumer spending) have not yet had the positive impact that was expected. This phenomenon may help to explain some of the disappointing economic data observed during the first quarter. Consumers are often slow to adjust spending habits, and that may well be the case here, meaning that consumer spending will likely be one of the most influential economic data points in the coming months.

Is the U.S. Equity Market Overvalued?

As U.S. equity indices again touched record highs during the first quarter, the appropriate valuation level for the market continues to be a popular topic in the financial press. Complicating the issue for investors is the tendency of the financial press to use different valuation methods interchangeably (trailing price to earnings, forward price to earnings, cyclically adjusted price to earnings, enterprise value to pre-tax income, etc.).

As U.S. equity indices again touched record highs during the first quarter, the appropriate valuation level for the market continues to be a popular topic in the financial press. Complicating the issue for investors is the tendency of the financial press to use different valuation methods interchangeably (trailing price to earnings, forward price to earnings, cyclically adjusted price to earnings, enterprise value to pre-tax income, etc.). Oftentimes different valuation methods will flash different signals and there is no single method generally accepted as the “correct” indicator. When confusion arises, it is natural to have Warren Buffett weigh in on the issue with his trademark simplicity. In a 2001 article appearing in Fortune Magazine, Mr. Buffett commented that at any given point in the market cycle, market-cap to GDP is likely the best long-term valuation indicator of the market.

In this week’s chart, we plot the market-cap to GDP ratio for the U.S. by dividing the average quarterly market-cap of the Wilshire 5000 index by the quarterly nominal GDP of the U.S. economy. At the end of 2014, this ratio stood at 122%, the highest level seen since the late 1990s and almost 2 standard deviations away from the 43-year average. Although revered by Mr. Buffett, this indicator should not be relied upon for its predictive power. Instead, it should serve as another data point that urges caution to investors considering outsized allocations to U.S. equity.

Has Oil Been Oversold?

Between June 2014 and the end of January 2015, oil experienced a precipitous fall from $107 per barrel to $45 as reduced demand and excessive supply combined to drive its price significantly lower. During that time, the Credit Suisse High Yield benchmark experienced a -3% total return, as 15% of the index is comprised of energy issuers. In February, oil recovered to $52 and the high yield benchmark rebounded by 3%. Given the wide dispersion of projected oil prices, we attempt to gauge how fairly priced both oil and high yield energy bonds currently are, based on the Baker Hughes North America Rotary Rig Count.

Between June 2014 and the end of January 2015, oil experienced a precipitous fall from $1071 per barrel to $45 as reduced demand and excessive supply combined to drive its price significantly lower. During that time, the Credit Suisse High Yield benchmark experienced a -3% total return, as 15% of the index is comprised of energy issuers. In February, oil recovered to $52 and the high yield benchmark rebounded by 3%. Given the wide dispersion of projected oil prices, we attempt to gauge how fairly priced both oil and high yield energy bonds currently are, based on the Baker Hughes North America Rotary Rig Count.

The Baker Hughes North America Rotary Rig Count is an important business barometer for the oil and gas industry because it tracks active oil drilling rigs and serves as a leading indicator for the demand for oil and gas products and services. The rig count nosedived from 1,931 at the end of September 2014 to 1,267 at the end of February 2015, a period of just five months.

This week’s chart divides the price of oil by the rig count. By doing this, we can see how overpriced or underpriced oil is in the context of active rigs. The blue line shows that oil was generally overpriced over the last six years and is now somewhat cheaply priced as it falls below its average shown by the dotted blue line; the significant reduction in rig count has helped to improve this ratio. The green line shows the spread of energy bonds in the Credit Suisse High Yield benchmark divided by the same rig count. It currently sits above its average, suggesting that perhaps energy high yield bonds have been oversold, and may offer a buying opportunity for value-driven investors.

1As measured by West Texas Intermediate crude, the benchmark for oil prices in the United States.

Emerging Trend in the Labor Force?

As of January 2015, the headline unemployment rate (U-3) stood at 5.7%. Since hitting a recession high of 10% in October 2009, this headline rate has steadily fallen to pre-financial crisis levels. However, headline unemployment is but one of many measures used by the Bureau of Labor Statistics to gauge the health of the labor market since one single measure can’t possibly tell the whole story.

As of January 2015, the headline unemployment rate (U-3) stood at 5.7%. Since hitting a recession high of 10% in October 2009, this headline rate has steadily fallen to pre-financial crisis levels. However, headline unemployment is but one of many measures used by the Bureau of Labor Statistics to gauge the health of the labor market since one single measure can’t possibly tell the whole story.

While the percentage of those officially counted as unemployed has fallen, that decrease also accounts for changes in the amount of those classified as marginally attached to the labor force (those who have stopped looking for work but still want a job) as well as workers employed part-time for economic reasons (those working part-time and unable to find full-time employment). The broadest measure of unemployment (U-6), which includes these two categories, was 11.3% in January.

Part-time workers as a percentage of the labor force have improved slightly over this time period, but not nearly as much as the headline rate has. There is a multitude of possible reasons for the increase and slower decline in part-time workers for economic reasons. Possible reasons include job-seekers lacking the skill sets that employers require, employers being more selective and/or hesitant to add new staff following the Financial Crisis, and the effect of the Affordable Care Act’s 30-hour threshold rule to be considered a full-time employee and receive health coverage. The trend of higher part-time workers as a percentage of the labor force bears watching as this may be part of a secular trend in the labor market.

Is the Bull Market in U.S. Equities Running Out of Steam?

Since the current bull market began in March 2009, the S&P 500 has posted an annualized return of 19.5%. During that time period, the trailing 12 month price to earnings ratio (P/E ratio) of the S&P 500 has increased from 14.2 to 18.1 (an increase of 27%). Over that same period, the trailing 12 month price to sales ratio (P/S ratio) has increased from 0.8 to 1.8 (an increase of 118%).

Since the current bull market began in March 2009, the S&P 500 has posted an annualized return of 19.5%. During that time period, the trailing 12-month price to earnings ratio (P/E ratio) of the S&P 500 has increased from 14.2 to 18.1 (an increase of 27%). Over that same period, the trailing 12-month price to sales ratio (P/S ratio) has increased from 0.8 to 1.8 (an increase of 118%). The current P/E ratio of 18.1 is below the 20-year average P/E ratio of 19.2 but above the longer-term average P/E ratio of 16.7. The current P/S ratio of 1.8 is greater than the 20-year average P/S ratio of 1.5 and is higher than it has been at any point since 2000.

As seen in the chart, the P/S ratio has grown at a much steeper rate than the P/E ratio during the past few years. Over this period, the growth in earnings per share of the S&P 500 has significantly outpaced the growth in sales per share. This tells us that cuts to bottom line expenses — not growth in top line revenues — have been the primary driver of earnings growth. It is fairly typical for this scenario to occur, especially in the early stages of a bull market, as companies tend to cut expenses in order to remain profitable following downturns in the economy. However, in order for earnings growth to be sustained over longer periods of time, there needs to be a pickup in sales growth, as there are limits to expenditure cuts. This is especially concerning because current forecasts indicate that the market expects negative sales growth for both the first and second quarters of 2015. To be sure, this may just be a statistical quirk caused by the significant drop in oil prices in recent months, but it bears monitoring nonetheless.

Is Student Debt Stifling Growth?

The total amount of student loans outstanding has grown from approximately $500 billion in 2006 to $1.3 trillion at the end of 2014. Of the $1.3 trillion in student loans outstanding, approximately $1.1 trillion are either direct loans from the U.S. Department of Education or outstanding loans from the now terminated Federal Family Education Loans Program (FFEL). The remaining $190 billion can be attributed to private loans.

The total amount of student loans outstanding has grown from approximately $500 billion in 2006 to $1.3 trillion at the end of 2014. Of the $1.3 trillion in student loans outstanding, approximately $1.1 trillion are either direct loans from the U.S. Department of Education or outstanding loans from the now terminated Federal Family Education Loans Program (FFEL). The remaining $190 billion can be attributed to private loans.

There are several reasons that have contributed to the rise in the amount of student loans outstanding: overall college/advanced degree enrollment has increased over the past decade, cost of higher education has increased, graduates pre-recession have had a difficult time repaying their obligations, and as a result of the recession, students are relying on financial aid more heavily.

This week’s chart illustrates the portfolio of direct and FFEL loans by their loan status at the end of 2014. We focus on the categories described as Deferment, Forbearance, Default, and Other (see glossary below). These categories represent over 30% of the loan portfolio and are considered the highest risk categories because payments have been postponed, suspended, or ceased completely.

The pace of the economic recovery has been muted for a multitude of reasons; however, the overwhelming student debt load that has accumulated over the past decade has only exacerbated the problem. Studies have shown that people with student loans are less likely to start businesses of their own, which leads to less job creation and investment. Young Americans are delaying marriage and household formation which leads to a decrease in consumption. Additionally, holders of student debt are delaying the purchase of their first home.

It’s difficult to say if the recession and increase in student loans is a cause and effect relationship or vice versa, but most Americans can agree that some reform is necessary with regard to the cost of tuition or the cost of debt. If neither is addressed, we may continue to see the high risk categories discussed earlier increase as a percentage of debt outstanding, thus further depressing economic growth.

 

Glossary:
In-School – Includes loans that have never entered repayment as a result of the borrower’s enrollment in school.
Grace – Includes loans that have entered a six-month grace period after the borrower is no longer enrolled in school at least half-time. Borrowers are not expected to make payments during grace.
Repayment – Includes loans that are in an active repayment status.
Deferment – Includes loans in which payments have been postponed as a result of certain circumstances such as returning to school, military service, or economic hardship.
Forbearance – Includes loans in which payments have been temporarily suspended or reduced as a result of certain types of financial hardships.
Default – Includes loans that are more than 360 days delinquent.
Other – Includes loans that are in non-defaulted bankruptcy and in a disability status.

2015 Market Preview

January 2015

Similar to previous years, we offer our annual market preview newsletter. Each year presents new challenges to our clients, and 2015 is no different: U.S. equities are at all-time highs, uncertainty reigns for international equities, and to everyone’s surprise, interest rates fell dramatically in 2014…but are poised to rise from historic lows over the next year. In the alternative space, real estate remains a solid contributor to portfolio returns, and private equity delivered on return expectations, though dry powder is on the rise. Hedge fund results were mixed, but have shown to add value in past rising interest rate environments. Further macroeconomic items that bear watching for their potential impact on capital markets include the precipitous fall in oil prices, the strengthening U.S. dollar, job growth, and international conflicts.

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Booming Biotech Still a Buy?

The Nasdaq Biotech Index enjoyed another great run in 2014, returning 34% for the year and over 220% since 2011. By comparison, the Nasdaq Index has gained 13% and 75%, respectively, over the same time periods. Currently, the Nasdaq Biotech Index is nearly 60% above its long-term average price-to-book (“P/B”) ratio, and while there’s an argument that most U.S. equities are currently overvalued, the Nasdaq Index is only about 13% above its long-term average P/B ratio.

The Nasdaq Biotech Index enjoyed another great run in 2014, returning 34% for the year and over 220% since 2011. By comparison, the Nasdaq Index has gained 13% and 75%, respectively, over the same time periods. Currently, the Nasdaq Biotech Index is nearly 60% above its long-term average price-to-book (“P/B”) ratio, and while there’s an argument that most U.S. equities are currently overvalued, the Nasdaq Index is only about 13% above its long-term average P/B ratio. As a comparison, the S&P Biotech Index is about 36% above its long-term average P/B ratio, while the S&P Index is only 23% higher.

These elevated valuation metrics even have biotech bulls questioning if a bubble is emerging in response to so much growth. Though these fundamentals alone may indicate that biotech is on the verge of a correction, there is still hope for the sector. Healthcare spending is a large portion of U.S. GDP and is expected to grow with our substantial aging population. As technologies and research methodologies improve, so do drug research possibilities and opportunities. Some of the prior rises in price may be explained by positive news that is not yet quantifiable or on positive trial data that is not yet able to be capitalized. Because of the lengthy trial and FDA approval processes, along with the current maturation of the sector, many revenue-generating drugs and technologies should come to fruition in the coming years, thus providing optimism for further positive returns from biotechs.

Fundamentals suggest that biotech has already experienced the majority of its run, is overvalued, and would not be an ideal investment for the faint of heart. However, the sector bears watching in the coming year as investors keep an eye out for progressing FDA phase data or new drug releases. Ultimately, in spite of current valuation data, biotechs should continue to deserve a healthy allocation within a well diversified U.S. equity portfolio.