15 February 2016

Economic Realities and Why the Fall in Stock Prices May be Over

Here are some numbers that help to tell the story of today's economy and what that suggests about whether the recent fall in stock prices is a warning of a coming recession. The punchline? I think that a recession is still unlikely, and here are some data to explain why.

Quits is an important measure of labor market confidence. You don't quit a job unless you think you've got good opportunities elsewhere and quits are at their highest rate in nearly 15 years. This is not an abstract measure of confidence. It's a practical measure that reflects how real people with real jobs feel about their prospects. It may be one of the most important leading indicators in economics, telling the story of people's optimism about better paying jobs or business ventures that justify striking out on their own.

Home prices are up 6.2% from a year ago, and the number of homes sold is up about 2 to 3%.

Gallup's measure of consumer spending remains stable - not really up or down significantly over the last couple of years.

But people are spending less on gas and energy, so if consumption is staying stable, it means that it is going up for things other than gas. In fact, the percentage of income that people spend on energy is the lowest it has been since the late 1950s and Bill McBride predicts it could hit an all-time low when the February numbers are reported. It is as if people are getting a raise in take-home pay when the price at the pump falls.
Incomes went up 2.5% in the last jobs report. Just as important from the perspective of the economy, total private sector wages are up 5% from a year ago and were up 6.3% the year before that. Total wages are up more than average wages because it measures the average raise everyone is getting AND the growth in the number employed (another year, another 2.7 million jobs created.) Meanwhile, net savings - which was up 30% through the end of 2014 - was actually down by 7% through the third quarter of 2015. This means that people are daring to spend again after years of paying down debt in the wake of the Great Recession. This is further evidence that the influence of the Great Recession is waning and that the economy will pick up.

Of course all of this data has still not spared Americans from an uneasy feeling. Among other things, they are made uneasy by China's apparent slowdown. (These being the same Americans made uneasy by China's economic acceleration.) Gallup's measure of economic confidence is down from a year ago. In spite of continued progress, Americans are worried. It might just be because they've got candidates coming on TV every week telling them how awful this economy is. And of course the stock market's spectacular fall of 10% to start the year has seemed like a harbinger of bad news. But stock prices might have less to do with the economy than with adjustments to fallen oil prices and raised Fed rates.

There are a few interesting theories to explain the fall in stock prices.
One is that oil money countries like the Saudis and Russians are having to sell off a chunk of stocks as oil prices fall. 
Two is that as the dollar rises against foreign currencies, it lowers profits measured by dollars. Lets say that an American company has sales of $1 in Canada in early 2014 and those sales stay stable through late 2015. While the sales are stable in Canadian dollars, they've dropped a lot in American dollars. That Canadian dollar is worth about 70 cents, so from the perspective of an American firm, sales have dropped. A lot. Not all currencies have dropped as much relative to the US $ but by some estimates the dollar's rise equates to a drop of about 11% in international sales.
The third theory about why stock prices are falling is because the market is trying to adjust for the fact that interest rates have gone up. When interest rates go up, fixed interest investments are more attractive. A rise in interest rates typically leads to a shift of monies from stocks to bonds, triggering a fall (however small) in stock prices.

Personally, I think that these three theories all have some credibility and could account for a drop of 10% in stock prices to start the year. Once that adjustment is made, I think that economic realities will be reflected in stock prices and we'll see a steady uptick in stock prices (although still characterized by the volatility that is the modern market). After getting it wrong by predicting a rise starting last week, I'm doubling down and betting that stock prices will start rising this week. And whether it is this week or next, the real point I'm trying to make is that there seems like no good reason for an on-going fall in stock prices. Probably sooner than later, economic fundamentals will prevail over current turmoil.

No comments: