Productivity Fell 0.2% In 2016; Stocks Rose 5.5% In Q1

The first quarter is now in the books. It was quite an interesting three months as President Trump was sworn in and stocks had an amazing run as they maintained the post-election momentum. The chart below shows the powerful rally in the S&P 500 since the election. The S&P 500 was up 5.5% for the quarter and is just 1.39% below its record high on March 1st. Looking at the quarter’s results, the Nasdaq had its best quarter since Q4 2013, the dollar had its second worst quarter since Q3 2010, and the Dow is now up six quarters in a row which is the longest streak since Q4 2006. Energy was the worst sector as it was down 7.0% and technology was the best sector as it was up 10.4%.

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The stock market rallying in the face of weak economic data has become the norm for the past few years. While GDP growth for Q4 was revised higher from 1.9% to 2.1%, the productivity report was dire as it showed productivity shrank 0.2%. This was not a one-off event as productivity growth has been below 1% in ten of the previous eleven years. In the ten years prior to that, productivity growth was above 1% in eight years. The long-term outlook for the economy looks bad as the population growth slows, productivity growth slows, and the debt rises. To be clear, the chart below is supposed to say “multifactor.”

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The high level of investment and low stock valuations of the 1960s and 1970s were fuel for the stock market rallies of the 1990s and 2010s. The expensive stock prices have been brought about by low inflation; the financial bubble era we live in has brought about lower domestic investment. Stock buybacks and acquisitions have replaced investment which could create innovation. This is an “emperor has no clothes’ moment as businesses and investors are buying into a market which is based off nothing.

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As I mentioned many times, the labor market is going to signal when the economy is finally rolling over. The monthly BLS report is coming out next week. It may show some signs of weakness because the weekly jobless claims metric bottomed in the last week of February. The latest report will be included in the March jobs report. As you can see from the chart below, jobless claims fell 3,000 from the prior week. However, this was 11,000 higher than expected. The four-week moving average rose to 254,250 from 246,500 which was the highest level since December. It’s too early to say this short-term trend means the labor market is about to weaken. Even if it were to stay above 250,000, that number would still be consistent with a strong labor market. The key is figuring out when the labor market will go from great to good.

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An industry which already in bad shape is the restaurant industry. The chart below shows 51% of restaurants had lower year over year same store sales. This is confusing because of the positive driving trends I mentioned in my last article, the strong labor market, and the high consumer confidence reports. Both the bulls and the bears have facts to form their theses on. Usually the restaurant industry is a good tell of where the economy is headed which is why I take reports from it very seriously.

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I think the best argument the bears have right now is that loan and lease activity growth is decelerating. There wasn’t even much of an increase in interest rates and the lending activity fell from growing about 7.5% to growing about 4%. If rates were to rise further, the system would come undone. Luckily for the borrowers, the ten-year bond yield has fallen to about 2.39%. The one inconsistent part of bearish arguments is bears claim inflation risk is rising while growth expectations are falling. While stagflation is a possibility, in the current situation when bearish economic news comes out, rates fall. We would need a paradigm shift where the labor market became overheated to see rising inflation. That hasn’t happened yet. In fact, most economists are hoping for hourly earnings to increase quicker. The way I see the economy, I don’t think rising wages will be the catalyst for the jobless rate to tick up. I think an uptick will come from a decrease in economic activity like the one signaled by the declining C&I lending we’re currently experiencing.

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The final topic of discussion I want to mention is the French presidential election. On April 23rd, the first round of voting will take place. Macron and Le Pen will be the top two finishers and make it into the second round of voting on May 7th. Macron will likely win the election as he is ahead of Le Pen by twenty points in the last two head-to-head polls. The argument for Le Pen winning the general election was that she would gain momentum after winning the first round. That argument was always suspect because gaining twenty points in the polls in two weeks requires more than momentum. It would require a massive scandal. That dubious thesis may not see the light of day as Macron has now overtaken Le Pen in the first-round polls as you can see in the chart below. This news of a centrist candidate winning the French elections is bullish for French bonds and European stocks.

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Conclusion

To sum up the stock market in one point, 2016 productivity growth was 0.2% and the S&P 500 rose 5.5% in Q1 2017. That dichotomy provides firm ground to be bearish on stocks. However, that logical perspective hasn’t worked as we are in the second longest bull market ever even as productivity growth hasn’t been above 1% since 2010. I look at the labor market to see any inklings of when this bubble period will end. While I expect the March jobs report to be weaker than February’s report, there’s little evidence that the labor market will crater in the next few months.