Employment Situation, April 2017

Happy Cinco de Mayo!

I’ll finish my value investing comment on Monday.

This morning, as usual, the Bureau of Labor Statistics of the Labor Department released its monthly Employment Situation report.

The April ES revises down the weak March figures from +98,000 jobs to +79,000.  However, the April figures have bounced back to +211,000 new positions, well above the recent trend of about +175,000 monthly hires.  This development also suggests that March weakness was a result of unusually warm weather at the start of the year that pulled forward hiring normally done in early spring into late winter.

No sign of accelerating wage gains, though.  Salaries continue to rise at about a 2.5% annual rate.   That’s slightly above inflation.  But despite the unemployment at a 4.4% low, there’s no sign of labor-strapped companies raising the ante in bidding for new employees.  That has been typical behavior in past business cycles, and would create the rising inflation (healthy, at this juncture) the Fed is looking for as a signal to tighten money policy more quickly.

Why is this cycle different?

One plausible alternative is that employees are still scarred by the recession and are afraid to make large wage demands.  Another is that employers are replacing labor with capital, in the form of robots/computers.

 

 

the French election, round 1: market reaction

As I’m writing this just after 8am est, the French stock market is up by about 5%, large-cap European issues are up 4%, the euro is up by 1%+ against the US$, and stock index futures show US stocks opening up about 1%.

This is all because yesterday’s first round of the French presidential election ended up pretty much as the polls had predicted.  Candidates with 5%+ of the vote, in their order of finish, are:

Macron          23.9%

Le Pen          21.4%

Fillon          19.9%

Mélenchon          19.6%

Hamon          6.3%.

Fillon, an experienced politician and candidate of the center-left, had been the early favorite, but was undone by a scandal involving no-show government jobs for family members that paid, in total, more than €1 million.   Fillon’s subsequent refusal to withdraw directly undermined the prospects for Macron, the centrist candidate, and gave life as well to Mélenchon, of the far left.

The market fear had been that, with the center/left vote split three ways, Marine Le Pen, the far right choice, might end up doing surprisingly well.  That worry was intensified by the Brexit vote, the Trump victory and a terrorist incident in France last week.

The stakes in this election are very high.  Le Pen’s key economic platform: leave the euro and repudiate French euro-denominated debt.  The euro would be replaced by a new franc, which would be rapidly devalued–à la Abenomics in Japan–in order to give the economy a short-term boost.  Repaying euro-denominated French government debt with francs would “solve” the problem of French national debt, but at the cost of destroying the country’s ability to borrow internationally in the future (think: Argentina).  Were the Le Pen agenda to be implemented, it’s not clear to me how the EU could survive.

The consensus view now is that the Fillon and Mélenchon votes will gravitate to Macron, giving him a large victory in the second round of the election, between Macron and Le Pen, on May 7th (and earlier version of this post had the incorrect date).  Let’s hope so.

We now have whole week until the potential US government shutdown over funding for the Trump-envisioned border wall with Mexico.

 

 

 

 

 

 

tallying up the cost of Brexit

How good is the UK, the part of the EU most American investors know best, as a way to participate in potential economic strength in Europe over the coming 12 months?

Probably not good at all.  Here’s why:

–since the Brexit vote last June, sterling has depreciated by 13+% against the US dollar and 8+% against the euro.  While the loss of national wealth in Japan through depreciation dwarfs what has happened in the UK, the blow to holders of sterling-based assets is still immense.

Depreciation lowers the UK standard of living and reduces the purchasing power of residents by raising the cost of imported goods.  While one might argue that the fall in sterling is in the past–and while the consumer will be in trouble benefits to export-oriented firms through lower costs are still to come–this may not be the case here.  More in point #3.

–there’s some evidence that UK residents, realizing last June that prices would soon begin to rise, did a lot of extra consuming before/while firms were marking up their wares.  If so, the UK economy could be in for a significant slowdown over the coming months, both because consumers are now poorer and because they’ve already used up a chunk of their budgets through anticipatory buying.

–much of the appeal of the UK as a destination for export-oriented manufacturing comes from its position as the large foreigner-friendly country in the EU, from which multinationals could reach into the rest of the union.  That’s no longer the case.  An article from yesterday’s Financial Times is titled ” Brussels starts to freeze Britain out of EU contracts.”  Its basis is an EU government memo, which, as the FT reads it, advises staff to:

–avoid considering the UK for any new business dealings where contracts may extend beyond the two year deadline for Brexit

–cancel existing contracts with UK parties that extend beyond the Brexit deadline

–urge UK-based companies to relocate to continental Europe, presumably if they want favorable consideration for new business.

It seems to me that the EU leaked this memo to the FT to get the widest possible dissemination of its new not-so-friendly-to-the-UK policies.  It implies that the post-Brexit business slowdown in the UK will start immediately, not in two years.

One set of potential winners:  UK-based multinationals that do little or no business with the EU.  These, like ARM Holdings, are also potential takeover targets–although it’s questionable if the UK will permit further acquisitions by foreigners.

 

Chinese economic growth

China, the largest economy in the world (by Purchasing Power Parity measurement), reported 1Q17 economic growth of 6.9% earlier today.  The best analysis of what’s going on that I’ve read appears in the New York Times.

The bottom line, though, is that this is a slight uptick from previous quarters–and good news for the rest of the world, since one of the big factors that is driving growth is exports.

Traditionally, the first question with Chinese statistics has been whether they attempt to represent what is happening in the economy or whether they’re the rose-colored view that central planning bosses insist must be shown, whatever the underlying reality may be.

I think this is a much less worrisome issue now than, say, ten years ago.  But in addition to greater faith in statisticians, we also have other useful indicators about the state of China’s health.  They’re all positive:

–As I wrote about a short while ago, demand for oil in China is rising.

–Last week, port operators reported an activity pickup, led by exports.

–And Macau casino patronage, which bottomed last summer, is showing surprising increases–with middle class customers, not wealthy VIPs, in the vanguard.

While I think that consumer spending in the US is probably better than recent flattish indicators would suggest (on the view that statistics are catching all of the pain of establishment losers but much less of the joy of new retail entrants), my guess is that increasing export demand for Chinese goods is coming from Continental Europe.

More tomorrow.

P&G (PG) and Gillette

Gillette

P&G acquired Gillette in 2005 for $57 billion in stock.  The idea, as I understand it, was not only to acquire an attractive business in itself but also to use the Gillette brand name for PG to expand into men’s health and beauty products.  More or less, PG’s a big chunk of PG’s extensive women’s line would be repackaged, reformulated a bit if necessary, and sold under the Gillette label.

Unfortunately for PG, millennial men decided to stop shaving about ten years ago.  The big expansion of new Gillette product categories hasn’t happened.  And PG announced two months ago that it was slashing the price of its higher-end shaving products by up to 20%, effective late last month.

It’s this last that I want to write about today.

pricing

The Gillette situation reminds me of what happened with cigarette companies in the 1980s.  I’m no fan of tobacco firms, but what happened to them back then is instructive.

the iron law of microeconomics

The iron law of microeconomics: price is determined by the availability of substitutes.   But what counts as a substitute?  For a non-branded product, it’s anything that’s functionally equivalent and at the same, or lower, price.  The purpose of marketing to create a brand is, however, not only to reach more potential users.  It’s also to imbue the product with intangible attributes that hake it harder for competitors to offer something that counts as a substitute.

cigarettes

In the case of cigarettes, they’re addictive.  It should arguably be easy for firms with powerful marketing and distribution to continually raise prices in real terms.  And that’s what the tobacco companies did consistently–until the early 1980s.

By that time, despite all the advantages of Big Tobacco, it had raised prices so much that branding no longer offered protection.  Suddenly even no-name generics became acceptable substitutes.  This was a terrible strategic error, although one where there was little tangible evidence to serve as advance warning.  As it turns out, in my experience there never is.

The competitive response?  …cut prices for premium brands and launch their own generics.  There certainly have been additional legal and tax issues since, and because I won’t buy tobacco companies I don’t follow the industry closely.  Still, it seems to me that tobacco has yet to recover from its 30+ year ago pricing mistake.

razor blades

The same pattern.

Over the past few years, Gillette’s market share has fallen from 71% to 59%.  Upstart subscription services like the Dollar Shave Club (bought for $1 billion by Unilever nine months ago) and and its smaller clone Harry’s (which I use) have emerged.

Gillette has, I think, done the only things it can to repair the damage from creating a pricing umbrella under which competitors can prosper.  It is reducing prices.  It has already established its own mail order blade service.  On the other hand, Harry’s is now available in Target stores.   Unilever will likely use the Dollar Shave Club platform to distribute other grooming products.  So the potential damage is contained but not eliminated.  Competition may also spread.

The lesson from the story:  the cost of preventing competitors from entering a market is always far less than the expense of minimizing the damage once a rival has emerged.  That’s often only evident in hindsight.  Part of the problem is that once a competitor has spent money to create a toehold, it will act to protect the investment it has already made.  So its cost of exit becomes an additional barrier to its withdrawal from the market.

 

 

 

Employment Situation, March 2017

The Bureau of Labor Statistics released its monthly Employment Situation report earlier this morning.

With an addition of +98,000 jobs, the figures were a little more than half the rate of gain or recent months.  Revisions to data from the prior two months clipped another -38,000 positions from the total.

Although the report isn’t great reading for stock market bulls, we’ve seen over the past eight years of economic recovery that bad months occasionally occur, even in the midst of a sharply upsloping trend.  In addition, although the monthly figures are seasonally adjusted, the weather during 1Q17 has been so unusual in the populated regions of the US–unusually mild in January-February, ugly in March–that the first two months probably look better than they should and March worse.

The only really eyebrow-raising aspect of this report, in my view, is that despite the unemployment rate being at a very low 4.5%, there is still no sign of acceleration in wages.  This implies no urgency for the Fed to raise interest rates aggressively.

reversing quantitative easing

US stocks were up by about 1% yesterday when the minutes of the last Fed meeting came out.  As Fed watchers saw the topic of paring down the Fed’s $4 trillion+ holdings of government bonds was mentioned, stocks (but not bonds) began to give back their gains and ultimately finished the day lower.

What’s this about?

  1.  The Fed typically uses the Federal Funds rate for overnight loan to loosen or tighten money policy.  In doing so, it depends on the banking system to broadcast increases or declines in interest rates into the market for longer-term debt.  The problem since 2008 is that the banks had destroyed their own creditworthiness through years of unsavory and unsuccessful speculative financial markets trading.  So they were ineffective in performing this crucial rate-determining role.  Congress and the administration were–and still remain–lost in their inside-the-Beltway alternative universe, so there was no hope of help for the failing economy from that source.  The Fed’s solution was to begin “unconventional” operations, by buying huge amounts of longer-dated government debt in order to push down long-term interest rates itself.  It now holds something like $4.3 trillion worth of Treasury and government agency debt.
  2. The Fed has long since stopped making new net purchases of longer-dated bonds.  But as its existing bonds mature, it has continued to roll over the money it gets from them into new bond purchases.  The next step for the Fed in normalizing the long-term debt market will be to stop this rollover.  The consensus is that this change will happen later this year or early next.
  3. What’s “new” from yesterday is that the Fed put this thought down in writing, without specifying any details.

My take:  while the Fed announcement may have been the trigger for an intra-day selloff in stocks, the Fed minutes are not a big deal.  There is an investment issue as to how the Fed will proceed, but that will ultimately be influenced by how capable Mr. Trump will be to get Washington working again.

The President’s early performance has had two consequences:  US investors are beginning to think about shifting money to Europe.  Despite Brexit, that region is beginning to experience its own economic growth.  As well, it is having deep second thoughts about electing Trump-like figures in their own countries (we’ll learn more in the first round of the French elections on April 23rd), thereby increasing their attractiveness as an investment destination.