Avoid The Noise
Our investment meeting this week followed the usual format. We review market performance, look at what our investment model frameworks are forecasting, then discuss what other issues, not reflected in our frameworks, might also impact market movements. Our investment mantra has been, and still is, “avoid the noise”. We believe by focusing on observable economic data, and avoiding the histrionics of cable news, talk radio, and the handful of print media still in existence, our process will avoid emotional decision making in favor of logical decision making. This has always proven to be a successful formula, eventually. Three weeks ago markets hit all-time highs, the noise makers were saying all was good. Then we sold off nearly 6%, we are told the end is nigh. Then we bounced back again and the S&P 500 hit its all-time high yesterday. Our suspicion is the Algos (sophisticated institutional traders) are making a fortune off the emotional retail traders. Expressing aggravation and frustration is generally non-productive and inefficient. We acknowledge that. Despite this, we also accept we are human and have the need to gripe occasionally. We appreciate you listening, it’s much cheaper than therapy. What annoys us the most about the noise is the lack of unique views and the repetitiveness of the opinions. So repetitive are these opinions that clichés and standardized talking points dominate the cable news on both sides of the political spectrum. Here at GreenPort, we crave something a little more thought provoking. Let’s take a look at last week’s employment report numbers. They were mildly below expectations. The Bears said this supports their view the economy is weakening. The Bulls point out that the overall unemployment rate is at record lows. Then they yell back and forth at each other. It’s stimulating. We have a different take on the employment report. We prefer focusing on the payroll numbers of the report while giving minimal weight to the employment numbers. The payroll numbers count the number of jobs while the the employment data counts the number of workers. Critical to our reasoning, the payroll number is based on observable payroll data. When a company hires someone that new employee is required to fill out paperwork so they can be taxed. I'm sure you've all experienced this joy. The upside of this process is that we now have hard data that one more person is now working. When someone leaves a job they drop off the payroll and we have hard data that one less person is working. It’s a real number. That’s why we like it. In contrast, the employment report is derived from a monthly government survey. While there is some value to the number, we believe fluctuations in the monthly employment number are often due to the survey method, not necessarily changes in the economy. Employment data is gathered by government employees calling individual households and asking a series of questions. “Are you employed?” “Are you looking for employment?” “Are you able to work?” It seems obvious to us that there are many flaws in this methodology. Survey calls are made to land lines. Many millennials no longer have land lines. In order to answer a call, you must be at home. If you are working, you likely aren’t at home. If you do work from home, you are more likely not to answer your land line phone. If you are able bodied and receiving unemployment benefits you are required to be actively looking for a job. You are likely going to answer that you are looking for a job even if you aren’t. The point we are making is this; how long you have to wait to get into a popular restaurant is probably a better indication of the economy than the employment survey numbers. For those still interested in employment survey data, the unemployment rate is 3.9%. According to economic theory, the “natural” unemployment rate is 6%. We are taught that due to frictional unemployment, (people moving jobs, firings, etc.), that full unemployment is 6%. If we drop below 6% the economy experiences a shortage or workers, which will result in rapidly rising wages. This causes inflation and corporate margin compression, which leads to lower corporate earnings and the next recession. So where is our much-promised inflation and recession?
Here’s what we think is going on. The latest JOLTS (Job Openings and Labor Turnover Survey) data show that there were 7.5 million job openings and 6.2 million unemployed workers. Therefore the math says there are 1.3 million more jobs than workers. We have a labor shortage.
Since there are more job openings than people to fill them, the labor market is tight. Wages should be rising at a rapid rate. However, actual hourly earnings only rose 3.1% y/y for all workers. That’s a solid pace and continues to outpace the inflation rate, but no where near where the rate increase should be given the labor shortage.
Our belief is that productivity has been making a comeback. If a company can’t find workers, or would need to pay new workers too much, companies will use technology to boost productivity. They also look outside of the domestic labor force, where there are no shortages of skilled labor willing to work for less. The 20-quarter average annual growth rate of nonfarm productivity was 1.3% through Q1-2019, up from a recent low of only 0.5% through Q4-2015.
Productivity growth allows the economy to grow, without inflation, despite the apparent shortage of workers. It keeps a lid on price inflation while allowing wages to rise faster than prices. Our view is that these real wage gains combined with productivity gains are allowing consumers to increase their spending without hurting corporate margins. This is positive for the economy and bullish for stocks. It's been crazy out there. Market fluctuations are enough to rattle the most seasoned investor. All we can do is focus on the fundamentals. The fundamentals are telling us this bull market still has legs and inflation is still in check. Another leg up in the stock market seems likely, along with many pullbacks along the way. Inhale then exhale, The GreenPort Team