Marcuard’s Market update by GaveKal Dragonomics
With US equities making new highs and another earnings season now under way, it is a good time to remember that to be sustainable, a bull market should rest on three pillars: liquidity, valuations, and growth. At any given point in time, however, just one of the pillars is likely to be doing most of the load-bearing. Consider the current bull market. At the outset, central bank liquidity played the key role. Then, last year was largely about valuations. While sales and earnings growth were lacklustre, an impressive multiple expansion brought valuations up from obviously cheap to roughly fair value. With valuations neutral and Fed policy not getting any easier, the growth pillar is now going to have to take the weight if we are to remain comfortable buying into this rally. Happily, the data is encouraging. Consider the following bullish combination:
Households have deleveraged. In early 2012, we set a low target for US household leverage. Largely for demographic reasons, we thought the debt/asset ratio needed to fall all the way back to levels that prevailed in the 1990s. The good news is that road has been traveled, with the leverage ratio now back at early 1990s levels. More importantly, households are comfortable with their balance sheets and have started to add debt again in the last few quarters. As long as asset prices hold up, healthy household balance sheets are positive for domestic demand.
The labour market is getting tighter and wage growth is back. For the middle to upper income brackets, the improvement in household balance sheets is huge. For lower income brackets, the state of the labour market and wage growth are more important. Here, too, we see positive signs. Private payrolls were surprisingly strong in June, up 262,000 (versus the expected 210,000 rise). Our preferred cyclical labour market indicator, the employment-to-population ratio for the core working ages of 25-54, also rose to 76.7% in June, from 76.4% in May (and up from 75% at the bottom in 2010-11). Headline unemployment fell from 6.3% to 6.1%. If we strip out 65% of the long-term unemployed, our adjusted unemployment rate is just 4.9%. No wonder private wages are rising 2.3% YoY. That is not stellar, but it is up significantly from the trough of 1.3% at the end of 2012. Sure, stronger wage growth could erode margins, but experience from the last cycle suggests the effect will be modest. US companies have become masters at managing labour costs, and if cost increases cannot be avoided, they will be passed on to consumers with recent business surveys and CPI readings suggesting pricing power is on the rise. At this stage, the dominant effect of rising wages should be increased top-line growth. With a more modest impact on margins, most of that should feed through to the bottom line.
Household formation growth is back, supporting homebuilding. The recession forced a lot of kids into their parents’ basements, but that is now behind us. Household formation growth is back at pre-recession levels; but homebuilding has still to catch up. That is good news for growth.
Business capex should then follow. Looking further ahead, if we are right that sales growth is set to rebound on the back of stronger household finances, then this should be followed by a rebound in capex.
How much of this will shine through in 2Q earnings we are not sure. But at the very least it should improve the earnings outlook for the rest of the year.
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