Peaking along with retail sales are the economic numbers that abound in the final weeks of each calendar year.
The year closing out and the year ahead are sending off their last and first indicators, respectively, of the state of the economy.
Adrift in the year-end deluge are the true signs of economic health…
By the Numbers
A stronger than expected employment report closed a week in which both the Yen and oil continued to drop. November payrolls grew by 321,000, much higher than expectations of 230,000, and the prior two months were revised upward by 44,000. Other notable positives were average hourly earnings rising by 0.4% month-over-month (versus expectations of 0.2%) and 2.4% year-over-year and the average work week rising to 34.6 hours, back where it was before the 2008 crisis.
The economy has added an average of 228,000 jobs per month over the last year, hardly a blockbuster rate in a population of 300 million, but enough to reduce the unemployment rate to 5.8% with the employment participation rate is still hovering at 40 year lows of 62.8%.
A closer reading of the report showed that part-time jobs rose by 77,000 while full-time jobs dropped by 150,000. Huge numbers of Americans are still being shut out from the recovery with 2.8 million out of work for more than six months and another 6.9 million working part-time because they couldn't find full-time work. Five years after the financial crisis these jobs numbers are nothing to write home about, but better late than never. The real question is whether this report will start a break-out to stronger numbers or was flattered by seasonal factors. The debate will now intensify regarding how the Fed can justify keeping interest rates at zero in the face of strong job growth and increasing signs that wage growth is beginning to set in.
The Dow Jones Industrial Average pushed forward to another record close, adding 131 points or 0.7% on the week to 17,958.79. The S&P 500 added 8 points or 0.4% to a new closing high of 2,075.37. The Nasdaq Composite Index peeled off 11 points or 0.2% to end the week at 4,780.76 (largely due to a rare weekly loss in Apple, Inc. (NYSE: AAPL)) while the small cap Russell 2000 added 9.2 points or 0.8% to close at 1,182.43. Trading volumes were generally muted as investors begin to wind things down for year end.
The Treasury yield curve, which has been signaling a slowdown all year, continued to flash warning signs after the jobs report. The two-year yield popped by 10 basis points to 0.647% after the report, its highest level since April 2011. As recently as mid-October, at the depths of the mini-panic, this yield was a low as 0.244%. The two-year note is considered the market's gauge of expectations about the timing of the Fed's interest rate hikes and clearly markets read the November report as moving forward the day when the Fed will act. A flattening yield curve normally signals a slowing economy and the yield curve continued to flatten as well. The 2/10 curve was down to 175 basis points and the 2/30 curve dropped to 234 basis points, below the levels it traded at when Lehman Brothers failed in September 2008.
Yet the stock market is sending a completely different signal even as commodities, including the most important commodity of all, oil (and everything related to it like the Russian Ruble) keeps falling. The CBOE Volatility Index (the VIX) plunged to a three-month low of 11.82, sending an all-clear signal to risk-takers. CNBC is now on "Dow 18,000" watch until further notice as a parade of Happy Faces tell its declining viewership why they should keep piling into overvalued stocks in our now booming economy.
These Retailers (and their stocks) are Stumbling…
Despite press reports crowing about how consumers and retailers are going to benefit from the plunge in gas prices, significant parts of the retail sector are struggling badly. Teen retailers Abercrombie & Fitch Co. (NYSE: ANF), Aeropostale Inc (NYSE: ARO) and American Eagle Outfitters (NYSE: AEO) reported more bad results this week, reflecting the problems facing retailers dependent on mall traffic for sales.
Other parts of the retail world also reflected the continuing impact of ecommerce on the industry as well as their own management miscues. Perhaps the most interesting news was J. Crew Group Inc.'s decision to write down the value of its retail stores by 57% or $536 million while leaving the value of its online operations untouched. The company was taken private in a $3.1 billion leveraged buyout in 2011. Other retailers continue to feel the impact of radical changes in the industry landscape. J.C. Penney Company, Inc. (NYSE: JCP) saw its stock fall by 16% by Thursday night after being downgraded by Goldman Sachs and is now down 28% year-to-date.
With sales still 30% below 2011 levels, e-commerce growth slowing and core customers not increasing their spending significantly, JCP appears to be stuck in a rut in its return to its pre-Ron Johnson strategy. These problems were also seen at Sears Holdings Corp (NYSE: SHLD), which announced a $548 million loss for its quarter ended Nov. 1 compared with a $534 million loss a year earlier. SHLD's revenues dropped to $7.21 billion from $8.27 billion a year mostly attributable to store closings and lousy same-store sales (the Land's End spin-off accounted for about 1/3 of the difference). While the company is holding out hope that selling a bunch of its stores to a REIT will solve its problems, this is a pipe-dream as the proceeds of about $1.5 billion would only cover 12-18 months of losses. After rising from $32.67 to $42.81 on November 7 on the REIT announcement, SHLD stock has steadily retreated and closed the week back at $33.31. Investors aren't buying what Eddie Lampert is selling anymore.
In a further sign that value continues to shift from the material to the immaterial world, Uber raised $1.2 billion of additional capital at a $40 billion valuation this week. This would make it more valuable than all but 31 companies currently traded on the Nasdaq Composite Index. This may not seem out of line in view of the recent IPO of Alibaba Group Holding Ltd (NYSE: BABA) whose stock has almost doubled since its IPO in September to a $270 billion market cap, but we are likely to look back at this like we do at 2000 Internet stock valuations when the current central bank-induced stock market spell is broken.
Where the Bubble is Thinnest
Barron's ran a cover article this week entitled "Crash? This Time Is Different" arguing that while valuations of Internet stocks are high today, they are not as extended as they were 15 years ago at the height of the Internet Bubble. Today, Barron's argues, the bubble is in private rather than public market valuations. The truth is that the valuations of all social media stocks are ridiculous whether they are privately or publicly held.
The wonder is that some of the so-called smartest investors in the world, including some very savvy hedge funds, are buying into the hype at these absurd levels. In 1999 and 2000, 632 technology companies went public; in 2013 the figure was just 43 and in 2014 just 46. Market changes have allowed companies to acquire huge market valuations before they go public. By the time they can pick the pockets of retail investors, they are already trading at stratospheric valuations that virtually guarantee huge losses in the years ahead. We have seen this movie before and it ends badly every time for the buyers while the investment bankers and venture capitalists make off like the bandits they are.
As Barron's writes, "the most dangerous words on Wall Street are 'This time is different.'" The truth is that the exorbitant valuations in both the private and public market for social media stocks reflects a wider overvaluation phenomenon in a world where central banks are printing money like drunken sailors and economic growth is consistently sluggish. Believe me, this time will not be different and these stocks should be avoided or sold short (using puts of course since the market can stay irrational longer than you can stay solvent).
Stocks have diverged from bond and commodity prices against a very fragile geopolitical backdrop. Investors are still counting on central bankers like Mario Draghi to bail them out. There is a reason that markets feel like 2000 and 2007 to experienced practitioners – they are overvalued and setting themselves up for a sharp reversal in 2015. Investors should not wait to react to the handwriting on the wall. The accelerating collapse of the yen and the sharp drop in oil prices are sending strong deflationary and destabilizing signals. Markets are living on borrowed time.
About the Author
Prominent money manager. Has built top-ranked credit and hedge funds, managed billions for institutional and high-net-worth clients. 29-year career.