Productivity analysis continued

Continuing the Productivity analysis, we can see that what should be happening, doesn’t seem to be happening.

Productivity and Output are reasonably stable, output should have in theory dropped precipitously. Employment, normally the stickiest metric by classic economic thought, has plummeted via “hours worked”. [See previous post]

Unit Costs

Are falling. This is in no small measure due to the contraction in wages/salaries from the slashing of overtime etc in the “hours worked” category. This is helping to maintain profitability in trying economic conditions.

Inventory/Sales

Ratio is falling. This for business is a good thing. You do not want building inventories as a business, the carrying costs and or obsolesence are bad for profits. The chart demonstrates that product is still being sold.

Capacity Utilization

There is still some slack in the system, which will ameliorate any demand pull inflation. Possibly the slack is on the employment side. The previous data would suggest that this could well be the case.

 

Productivity analysis

Productivity measures the amount of output that is being produced with given amounts of inputs [land/capital/labour]

Measurement recorded in one of two ways;
*Output per worker
*Output per man hour

Economic growth [GDP] reflects growth of the labour force plus growth of labour productivity. Conversely the opposite is true, falling labour force, or increasing unemployment plus falling productivity results in falling GDP.

An important factor that impacts productivity is the investment of new capital, that raises the Capital/Labour ratio, which is technically known as factor substitution.

Historial trends in Factor Substitution;

………………………………..1960-1973………………..1973-1979…………..1979-1989
Technological progress………2.8%………………………..0.6%………………….0.8%
Factor Substitution………….1.3%………………………..0.9%………………….1.0%
Total labour productivity……4.1%………………………..1.5%………………….1.7%
Labour input………………….1.1%………………………..1.4%………………….1.0%
Total Output…………………5.2%………………………..2.9%………………….2.7%

Here we have in graphical form the years from 1998-2007

Productivity figures are indexed, thus the important base figures are lost, thus distorting analysis. However, trends in the data are important.

For example, if Output per person increases, an increase in wages can offset this, resulting in an unchanged profitability for the corporation.

Cycles in Productivity.
Under classic economic theory, productivity is highly cyclical. Thus, when production falls, after a peak in economic activity, employment declines less rapidly and output per head plummets.

As can be seen from the graphical data, this just does not seem to be the case currently. The metrics requiring further study are Unit Labour Costs and Factor Substitution.

 

Trends

With the consumer driving some 70% of GDP through consumption, for the economy to perform well, and by implication, earnings for listed companies, the following should be true;

*High employment
*Growing demographic trends
*Wages that match or exceed inflation
*Steady state interest rates

Demographic trend;

Employment trend;

Wages & Inflation;

As can be seen, this data is from 2004, when inflation was low, and interest rates were rising, or at least at the natural rate. This has changed for the worse, with inflation running rampant currently.

These are the “official” figures. I suspect the actual rate is higher.

Producer prices [commodities] have been reflecting a far more accurate gauge of inflation.

Wages;

Wages have lagged. With increasing unemployment, the effects of this total loss of purchasing power will manifest itself into the real economy and corporate profits.

What is somewhat of an unknown, is the difference between corporate profits that are derived from a global source, as opposed to smaller companies that derive revenue from purely domestic sources.

In summary, the fundamentals currently do not suggest that the building blocks for a dynamic economy, and therefore a bull market in common stocks are currently in place.

Certainly, as previously detailed the Federal Reserve averted a full scale systemic shock via a collapse within the financial system, via the cutting of interest rates, and innovatively by accepting collateral MBS as an exchange for Treasury paper.

The drop within the Fed Funds Rate however has initiated a pernicious inflation through commodities via a collapse within the US$. This will need to be addressed prior to any launching of a fresh leg in an equity bull market.

 

Unemployment…the reality?

Although not strictly unemployment alone, but a combination of over-leveraged lifestyle and low wages, this article makes harrowing reading;

Economy great - for pawnshops
By Alfred Lubrano

Inquirer Staff Writer

Carin Dillingham handed over her watch to the pawnbrokers at Society Hill Loan as if she were giving up one of her bones.
The 30-year-old bookkeeper stood pregnant, broke and sad under rows of pawned guitars hanging like curing hams from the ceiling of the ragged South Street shop. She got a $20 loan for her $200 Bulova, a gift from the Harley-Davidson Co., where she used to work.

“It feels so weird,” said Dillingham, accompanied by her fiance, Pat Lapetina, 35, an unemployed ironworker doing painting jobs on the side. The couple recently moved to South Philadelphia from Florida to build a life.

“I worked hard for this watch. I’m middle-class, not poor. I can’t believe I have to do this to buy gas.”

Federal Reserve Chairman Ben S. Bernanke won’t call what we’re living through a recession. But at Society Hill and other such shops - where they measure economic misery in increasing volumes of pawned bling - they’ll tell you that hard times are hard times, whatever label the eggheads affix.

“People are cleaning out their houses of gold, silver, whatever, to get money just to fill their cars with gas,” said Nat Leonard, 51, whose grandfather opened Society Hill in 1929. “People are pawning out like crazy.”

Business is up maybe 20 percent over last year.

“With this economy, we’re not done yet with bad times,” Leonard continued. “Not even close.”

Things are so awful, he said, he’s getting loads of first-time customers.

“I’ve got business owners coming in to pawn things just to make their payrolls,” Leonard said, incredulous. “I’ve never seen that before.”

In this economy, people aren’t buying as much jewelry as usual, so retail jewelers on and around South Street have to pawn inventory to pay their workers. “One jeweler owes me $150,000,” Leonard said, showing off the pawned collateral in a backroom safe.

Deep in the dark depository, dozens of plastic bags hold a pirate’s booty of rings, master-of-the-universe Rolexes, diamonds, and back-of-the-closet Krugerrands. Bunched and intertwined, the pieces collectively look like junk.

But take them out one at a time under Leonard’s fluorescent lights, and their inherent worth shines through.

Less valuable jewelry fills Leonard’s front-of-the shop glass counters. Typically, a person brings in a piece of jewelry whose worth Leonard or an associate will assess. Leonard may offer around one-third the value in a loan, at 3 percent interest. If the person doesn’t return within eight months with principal and interest, Leonard has the right to sell the jewelry.

Increasingly these days, people are forced to pawn signficiant pieces - many of them obviously gifts - and are unable to pay back the loan.

Given in love, they were pawned for gas, food, whatever.

“This makes me sick, sick to my stomach,” said Bobby Doran, 42, a South Philly brick repointer. He had just come in to reclaim his gold crucifix, paying back the $70 loan Leonard gave him plus $2.50 interest.

“This thing is sentimental. It’s important to me,” Doran said, gripping the cross, which Cardinal Justin Rigali had blessed. “I pawned it for gas for the week.”

It’s not just fuel that’s bringing new people to pawnshops. And they’re not all brick pointers.

“Upper-income people are in pawnshops nowadays, needing money right away to meet payments,” said Bill Stull, chairman of the department of economics at Temple University’s Fox School of Business and Management.

“We are in an economy in which many people are living right at the margins, even middle- and upper-income people. They have little savings, they’ve borrowed so much, their credit-card bills are high, and their house values are going down.”

Over at Carver W. Reed & Co., a pawnshop at 10th and Sansom Streets since Lincoln was president, more and more higher-echelon people are filing in, owner Tod Gordon said.

“The upper middle class is feeling the crunch like never before,” he said. “They’re bringing in diamonds and gold to pay for margin calls on stocks. There’s a feeling of despair.

“These people are used to paying their bills, no problem. Now it’s a whole new world. They’re struggling. So maybe they won’t go on vacation this summer, and they’ll pawn jewelry to fix the roof.”

As a result, pawnshops are more frequently becoming the secret repositories of great local wealth.

Somewhere in the recesses of the Society Hill shop or one of its storage facilities is a huge art collection that a well-to-do patron was compelled to pawn. Also, Leonard’s associate Jim Shea said, he recently lent $17,000 on a historic Philadelphia fire hat worth around $50,000.

And the shop is holding 30 guitars, worth $170,000, that a Grammy Award-winning Philadelphia musician owned. “He bought a bunch of properties right when everything in the economy was hitting the fan,” Leonard said. “I feel awful about it. I don’t want to sell his stuff out.”

Of course, as always, things are worse at the bottom of the ladder.

“I’m seeing people extending their loans, unable to pay back their $100 loans for diapers, food, medicine,” said Bob Sink, owner of JR Auto Tags & Pawnshop in Bristol Township.

“These folks are making $10 an hour or whatever working at Home Depot and can’t cut down on expenses any more,” Sink said. “So they borrow against a gold chain or a new tool. The economy is really hurting them.”

Also stung are young people, hitting pawnshops in unprecedented numbers.

“We never saw so many people in here 30 and younger,” Society Hill associate Damien Robinson said. He spoke as a 22-year-old Neumann College graduate walked out with a $75 loan on her Dell laptop computer. “What are young people going to do for rent now that apartments are so expensive?”

It’s a question that Dillingham, currently light one Bulova watch, is straining to figure out.

“I didn’t think living in Philly would be so hard,” she said. “I thought things would fall into place.”

Hearing his fiancee’s anguish, Lapetina said quietly, “It was hard to pawn her watch ’cause it’s one of her favorite things. It’s just been so rough. But I told her I’ll get it back for her. Soon.”

On the unemployment front, we have the usual obsfucation from the BLS.

 

Employment…the driver going forward.

Start…………..End……………Duration……………Unemployment/Rate…………..Change/GDP
8/1929………..3/1933………….43………………………..24.9%……………………….[-28%]
4/1960………..2/1961………….10………………………..6.7%…………………………+2.3%
12/1969………11/1970………..11…………………………5.9%…………………………+0.1%
11/1973………3/1975………….16………………………..8.5%………………………….+1.1%
1/1980……….11/1982…………6………………………….7.6%…………………………[-0.3%]
6/1981……….11/1982………..16…………………………9.7%…………………………[-2.1%]
6/1990……….3/1991………….8………………………….7.5%…………………………[-0.9%]
3/2001……….11/2001………..8………………………….6.0%…………………………..+0.5%

The duration, and contraction of a recession is very much dependant upon the level of unemployment, which is due to consumer spending contributing some 70% of GDP. Thus, to get an idea of how deep the recession may be, examining unemployment will shed light on the subject.

Typically recessions originate within a “shock”…unexpected bad events, the prototypical Black Swan event that then morphs into the economy. We have had in the past, oil crisis, terrorist attacks, natural disasters etc.

The shock, that has triggered this recession will most likely be attributed to housing, sub-prime, and financial system melt-down.

The duration, depth and damage that a recession can cause are all tied to the ability of prices to adjust. If prices can adjust quickly, the recession will be shallow, if they cannot adjust, or adjust very slowly, the recession picks up momentum.

This is why stockmarkets tend to lead the economy, both up….and down. The pricing mechanism in financial markets is very transparent, the liquidity generally, is high, thus prices can, and do adjust very quickly.

House prices, by comparison, are less transparent, less liquid, and adjust by comparison, very slowly. Having said that, housing prices are adjusting very quickly to the downside. While people are certainly not happy about this, particularly if they purchased near the top, as far as housing remaining a recessionary driver, this is a very positive outcome that will shorten the recession.

Employment has very sticky prices, which is why unemployment becomes such a factor. Businesses that experience falling demand for product inventory, will, to sell the inventory, drop prices. Future inventory, to remain profitable, must cost less to produce. Cost of Goods, the line entry on Financial Statements accounts for usually some 70% of costs, much of this falls under wages.

Will workers accept pay cuts?

No, they tend not to…thus, rather than cutting wages, management cut workers, thus unemployment increases.

The second factor that affects product pricing are the inputs, raw materials. Currently, these are suffering high inflation, oil, foodstuffs, etc. Thus, again, to make a profit, producers cannot drop prices below their costs, due to high commodity costs.

Therefore, due to the stickyness of commodity prices, unemployment must rise, to allow inventory prices to fall. This outcome will be politically unpopular, and unacceptable, thus, once the financial crisis within the banks has been solved, which is underway, the next order of business will be once again to tackle inflation.

Commodities are responding to the below natural rate, interest rates, lowered due to the “shock” applied to the financial system. Only when rates again return to the natural rate, or slightly above, will we see a return to supply/demand equilibrium within the commodity markets.

With todays FOMC meeting, I suspect the reduction in rates will end, and signals will be sent that the future direction of rates will be upwards…thus we can expect in that scenario, sector rotations that will reflect the price of money.

This will need to be done carefully, as rising rates, will trigger a sell-off in the Bond market, as investors close out profitable positions. This sell-off will raise yields, making by comparison, stockmarket yields less attractive.

Thus, the Fed will need to maintain a delicate balance, as falling equity prices could re-threaten the banks and their capital ratio’s [again] if there is a particularly violent sell-off in equity markets. Volatility is not going to disappear just yet.

 

Unemployment…the next crisis

The banking crisis, as noted several weeks ago, pretty much resolved with Bernankes intervention and rather innovative solutions to the banks dilemmas. Whether they were all legal, is immaterial, they cauterised the hemmorage.

Not so easy a problem to solve will be the increasing momentum within unemployment. Employment is known as one of the sticky economic metrics, and for good reason.

The crisis will simply morph from the financial sector [in stock market terms] into any and all sectors where employment impacts the financial condition of the statements.

Economic data in the US have taken a notable turn for the worse. Most im­portantly, the already weakening employment outlook is being further undermined by a widely diffused build-up in inventory and falling profitability. History suggests that the latter two factors lead to significant employment losses.

While the financial system, within the major money centre banks and broker/dealers, have taken steps to enhance balance sheets, they speak essentially to addressing the consequences of excessive leveraging and imprudent financial alchemy. As such, the nasty turn in the real economy may fuel another wave of disruptions that, this time around, would also have an impact on mid-size and smaller banks

The focus will also be on the reaction of policymakers. Here the outlook is mixed. The good news is that the crisis is now moving to an area where traditional policy tools are more effective. This is in sharp contrast to the situation of the past few months, where central banks were forced to use instruments that were too blunt for the purpose at hand.

But there is also bad news. The sharp slowdown in the US real economy will occur in the context of continued global inflationary pressures. As such, the Federal Reserve’s dual objectives – maintaining price stability and solid economic growth – will become increasingly inconsistent and difficult to reconcile. Indeed, if the Fed is again forced to carry the bulk of the burden of the US policy response, it will find itself in the unpleasant and undesirable situation of potentially undermining its inflation-fighting credibility in order to prevent an already bad situation from becoming even worse

Hours worked, is the sharp end of the stick with regards to employment. Employment is sticky, thus, overtime hours are always reduced prior to any permanent reductions in the workforce.

We have seen over the past few months increasingly poor employment stats, sugar coated via the birth/death black box model

Let’s look at different sectors;

Financial sector

Construction;

Retail;

Mining;

Transport & Utilities;
Note here, the interesting divergence twixt the real economy, and stockmarket.
More on this at a later date.

Education & Health

But you get the general idea. The market has been through all of this previously, historically speaking, thus, it is unlikely that there will be a new bull market, based on the facts that too many sectors are going to be problem areas.

Obviously, further analysis into business cycles, sector rotation, and asset classes would potentially improve returns down the short-term, intermediate term road.

 

Employment

Employment and unemployment are highly cyclical. When demand increases, businesses tend to first increase overtime hours. New employees are only hired when the ability to meet demand can no longer be satisfied via an increase in overtime.

Conversely, when demand falls, overtime is first reduced. If demand continues to fall, only then are jobs shed.

Thus, the first signs of an ultimate bottom within this current recession [as opposed to the financial markets which will exhibit increased volatility] will be an increase in overtime hours, followed by an increase in job creation.

Hours overtime;

Employment;

As can be easily discerned, the recession hasn’t bottomed yet.

 

Economy

The state of the economy looks to be intensifying to the downside. Employment, always a lagging indicator, but the vital one, seems gradually to be confirming the trend.

State Budgets are also heading the wrong way. This inhibits any slack within the employment numbers being cushioned by a Keynesian spend. Just the opposite in fact, as budgets further deteriorate, so cuts must be implemented, and jobs are very often an expense that can be cut.

 

One problem for the economy

Take a look at this chart.

Herein lies a problem for the economy.
As the consumer is responsible for some 70% of GDP, and already overleveraged, with the Banking system capital constrained and unable to lend in the short-term, where will growth come from.

The short answer, is, it won’t. Corporations that haven’t wasted money on share buybacks, will not be increasing capital spending anytime soon. The question from the 2000 bust was when will corporate capital spending increase? It never did, and won’t again.

Common sense dictates that if the consumer is struggling, demand across the board will fall, thus why increase output via new investment?

Will inflationary pressures be able to be transferred to the consumer? Increasingly the answer looks like, not likely. Thus the stagflation era looks to be returning once again.

Low earnings, high costs, decimated American corporate valuations in the late 1960’s into really the early 1980’s, the 16yr secular bear market, one of the most brutal on record.