An ancient but appropriate Asian tale has it that a fox foraging for food once
found itself far from the jungle and in the middle of a town. Spotted by a pack
of dogs, the fox ran for its life, and in its hurry ended up in the coloring
vat of a textile weaver. It emerged from the vat resplendent in blue; a color
that instantly scared off the dogs. The blue fox went back to the forest, where
it duly proclaimed itself king by virtue of its unique color among all the
mammals living there.
A few months later, the monsoon arrived and with the rains, out came the blue
color from the fox; leaving in its place an ordinary
brown and red animal. With the color transformation, the fox's reign also
ended, and it soon rushed back to the depths of the jungle never to be heard
The story resonated with the markets on Thursday, after the preliminary
estimates of US non-farm payroll (NFP) for June showed a decline of 467,000
jobs, a number that was some 100,000 worse than the market expectations as
surveyed by Bloomberg. With it, hopes that had been building up in the global
markets over the past few months that further improvements in US employment
would help spell the end of the current recession were dented, if not
Now, I would be the first to caution everyone about extrapolating from a single
number, and in particular a noisy estimate that was hurriedly cobbled by people
in the US Labor Department ahead of a long weekend to celebrate the country's
Independence Day. Bloomberg reported as following:
The jobless rate
jumped to 9.5%, the highest since August 1983, from 9.4%. Unemployment is
projected to keep rising for the rest of the year just as the income boost from
the stimulus package fades, undermining prospects for a sustained rebound in
household purchases, analysts said. As companies from General Motors Corp to
Kimberly-Clark Corp cut costs, the lack of jobs will restrain growth.
"This will be another jobless recovery," said John Silvia, chief economist at
Wachovia Corp in Charlotte, North Carolina. "We may get positive economic
growth driven largely by federal spending, but people on the street will say,
"Where are the jobs?"
Still, going back to the story of the
blue fox, it is tempting to note that a number of data points of late haven't
quite backed up the notion of green shoots being visible in the US or European
economies. After that observation, it is relatively simple to point out that
the rally in various really risky assets would likely end rather quickly if the
notion of an incipient economic recovery were disproved.
Why is jobs data so important? In pure economic terms, it is fair to suggest
that US monthly jobs attract more than their fair share of market interest, as
many believe that the number helps to validate short-term observations for the
economy, such as sales growth, production increases, exports and so forth, all
of which help to boost the case for overall economic growth and from it, the
picture for stock market growth.
The second reason why jobs data is important is their implication for consumer
spending, credit quality and other indicators of interest to credit markets (as
well as stocks). In the event, the decline in working hours for the second
consecutive month points to growing under-employment (that is, people getting
work for fewer hours than they want to actually) in the US.
This is an important indicator because if people get less work than they want,
it also means that they are getting paid less than they usually receive, or
indeed than they would like to get paid. That could well be the function of two
different things: employers want to pay them less on an hourly basis
(disastrous deflation) or eventually will want to cut the number of workers
once they can justify it - because you cannot fire a third of a person.
From there, we can gather that people are more likely to save rather than
spend; that the increase in government debt is offset by personal savings;
another indicator of really lousy economic conditions (think Japan, but
multiplied a few times).
That means retail sales with and without durable goods will continue to drag
along while the inventory build-up over the second quarter that helped to spark
all kinds of optimism in the stock markets will quickly be replaced by
de-stocking. All of that is bad, really bad, for economic numbers in coming
There are two major problems with global stock markets today. The first is that
the idea of permanently lower corporate earnings hasn't quite sunk into equity
investors in either the US or Europe. Why permanent? Because the very structure
of the US and European economies will have to be overhauled in reaction to the
current credit crisis. That's a pretty fancy way of saying that basically, the
US and Europe simply cannot consume as much as they did previously and will
have to focus more on production for Asian and emerging markets.
This in turn implies that the earnings of Asian exporters will need to implode
as their ability to turn profits from the sales of minor widgets to the US and
Europe will have to disappear over the near term (one to two years), to be
replaced by gigantic profits of goods to their own consumers over the
medium-long term (anywhere from three to 10 years).
The second point is that today's earnings multiple that are arrived at by
dividing stock prices by average earnings are totally incorrect in this era of
wholesale change. In other words, any double-digit price earnings ratio (PER)
is essentially a triumph of hope over (most likely) experience, with almost no
chance that the expected growth in dividends will ever take place or at least
not quickly enough to justify such lofty multiples.
Thus, equity investors will have to contend with the specter of both lower
earnings and smaller earnings multiples - the perfect double whammy on their
current positions. Suppose you currently own a stock at $150 per share, which
is explained to you as $10 of earnings per share annually, and a multiple of 15
times that earning (in other words, your claim on the company's earnings for
the next 15 years must be paid upfront).
Based on the above correction, lets say we can suggest new earnings of $7.5 per
share - a decline of 25% - but also a lower multiple of say 10 times that
earning, which is more appropriate given the risks of that basic earning. So
your stock price is now $75, which is exactly half the $150 you were asked to
pay previously. In effect, that means it would take a pretty large decline in
current stock prices for any meaningful bargain-hunting opportunities to be
It is a truism that while debt markets fear inflation, they absolutely detest
deflation; especially when one looks past the absolutely safe end of the fixed
income spectrum (that is, the government debt of some countries).
In other words, any debt issued by entities that have no ability to print their
own currencies - in which hopefully the debt is also denominated - will have to
confront lower revenues entailed by deflation, which is only partially offset
by lower borrowing costs.
I wrote in various columns previously (see, for example,
Easy bets with other people's cash, Asia Times Online, May 23, 2009)
that the game of investors purchasing risky debt - such as that issued by
companies rated below investment grade - cannot be explained by economic
fundamentals. Such companies have a high dependence on cashflow growth in order
to sustain their debt loads; when economies collapse they will inevitably run
out of cash faster than they will run out of debt, that is, they will have to
default on their obligations.
A scarier version of this problem is represented in the position of various US
states, ranging from California to Florida. As state governments issue their
own debt that is expected to be repaid by their revenues from taxes and
services locally, a deep recession is more likely to hurt these governments
than the federal government, especially as the latter can print its own
A report on Yahoo! Finance summarizes as follows:
drop in tax collections, coupled with a prolonged recession, has states facing
their worst fiscal crisis in decades. Several states are entering the first
weekend of the fiscal year and July Fourth holiday without a budget in place
and facing the prospect of government shutdowns and program cuts. California is
ready to start issuing IOUs to vendors because the state is out of money.
The sputtering economy has ravaged all forms of tax collections. Taxes ranging
from sales to personal income to property are all down, said Brian Sigritz, a
staff associate with the National Association of State Budget Officers in
The problem for debt markets is that the
so-called municipal market in the United States runs into hundreds of billions
of dollars. With financing down, and various states running the danger of
essentially issuing IOUs rather than hard cold cash (Republican-run California
has already gotten there), there is a real possibility that the entire market
could shut down over summer.
In turn, that would mean the opening of a new front in the financial crisis, as
millions of investors lose their investments in such bonds, or at least have to
stomach huge losses over the near term. The scale suggests something similar to
two years ago when the market for auction rate securities completely froze up,
sending many states, cities and other government-linked borrowers to emergency
That crisis could overturn the sunny news from credit markets for much of this
year, as shown by new bond issues and generally tighter credit spreads.
It is fair to say that over the past 15 weeks or so, the notion of incipient
market recovery has aided emerging markets by providing greater investor
interest and allowing for contiguous if not spectacular stock market rises
along with slightly better currency values and decent trade numbers.
Step back from the brink though, and as I pointed out in the previous article
Jackson Factor, Asia Times Online, June 30, 2009), actual gains from
consumption have been minimal, with government spending programs doing much of
the heavy lifting. This is indeed appropriate for various Asian governments,
including China's, to indulge in, but not for countries with current account
and fiscal deficits such as India.
Even for countries like China, I fear that much of today's efforts are being
misplaced in production infrastructure for non-existent export markets. It
almost doesn't matter that goods can get from the Chinese hinterland to ports
on the southeast coast; as the ships docked there aren't going anywhere soon.
Much of the blame for this situation lies with Asian central banks that insist
on a gradual approach to the current crisis, when clearly more radical and
forceful steps are warranted. At the very least, a few need to be immediately
1. Cut the currency umbilical cord with the US dollar and allow a free
float; 2. Reduce holdings of US and European government debt, instead using the
money to upgrade infrastructure and deliver better services to their own
citizens; 3. Strictly police the loan growth at domestic banks, much of it being
misapplied to risky speculative ventures rather than the credit creation
intended by the government; 4. Pray.
Health warning: As with any of my commentaries on stock and other asset
markets, readers must not depend on the words of a pseudonymous commentator in
making their decisions. You should instead consult proper experts that can
advise on your specific situation and if no such experts can be found use your