Caterpillar Is A Buy At These Levels

This is not a solicitation to buy or sell this security.  Do your own research and come to your own conclusions.  I own this.

     According to Finviz.com, there are 14 companies in the farm and construction machinery sector.  With a $49 billion market cap, Caterpillar is the largest.  John Deere is a distant second with a total valuation of ~$29 billion.  Attesting to Cat's dominant position, the third and fourth largest companies are much smaller at $11.3 and $4.1 billion, respectively.  This industry faces a difficult international environment.  Not only is the strong dollar hurting competitiveness, the commodities super cycle is slowing, which lowers demand.  Domestically, durable goods orders have slowly decreased since mid-summer.  This challenging environment is a primary reason why most companies in this sector are trading at attractive levels.

     Here is the weekly chart, going back three years

 

The stock has fallen about 30%, moving from the 109 level in mid-2014 to its current level in the lower 80s.  There is strong technical support at these levels from several years ago.  The chart may have formed a double bottom in 1Q14.  Finally, the low reading of the MACD implies a move higher is possible. 

     Here is a table from Morningstar of the relevant valuation metrics:

 

On a PE basis, the company is slightly overvalued relative to the industry.  Supporting this is the slightly better than average return on assets and equity.  However, the company’s growth is less than the industry average.  Although the company is pretty fairly valued, its dominant industry position warrants a better than average PE.

     Caterpillar’s balance sheet shows the company is financially well managed.  Receivables decreased from 26% of assets in 2010 to 19% in 2014.  Although the receivables turnover ratio has increased from 2.77 in 2010 to 3.25 in 2014, the size of the increase is statistically meaningless.  Inventory increased from 14%/assets in 2010 to 17% in 2012, but returned to 14% over last two years.  Since 2010, inventory turnover has slightly increased, moving from 95.84 to 113.95.  However, these increases in inventory are very small and don’t detract from the company’s overall attractiveness.  The current ratio is 1.39, indicating the company has ample liquidity.  Finally, long term debt is a conservative 32% of liabilities.  With well-managed receivables and inventory accounts along with a conservative debt structure, Caterpillar’s balance sheet should appeal to any conservative investor.

     The company’s income statement, however, could be better.  The biggest problem is the two year drop in top line revenue, from $65.9 billion in 2012 to $55.1 billion in 2014.  While the COGS percentage has been stable for the last five years, there has been a 2% increase in SGA expenses, leading to a 2% drop in the net margin over the same period.  The dividend payout ratio of 44% firmly supports current dividend levels.  Perhaps most importantly, the interest coverage ratio stands at 12.79, indicating the company’s debt load is anything but a problem.

     And finally, we turn to the cash slow statement, which dividend investors should cheer.  The company has been cash flow positive for the last five years.  With the exception of 2012, the dividend was funded entirely from operations.  The company has the option of ending a stock buyback program (which totaled $4.2 billion in 2012) to protect future dividend payments if necessary.  And with operations investments steady between $1.7 and $1.9 billion for the last three years, there is little reason to think any major change in dividend policy is on the horizon.

     Given the low interest rate environment, Cat’s 3.35% dividend yield is very attractive.  Their financial condition is solid, meaning there is little reason to see a cut in the near future.  The current price level, which is near the lowest of the last three years, is attractive from a long-term investment perspective.  Adding all these factors up, Cat is a buy at these levels.   

    

    

                               

    

International Economic Week in Review: Growing Concern, Edition

This is over at XE.com

This is the graph that scares me still

  - by New Deal democrat

Three years ago I ran a post entitled, "This is the graph that scares me," featuring the graph of  median wage growth, which I've updated below:

Below is an abbreviated version of what I wrote then:
----------------------
[Median wage growth] has been running at under 2% at all times since the financial collapse of 2008.

So, even if inflation runs at the very modest rate of only 2% ..., more than half of all workers fail to keep up.

You simply cannot have a durable economic expansion where most workers are consistently falling behind.

Lower mortgage rates in the last several years has enabled a huge number of consumers to refinance ... [and therefore] the average household has a lower carrying cost of debt, compared with their income, than at any point in the last 30 years.

In the past 30 years,as shown in this graph of mortgage rates, which highlights those periods where interest rates are higher than they were 3 years prior in red, once households have been able to refinance, it took at least 3 years without new lows being established, before the economy fell back into recession.



[in 2012 I continued:]

We just set new lows.

It's difficult to imagine any further round of refinancing once this one is done.  Can rates really go much lower?

If median wage growth doesn't improve soon,  there will be no escaping another recession once the effect of refinancing has run its course ....

[In the Great Recession], we managed to escape without actual wage deflation (although laid off workers may not have been able to find work at the same salary they were making previously).  I doubt we will be so lucky a second time ....
--------------------------
One year ago I updated this post, saying the graph still scared me, and pointing out that YoY growth in median wages was still paltry.

So where are we now?

Here is mortgage refinancing through last week, courtesy of Bill McBride a/k/a Calculated Risk:

Refinancing all but died in mid-2013, and except for a mini-spike at the beginning of this year, has remained asleep ever since.

Refinancing had helped households lower their debt ratios to 30+ year lows:

That deleveraging has all but stopped.

Here is an update of the graph of mortgage rates, focused on the last 5 years:

Mortgage rates bottomed in December 2012.  Eight months from now will mark 3 years since that time.

The good news is, the big decline in gas prices has meant that real median wages have increased to new highs, and most recently nominal median wages have grown at a 2.3% rate.  If gas prices remain low, and if the economic expansion continues for awhile longer, hopefully real median wages will continue to rise.

But I remain very uncomfortable with paltry nominal wage growth. And the next recession is out there somewhere. When it hits, growth in nominal wages will decline.

We entered the Great Recession with wage growth as high as 3.5%, and ended it with 1.5% nominal wage growth.  A similar decline from the current 2.3% nominal wage growth would tip us into outright wage decreases, with all of the horrors of debt-deflation that implies.  This is still what scares me.

What's the culprit behind recent retail sales and jobs weakness?

 - by New Deal democrat

What is behind the recent slowdown in so much economic data?  Candidates include the weak global economy and the related strong dollar, the West Coast ports strike, and unusually poor winter weather, among others. The issue is important because, while winter has given way to spring, and the ports dispute has been settled, the Oil patch weakness is continuing and may even intensify.

Breaking the reports down on a state by state basis helps us determine which of the potential issues was the primary driver of the data.  To cut to the chase, it looks like Oil patch weakness is the prime ingredient in the punk March jobs report, although weather may have played a supporting role.  By contrast, weather appears to have been the primary culprit in hiring in February, and poor retail sales in January.  We will get further information on these later this month, with state-by-state breakdowns in the unemployment rate, and state revenue reports for March, which will reflect actual retail sales in February.

Ironman at Political Calculations offers supporting data that the March employment report reflected a particularly bad month in the Oil patch.  As I pointed out the other day, there was a big increase to over 300,000  during the weeks ending February 7, 21, and 28.  He shows us this graph of how much of that increase can be traced to the 9 states most impacted by fracking:

Note that the big increase starts in February, increasing to 15,000 per week. This showed up in the March employment report, which of course nets hires and fires.

Meanwhile, on Tuesday we got the JOLTS data for February.  Here is Doug Short's graph of the monthly numbers and 6 month moving averages for openings, hires, and discharges:

Note that, through February, there has been virtually no upward movement in discharges.  what has changed is that, while job openings are growing at an increased pace since early 2014, the growth in actual hires, which had accelerated even more than openings, has decelerated in the last few months.

This suggests that, through February, the Oil patch and the West Coast ports strike, which would have increased discharges, were not significant.  That conclusion is buttressed when we look at the breakdown of openings and hires broken out by job sector:

Note that openings in February increased vs. January in virtually all job sectors.  Meanwhile, hires for those openings decreased in virtually all job sectors, although the biggest percentage decrease was in construction (which is where we  would expect the Oil patch weakness to be most felt.  In other words, while Oil patch weakness played a role, the primary driver of hiring softness in February was probably the weather, since almost all job types were affected.

Finally, there is the anomalous decline in retail sales, which has happened in the face of a big increase in real personal income due to savings on gas purchases.  Thus it is hard to assign this to importing global weakness or concentrated declines in the Oil patch.

And looking at reports of state tax revenues appears to confirm that weather is the big culprit behind the recent weakness in retail sales.  Below is a chart of reports through February of sales tax revenues (recall the businesses typically pay sales tax receipts in the month after the goods or services are sold, so the February reports are primarily January sales):

State	Dec		Jan	Feb
CA	+3.8		-12.4	+34.8
TX	4.3		+11.2	+11.7
NY	+3.1		+4.2	-0.3
MA	+0.9		+0.5	+0.2
NJ	-1.6		+2.9	+2.6
VA	-1.0		+11.2	+4.2
GA	+5.2		+8.2	+5.7

If the West Coast ports strike was the big culprit, California should be faring the worst.  Instead in February it reported a large YoY increase.

If the Oil patch were the primary driver, Texas should be faring poorly.  Instead Texas also reported large YoY gains in February.

But look at the northeast, especially New York.  Alone among all states, New York reported an actual YoY decline in February. New Jersey and Massachusetts also saw declines in positive comparisons between January and February, and even Virginia saw a similar decline.  Georgia was unaffected.

The slew of winter snowstorms that broke Boston's record of annual snowfall started at the end of January.  New York City, for the first time in over 100 years, shut down its subway system due to a (blown) blizzard forecast, which even at the time was estimated to cost in excess of $750 Million in revenue.

The Fed's Beige Book also points to weather as the main culprit in February.  Here are a sample of the observations:

New York District:  [some] contacts say that early 2015 sales continued the positive trajectory in place by the end of 2014, but business dropped off noticeably in late January, when the first of four (to date) significant winter storms hit. One retailer reports that over the last month, about 200 of their stores based in New England had been closed for a few days because of the severe weather

Retail sales have improved somewhat, on balance, since the last report. A major general merchandise chain indicates that sales were up strongly from a year ago and also above plan in January but slowed a bit and were on plan in the first half of February. Similarly, a major retail contact in upstate New York describes January as a solid month and February as fairly strong. In both cases, harsh winter weather was said to have hindered business somewhat. In general, retailers report that inventories are in good shape and that discounting remains prevalent.

Philadelphia: A Pennsylvania contact described sales levels throughout the state as being strong overall through mid-February despite the typically softer seasonal levels. New Jersey contacts reported strong statewide sales for January; however, weather was taking a toll on early February sales. Auto dealers expect growth to continue in 2015 as it had in 2014.

Richmond:  Retail activity slowed in the weeks since our previous report. Sales of cars and light trucks were generally flat, according to dealers in Virginia, North Carolina, and South Carolina. A dealer in the eastern panhandle of West Virginia reported slightly slower sales. Grocery and convenience stores reported a decline in food sales in in the past month. According to the manager at a Virginia chain of discount stores, holiday and post-holiday sales were softer than expected, but still higher than a year ago.

Kansas City:  Consumer spending activity was flat in January and early February, but remained higher than a year ago with solid expectations for the coming months. Retail sales declined from the previous survey but were around year-ago levels. Several retailers noted a drop in sales of luxury products, although sales of winter and lower-priced items were steady.

Dallas:  Retail sales rose during the reporting period, but the pace of growth was mixed. Demand continued to be up year over year, and a few retailers noted slight improvement in foot traffic since the last report. Two national retailers said Texas' sales performance was in line with the nation overall, while a third national retailer noted Texas was outperforming the national average. Outlooks were positive, and contacts expect modest sales growth over the next three months.

San Francisco:  Overall retail sales activity grew moderately during the reporting period....  Merchants in some areas showed very strong holiday sales and would have seen even larger volumes if not for delays receiving merchandise caused by labor disputes at West Coast ports. In other regions, holiday sales were not quite as strong as expected, and, as a result, retailers in those areas still have a little excess inventory.

The beige book shows that, with the exception of Kansas City, all of the slowing was in the Northeast and Mid-Atlantic.  Meanwhile, Texas was strong, and the only impact of the West Coast ports strike in California was a decline in inventory, not sales.

To summarize:

• retail sales through January into February appear to have suffered primarily due to the unusually poor winter weather. 
• hiring in February was also primarily affected by the weather, although Oil patch weakness played a contributing role.
• jobs in March so far look like they were primarily affected by Oil patch weakness.

I will update this once we get further information by the end of this month.

Oil's Price Drop Hurting Canada

This is over at XE.com

Corporate profits vs. stock prices: an update

 - by New Deal democrat

I have a new post up at XE.com.  Since corporate profits are a long leading economic indicator, and the stock market is a short leading indicator, it makes sense that, contrary to common investor wisdom, stock prices follow rather than lead corporate profits.

So what does that mean now?

The simple reason there will not be a US downturn

 - by New Deal democrat

Houses and cars.  This post is up at XE.com.

The punk March jobs report looks primarily like an Oil patch story

 - by New Deal democrat

At first blush, the relatively poor March jobs report looks like an Oil patch story, not a weather story or a West coast port strike story.

Changes in initial jobless claims during a month have a pretty good correlation with the same/next month's jobs report (since the reference week is the one including the 13th of each month).  Here's the relevant scattergraph and regression line for this expansion:

We had 3 bad weeks in February of new jobless claims over 300,000 a month.  To find out if the weather was a big factor, or if the primary weakness was the Oil patch,  I compared TX and OK with NY and Mass, going back to the first of the year.  This can be done using the Department of Labor's state-by-state breakdown of initial jobless claims, which is reported with a one week delay.  

The result was that NY and Mass. had lower claims on average in 2015 in the reference weeks compared with the same week in 2014. TX and OK, by contrast, had about 15% more initial claims in those weeks during 2015 vs. 2014 during the reference weeks for the March report.

Oklahoma's jobless claims increased YoY starting at the end of November.  Texas turned negative YoY in late January.

Massachusetts had one week wherein 2015 claims equalled 2014 claims. All other weeks were lower. New York had two weeks in 2015 slightly higher than 2014, but the other two weeks were significantly lower than 2014. 

While the since-resolved West coast ports strike could have nationwide impacts, one state where it would surely have an impact is California.  California did have one negative YoY week of jobless claims, all the way back in early January.  It also had comparatively small decreases in jobless claims in 2015 vs. 2014 during the weeks ending January 31 and February 7. During the 4 reference weeks for the March jobs report, however, it went back to strongly positive YoY readings (i.e., steep declines in jobless claims in 2015 vs. 2014).

Tomorrow's JOLTS report will be for February, so it will give us little insight into March.  State-by-state unemployment rate changes won't get reported until the end of this month. For now, what we can say is that the relatively poor March jobs report looks primarily like an Oil patch story and only secondarily a weather story, and not a West coast ports strike story.

US Equity Market Review For the Week of March 30 - April 3; Economic News Weighing Negatively, Edition

This is over at XE.com

Weekly Indicators for March 29 - April 2 at XE.com

 - by New Deal democrat

My Weekly Indicators post is up at XE.com.

The US appears to have "imported" a near-recession limited to production and spending for the first time in over a century, while income and employment still show a good domestic economy.

International Economic Week in Review: Highlighting Global Problem Spots, Edition

This is over at XE.com

March jobs report: the good streak is broken

- by New Deal democrat

HEADLINES:

• 126,000 jobs added to the economy
• U3 unemployment rate unchanged at 5.5%

With the expansion firmly established, the focus has shifted to wages and the chronic heightened unemployment.  Here's the headlines on those:

Wages and participation rates

• Not in Labor Force, but Want a Job Now: down -169,000 from 6.538 million to 6.369 million
• Part time for economic reasons: up 70,000 from 6.635 million to 6.605 million
• Employment/population ratio ages 25-54: down -0.1% to 77.2% 
• Average Weekly Earnings for Production and Nonsupervisory Personnel: up +0.2% from $20.82 to $20.86,  up +1.8%YoY (this YoY change is a bounce from last month's +1.5%). (Note: you may be reading different information about wages elsewhere. They are citing average wages for all private workers. I use wages for nonsupervisory personnel, to come closer to the situation for ordinary workers.)

January was revised down by -38,000 from 239,000 to 201,000.

The more leading numbers in the report tell us about where the economy is likely to be a few months from now. These were generally negative for the second month in a row.

• the average manufacturing workweek declined -0.1 to 40.9 hours.  This is one of the 10 components of the LEI and so will affect it negatively.


• construction jobs decreased by -1,000. YoY construction jobs are up 282,000 YoY.  


• manufacturing jobs also decreased -1,000, and are up 188-,000 YoY.

• Professional and business employment (generally higher-paying jobs) increased 40,000 and is  up  662,000 YoY.


• temporary jobs - a leading indicator for jobs overall - increased by 11,400.


• the number of people unemployed for 5 weeks or less - a better leading indicator than initial jobless claims - increased by 57,000 to  2,488,000, compared with December 2013's low of 2,255,000.

Other important coincident indicators help us paint a more complete picture of the present:

• Overtime decreased by 0.1 hour from 3.4 hours to 3.3 hours


• the index of aggregate hours worked in the economy fell -0.2 from 103.1 to 102.9.


• The broad U-6 unemployment rate, that includes discouraged workers decreased from 11.0% to 10.9%

• the index of aggregate payrolls rose by 0.2% to 122.1.

Other news included:

• the alternate jobs number contained in the more volatile household survey increased by 34,000 jobs.  This represents a 2,535,000 million increase in jobs YoY vs. 3,128,000 in the establishment survey. 


• Government jobs increased by 1,000.

• the overall employment to population ratio for all ages 16 and above was unchanged at 59.3%,  and has risen by +0.3% YoY. The labor force participation rate declined -0.1% from 62.8% to 62.7%  and is down -0.5% YoY, and is equal to its 2014 low (remember, this includes droves of retiring Boomers).

SUMMARY:

Obviously this was a disappointing report relative to the last year of reports.  The headline numbers were positive or neutral, but most of the internal numbers declined. That there were downward revisions to the previous two months' numbers is also not something that happens in a robust expansion. Most of the leading indicators in the report also declined.

There were a few bright spots, as wage growth increased, and those not in the labor force who want a job now decreased.  But these really just reversed last month's poor numbers.

In the longer view, while this is a bad month, I do not think the expansion itself is in danger.  We are importing some of the global weakness, and the oil patch has a very focused decline, which has shown up in the initial jobless claims in the last month or two.  In fact, the most noteworthy item in the report was that there have been -11,000 job losses in areas that typically support the oil and gas industries.

If we were to see a real decline of concern, it would show up in housing and vehicle purchases.  We just got a good March report on vehicle sales, so the reports on the housing industry this month are of added importance.

Chevron's 4% Dividend Is Safe

I own this.  This is not a solicitation to buy or sell this security.  Do your own research and come to your own conclusions.

    Oil’s recent sell-off provided one of the best buying opportunities in the energy sector since the Lehman crash.  Of course, the next logical question is, “what security?”   I started by looking at the big, multi-national oil companies.  What first attracted me to CVX was its dividend, which is currently yielding a healthy 4%.  On deeper analysis, I believe the dividend is safe, making this a very attractive company, especially at current price levels.

     Let’s start by looking at the weekly chart:

 

Prices are currently near their lowest level in the last three years and are consolidating around the 200 week EMA.  Momentum is weak but stabilizing and relative strength has upside room.  With a 4% dividend, the shares have built-in price support.  Just going by the chart, CVX is a bargain.

     Charts, however, aren’t the whole picture.  Let’s turn to CVX’s valuation by looking at this table from Morningstar:

 

CVX’s P/E is a few points below the industry average which is probably due to its revenue growth being lower than the other major’s.  Nevertheless, the company has better margins, ROA and ROE than its competitors.  Adding to the bullish case is the company has the fourth lowest PE in the industry according to the Finviz.com website.  Adding these factors together, one can arrive at the argument that the stock has at least a few points of upside potential.

     Turning to the company’s financials, CVX’s balance sheet demonstrates the company is well managed.  Accounts receivable has decreased from 11.24% of assets in 2010 to the current level of 6.29%.  Inventory levels have been consistently between 2.5% and 3%.  The current ratio is 1.32, giving the company a bit of financial flexibility.  On the other side of the balance sheet, long term debt is only 9% of liabilities.  Value investors should be impressed by the increase in book value, which rose from $105 billion in 2010 to $155 billion in 2014.  Although not bullet proof, CVX’s balance sheet is in good shape. 

     This is fortunate, because the income statement shows some weakness.  The company’s revenue fell from $254 billion in 2011 to the current level of $211 billion.  Over the same period, the cost of revenue has decreased from 66.2% to 56.4% while operating expenses have increased by the same amount.  The result is net margin has consistently been between 9%-10% for the last five years.  Management has been distributing a large minority of these earnings.  The dividend payout ratio has increased from 30% in 2011 to its current level of 41%.  This is a key reason why the current dividend is safe.  Top line revenue would have to fall by 40% before the payout ratio was challenged.  With a company of this size, a drop of that magnitude is highly unlikely. 

     Finally we have the cash flow statement.  Free cash flow (operating cash flow – investment expenses) has been positive in all but one year for the last five years.  From 2010-2102, the company added $38 billion in cash before considering investment activity; the only year of decreases saw a drop of $607 million.   

     To conclude, the company is a bit undervalued.  Its balance sheet is solid, with a well-managed short-term asset position and a reasonable amount of debt.  Although revenue has declined, it would have to drop at least 40% more to threaten the current dividend.  The company has been cash flow positive for the 4 of the last 5 years.  Finally, the 4% dividend gives the stock built-in price support.  At these levels, CVX is buy.    

    

    

 

 

 

 

         

The long leading indicators updated through Q1 2015

 - by New Deal democrat

I have a new post up at XE.com.

What do those indicators that forecast the economy more than 1 year out say now?

I'm Raising the Caution Flag On the US Economy

This is over at XE.com

Once more into the breach on wages and income since the Great Recession

 - by New Deal democrat

Two articles were posted elsewhere this morning discussing wages and income during this expansion.  Both have misleading aspects to a lesser or greater degree.

The first is an article by Pavlina R. Tcherneva of the Levy Economics Institute.  While I do not disagree with its overall emphasis or conclusion, I do have a significant quibble, because there is one erroneous comparison which can be misleading.

Tcherneva says:

"In the postwar period, with every subsequent expansion, a smaller and smaller share of the gains in income growth have gone to the bottom 90 percent of families. Worse, in the latest expansion, while the economy has grown and average real income has recovered from its 2008 lows, all of the growth has gone to the wealthiest 10 percent of families, and the income of the bottom 90 percent has fallen [through 2013]."

....

Consider what has happened to the incomes of the bottom 99 percent of families in the meantime. Average real income for the bottom 99 percent, which fell after the crash—from $50,400 (2007) to $47,000 (2008) —continued falling during the expansion, to $44,300 (until 2011). It finally showed a small uptick in 2012, to $44,900, but in 2013 it remained essentially flat. Thus, any “improvement” in the income distribution is not due to improvements in the well-being of the bottom 99 percent of households."

Included in the article is a graph, which is likely to see wide distribution, and which is the problem with this article:

The problem with this graph, and its description, is that it purports to measure income growth during entire expansions.  But that's not quite true, since the current expansion did not end in 2013, but is ongoing.  Thus the measure of the relative income shares of the bottom 90% vs. top 10% in prior expansions is not directly comparable. 

To be directly, comparable, Tcherneva should have measured relative income shares during the first 4 years of each expansion.  I should emphasize that, had she done so, the results would have been similar, using the Saez and Piketty tax return data, which can be found here,

Aside from technical  accuracy, I am highlighting this issue because a slightly deeper look can give us much more information.

To begin with, the Saez and Piketty numbers are based on "tax units," i.e., tax filings.  Thus it is very similar to, although not identical with, households.  Thus the data is subject to all of the same issues that we get into when we discuss median household income - e.g., distortions based on the tsunami of Boomer retirements, and the importance of the unemployment rate (since the unemployed are counted in households and tax units, but not for purposes of median or average wages.

The second is best summed up in this graph, from Doug Short, which shows the real median income of the bottom 90% from the Saez and Piketty data, for the entire last century:

Note that income first peaked in the early 1970s, and has only exceeded that peak one time, briefly, during the tech boom of the late 1990s.  Of particular interest is how long it took in each economic recovery since 1980, and also the plateauing of income in the late 1980s.

Tcherneva herself posted a graph several months ago showing what happened with the comparative incomes of the bottom 90% and top 10% from income peak to income peak:

Note that in the early 1980s, like the present, the average income of the bottom 90% actually fell -- just has it did in the present expansion through 2013.

This tells us the importance of three trends: (1) after the second Oil shock of 1979, and particularly in 1986, real gas prices fell dramatically, in contrast to the rise of gas prices from a low of $1.40 in 2009 to a high of $3.95 in 2012 and 2013; (2) household income rose dramatically in the early 1980s, despite a fall in real wages, due to the huge numbers of women entering the workforce; and (3) wage growth declines after particularly severe recessions like 1981 and 2008-09.

In short, if we want to explain Tcherneva's data, both during the current economic expansion, and over the longer term, we really don't have to look further than three things

1. 1. the increase of gas prices post-Great Recession currently, and its volatility since 1974, 
2. 2. the decline in labor force participation rate since 2000, and its dramatic rise in the 1970s and 1980s due to women entering the workforce in huge numbers; and 
3. 3. the decline of labor bargaining power due to the collapse of unionization and the correlative rise of globalization. 

 The other article this morning deals with wages, and comes from the Cleveland Fed via Barry Ritholtz.

The purpose of the study was to determine what has happened with real wages during this economic expansion - are they stagnant or have they fallen?  If so, why?  
As the authors state, "This article answers the question: What fraction of recent changes in the average wage is due to changes in the occupation mix versus changes in wages within occupations?"  The answer is given in the below chart:

Interestingly, the authors find that, through 2013, the jobs added in the recession have NOT been, as commonly assumed, low wage jobs, but have actually skewed towards higher paying jobs.  They do find, however, that within occupations, real wages actually fell slightly.

My big problem with this article is in its explanation for the data. To begin with, it is not demographically normalized.  While it is always true that old fogies retire and young whippersnappers take their places at entry level incomes, this has disproportionately been the case as Millennials move into the labor force as Boomers retire.  This is likely to place some unusual downward pressure on wages.

But here is my real problem.  The authors conclude:

"Why did wages rise during the recession and fall during the recovery? It may be due to what are called “selection effects.” During recessions, firms tend to retain their most productive workers, both across and within occupations. ...

"It is also possible that wages declined more in the recovery than in the recession due to what economists call “sticky wages.” Reducing real wages is one of the ways the labor market adjusts to drops in demand for labor. ..."

You have got to be kidding me.

Wages rose during the recession because the price of gas fell was $3+ at the end of 2007 when it began and was under $2 a gallon when it ended.  Wages fell from there to 2013 because the price of gas went up to $3.95 a gallon during 2012 and 2013 (red, right scale in the graph below). This translated into actual deflation during the later stage of the recession, and 3%+ inflation during 2011 (blue, left scale), while nominal wage growth  slowly decelerated from 4% YoY to 1.5% YoY (green, left scale):

Period.  End of story.

Let me emphasize that this is not an issue of nominal vs. real wages.  The authors state, "We adjust all wages to 2013 dollars to make it easier to compare values across time. For brevity, we call the 'real average hourly wage' simply the 'average wage.'

It continues to amaze me how the huge impact of the Oil Choke Collar has been almost completely overlooked.

International Economic Preview For the Week of March 30-April 3

This is over at XE.com

International Economic Week in Review: Euro Turnaround May Be In Process Edition

This is over at XE.com

US Equity Market Review For the Week of March 23-27; Hey, We're Still Consolidating, Edition

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Weekly Indicators for March 23 - 27 at XE.com

 - by New Deal democrat

My Weekly Indicator post is up at XE.com.

Signals are very mixed.

Three very mixed forward looking signals from this morning's GDP revisions

 - by New Deal democrat

I have a new post up at XE.com.

This morning's final revision to 4th quarter GDP actually contained 3 pieces of forward-looking news, and that news was decidedly mixed.

International Economic Week in Review: Euro Turnaround May Be In Process Edition

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Housing is still a positive for 2015

 - by New Deal democrat

At the beginning of the year, I forecast continued growth, in large part due to lower mortgage rates and an improving outlook for housing.

My first update is up at XE.com.  So far, so positive.

Kraft is a Great Company For Heinz to Purchase

     Today’s blockbuster news event was the announcement the Heinz and Kraft would merge.  Bloomberg provides a good,overarching analysis of the deal:

The deal creates a stable of household names -- everything from Heinz ketchup to Jell-O -- with revenue of about $28 billion. It also could presage more consolidation in the U.S. food industry, which is struggling to reignite growth. Buffett and 3G, the private-equity firm founded by Brazilian billionaire Jorge Paulo Lemann, previously teamed up to buy Heinz in 2013 and they cut costs, a strategy they aim to repeat with Kraft.

It’s impossible to argue against the logic of this deal.  Heinz, which, like Kraft, owns numerous iconic American brands, was taken private a few years ago.  Now that private equity has cut costs and increased the company’s efficiency, the next logical business step is to go into acquisition mode to increase the company’s product offerings and market footprint.  Not only do Kraft’s product offerings complement Heinz’s, but the companies can potentially achieve a large amount of synergy and cost savings from their respective positions as market leaders in the consumer staples industry.  The deal illustrates why numerous investors still have tremendous admiration for Buffet’s investing acumen.

 

     Let’s take a look under Kraft’s financial hood starting with their balance sheet.  Asset structure has been remarkably consistent for the last four years, with total assets fluctuating between $21-$23 billion and the composition of those assets remaining near constant levels.  In 2012 the company added $9.9 billion in long-term debt.  But, using their highest interest expense and lowest EBITDA readings for the last five years, interest coverage is still a healthy 4.74.  The current ratio stands at one.  While this would normally create a bit of concern,   receivables and inventory levels are firmly under control, indicating the company is very well managed financially. Finally, with a large consumer staples company like Kraft, a tighter balance sheet should be expected.   

     Kraft’s income statement shows why this merger has tremendous opportunities.  Top line revenue has stalled between $18.2-$18.6 billion for the last four years.  Their biggest problem is the ease with which consumers can purchase substitute goods -- an especially prevalent activity when overall wages have stalled.  There have also been some short-term issues.  Last year the company had a huge, 10% drop in their gross margin, which was entirely attributable to a recalculation of pension liabilities.  Without this loss, EPS would have been 4.82.  But with the loss, EPS was $1.74.  While the company also had an increase in SGA expenses, the overall level rose to one more consistent with recent history.  Because Kraft and Heinz are in the same business, the merger should create tremendous cost savings and synergy, leading to margin expansion over the next 1-3 years.

     Finally, free cash flow to the firm has fluctuated between $1.4 and $2.5 billion for the last five years giving the company ample funds to self-fund all of their activities.  And their cash investing needs, which are solely derived from plant, property and equipment investment, have been very predictable for the last five years; they’ve fluctuated between $440 and $557 million.     

     Kraft was a great company before the merger.  It was the owner of numerous brands that are a staple of the US market.  The company managed its assets incredibly well and literally printed money.  Now with the addition of another major US consumer staple company, the combination can achieve major cost savings by eliminating duplicative operations and achieving even larger economies of scale. 

    

 

 

   

Has the EU Finally Turned the Economic Corner?

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Five graphs to watch in 2015: second update

 - by New Deal democrat

At the end of last year, I highlighted 5 graphs to watch in 2015.  Now that we have all of the February reports, let's take another look.

#5.  Mortgage refinancing

After a mini-surge at the end of January (light brown in the graph below), The Mortgage Bankers Association reported that refinancing applications fell back to somnolence during February, due to higher interest rates (blue)  Mortgage News Daily has the graph:
 

Over the last 35 years, refinancing debt at lower rates has been an important middle/working class strategy.  There is little room left for that strategy. David Stockman had an interesting graph last week showing that in this expansion, wage growth and consumer spending have been almost perfectly correlated.  If mortgage refinancing stays turned off too long, and wages don't grow in real terms, then consumer spending falters and so does the economy.  

#4 Gas prices

Here is a graph of gas prices (blue, inverted and averaged quarterly) compared with real GDP (red) over the last10 years:

Once gas prices reach a critical point, roughly $4 a gallon in present real terms, GDP falters.  The cheaper gas prices are from that point, the more GDP can be expected to rise, with a slight lag.  In February, gas prices rebounded as expected over $0.30 from their late January bottom.  This is a typical seasonal increase and so is a neutral. All else being equal, by the 2nd quarter, this should be reflected in more positive real GDP.

#3 Part time employment for economic reasons

This is a graph of part time workers for economic reasons expressed as a percentage of the labor force:

In February this ratio continued to improve, bringing us equivalent to its levels in 1988, but still 2% (about 3 million) above the boom level of 1999 and about 1.5% (2.25 million) above the level of 2007.

#2 Not in Labor force but want a job now:

This moved in the wrong direction in February.  It is now about 900,000 above its post-recession low of November 2013 (just prior to Congress's cutoff of extended unemployment benefits) and some 1.9 million above its 1999 and 2007 lows.

#1 Nominal wage growth

After an anomalous decline in average hourly wages in December, and a big positive reversal in January, wages for nonsupervisory workers were totally flat in February.  Nominal wage growth YoY has now declined back to its post-recession low.

The decline in the last 6 months is  troubling.

Compare our present expansion with the previous three.  In the 1980s and 2000s, by the time we improved to 5.5% unemployment, nominal wage growth was approaching 3% YoY.  In the 1990s expansion, at worst wage growth was on the cusp of acceleration, but was nevertheless 3.5%. Unless wage growth starts to accelerate now, the pattern is not holding.

There have been a few interesting notes about the lack of wage growth.  The staff of the Federal Reserve has done a study indicating that the number of long-term unemployed plays an important role (since presumably these people are more desperate).  It has also been suggested that the disproportionate (compared to normal times) percentage of relatively highly paid employees (Boomers) retiring from the labor force, and being replaced by younger workers, is holding down wages.

Two months of data into the year shows two series positive (gas prices, involuntary part time employment), and no or little improvement in the other three (refinancing, discouraged dropouts from the labor force, and nominal wage growth).  Should wage growth not improve, and mortgage refinancing remain dormant, we are going to run into trouble, and I will be looking for other long leading indicators to start rolling over.

Microsoft is Still a Growth Story

I do already own the company.  But, this is not an invitation to either buy or sell these securities.  Do your own research and figure it out for yourself.

 

     It’s hard to believe that a company such as Microsoft could still be considered a growth story.  After all, a thirty-year old company that is dominant in their industry is usually considered “mature” – a corporation whose revenues grow incrementally at best.  However, this description does not apply to Microsoft which has had year-to-year top line growth between 5%-11% since 2010.  Buy-side analysis, however, does not end here.   Potential investors should avoid purchasing an issue when solid growth is not supported by a strong balance sheet or solid cash flow.  Fortunately for potential investors this tech company has a rock solid balance sheet and continuously strong free cash flow.  One additional factor is the company’s current dividend yield of 2.889% and five-year history of increasing dividend growth.  When these fundamental factors are added together, the decision to buy becomes a matter of when and not if.  And, as an analysis of the chart shows, the time to buy is now, as the security is trading about 5 points above is 1-year low.      

     Let’s begin our analysis by looking at their one-year price chart:

 

  

Microsoft rallied from May 2015 until early November, when prices started to slowly move lower.  They consolidated in a triangle pattern from mid-December to mid-January.  Prices broke through support at the end of January on a disappointing earnings report.  Since then, they have been consolidating between the lower and mid-40s.

     At these price levels, MSFT is slightly under-valued, as shown on this table from Morningstar:

MSFT is slightly under-valued on a PE, price/sales and price to book level.  This gives us room to move a few points higher which is increased slightly when you consider the company slightly outperforms their industry peers on ROA, ROE and net margin. 

     Let’s turn to their financials, starting with their balance sheet.  Like most tech companies whose primary asset is intellectual property, this is a beautiful financial document.  The current ratio is 2.45 while the quick ratio is only slightly lower at 2.24.  The company has been keeping a close eye on receivables, with their percentage of assets dropping from 15.1% in 2010 to 11.34% in fiscal 2014.  They also keep a ton of cash handy; they’re got $85 billion on their 2014 balance sheet, with most of their holdings in short-term securities.  Fundamental investors should like that their overall book value has increased from $46.175 billion in 2010 to $89.784 in 2014, which is almost a doubling in five years.  The only “drawback” is their increased use of long-term debt, which now totals $20.6 billion.  But with an interest coverage ratio of 50.8, it’s difficult to be concerned.  The balance sheet indicates they have ample liquidity and have kept receivables well-managed.  Their near-doubling in book value over a five year period also indicates they have shareholder interests at heart.  Finally, they most likely tapped the debt markets to prevent a high tax bill from repatriation of foreign holdings. 

     Their cash flow statement is no less impressive.  They’ve had free cash flow to the firm of between $22 billion and $29 billion over the last five years giving the company ample financial maneuvering room.  This allows them to self-fund most small acquisitions (those involving both companies and property) if they desire. 

     And finally, we have their income statement.  As mentioned in the opening paragraph, the company is growing between 5%-11%/year.  They did have a large 5% jump in COGS in their latest annual statement.  They offered the following explanation in their 10-K: “Cost of revenue increased mainly due to higher volumes of Xbox consoles and Surface devices sold, and $575 million higher datacenter expenses, primarily in support of Commercial Cloud revenue growth. Cost of revenue also increased due to the acquisition of NDS.”  This trend continued in their latest quarterly statement, increasing COGS by 8.1%.  While this is not an optimal development, it is partially caused by their move into cloud based computing, which most analysis (myself included) believe will provide solid growth avenues for the foreseeable future.  In addition, there are continued costs related to the Nokia acquisition, as they noted in their latest 10-Q: “Cost of revenue increased, mainly due to the acquisition of NDS.”  These increases should subside in the next 4-6 quarters.

     I have to admit that I have made my fair share of Microsoft jokes, even referring to them as the evil empire on more than one occasion.  But all kidding aside, it’s hard not to like the company.  They have solid revenue growth, a very strong balance sheet and the company literally prints money.  They’ve been increasing their dividend for the last five years, and have ample cash and potential revenue growth to continue this practice for the foreseeable future.  All these factors add up to a solid company.

           

International Economic Preview For the Week of March 23-27

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US Equity Market Review For the Week of March 16-20: Small and Mid-Caps Outperform, Edition

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