New Home Sale were just released and they were the strongest since January 2008 rising 16.6% to a seasonally adjusted annualized rate of 619k.  The past 3 months were revised up also making this a very strong upside surprise.  A quick disclosure:  Bellaire Capital Management, LLC has been overweight housing stocks in client accounts since 2010 through holdings in ITB & XHB.

Inventories of New Homes are currently at 247k which represents 4.7 months of inventories at current sales levels.  6 months of inventories is considered normal for New Home Sales.  Lower inventories predict continued increases in home construction.

Initial Jobless claims were released yesterday and there were 278k new jobless claims in the U.S. versus 294k the previous week.  The four week moving average is now 275.75k jobless claims.  Prior to the last 3 weeks, jobless claims were at their lowest levels since at least 1975.  There is some noise in the past 3 weeks data with a Verizon strike probably adding some 10-20 in claims.

Although jobless claims are still near their lowest in 40 years and have dropped by two thirds since the depths of the great recession, the four week moving average of jobless claims is now higher on a year over year basis for the first time since 2012.

The increase in claims on a year over year basis will deserve our full attention - if it extends for another couple of weeks past the impact of the Verizon strike.  Many employment indicators have weakened in 2016 and if initial claims start trending higher a greater sense of caution towards risk assets will become warranted.

Kevin Spires, CFA, FRM

Corporate Profits, the mother's milk of stocks and the economy have weakened dramatically over the past 6 quarters.  Energy firms, Apple, and the ending of many corporate tax credits have all caused a deterioration of overall corporate profitability.  Without profits firms are unable to increase investment and expand hiring and if credit conditions deteriorate as well then corporations start to shed employees and cut back dramatically on investment.  Over the past 10 quarters, overall after tax domestic profits have dropped by over 20%.  As a percentage of nominal GDP the drop is more dramatic with a drop of almost 27% - dropping from 7.57% in Q2 2013 to 5.53% at the end of 2015.

S&P 500 Earnings per Share (EPS) tend to lag the overall profitability of the economy by 3-4 quarters.  The relationship is pretty good over time - making a large profit rebound in 2016 in S&P 500 EPS unlikely.  In the chart below, S&P 500 EPS are in red and clearly following the drop in overall domestic profits.

The situation is not yet dire, but one might characterize the profit situation as a "Yellow" caution light for this economic expansion.  Further deterioration coupled with tighter credit conditions would be a harbinger of an overall economic recession.

Kevin Spires, CFA, FRM

Last Friday's employment report was a bit disappointing with only 160k employees added in the U.S. versus an expectation of 200k.  I believe the next few months are going to be as disappointing or worse.  Almost every employment indicator I follow has degraded in the past few months - auguring the poorest job growth in the cycle is just ahead.

• Temporary Help jobs have contracted so far in 2016.  Some like to argue that strong growth in temporary jobs is a sign of poor labor market health.  The data suggests just the opposite - growth or contraction in temporary jobs leads growth or contraction in overall job growth by 2-3 months.  Employers tend to first expand hiring through temporary positions and then make those positions permanent if demand for the employer's good or service continues.  Temp employment has contracted in 2016 - down over 27k in the first 4 months of the year.
  

In summary, 3 indicators that I use to predict employment growth over the next 1-3 quarters have all turned negative in the past 3-4 months.  While none of the indicators are currently at recessionary levels, further slippage without a quick recovery would put the current expansion at risk.

Kevin Spires, CFA, FRM

Kevin Spires, CFA, FRM

Business Insider has an article by Advisor Perspective's Robert Huebscher giving David Rosenberg's outlook on the odds of a recession over the next year or two.  The best quote is Rosenberg saying that 

The U.S. economy is incredibly resilient, he said, and he agreed with the adage 
that a recovery never “dies of old age.”  It takes a “negative shock” to  start
a recession, he said ­‑- “and those always have the Fed’s thumbprint  on
them.”

This is directly in line with my adage that expansions do not "commit suicide but rather it is always murder."  The slope of the Treasury Yield Curve is a great predictor of recessions and Federal Reserve, with its near total control of the shortest maturities, is the one in control of that slope.

Read more:  http://advisorperspectives.com/newsletters14/David_Rosenberg-No_US_Recession_in_Sight.php#ixzz2v25SJBe3

Kevin Spires, CFA, FRM

I have mixed thoughts about the fiscal cliff.  While I think the increase in taxes will result in a lower growth rate in 2013, I do not think it will be a distaster on a level that requires a countdown clock on the business news channels.

Why won't it be a disaster?  The current tax cuts, as structured, did not spur massive economic growth.  The current "stimulus" that will expire did not spur massive economic growth either.  The current tax cuts, because they automatically expired and because spending went up, not down in response, were like an individual increasing their number of exemptions on their W-4 and getting a bigger paycheck, but having a big tax bill due on April 15th.  The weak growth of the past few years can be traced, in part, to the uncertainty created by temporary tax measures.

Spending is what matters - and we will have to increase taxes 2 or 3 more times to catch up to the expected spending that is already on the books in current law.  Obamacare, Medicare, and Social Security will all take increasing proportions of the budget in the next 10-20 years - but there is little support for cutting these programs. Below is some commentary on a recent opinion poll on different options for closing the budget deficit.

The message seems to be to never cut spending and only raise taxes on the millionaires and billionaires.  This is a recipe for fiscal disaster.  A country cannot borrow 30% of the money it spends year after year without facing a solvency crisis at some point.

Taxpayers have had a free ride - especially those demanding more government spending.  It has to be paid for and the "Rich" tend to become quite scarce if unfairly targeted.  I am in favor of taxes going up across the board with the message being if you want current spending levels, you will have to pay the price in higher taxes. 

Kevin Spires, CFA, FRM

At National Review online, Victor Davis Hanson rants about the false choice of Austerity vs. Growth.  Dr. Hanson bulldozes the idea that we have even begun to see Austerity.  He sees the current language as obscuring what is actually happening - a debate of not of 

     “growth” versus “austerity” but of “borrowing and spending” versus “fiscal discipline,”

Personally, what I believe we are seeing is the end game of democratic socialism.  Past a certain point, if the State's share of the economy grows too large, the perverse incentives - to not work, to cheat on one's taxes, for cronyism, for graft and corruption, for entrenched public unions to gorge themselves at the public trough - turn into a massive economic self destruct mechanism. 

A program of economic self destruction is what has been wrought.  Vast swaths of the Western world have been taught that Keynesianism and Socialism are a sort of perpetual motion machine - that the more profligate a society - that if they borrow enough, then prosperity will follow.  The math has never worked to anyone unwilling to believe that 2+2 does not equal five - especially when our eyes tell us that those portions of the economy run by the government (think the DMV or Post Office) tend to turn 2+2 into three.

Kevin Spires, CFA, FRM

With the update to first quarter GDP, the BEA released their first picture of Corporate Profits for the first quarter.  I like to look at after tax corporate profits as a percentage of Nominal GDP.  On this basis, Corporate Profits dropped to 7.2% from 7.6% in the 1st quarter of 2012 from the 4th quarter of 2011.

As Larry Kudlow likes to say Corporate Profits are "the Mother's Milk of stocks, business success and job creation."  Corporate Profits reported in the GDP Report tend to lead reported corporate profits of companies in the S&P 500 by 2 quarters.  With the potential peak in Corporate Profits for the GDP report, S&P 500 earnings may be about to peak as well. 

Trouble could be brewing.  The stock market tends to peak after the peak in corporate profits.  The timing is uncertain as the stock market peak follows with an uncertain lag.  It took three years from the 1997 peak in profits to the 2000 peak in stocks while it only took one year from the 2006 peak in profits to the 2007 peak in the stock market. 

Once Stocks peak, given a peak in corporate profits, then a recession is usually just around the corner.  If the peak in Corporate Profits is confirmed over the next two quarters, the Stock Market - and the whole economy - will enter a much more fragile stage of the economic cycle.

I am skeptical that the current expansion is about to fall apart of its own accord, but the dual uncertainty of tax increases on the table for the end of 2012 and the pending implemenation of Obamacare have caused a certain amount of investment and hiring to be pushed back by Corporate America.  A potentially strong expansion based on Corporate Profitability has been turned into the weakest recovery outside of the Great Depression. The upcoming U.S. Elections will be crucial for relieving economic uncertainty and I expect many months of choppy performance in the markets as uncertainty reigns. 

Click here for our Corporate Profits Chart Package.

Kevin Spires, CFA, FRM

In yesterday's Wall Street Journal, Tim Know and Ryan Bourne presented the results of research showing that the smaller the size of government, all else equal, the faster the growth rate of an economy.  In their own words  "our results suggest that reducing the ratio of taxes or spending to GDP by five percentage points increases the growth rate of GDP per capita by 0.5 to 0.6  percentage points per year. "  Over 25 years those .5% to .6% a year matter, leading to a smaller government economy outgrowing a larger government economy by "115% to 64%."  

Their suggestion for resolving the European Economic Crisis is to put government on a diet.  They correctly point out that "Austerity" as the Europeans understands the word is higher taxes on the private sector and no cut backs in the bloated state sector (some editorializing on my part-ks).  To create sustainable, higher growth rates, a small state sector and smaller taxes are warrented.  Seems pretty straightforward to me.

The combination of smaller government and smaller taxes can also be a winner politically as well.  Scott Walker, the Governor of Wisconsin, who pushed through "Austerity" by cutting into the inefficiencies of the Government Union Bureaucracy and did not raise taxes to close a big budget hole.  The European political parties should take note - as whomever is in power has been getting bounced from power at the next election due to their failed policies.