Deutsche Bank’s stock price has crashed to all time lows, while its market-implied default risk is back to just shy of record levels…
… which is what likely prompted its chief economist to admit today that all is not well in the state of European banking, asking for a €150 billion (to start) bailout for European banks (of which DB is a member).
However, that in itself is unlikely to occur absent a major dislocation in the global economy, and especially the “cleanest dirty shirt”, i.e., the United States. After all, the already angry population will be foaming at the mouth if hundreds of billions in taxpayer funds are used to rescue not only Europe banks but Europe’s biggest bank at a time when the S&P500 is trading at all time high and the US labor market is – supposedly – humming along.
So something has to snap in order for Deutsche to get its much desired bailout, and that something may be nothing less than a sudden swoon in the economy and market: just like the one unleashed by the failure of Lehman. That is precisely what DB’s Dominic Konstam is expecting will happen by looking at the trends in the US labor market that are being so aptly masked by the headline prints reported each month by the BLS.
Here is why Konstam thinks monthly job growth is about to hit a brick wall, and plunge to just 50-60K per month.
Long-time readers might remember when we pointed to what we call the labor productivity gap, or the difference between productivity growth and labor input (as measured by payroll aggregate hours), turning negative roughly 15 months ago. The hypothesis was that firms that had been hiring full steam in the past several years and have yet to see return on their investment in the form of higher output (because productivity has been lagging) will respond by reducing their demand for additional labor, or otherwise wages will outstrip production and their profits will suffer. This hypothesis is supported by data going back until at least 1989, when each time the labor-productivity gap started to deteriorate it predicted a deceleration in labor input growth roughly one year later.
We can use historic betas of the gap to labor input momentum to predict implied job growth. Applying the historical beta of employment growth on the labor/productivity gap, the current labor/productivity gap implies that over the next 4 quarters, the cumulative slowdown in labor input growth should be 4.5 percent. This implies that aggregate hours (which most recently have been expanding at a 1.6 percent annual rate) would average just 0.5 percent (1.6 – 4.5 / 4). Expressed in terms of new jobs, this means that unless firms cut back on employee hours, monthly job creation would average close to 60K next year, which is a substantial drop from the 200K running average of the past 12 months. If we are correct, then the abysmal report in May could be less an aberration than a preview of a new norm.
The flip side to late cycle dynamics is the implication for stabilizing profits. The price-unit labor cost spread has collapsed, signaling the extreme loss of profit momentum and, based on past cycles, implying a cumulative deceleration of labor input to 0.4% in 2017 and zero growth in 2018. Again, this would imply job creation slowing to 50K per month, which is consistent with our earlier analysis using the labor- productivity gap.
What are the implications of this collapsing new economic normal?
The important difference between this “cycle” and others, however, is that while the symptoms may be the same, the underlying causes are very different. We think this is less about negative demand shocks and overly tight financial conditions than about stagnating demand related to the absence of positive demand shocks such as demographics, globalization, deregulation etc. This in some ways makes the problem appear “less bad” but in other ways it is also more insidious since the solutions may be harder to achieve in practice and may not be observable for some time.
The result is a prolonged period of financial repression where real yields are necessarily very low. The equilibrium is that risk assets, subject to their real yield sensitivity, perform relatively well. Unlike prior “cycles” the rebalancing of growth is therefore not about a risk off/risk on trade, but is more about rotating investors into higher yielding assets as nominal yields fall, lead by real yields. Specifically for the SPX we can argue that performance is not driven by top line earnings expansion or even expanding P/Es but instead a declining earnings yield premium to bond yields. It is the collapse in real yields above all that drives this, in our view.
In other words, it all goes back to central banks keeping the “market” supported, as neither the economy (productivity growth) nor fundamentals (earnings) justify the S&P where it is.
And here is the paradoxic: with DB’s pleas for the ECB to end NIRP having fallen on Draghi’s deaf ears, the German bank is both warning, and tacitly requesting, that central banks allow some renormalization. After all, the only way that a request for another bank bailout may have even a remote chance of passing is if the population sees not only a market swoon but an economic one as well. The alternative is far worse: instead of sacrificing someone else, DB will itself become this cycle’s Lehman, unleashing precisely the events that Konstam has been warning about for so long.
Which is why the economy and the “market” better let off some steam in the very near future… for Deutsche Bank’s sake.
The post Why Deutsche Bank Expects A Collapse In Monthly Job Growth To Under 60,000 appeared first on crude-oil.top.