The week ahead

Only two things matter in this first week of the new year: China and jobs. And China, frankly, isn’t looking too good.

The market plunged at the open Monday on news that Chinese manufacturing was far worse than Wall Street expected. The Chinese purchasing managers’ index fell to 48.2 last month, vs. 48.6 in November, it’s 10th consecutive decline. When the index is below 50, the manufacturing sector is in recession.

The Chinese stock market took one look at the numbers and promptly plunged 7% before circuit breakers kicked in. Wall Street took a sober look at the Chinese market’s reaction and promptly panicked. The Dow Jones industrial average is down 318 points, or about 1.8%, as I write this.

China takes these things seriously: So seriously that Chinese CEOs are starting to mysteriously disappear. If I were a Chinese CEO today, I’d be hastily packing my bags.

The stalling Chinese economy will weigh heavily on the U.S. market, since so many U.S. companies have been counting on China for increased sales and growth. So today, the stock market will be digesting this news, and discounting stocks across the board.

fredgraphAfter that, Wall Street will spend the rest of the week fretting about jobs. And there are all sorts of indicators to watch in the run up to Friday’s jobs report. (Which, for the record, is expected to show 200,000 new jobs in December, vs. 211,000 in November.)

  • Tuesday is motor vehicle sales, which should show fairly robust growth in what was once the nation’s largest employers. Analysts are expecting fairly robust gains in December, thanks to low gas prices and the prospects of modest raises in 2016. Another factor: The average U.S. auto is more than 11 years old. Cars age better than they used to, but there’s a lot of pent-up demand for new cars.
  • Wednesday is the ADP Employment report, which is a pretty good predictor of how the Friday jobs report will turn out. The consensus on the report, which excludes government jobs, is for 190,000 new jobs in December.
  • Thursday is the volatile weekly unemployment claims report, has ticked up to the highest levels since July, when the numbers flirted with lows unseen since the Nixon administration. Another important report is the Challenger Job Cut Report, which measures mass layoffs. Many companies choose to lay off employees just in time for the holiday season, so it should be an interesting report.

 

Here’s what has the Fed worried

Even though the job market has been picking up, the Federal Reserve is still worried about the specter of deflation — a period of falling prices. And that’s why it declined to raise short-term interest rates at its most recent meeting.

Federal Reserve Chair Janet Yellen
Federal Reserve Chair Janet Yellen

If you know anyone who lived through the Great Depression, you’ll know that falling prices are a terrible thing. As prices fall, companies have to cut prices to produce goods. Typically, that means cutting wages. When wages fall, people can afford fewer things, and prices continue to fall. It’s a miserable cycle of poverty for working people.

But wait, you say. Rents are going up. Car prices certainly aren’t falling. And any number of things that you buy day to day — like, say, a burrito at Chipolte — are increasing. All true. In fact, if you exclude food and energy from the government’s Consumer Price Index, prices have gained 1.8% since June 2014.

As people like to point out, food and energy is a big darn exclusion. Food prices have risen 1.8% the past 12 months. But energy prices have fallen 15%. We’re in the middle of the longest gas price slide since January. And a gallon of unleaded now averages $2.69 a gallon, 83 cents less than a year ago. If you fill your 14-gallon tank once a week, that’s an annual savings of nearly $604.

But what probably worries the Fed is not falling oil prices, which is generally regarded as a Good Thing by the average consumer. Here’s a chart of copper prices the past three months:

copper

 

 

 

 

 

Here’s what silver looks like:

silver

 

 

 

 

 

Here’s cattle prices:

cattle

 

 

 

 

 

A few charts don’t necessarily bode deflation. But they could bode slowing economic activity. If that’s the case, raising interest rates would simply slow the economy further.

By this time, even hermit Japanese soldiers from World War II have figured out that the Fed will raise interest rates sooner or later. By and large, the stock and bond markets have priced in a 0.25% interest rate hike sometime between now and the end of the year. But the odds of any sudden increase in rates seem increasingly long, at least as long as there’s the faintest whiff of deflation in the air.

 

 

On the road

As we start the summer driving season, it’s a good time to reflect on the fact that the average U.S. passenger vehicle is a record 11.4 years old, according to Polk.

Part of this is because most cars really are better these days: You can go 100,000 miles without changing spark plugs, and hitting the 100,000 mile mark is now more a sign of middle age rather than utter decrepitude. And if you’re in a major city, you can get by with taxis, Uber and Zipcars.

The other part reason the U.S. auto fleet is so old is that many people still don’t feel secure enough in their jobs to make a major purchase like a new car. Nor do they earn enough. The median family income is about $50,000; a modest new car will set you back $15,000 to $25,000.

President Coolidge shows off his radio-equipped auto.
President Coolidge shows off his radio-equipped auto.

And it’s not entirely the auto industry’s fault that cars are so expensive. In 1970, a Volkwagen Beetle cost $1,874. Adjusted for inflation, that’s $11,427 today. And current starter autos have nice touches like air bags and heat.

Nevertheless, it’s a reasonable bet that car sales will accelerate a bit in coming months, assuming the unemployment rate remains steady and wages tick up a bit. And that, in turn, could be good news for auto stocks. So far this year, automakers are up 8.49%, vs. 3.23% for the Standard and Poor’s 500 stock index. Toyota has gained 9.89% this year, Honda’s up 15.92% and Volkswagen has gained 16%.

The laggards are U.S. automakers. Ford has fallen 0.19% this year, and GM is up 3.9%. Both are dead cheap stocks, however: GM trades for 6.6 times estimated 2015 earnings, and Ford clocks in at 7.6 times earnings. American cars, by and large, are sturdy and well priced. They might finally start to accelerate later in the year, if the economy doesn’t sputter too badly.