No de-coupling for U.S.

April 6, 2012

April 6 (Reuters) – This time around it looks that when the
rest of the world comes down with a cold, the United States
starts sneezing, too.

Arguments for American exceptionalism, or even that
much-vaunted but seldom seen phenomenon known as “de-coupling,”
were undermined on Friday when U.S. payrolls data disappointed
deeply.

For investors, this is somewhat dispiriting, as many were
hoping to ride out the effects of a sharp European slowdown and
weakness in emerging markets by investing in U.S. shares, which
had a great first quarter, driven by strong signs out of
manufacturing and a brightening jobs picture.

Non-farm payrolls increased by 120,000 in March, a territory
barely in squinting distance from the 203,000 consensus of
economists’ estimates. The unemployment rate fell to 8.2
percent, but as a drop of 31,000 jobs in a survey of households
and participation data shows, this was driven entirely by people
getting out of the workforce.

Perhaps most disturbing of all was the extent to which the
poor showing was driven by weakness in manufacturing employment,
which after all is ultimately the U.S.’s path to sustainable
prosperity. Weekly hours worked in manufacturing actually
declined, by 0.3 hours to 40.7, in a sign that just maybe the
weakness being seen elsewhere in the globe is hitting home in
the United States.

So, manufacturing is showing incipient signs of weakness,
and frustrated job seekers are still giving up and going home.

While it is true that the last several months of U.S. data
have been generally encouraging, a broader look at the
international backdrop shows why the U.S. may be flagging.

Europe is, very likely, in recession, as savage cuts to
public spending in many countries combine with a really quite
serious lack of available bank funding to grind the economy
down. The bank finance issue – itself driven by banks’ need to
shore up capital – is critical, especially in an economy like
the euro zone’s, which is heavily reliant on bank loans rather
than capital markets.

The euro-zone purchasing managers index fell to 49.1 in
March, slipping farther below the 50 mark that denotes outright
contraction. In India the PMI is still well above 50 but hit a
five-month low and was accompanied by the lowest level of
business confidence since 2009. China, as you would expect, is
also feeling the chill wind: its manufacturing PMI fell below 50
for the first time since 2008.

OKUN TAKES HIS REVENGE

The real question becomes not why is the United States
slowing, but why were we so encouraged in the first place. In
part it is because the employment numbers have been so robust,
taking the unemployment rate down and giving hope that perhaps
the worst of households’ balance sheet repair work is finished.

Sadly, as noted by Federal Reserve Chairman Ben Bernanke,
employment growth in the United States has violated Okun’s Law,
which states that the jobless rate shouldn’t fall in a sustained
way if overall economic growth is below a country’s long-run
average.

That’s a bit of an issue for the United States right about
now, given the economy is growing at barely a two-percent clip,
well below its 2.5-percent long-run potential. The rebound in
hiring may have simply been companies compensating for being
overly aggressive in layoffs during the downturn but may also
have been caused by the unusually mild weather recently.

In any event, while one month does not make a trend the data
seen in a global context makes a slowdown look possible.
Ironically, no sooner had the bad data crossed the wire than
speculation began that the Fed will soon make noises about
further quantitative easing.

Given the tone of the last Fed minutes, that process, if it
happens, will take some time, leaving equities vulnerable to
further bad data at home or abroad.

So, where to shelter if in fact we are entering a down cycle
in the United States? That’s an exceptionally tough question.

Probably not Europe, given the high level of event risk
still embedded in anything denominated in euros. China and
India, too, are likely to be highly volatile if global
conditions deteriorate.

Then there are government bonds. Clearly if you think QE is
coming back you will see outperformance there, but with interest
rates already extremely low, government bonds carry a lot of
risk compared to historical norms.

Perhaps a decent allocation to U.S. shares is actually
warranted, though one made without expectations for out-sized
returns. The United States still has a currency to depreciate
and a central bank that has shown it will be activist. These are
assets, though much less so if you are an investor not based in
dollars.

Finally, the more uncertain things are, the better the
argument for gold and cash, not because the world will end but
because they give investors option value: the ability to take
advantage of events as they unfold.

Unfold they will. I can hardly wait for next month’s jobs
data.

(James Saft is a Reuters columnist. The opinions expressed are
his own)

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