Low growth, low risk and low returns

Equity markets barely fluttered on Tuesday after the President’s Day holiday, as investors tried to work out how weak the US economy was, how weak corporate profits might be, and whether a dovish Fed would counterbalance a sluggish economy.

Last week’s reported plunge in US retail sales surprised analysts, so much so that a large part of the commentary doesn’t believe the number at all. The measure to watch in my view is year-on-year change, which has been declining for several months. If the Commerce Department’s number was right, real retail sales are flat. Optimists pointed to Wal-Mart’s 4% year-on-year gain in same-store sales, which prompted a gain of more than 3% in the retailer’s stock.

One feature of the economic landscape is radically different from anything we have seen in the past: Employment is growing in the overall economy but falling among exchange-listed companies. During the past year, the US economy added more than 2 million jobs, but listed companies shed about a million jobs. That means small business added 3 million jobs.

Most of the new jobs went to the employment categories dominated by small business: leisure/entertainment, health and educational services, and business services (some of which is outsourcing of work from large corporations). There was also a notable gain in construction and manufacturing employment.

For better or worse, this is Donald Trump’s economy. The surge in small business activity reflects the impact of tax cuts, deregulation and $1 trillion a year in deficit spending. CapEx by large corporations remains at miserable levels, in part because of uncertainty about global supply chains, and that element of economic weakness can be laid at the president’s door next to the boom in small business activity.

The trouble is that most of the employment added by small businesses involves lower pay, fewer benefits and less stability than employment at large firms. That might explain the discrepancy between continued high employment growth, disappointing retail sales, and expectations about future employment. The Conference Board’s survey of consumer confidence shows that Americans are worried about future job prospects even while the economy continues to add jobs at a good clip.

The end of 2018 saw a plunge in the percentage of respondents who expect to have more income or a greater likelihood of finding a job six months hence.

That leaves us with low but steady economic growth, and few likely surprises. The central banks of the world have responded to weaker growth by leaning towards monetary ease. The policy response explains the coincidence of economic weakness and low equity market volatility.

A low-growth, low-risk environment favors carry (income-earning assets vs growth). I’m not particularly enthusiastic about the prospects for equity markets under these circumstances: It is unlikely that large corporations can generate enough productivity to offset a lower headcount, which means that revenue growth should be weak. But corporate credit, REITs, and other income vehicles should hold up well.