Minimum Wage

I was messing around with minimum wage data some more. (I revisited the data later here.)  I took employment data for several age groups back to 1954, and I did a regression of the Year over Year % change in the number of employed people within each age group against changes in the minimum wage.  This will help to account for both people who are categorized as unemployed and people who leave the labor force.  Since many minimum wage jobs are temporary, discretionary, or held by people who are marginally in the labor force (teens, seniors, and homemakers, for instance), much of the effected workers leave the labor force instead of showing up as unemployed.

There are slight differences, depending on how I describe the change in the minimum wage.

Here is the change in employment per dollar increase in the minimum wage, which doesn't account for increasing incomes over time:

Here is the change in employment per 100% increase in the minimum wage, which doesn't account for the increasing effect of the minimum wage as it increases (eg.  if the minimum wage was 2 cents/hour, we wouldn't expect a doubling to have an effect on employment):

Here is the change in employment given an increase in the minimum wage roughly equal to the average wage.  (eg. if there were no minimum wage and a new minimum wage was enacted, set at the average wage level, this would be the effect on employment).  Of course, this would not be a linear relationship, as very low levels of MW would have little effect, and if we tried to implement a MW as high as the average wage, the labor market would implode.  So, this way of addressing the effect is imperfect, but probably gives a decent result, given the typical level of the minimum wage, and it helps to scale the effect without the problem of inflation or changing MW levels, compared to the previous two charts.
It might give better results to do a regression against both the change in MW and the level, but I don't want to get too complicated for this post:

 

So, depending a little bit on how we measure it, we see a very large effect among teenagers, a negligible effect on middle-aged workers, and a somewhat strong effect on older workers. This is basically intuitive, since teenagers and very old workers would be more likely to be working in low-marginal-productivity jobs.  The results for 25-54 year olds tend not to be statistically significant, because only 1-3% of these age groups are working at low wages at any given time.  In recent years, 8% to 18% of teens have been working at or below minimum wage at any given time, so a change in the price floor has a statistically significant effect on them.  The one surprising outcome here is the apparent positive effect on 20 somethings in the last chart.  I wonder if there is a substitution effect happening there, where teenagers are priced out of work, which leads to a recasting of the lost jobs into more productive jobs that slightly older workers with more experience and dependableness can perform.  This could be pointing to a mitigating factor that keeps the negative effect on employment from being worse.  Low productivity workers are put out of work, and so if there are some higher productivity workers who are available for those jobs, there could be a contrary effect where there are more jobs for those workers.

 

Over a long period of time we have seen labor force participation decline among young people.  The minimum wage hasn't risen over this time relative to average wages, but we do see the LFP rate decline as new minimum wage increases are implemented.  A combination of the effects of the minimum wage and cultural changes appear to be leading young people into schooling as a substitute for entry level employment.  This probably relates to the internship issue I recently considered, and the distinction between training through work or school.  Wage floors force workers to seek employment status signals outside of actual employment.  They have to try to build up enough personal capital to be productive enough to earn a legal wage level.  This pushes a lot more young people into extended schooling that is probably not an optimal use of their time.  I suspect we would be a lot better off if the pendulum could swing back toward an equilibrium where more young people gained skills and status on the job.  A lot of effort and resources are being put into schooling that costs young people a tremendous amount.  The attitudes of most students about school content suggests that it is an expensive signal that is not strongly related to the accrual of actual skills.  In the alternative world, many young people would be producing instead of consuming, earning income instead of building debts, and likely would gain more skills and status in the process.

 

Why is it considered enlightened to have a public policy that leads to a bunch of 21 year old kids with $20,000 in debt and 2 1/2 years of classes for a liberal arts degree they're never going to get, but it's inhumane for them to stock shelves for a retailer for a couple of years for $6/hour.  It doesn't even look like a contest to me.  Instead of letting these kids do what's best for them, we're imposing anti-market biases and bourgeois pretenses on them, to nobody's benefit in the long run.

There was no housing bubble

http://worldofinterest.wordpress.com/2013/07/09/about-that-housing-boom/

I think most of the real estate inflation of the aughts was a product of demographics - baby boomers were bidding up the price of low-risk stores of value.  Houses were seen as an especially useful means for this.  Of course, Fannie, Freddie, subprime, securitizations, Basel II, CRA, etc. etc., fed the price increase.  But, we are seeing some decent housing inflation now, again, without many of those factors.  It seems reasonable to me that baby boomers would be willing to bid the housing stock up above what you might normally expect, given rent/own ratios, etc.  It's related to the low real interest rates we are seeing.  The demographic pressures are strong enough to push the marginal investor to a new price level.  We should expect this to be at least as strong in housing as in bonds.

It's probably a factor in gold, too.  Gold is normally seen as an inflation hedge, but I think it correlates more strongly to real interest rates, and the increases in gold prices over the last decade are a reaction to low real interest rates, not inflation.

For several more years, we should expect gold, bonds, and housing to return negative real returns in a low inflation environment.  When baby boomers have fully entered retirement, so that they are, on net, dissaving, we will see those trends reverse so that asset prices will decline (returns will increase), and inflation pressures will increase.  Normally, I would expect these pressures to be absorbed by market arbitrage, but I think the demographics are too strong, and the time frames too long, for that to happen completely, so that we will continue to see long term predictable trends in these prices.

One cognitive habit that hurts us here is the tendency to think of price changes in terms of changes in the number of buyers and sellers, but of course, every transaction has both a buyer and a seller.  I think it is usually more helpful to think of price changes in terms of changes in the expected value of assets.  Especially savings, whose value is composed of unknown future cash flows, the value of the savings vehicle can change based on a change in expectations as well as a change in discount rates applied to those expectations.  Prices can change without a single trade.

Current Yield Curve & Risk Premiums

Vince Foster always is a challenging read:

http://www.minyanville.com/business-news/markets/articles/What-Drives-the-Market-Multiple-yield/7/22/2013/id/50922

Sticky Wages vs. Sticky Employment

Here is an interesting article that suggests unemployment manifests itself differently in Japan compared to other developed economies, because companies here tend to try to hold wages, so they cut costs through layoffs.  In Japan, they cut wages in order to avoid layoffs.

http://soberlook.com/2013/07/the-clock-is-ticking-on-abe-to.html

Here, we consider sticky wages to be a market friction that the Fed can lessen through inflation, but how would we deal with the Japanese labor market?  I suppose inflation would help there, too, as wages of unproductive workers would be pushed down in real terms as other workers received cost of living raises.  Rising profits would lead to new investment where those workers could be productive again.  But, the act of leaving the original job for a new job would still have to overcome a lot of labor market frictions, with search costs, etc.

This is counterintuitive.  We normally would consider sticky wages to be a market imperfection, but it seems like maybe in the long run, layoffs allow for a more efficient transition to new productive outlets for labor.

Sumner & Soltas on the Fed & Business Cycles

http://www.themoneyillusion.com/?p=22562

There's a lot of wisdom there, including the comments, with George Selgin coming in at clean up.

Falling investment is the problem in recessions, not falling consumption.

Falling interest rates would normally be a sign of a structural problem, and the effect of markets adjusting to lower investment return expectations.  So the Fed tends to follow the rates down, but communicates as if it's leading the parade, so we end up with tighter money than we should have in the Fed's absence, but conventional wisdom is that the Fed is loosening.

Rates have been in a long term secular decline, which is mostly due to demographic and long term economic changes, and if the Taylor Rule doesn't account for this, then the Fed will inevitably tighten too often so that we end up with the double whammy of low real rates and low inflation.  If the Fed doesn't account for this, we are likely to be back at the zero bound when the next recession comes.

Especially with our screwy way of accounting for health benefits, with real interest rates being very low, a 4-5% inflation target would probably be better than the 2% targets we have been at.  Of course, it would be even better if we could somehow get some structural improvements in health care spending.

Those are my thoughts.

HTCH

Well, Hutchinson has taken quite a hit today.  I suppose this is my worst case scenario from the other day - that the market reacts poorly to Western Digital and Seagate on Wednesday, and also to Hutchinson on Thursday.  I'm not sure why the reactions have been so bearish.  The companies' results and forward guidance seem more or less in line with expectations.  The only thing I can figure is that investors were hoping to see stronger forecasts for hard drive sales into 2014.

Looking at Hutchinson specifically, this is what I said in the pre-earnings post:

The main news will be Hutchinson's guidance on sales in the coming quarter and any color they add about further gains in the DSA (dual stage actuator) segment.  I don't expect it, but any more delays in additional sales from new DSA projects or larger than expected drops in TSA+ sales would require some soul searching about future expectations.  What I would like to see is a firm path to 125 million units per quarter over the next few quarters, with a good jump in sales in the 4Q 2013 guidance to something over 110 million units.

On this front, they forecast 100 to 110 million units for this quarter, which is slightly less than I had hoped, and in the conference call they pointed to a level of 130 million units by the summer of 2014, which is basically in line with what I had hoped.

It is odd to be disappointed with a stock that is still up 150% in 9 months, even with this drop.  In September 2011, they had quarterly production of 127 million units.  76 million of those were TSA+ and basically none were DSA.  Then the floods hit Thailand.  TSA+ sales had doubled over the previous year at that point, and I would have hoped to see a continuation of some aggressive trend of TSA+ sales once the flood effects subsided.  This is where my forecasts were wrong.  Net of DSA sales (DSA suspensions include TSA+ or TSA flexures), TSA+ sales last quarter were about 70 million units - basically flat from September of 2011.

Now, one thing that happened was that hard drive TAM (total available market), has declined unexpectedly over that time, due to declines in PC and laptop sales, but even given that, I was surprised by the abrupt change in the trajectory of TSA+ sales.

In the meantime, company guidance has been pretty accurate.  DSA sales are about where the company has always guided.  And, cost cutting measures have generally been near the company's guidance.  So, I can't really fault the company for my optimistic forecasts, and for all of my disappointment, the basic long-term story here is intact.

An optimistic speculator has to be careful not to give in to confirmation bias and friendly revisions in the narrative which causes him to go down with the ship.  But, I'm still pretty confident that this story remains basically on its long term path.  My earlier forecasts for Hutchinson factored in a probability of bankruptcy of 1/3 or more.  At this point in the story, that danger is basically off the table.  The very bad and the very good possible outcomes have been trimmed down, and we are basically gliding along to a valuation somewhere above $10.

One of my early valuation models was one that back-tested surprisingly well, based only on the level of the NASDAQ and gross margins.  Here is the model:

E(HTCH) = E(HTCH/trend) * HTCH(trend)

HTCH(trend) = 3.58*e^t*-.008 * (NASDAQ / 435.5)^1.48492

                                                                                   (9.8)

E(HTCH/trend) = .066538 + 12.44242*(GM) + 2.572864*(CGM)

                                (.42)               (14.5)                    (3.9)
 

E(HTCH) = forecast share price of HTCH

t= number of months since March 1990
NASDAQ = level of the NASDAQ Composite Index
GM= trailing 15 month gross margin
CGM = 6 month change in quarterly gross margin

 

 

This is a backward looking pricing model, although the gross margin trend would bring in a sort of forward looking effect.   I developed this model in late 2011, so the period since then is out of sample.  It continues to work well.  In fact, it predicts a price today, based on last night's news, of $3.84!  Normally, I would naysay a backward looking model, but it could be the case that Hutchinson's extended period of bad performance has eroded management credibility enough that the market is discounting their projections.  But, in the several years that I have been following them, their guidance regarding margins has been very credible.  The dip in margins this quarter was from a mixture of issues that they had warned about and a reasonable one-time issue.  They are not a management team that comes up with one-time problems to explain every quarter.  And, in fact, last quarter had very good margins, which management warned were due to timing issues that would reduce margins this quarter.

 

In any case, here is the model, with a forecast price based on a gradual increase into late 2014 of quarterly production of 130 million units with gross margins rising to about 19% by then.  It's worth noting, though, that even if the current running, normalized sales and margins are used, with no sales growth at all and no savings from Thai production, this model still produces a target price of $9 to $10.

 

 

The fruition of this position is still dependent on margins coming through.  Here is a graph of recent gross margins:

 







After several years in the low single digits, gross margins are now near 10% again.  Even with no sales increases, margins will gain another 3% as production continues to be transferred back to Thailand.  Margins are only at 19% at the top end of the forecasted price level above, which is still conservative.  If the company's plans for DSA units continue to play out, gross margins would get into the 20% to 30% range again, at least until the next disruption in their market.

 

As a reality check, here is how my forecast looked at the beginning of 2012:

 

At the time, I had 3 scenarios for sales levels.  Except for Scenario 1, they were all too optimistic for this time frame, although the differences aren't as great as they seem.  The market doesn't seem to be smoothing out the noise of the last couple of quarters in it's valuation.  The forecasted margins that fed this forecast were near the margins that the company is experiencing.  The top end of guidance for this quarter would basically match scenario 2, with a one quarter delay in the timeline, which is acceptable considering the decline the hard drive market has seen compared to expectations from early 2012.

 

I am confident also because they have a tremendous asset base, which due to accelerated depreciation and write downs during the previous years where sales have lagged, is largely off-balance-sheet.  This means that GAAP profit will understate cash flows by around 70 cents per share for some time.  In this case, that difference warrants the same valuation multiple of GAAP earnings.  So, even on a no-growth trajectory, with a very low PE multiple, we are looking at conservative valuations above $5.  Those valuations increase substantially as DSA sales continue to grow.

 

In summary, this looks like a position that a strong investor needs to hold onto through volatile noise.  Operationally and financially, this is actually a much safer position than it has been any time in the last several years.  I'm not always right about these things.  I've ridden my share of positions to zero.  So, while I can't promise that this position will avoid future losses, I can promise that the speculator who tends to sell this kind of position when markets move like they did today will always in the end lose everything.

 

The one change in position that might be warranted going forward could be to replace some long shares with February (or May, when they come out) call options, which, at the appropriate leverage, could provide some downside protection in a worse case scenario where DSA sales don't come through, and higher gains in the scenarios which I expect to see.  The high volatility makes the options look expensive, but I think they have been worth the high price more often than not, and will continue to be as the company goes through this paradigm shift.

PATK

Patrick released another stellar quarterly report today.

http://finance.yahoo.com/news/patrick-industries-inc-reports-second-125000368.html

Back when I first came up with a long term $20-$30 valuation, my DCF models were somewhat dependent on the long term recovery of manufactured homes, which used to be half of their revenue and are now less than 20%.  As well as they have managed the past few years, there could easily be a couple more doubles left here, if manufactured housing ever sees a recovery.

This is what I said in early November, 2011, with Patrick at around $2.50:

This is one of the easy ones.  This is up 30-40% in the last month, and I hate to chase stocks up, but at these prices, I have to say, back up the truck.  This is worth easily 5 times what is sells for today, and all of their target markets are in slumps.  They should see significant cyclical growth over the next several years.  There is the possibility of a "10-bagger" here, and I don't see any unusual risk.  No need for a 40 page report.  My report on this one is "Dude...come on."

Who would have thought that that forecast was too bearish?! Ha!

NAFTA helps poor Mexican farmers

http://faculty.weatherhead.case.edu/prina/pdfs/prina_rde_2012.pdf

HT: Cherokee Gothic

Is this the last shoe to drop for Obamacare?

Labor is turning against it.

http://www.forbes.com/sites/theapothecary/2013/07/15/labor-leaders-obamacare-will-shatter-their-health-benefits-cause-nightmare-scenarios/?partner=yahootix


I don't understand the public choice implications of all of this.  None of this should be a surprise.  Why were unions for it in 2010, only to turn against it now?  Is there some sort of Machiavellian knot that is being worked out here, or were the bill's supporters really that clueless about the complex consequences of piling dozens or hundreds of inter-related mandates and fees on top of each other?  Could our federal governance have gotten that bad?

Employment Flows

The BLS has tons of great data.  Building on yesterday's post, I was really hoping that I could find employment flow data broken out by age.  I'm coming around to the idea that so many trends that we would like to attribute politics, money supply, etc., etc. are largely demographic issues.  I was hoping to test whether the tepid JOLTS data could be a product of demographics.  Characteristics of older workers could explain the low level of quits, the high proportion of job openings to hires, etc.  But, unfortunately, I don't see it broken out that way.

The flow data is interesting, nonetheless.  Here are the historical graphs concerning flows to and from "Not in the Labor Force".  First, here is a graph of "Not in Labor Force" population.  We can see the acceleration in this category over the last 15 years, as a result of an aging workforce.  And, we can see the slight movement above trend in 2003-2005, then the slight movement below trend in 2006-2008, with a recovery back to trend in 2009 and after:

In the next graph, the blue line shows "Not in Labor Force to Employed" and the green line shows "Employed to Not in Labor Force".  I would guess that the secular growth in these categories stem from the aging labor force that I covered in the previous post.  In the 55+ age group, there are a large number of people who would not consider themselves "unemployed", but fill their days with a combination of civic involvement, odd jobs, consulting, political activities, etc.  Some of these activities would count as "employment", but for the growing number of people that meet this description, life would not fit nicely into a employed/not employed context.  We can see the long term increase of aging baby boomers here, with a temporary decline during the recession from labor market anemia, although even at the bottom of the recession, there were more flows between employment and NLF than there had been in the 90's in a booming economy with fewer older workers.  (Students could be an effect of these flows, too.)

The red line shows flows from "Not in Labor Force to Unemployed" and the purple line shows "Unemployed to Not in Labor Force".  The conventional image of the recession is that the UE>NLF flow would have increased.  But, the full picture is more complicated.  Flows in both directions have increased together.  Looking back in time, there is some cyclical behavior in these flows, but not the secular increase that we see in the employment flows.  The recent persistence of the increase in these flows is probably related to the large number of long duration unemployed.  It is interesting to note that while 11 to 12 million workers are still unemployed, there is a flow of more than 2.5 million workers between unemployed and "not in workforce" each month.  With that much circular flow, it is amazing that we don't see more noise in reported unemployment rates each month than we do.

 

 

 

To get more insight into how these flows relate to the business cycle, I have graphed the net effect of the "Not in Labor Force" flows to and from employment (blue) and to and from unemployment (red), and the net flows to "Not in Labor Force" from both employment and unemployment.  These are 12 month moving averages to eliminate noise.  There is always a net flow from employment to "Not in Labor Force" and from "Not in Labor Force" to Unemployment.  The persistence of these net effects relates to persistent aspects of the economy, such as the constant flow of new young people into the labor pool, retirements of employed people, etc.  The net NLF figure here does not account for non-employment related changes, such as population changes.  The changes in trend are what's important here.

 

First, on the total net flows to NLF (Not in Labor Force), there is probably a persistent negative flow (a flow into the workforce) over time.  Here the unsustainable trend of flows into the labor force in 2004-2005 are visible, and the unusual flows out of the labor force in 2009-2010 are visible, with the return to a neutral flow since then.

 

When we look at the separated indicators, we can see that there is a counteracting dynamic happening.  In the early phases of the last two recessions, the "Not in Labor Force" category was inflated by workers moving directly from employment to NLF, and this was countered by workers moving out of NLF and into Unemployment.  It is only later in the recession that we see relatively more workers moving from unemployment to NLF, which is then countered by relatively less workers moving from employment to NLF.  I would characterize the period in 2009 & 2010 where we saw the biggest dip in Labor Force Participation as mostly the product of a decline in workers flowing from NLF directly to Employment.  Looking back at my previous post, where we see the most anomalous movement in LFP among the youngest and oldest workers, I would speculate that this stemmed from older workers who normally tip back and forth between Employment and NLF having a harder time finding temporary employment, and younger workers who were having more difficultly getting entry level jobs in the face of stagnant hiring markets, exacerbated by the last hike in the minimum wage in late 2009. 

It seems as though there could be a leading indicator hidden in here somewhere, since early in recessionary markets we see a local minimum in flows through unemployment, a local maximum in flows through employment, a divergence of flows between NLF and Unemployment as well as between NLF and Employment, and, as shown in the last graph below, an increase in the persistence of unemployed workers.

The counteractivity of many of these indicators means that these movements can start to be visible here before they are visible in measured LFP or the unemployment rate.  Interestingly, the last chart also shows how flows in and out of NLF and the persistence of unemployment are much more volatile than the flow of workers from Employed to Unemployed.

Surely, there is a leading indicator buried in here somewhere, although the noisiness of this data might make it hard to read in real time.  These will be interesting to watch when we enter the next bear cycle.  These indicators certainly do not bear out my earlier concerns about weakness in the JOLTS data, so this is more evidence that we have a ways to go before we need to worry about a new downturn.