GDP, GO (Not General Obligation), A Reader’s Request and PREPA

Categories: Commentary, Uncategorized |

August 4, 2014

This week we go far and wide with a look at GDP and GO (not General Obligations) as measures of economic growth.  At the request of a reader, we follow up on last week’s employment discussion by focusing in on Labor Participation.  We take a look at muni issuance vs. other markets.  We also include a few takeaways and a slide from Mike’s presentation on the PREPA webinar.  If you missed the webinar, scroll down to the Puerto Rico section for the link.

Sign of the Times

A Wall Street Journal headline from last week – “Battle for Poor Shoppers Fuels Dollar-Store Deal” – notes that the number of Americans living in Poverty has increased by about 40% and wages have not been rising very much (if at all for lower wage earners).  See the June 23, 2014 Commentary for a discussion on Wages.

GDP and GO (not General Obligation)

The “advanced” second quarter national GDP figures were released by the Bureau of Economic Analysis last week and showed 4% growth vs. expectations of +3% growth. Inasmuch as the BEA reminds us this first estimate will go through several revisions, this data falls under the category of “just reporting the facts.”  The progression of the Q1’14 observations serves as a good illustration of the risks of relying on the “advanced” figure or even on the first revision. The Q1’14 value moved from up +1% to down -2.9% to down -2.1%.  The “second” estimate for the second quarter, based on more complete data, will be released on August 28, 2014… stay tuned.

On July 25, the BEA started publishing “gross output” by industry at the national level.  Gross output (“GO”) measures the total output of an economy, including investments made by businesses in order to produce their goods (capital outlays on new equipment, raw materials and other B2B transactions).

John Mauldin’s Thoughts from the Frontline, July 26, 2014 refers to GO as a “new tool in the economic toolbox.”   Mauldin is a big fan, seeing its focus on supply in the economy (vs. GDP focus on demand) as a superior measure of total economic activity.  We encourage BEA to continue to track national GO and to expand the calculation to the State level.  For more background on GO, see BEA’s answer to the question:  “What is gross output and how does it differ from gross domestic product by industry?”

Below is a graph reproduced from the BEA that shows a breakdown of Gross Output:


In future Commentaries, we will be looking more closely at the GO data and correlations to GDP, employment by industry, and other related categories.

While GDP and GO are valuable indicators, they are backward looking. This week, the Philly Fed released their Leading Index – its prediction of the future economic prospects for the States’ economies.  The Leading Index is based on their Coincident Index and “variables that lead the economy” including housing stats, initial unemployment claims, interest spread between 10 year and 3 month Treasury Bills and delivery times for the Institute of Supply Management.

The news is mostly good: the Philly Fed Leading Index is predicting growth for 46 States with only four States below zero (Alaska, Vermont, Virginia and Wyoming). However, of the 46 states with growth projected, only 14 are predicted to have growth greater than +2%.

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DIVER Analytics, Map Module; Philadelphia Federal Reserve Bank

By Request: Labor Force Participation

Following on last week’s commentary about employment data and our suggestion that the data pointed to improvements in some places, a reader asked that we revisit the broader picture around the Labor Force Participation Rate (see the graph below, courtesy of the BLS).  The June 2014 rate of 62.8% matches the lowest level we have seen since the start of the recession and levels not seen since the mid-1970s.

Our reader’s point, which echoed ours, focuses on the details underlying numbers of employed and unemployed, population trends and employed as a percent of the population.  It is also worth looking at the type of worker dropping out of the labor force.  These days, we see an uptick in retired folks.  While that may soften the blow to the employment-related numbers, it doesn’t bode well for those unfunded retirement liabilities.

Labor Force Participation Rate, BLS

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Why Isn’t Muni Issuance Up in a Low Rate Environment?

Much is made these days of the low level of issuance in the municipal market space (Bloomberg ran an article highlighting the ‘bear’ market for muni credit analysts – seems odd at a time when muni credit stress and retirement underfunding dominates the headlines).  Year to date issuance is $177 billion, down just over 15% vs. 2013.

While we don’t believe muni issuance will go the way of the dinosaur (although we are not sure it will return to the peaks of prior years any time soon), the fact that interest rates remain at historic lows and the Treasury (+15%), corporate (+8%), and asset-backed  (+22%) markets are showing solid growth year to date, may give one reason to pause.

In conversations with market participants, the views regarding the root causes of low issuance range. The common themes are that municipal governments continue to take steps to get their fiscal houses in order (limiting the issuance of “non-productive debt” – pension obligation bonds, debt issued to pay back Uncle Sam for loans to fund the extended unemployment benefits and the like); are concerned about the medium term impact of the Affordable Care Act (especially when the subsidies to the municipalities begin to decline); and are worried about the dual problems of underfunded pensions and unfunded retirement obligations.  If these are the causes, low issuance is a good sign for the fiscal health of our States, cities and towns (however much angst it may cause for market participants).

The chart below compares municipal and corporate bond issuance over time as a percentage of outstanding.

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Source: SIFMA

It is appears that corporate treasurers are viewing the current environment as a good opportunity to borrow.  The picture in the muni market is dramatically different.  New money borrowing in the muni market has been below 5% of outstanding bonds for the last four years. During the late 1990’s and early 2000’s issuance averaged over 10% of outstanding (the peak year was 2003 at 14%).

How long this new era of low issuance will last is a question with significant public policy, business planning, and career implications.

Despite the wisdom of this fiscal prudence, some are confounded that municipalities are not following the lead of corporations and the asset-backed borrowers and loading up on cheap money lent with arguably relaxed underwriting standards.

Brian Pellegrini attributes the corporate behavior to “qualitative easing”

“Given that interest rates are already so low, the result has been qualitative easing through a deterioration in underwriting standards.  …  Extremely low long-term real rates of interest and the explicit confirmation that they will remain low ‘for some time’ are heavily incentivizing more borrowing and riskier lending.”  Connolly Insight, 7/23/2014.

Again, while these statements accurately reflect broader fixed income market trends, the same is not reflected in the muni space.  The elephant in the room is whether municipalities are smarter or will pay the price (literally) in years to come.  Time will tell.  Send us your thoughts.

PREPA in the Crossfire

We participated in a webcast last week focused on the issues facing Puerto Rico Electric Power Authority. Our focus was on the economy of Puerto Rico and its prospects.

The recent weakness of the Puerto Rico economy has been widely discussed, but we think the chart below highlights several key issues:  Puerto Rico’s economic difficulties pre-dated the US recession and its recovery is still in doubt.

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We made several key points regarding the economy:

  • The economic challenges Puerto Rico faces today are not new, some elements trace their roots back 250 years.
  • Because the Commonwealth’s problems are so deeply rooted, visions of creating a new Puerto Rico or finding a miracle solution to its economic issues should be treated skeptically. If the economy improves the path of improvement will be gradual, not dramatic.
  • While Federal financial assistance is not likely, there are steps that the US could take to help, in particular, relief from the minimum wage rules and the Jones Act.

A replay of the webcast is available here: Webcast Link

This week Gregg, Pete and Tim will spend part of their week in NYC.

Have a great week,


Gregg L. Bienstock, Esq & Michael Craft, CFA

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