Eurozone economy picks up

If anything stands out in today's ISM service sector report, it is the pickup in the Eurozone. The Eurozone economy is clearly picking up, after suffering from a two-year recession. This improves the outlook for the global economy, and removes one of the many drags on the U.S. economy.

The U.S. service sector report was a bit weaker than expected (54.4 vs. 57), but it's been jumping around for the past several years so that is not unusual. As the second chart above shows, conditions in the service sector have been modestly positive on average, and last month's report was only modestly lower than the post-recession average. While there are no big changes underfoot in the U.S. economy, the Eurozone economy is experiencing a welcome revival, and that is big news on the margin.

Announced corporate layoffs have been very low for the past three and a half years. No sign of any deterioration in the outlook here.

Weekly unemployment claims have fallen significantly over the past several years, and are now about as low as we could hope to see. An important part of every recovery is the tightening of business belts: cutting costs, laying off nonessential personnel, scaling back expansion plans, etc. It's good to know that process is now essentially complete. What's missing, of course, is the scaling up of expansion plans and a wave of new hiring. That's going to require a better policy environment, and unfortunately we're not likely to see one any time soon, unless Obamacare is postponed for another year and revamped in the process.

The threat of another recession is still very low, and thanks to the pickup in the Eurozone, there is more reason to remain optimistic about the future. With the yield on cash still stuck at zero, it's thus very difficult for investors to justify a defensive posture. Sitting in cash can only be rewarded if economic conditions deteriorate more than is already priced in.

As the three charts above suggest, the market is still braced for very week growth conditions. PE ratios today are about average, even though corporate profits are at all-time highs—a clear indication that the market expects the corporate profits outlook to deteriorate. 5-yr TIPS real yields are still negative, which suggests the market expects U.S. growth to be very weak for the foreseeable future.