Employment Report And The Market
If you listen to the bleating of the mainstream media and economists there is absolutely nothing to worry about and Friday’s employment report proves it. The official unemployment rate remained steady at 8.3 percent, and 227,000 jobs were added. Just don't look at the number of long-term unemployed, or those without jobs for more than six months, that stayed the same at 5.4 million. Don't talk about the number of those working part time but wanting to work full time, at 8.1 million, which remained unchanged as well. Most importantly don't mention that the number of new entrants into the unemployment ranks rose sharply last month as we discussed in this past weekend's newsletter. If you are lucky enough to have a job, and particularly an hourly pay job, there was little change in hours worked per week and real disposable incomes continue to lag behind inflation. With oil and gasoline prices on the rise the noose around the household budget was just drawn a bit tighter.
While the recent employment report will most assuredly give the current Administration plenty to boast about the underlying trends are far more disturbing. The ongoing structural realities, the fact that many of the jobs that have been destroyed will never return, combined with the demographic shift make the headline number much less important compared with the emerging trends. Take a look at a recent Gallup Organization poll which polls weekly, rather than one week out of a month with BLS, in regards to the emerging trends of employment. The most recent poll update shows the trend of the percentage of unemployed rising. As you can see the Gallup survey tends to lead movements in the BLS poll by about 4 weeks or so. Therefore, it is highly likely that in the coming month as the massive seasonal adjustments in January and February fade out we will see the unemployment rate rise back towards 8.5%.
More importantly, the trends of the data, reveal the existence of a very large class of unemployed, underemployed, and employed but poorly paid workers. Gallup this month actually showed the pace of layoffs increasing in January, and its surveys reveal very little change in the past two years of unemployed and underemployed, with a peak of just over 20 percent in 2010 and declining only to 19.1 percent today. According to Gallup, the jobs situation was actually better at the end of 2010 than it is now.
One of the most important components to employment is wages. An economic system whose primary growth comes from bartenders, wait staff and store clerks is not the recipe required for long term economic growth and expansion.
The year over year trend in average hourly earnings is a testament to the shift of employment in recent years. The trend toward temporary hires continues to exert downward pressure on wages. While good in the short term for corporate profit margins - it is a long term economic anathema. Without incomes growing at a rate to offset inflationary pressures consumption is constrained. As we have seen in the recent releases of consumer credit - consumers are being forced to expand credit usage without increasing consumption.
The good news that is shared by all of the employment reports released as of late is that there has indeed been job creation. Unfortunately, for the average American, it is almost been entirely in lower-income jobs. According to the recent releases of the BLS employment report the fastest-growing sector of employment is “professional and business services.” While this category sounds very impressive on the surface and brings visions of men and women with white button down shirts, dark blue business suits and "power lunches" - in reality it which includes temporary hires. In this month's BLS report 45,000 of those 227,000 hires, roughly 20%, fell into that temporary hire category. The next fastest growing category is "health-care services", mostly lower-paid jobs such as caretakers, aids, and assistants followed by the "leisure" category. Most of the jobs created in the "leisure" arena were in “food services and drinking places" and includes wait staff, bartenders and cooks.
As I stated above, an economic system whose primary growth comes from lower order jobs is hardly the recipe for long-term affluence and global preeminence. Don't get me wrong - all of these jobs are very necessary and they require hard work which is most respectable. That is not my point. What is important here is understanding the shift that has occurred and the impact on the future of the economy.
When it comes to investing in the markets expectations for a high return market in a low growth economy does not compute. While the market can remain detached from the underlying economic strength, especially when plied with enough liquidity to buy 1/3 of the entire world, the reality is that eventually the markets are a function of the economy and not vice-versa. However, this is not just an employment problem. It is also a demographic problem.
While analysts and economists are quick to point out that the aging baby boomers moving into retirement is the reason for the decline in the labor participation rate. The reality is twofold. First, many of the baby boomers retiring is no longer an option after two major market declines in the last decade that has destroyed a large chunk of their retriement capital. Furthermore, most individuals are heading into their retirement years sorely underfunded and working well into their "golden years" is not a choice but a requirement. Secondly, if the assumptions that 78 million baby boomers are indeed moving into retirement then the effect on the investing markets is much more dire than analysts and economists are giving homage to. Current expectations are that they market will continue to grow over time and investors should remain committed to long term investment portfolios. The chart above is the employment to population ratio of Japan compared to the Nikkei 500. Japan has been locked into the same scenario for the last 20 years that the U.S. faces today. As employment falls relative to the population there is less and less contribution to the financial system and more demand. This supply-demand inversion has led to not only lagging stock market but also declining economic prosperity.
Unfortunately, this effect is not just related to Japan. The chart shows the S&P 500 versus the employment to population ratio in the U.S. (the dotted lines are estimates for demographic shift in the economy) The rise and fall of the financial markets coincide with the adjustments to the level of employment in the economy. The lack of real employment relative to the population, as a whole, has a long term impact on the financial markets. If the economy remains at sub-par growth rates for an extended period the employment to population ratio will continue its decline. This will lead to more assets being taken out of the investment scheme in order to fund basic living requirements. This fact will be further compounded by the massive underfunding of pension schemes that are still banking on very high rates of return to shore up a decade of shortfalls. Eventually, the strain on the system over time will be reflected in the financial markets.
Much like Japan the battle in the future will be the effect of net withdrawals from the financial system. As more and more individuals move into retirement, either by choice or force, it will contribute to sustained higher levels of real unemployment. While the headlines are replete with messages of employment growth and a return of the economy - the real question should be the return of what type of economy? The structural shift of employment into lower income producing jobs doesn't bode well for a resumption of economic prosperity or a stock market that will embark on the next great secular bull market run.
For economists and mainstream analysts the trend of the data is far more important than the headlines. For investors it is critically important to understand the impact of a sustained decline in the employment to population ratio. This is the P/E ratio that we need to be watching in the future.