Why the US employment situation matters more than any other indicator...

financial-markets

Why the US employment situation matters more than any other indicator right now

Once a month on the first Friday, the US Bureau of Labor Statistics releases the "Unemployment Situation" for the previous month.  The data include:

 

  • Total change in employment, with breakdown by sectors.  The "Non-farm Payrolls" number is the headline number.
  • A survey of households to estimate the "Unemployment Rate"
  • Calculations of: average hourly wages, length of the work week and aggregate hours worked.

The estimates are from perfect.  For example, small businesses account for the majority of new hires, but Joe's Auto Repair is ill equipped to update the BLS, compared to, for example, General Motors.  The unemployment rate can swing wildly based on weather, as we saw last month.  Further, surveyed people are only counted as unemployed if jobless but actively looking for work.  "Discouraged" workers in the current environment could account for a "true" jobless rate of around 15%.

From the February report (data through January):

We see a brief spike last spring followed by a sharp loss from hiring to record the US Census. 

Other than that, jobs growth is barely positive in recent months.

The one statistic relatively free from adjustment factors is the total number of Americans employed, which is barely above the trough set during the 2002 recession.  8 million jobs were

gained between 2003 and the beginning of 2008 - about as many as were lost over the next two years.  Meanwhile, the US population gained 16 million from 2000 until the present.

Economists use data from the weekly unemployment reports, ADP and Paychex for payroll data, Monster Worldwide for recruiting, Manpower for temporary workers, and Challenger Gray for layoffs, to forecast the jobs numbers.  In the last year, economists have generally forecast gains that exceeded actual jobs.  To actually bring unemployment down to a 5% level, job gains would have to exceed $250K/month for years. 

Normally, we see substantial initial gains as employers resume production.  What is exceptionally worrisome right now, compared to any recession of the past 50 years, is that not only were jobs lost for a longer period of time, but that more than a year after the official "end" of the recession, we see no meaningful pickup in employment.

What's different about this recovery?

The heart of the matter is a "crisis of confidence" among the Americans most likely to make hiring decisions.  Americans like to think that they live in a "classless' society, but there are clear class stratifications across educational, professional and income characteristics.

William Thomson & Joseph Hickey provided these definitions in their 2005 book Society in Focus:

Upper class (1%)
Top-level executives, celebrities, heirs; income of $500,000+ common. Ivy league education common.

Upper middle class (15%)
Highly educated (often with graduate degrees) professionals & managers with household incomes varying from the high 5-figure range to commonly above $100,000

Lower middle class (32%)
Semi-professionals and craftsman with some work autonomy; household incomes commonly range from $35,000 to $75,000. Typically, some college education.

Working class (32%)
Clerical, pink and blue collar workers with often low job security; common household incomes range from $16,000 to $30,000. High school education.

Lower class (20%)
Those who occupy poorly-paid positions or rely on government transfers. Some high school education.

Over the last 20 years, the majority of US economic gains have gone to the top 1% of society, perhaps deservedly so to the Warren Buffet's, Larry Ellison's and Mark Zuckerberg's who actually create value, but also to a pantheon of hedge fund and private equity practitioners who extract value from the markets at the expense of other investors, to a tiny fraction of professional athletes such as Tiger Woods and David Beckham, and to professional entertainers such as Oprah Winfrey and James Cameron.  We call this the "winner take all" society.  The recent recession affected that group not in the slightest.

The upper middle class was impervious to economic downturns in the past, but the "Great Recession" hit hard.  Not only did this group experience a loss of wealth in the value of real estate holdings and investment accounts, but many experienced layoffs and a reduction in income for the first time in their lives.  A generation ago, doctors, lawyers and bankers all made about the same pay, reflecting similar levels of professionalism and education.  By 2008, lawyers made twice what doctors made, while bankers made about ten times as much income.  Why?  Because medicine is a labor intensive business while banking is a capital intensive business.  Particularly when financial services leveraged themselves into the financial crisis, pay packets were outrageous!  Wall Street paid out record salaries and bonuses in 2010, but that may be a temporary confluence of trading profits and government support.  Compared to pre-crisis 2008, there are 670K fewer jobs in financial services, which includes not only Goldman Sachs employees, but also regional bankers and mortgage brokers across the country.  Job reduction in the legal services sector is not so dramatic, down 60K, but law firm revenues are down sharply as corporations squeeze costs.  In this recession, quite a few upper middle class professionals are sweating blood!  If we were college students today, pre-med would be looking pretty good.

The continued export of manufacturing jobs hits the lower middle class the hardest.  The pain was disguised for a few years when home building ramped up between 2000-2006.  Now that construction, electrical and plumbing jobs have disappeared, it's painfully obvious how many light and heavy manufacturing jobs have moved to Mexico, Brazil, Taiwan, China, Vietnam, and India.  Millions of Americans face the end of unemployment benefits within months.  Skills atrophy from lack of use - many employers have help wanted signs out, but can't fill the jobs they do have.  Our nightmare scenario is the creation of a permanent under-class of unemployables, which has been the experience of much of Western Europe for a generation.  Reread the transcript of President Obama's State of the Union address if you want a sense of how close we are to a permanent break down of the connection between work and society.

Working class workers face incredible insecurity.  Not only are these workers competing with legal and illegal immigrants for jobs that pay $10-20/hour, but even when they obtain such employment, it's impossible to buy a home or start a family on $30K/year.

Lower class Americans who can't write or speak standard English, or perform basic math, are probably permanently excluded from the work force.  Even the US armed services have minimum education standards that these Americans can't meet.

So two factors prevent the normal resumption of hiring after a recession:

  1. The cost of hiring an American worker is not competitive with hiring a non-American alternate. 
  2. A "crisis of confidence" exists among the professional upper middle class.  These Americans are frightened for their own future, and are uncertain about the health care costs and tax costs of taking on a new employee.

The longer hiring remains depressed, the bigger the risk of long term damage to the economy as skills atrophy.  Unfortunately, we don't know of a magic solution to turn things around.

Strategy

Americans are in a tough spot, but American business is in great shape with record profits, strong balance sheets and solid revenues from international operations.  The stock market is getting frothy, as typified by increasing M&A activity.  In five weeks, the S&P 500 is already up 5% on the year, and our forecast for the whole year is 8%, which gives us that "walking on thin ice" feeling.  We're not in the position to jump out of the market, but we continue to rotate to our dividend paying REIT, utility, telecomm and energy pass-through positions.  Those stocks would be harmed least by a pullback, which is probably overdue.  We also like corporate bonds and preferred stock, but are avoiding government bonds.  High grade municipals are attractive after the recent Meredith Whitney inspired selloff, but we avoid low grade munis because tax revenues remain impaired.  We would turn bullish if we got sustainable job growth of 250K/month or better.