Three Yards and a Cloud of Dust: The State of the U.S. Recovery
Employment and the stock market are currently telling two different stories
The business of market forecasting is generally divided up between two different types of data. There are indicators that generally presage economic activity, and there are those that generally react to it. The former is known as a leading indicator, and the latter a lagging one. Unfortunate-ly, the broader investing world consistently confuses the two, desperately trying to infer the future from lagging indicators, and vice versa.
Employment statistics are decidedly in the lagging indicator column, yet they’re often viewed as just the opposite. Granted, the 103,000 jobs created in December was anemic at best, even when accounting for seasonality—a healthy economic expansion generally creates well over 200,000 new jobs per month in early stages and settles to 150,000 or so as it matures—so it was little surprise to see the markets seize upon January’s murky and messy U.S. payrolls report with unusual intensity. Payrolls are always among the most-watched economic indicators each month, and although there are numerous problems with the way the data is calculated, the twin statistics of job creation (or lack thereof) and the unemployment rate generally get a lot of media coverage without a lot of attendant explanation. This has been even truer during the present cycle, which has been marked by extremely cautious hiring by corporations that by most measures are still in a bunker mentality.
And as for the much-heralded drop in the unemployment rate, there is more to the story than meets the eye. The official rate dropped to 9.4% from 9.8%, which on the surface makes for pretty good news. But each month’s report is actually made up of a two surveys—one of households and one of employers. Dig a little deeper, and one finds that that the majority of the December drop comes from a decline in the participation rate, loosely defined as those “in the market” for jobs and currently around 64.34%. This drop was responsible for a whopping two-thirds of the rate decline. At the start of the recession, participation was roughly 66%, and when adjusted for population growth, the decline in participation since then translates to roughly four million people no longer considered to be in the labor force. On the surface, a falling unemployment rate looks good and makes for a lot of positive headlines. But when it is primarily due to a falling participation rate and not because of a good, old-fashioned early-expansion hiring boom, it is not very good news. On the contrary, early stages of recoveries are usually met with rising, not falling, unemployment since participation rates rise as workers return to the labor force.
The bottom line is that the current expansion is much more of a grinding, three-yards-and-a-cloud-of-dust type of thing than is typical for this stage in a recovery. But while lagging indicators tell you what has been happening in the economy, they say little about what will happen in the future. At best, statistics like employment can confirm or undermine signs of economic strength visible in other areas of the economy, like factory orders or retail sales. Importantly, a reduction in the number of layoffs does not mean companies are hiring again—on the contrary, the severity of the recession almost guarantees a relatively long period during which companies have stopped cutting headcount but are unwilling to hire. Indeed, this recovery has been singularly lacking in job creation, and we will need several more months before momentum in the U.S. economy shows up in both rising payrolls and an unemployment rate that is declining for the right reasons.
In the meantime, the stock market—which is a leading indicator, since investors collectively handicap future corporate performance far earlier and more accurately than any government statistics—has made it apparent that the U.S. has conclusively emerged from the economic netherworld of last year. If anything, we’re concerned about short-term speculative excess in risk assets like commodities and small-caps, and early signs of over-extension in some cyclical areas. In typical fashion, the Federal Reserve’s policies have done much to fuel this setup, providing extraordinary liquidity at a time when it would normally begin looking at tightening it. With continued unwinding taking place in fixed-income markets, equity markets should continue to benefit from positive capital flows virtually across the board. In the meantime, we remain convinced that short-term fluctuations aside, commodities and Asian markets will continue to be the two of the strongest strategic trends we have ever seen.