Posted by Don Martin on Tue, May 14, 2013 @ 09:11 AM
Will full employment economy create massive inflation?
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When the economy returns to full employment, will that result in massive inflation?
I doubt it. Most of the unemployed people are those who, if they became employed, would only earn close to minimum wage. Since many of the so called hidden discouraged unemployed people are receiving lucrative tax free welfare benefits then they would be reluctant to give those benefits up and go to work. If they did work then their after-tax income would be no higher than it is now, so they could not increase their consumption. When people and businesses get bank loans and spend it on non-productive consumption then this is what causes inflation. If someone getting close to minimum wage in terms of the value of welfare benefits suddenly became employed at a similar amount of income then his need for basic survival expenses would mean that he couldn’t qualify for a loan and thus couldn’t participate in the creation of inflation.
A return to full employment would awaken the bond market vigilantes and the Fed and this would result in interest rates increasing, which would act to cool down an overheating economy. When interest rates go up people are forced to get a smaller than planned for loan and thus the inflation causing nature of new loans would be diminished.
The consumers who can create inflation by getting a loan are the skilled professionals who currently experience an unemployment rate in the 3.9% level (for college graduates), which is below the hypothetical full employment rate of “natural unemployment” of 4%.
The economy is already at full employment in terms of the type of labor force members who are untainted by either an extended adolescence living with their parents or welfare-queenism. The groups “married men” and “married women” have a 4.4% unemployment rate regardless of skill or education. Thus the main risk of inflation occurring would not be from a change in the unemployment rate (nominally at 7.5%), rather it would come from those now fully employed who increased their work hours or hourly rate. Once they are armed with higher income they would qualify for and get bigger bank loans and then spend the proceeds on consumption. Most people don’t want to go into excessive dent that is based on a temporary surge of income and bankers have rules to filter out people who don’t have long term track record of being at a new, higher level of income, so this type of reason for bank lending to increase is unlikely to occur.
I have written an article “Employment better than appears”.
Investors should seek independent financial advice.
Posted by Don Martin on Tue, May 07, 2013 @ 02:37 PM
Don’t fooled by unemployment statistics
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If the average salaried person lost his job on average every three years and took a month’s vacation while claiming unemployment insurance and while experiencing no problem finding a job that would contribute an erroneous 2.56 percentage points to the unemployment rate. For example if one claims to be unemployed for a month while on vacation that is 7.69% of a year. If this is done every three years then divide 7.69 by 3 equals 2.56. If the natural rate of unemployment is 4.0% and everyone decided to take a month long vacation while listed as unemployed and looking for work the result would be a 6.7% unemployment rate. The current unemployment rate is 7.5%. What if every salaried or wage earning person on average lost his job every two years and took a month long vacation while claiming unemployment. This would contribute 3.85 percentage points to the unemployment rate. If the natural rate is 4% and one adds 3.85% to 4% the result is 7.85%. Of course economists constructed the 4% natural rate of unemployment in part to account for hidden vacation taking while one is registered as unemployed. My point is that such activity is difficult to measure. What is easy to measure is that for college grads there is a full employment economy with a very low rate of 3.9%. Also for the groups “married men” and “married women”, regardless of skills, they also have a low unemployment rate of 4.4%.
The ironic thing is that as the economy gets hotter workers work longer and harder and defer vacations so as to help their employer meet deadlines. Then when the layoff comes its payback time where the unemployed person makes up for a much needed vacation. However if the unemployed person files for unemployment benefits the government statistics imply that someone is unemployed, yet the worker may not feel economic distress and may feel confident that work offers will be available. By contrast, in a recessionary economy a recently unemployed worker would be more rested and more eager to accept a job right away, so by contrast a full employment economy can create a false symptom of unemployment as people who have become newly freed from excessive work dig into a well-earned, overdue vacation.
There was an article in Bloomberg Businessweek “Migrants Stay Busy as Unemployed Greeks Spurn Menial Jobs” about Greek workers who refused to pick fruit and instead the farm owners hired illegal aliens from Bangladesh. So on one hand there is a 27% unemployment rate in Greece and yet the natives refuse farm employment. Is it possible that the modern Welfare State encourages and subsidizes those who register themselves as unemployed? In Ireland some welfare recipient families get over €100,000 (USD $133,000) a year in benefits.
We have a global “welfare state bubble" that creates a false signal of high unemployment which results in the Federal Reserve making interest rates artificially low. This in turn enriches irresponsible Wall Street speculators who borrow using cheap margin loans and buy overpriced stocks so as to participate in “Greater Fool” theory activities like “momentum trading”.
I have written an article about how rising interest rates (related to a reduction of unemployment) will undermine the value of stocks, long term bonds and real estate. See “Improving employment rate to hurt investments”.
Investors should seek independent financial advice.
Posted by Don Martin on Fri, May 03, 2013 @ 01:45 PM
How Does Today’s Non-Farm Payroll Report Affect the Stock and Bond Markets?
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The monthly employment report was released today with a 0.1% drop in unemployment to 7.5%. At this pace unemployment will be 6.5%, the Fed’s target, by year end. The implication is that the Federal Reserve would begin to slowing back away from Quantitative Easing. The markets often anticipate economic events several months early. Thus by late summer perhaps the market will decide that the Fed will cool down its stimulus program. This could make stocks, bonds, and real estate go down in price. The stock market has seasonal tendencies to rise from January to May and then go down. If the seasonal pattern occurs when interest rates rise then that would act to lower stock prices.
The traditional BLS measures of unemployment are severely compromised by those who enjoy the generous benefits of the modern Welfare State. Any unemployed person who has a market value of less than $40,000 income may be tempted to live off the public dole and avoid seeking work. The way to bypass this compromised data is to look at the segment of workers who are in the mainstream of the labor force and who have historically had low unemployment rates. These groups are married men or married women. Their rate of unemployment at 4.4% is quite low although still higher than during boom times. The rate of unemployment for all college graduates is low at 3.9%. A 4% rate is considered full employment for the general population and 2.5% would be the low rate for the married people or college graduates. The unemployment problem is clustered among either very young or very uneducated people. At some point labor economists will have to redefine what is the definition of being a worker who sincerely seeks to work, as opposed to an unemployed dreamer with unrealistic goals.
When the Fed realizes that a new definition of unemployment needs to be devised then they may decide they have done enough to stimulate the economy and begin to withdraw the stimulus. From the standpoint of traditional cautious prudent policy the massive distortions, or future risk of them, caused by zero interest rates and QE are scary. And well educated economists don’t like scary, high risk entrepreneurial scenarios. Thus many Fed members may become increasing nervous about the risks of severe distortions caused by QE. They could suddenly decide it was time to back away from QE. Of course any retreat would be gradual, but the markets will see it as a hint of a non-gradual retreat.
Lack of yields has provoked investors into getting “yield” by the dangerous act of writing naked Put options, which are sometimes packaged and sold as “Structured Notes” giving the false appearance of simply another type of bond. This helps to push up stock prices by creating a supply of cheap Put options that enable over-leveraged investors buy stock. Margin loans have increased a lot in recent years. Thus QE definitely inflates stock prices.
The prudent thing to do is to assume that somehow QE will end and stocks will go down. Perhaps today’s market is like 1999 when there was bubble but the bubble got bigger for another year then took a year to collapse. It takes nerves of steel to ignore the misguided optimism of the majority and to remember the bubble of 1998-2000.
The best benchmark for asset valuation is income flow, including making adjustments for sustainability and credibility of the flow. This means using PE10 to estimate values. PE10 implies that stocks are 55% overpriced and need to drop a third to reach equilibrium. So even though it hurts to suffer the opportunity cost of missing stock market rallies, if the economy is repeating the bubble of 1998-2000 then the prudent thing to do is to avoid bubbly asset classes.
Inflation caused by a recovering job market is not a threat, thanks to the extreme weakness of Europe and Japan and thanks to the modern era of globalization, de-unionization, etc. Thus the healing of the job market will not result in a return of high interest rates and high inflation. However, shifting from a 2% interest rate that some people now pay to a more normal rate of 6% will slow down some consumers and business.
I have written an article “Correct data on unemployment may hurt investments”.
Investors should seek independent financial advice.
Posted by Don Martin on Fri, Apr 26, 2013 @ 06:53 PM
Will increased recognition of intangibles result in lower unemployment?
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The structural nature of the U.S. economy has been changing from manufacturing to service for many decades. Starting in July the Bureau of Economic Analysis in the Department of Commerce will calculate GNP using new measures for intangible services. This will artificially increase the GNP by 3%. To make things comparable they will adjust figures going back 83 years. The WSJ had an article about this.
The move highlights the fact that trying to forecast the economy is like aiming at a moving target. A good research scientist knows that one must constantly be willing to change their core beliefs if new evidence is uncovered and they must be willing to abandon cherished paradigms and embrace new ones when the old ones has become discredited. I see this as a move towards greater recognition of the job generating sector that produces intangible services. Economists need to move away from unbalanced calculations of the effect of unemployment in old declining blue collar industries and move towards identifying hidden positive news such as the increased use value of services. If a foreigner comes to the U.S. to go to college and pays full non-resident tuition then they are like a foreign consumer who is buying our exports, but it doesn’t show up in the export records. When the iphone is built in China most of the sales dollar goes to Apple and not to the Foxcon factory in China, so the importation of an iphone is not really that much of an foreign import. What is important is that service industries including chip design shops add more value and pay better wages than many blue collar industries. In some countries old smokestack industries are subsidized by the taxpayers to create jobs.
The point is that unemployment, which is clustered mainly with low skilled workers, is mis-measured because it should be weighted towards the income of the worker and not simply a binary question about does someone have a job or not. Service industries create jobs and wealth and continue to be under-calculated compared to tired old blue collar industries. As more recognition is given in this sector then perhaps economists will revise the definition of unemployment, especially the “natural rate” of unemployment.
According to economist David Rosenberg the “insured unemployment” rate is now 2.25% which is about at average level and not too far from full employment levels for that group. My opinion is that even though the general public has a 7.6% unemployment rate, what matters is the rate for mainstream breadwinners. Since more sophisticated measures of unemployment show we are close to full employment then it is only a matter of time before the Fed and the bond market vigilantes change their opinion and make interest rates go up. The key determinant of interest rates are unemployment and inflation.
When rates go up then stocks, bonds and real estate go down.
I have written an article “Employment better than appears”.
Investors should seek independent financial advice.
Posted by Don Martin on Thu, Apr 25, 2013 @ 02:02 PM
Is the underground economy a huge source of hidden jobs?
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If the U-6 unemployment rate which includes “discouraged” jobless people is 13.8%, how many of those people are secretly working in the underground economy for currency? What would the unemployed rate be if these people were accounted for?
According to an article in Yahoo! Finance “How Big Are Underground Payrolls? Try $2 Trillion” the underground economy has doubled since the 2009 crash. The study says the underground economy is 8% of GDP. My view is that if workers get about 55% of GDP then this would imply roughly enough income to support 4% of the population, however, if those people are low wage workers then it could be a much larger percent of the population that is supported by the underground economy.
There are 12 million illegal aliens in the U.S., most of them working. This is 9% of the U.S. labor force, or one out of every 11 workers. If they can find work even without a Social Security number and proof of legal presence which is required to get a job then why can’t citizens get a job? And if 12 million illegal aliens manage to sneak through the system does that somewhat reduce the credibility of labor economists who claim to have calculated the unemployment rate?
My point is that the best gauge of unemployment is the BLS statistic of the group “married men” or “married women” also works well. This group tends to take a serious, plan-ahead view of life and is focused on finding work to pay for children and mortgages, etc. Married men have an unemployment rate of 4.3% which is close to the “natural rate” of unemployment of 4% which is the definition of a full employment economy. (During boom times married men’s unemployment has been as low as 2.4%). The true status of the U.S. labor force, after subtracting out those who collect welfare benefits without truly seeking to find work or enjoy loafing in their parent’s home and are not really in the market for work, is one that is close to full employment.
In addition economic statistics need to be weighted for the effect of above average earners on consumption. The higher one’s skills the lower the unemployment rate and the greater the consumer confidence and ability to spend. If the reason for monitoring unemployment is gauge the ability to buy goods and services then one must weight the study based on income. Also the study of unemployment must be based on screening out those who appear to be unemployed but are actually either earning a living in the underground economy or who are willfully loafing on the dole or at their parent’s expense.
We may be close to a full employment economy. When the Fed realizes it then interest rates will go up, which will be a shock to stocks, bonds and real estate, making them go down in price. Of course an improving economy means consumers will have more to spend, but if the spending has already been discounted by the marketplace in terms of valuing corporate earnings then the net effect of a surprise improvement in unemployment would be bearish for the markets.
I have written an article “Employment better than appears”.
Investors should seek independent financial advice.
Posted by Don Martin on Thu, Apr 11, 2013 @ 01:19 PM
Employment calculation flawed; interest rates will rise when the market learns this
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Employment data needs to be reinterpreted for modern times. The BLS needs to adjust the definition of unemployment to reflect that some unemployed people don’t need to take undesirable low wage jobs. The highest concentration of unemployed people are either young people in their 20’s or the least educated, least skilled people. Both of these groups should be working in low wage jobs but they have the alternative of going on welfare or living with their parents. They should not be used as a data point for calculating unemployment. Instead the best indicator of unemployment is the group “married men”. They may have a mortgage and a baby to feed. Traditionally members of this group always managed to find a job, so one should examine the percent of them who were unemployed in the 2007 peak, the 2009 bottom and now and see how that has changed. Yes, I understand that to get married it helps to have above average employment and social skills so it maybe the group is skewed, but they are a better benchmark than an unreliable benchmark of people who can shirk work and go on welfare and are thus not an objective measure of unemployment.
During recessions people need to be flexible and change the definition of work; people should accept less desirable work but due to the welfare state the employers offering lower rung jobs can’t compete against the welfare check.
On April 8 the Wall Street Journal ran article about the rising number of people on disability. The article mentioned that after two years on disability they get to access Medicare even if under age 65. That could save some people over age 55 over $10,000 a year in medical insurance. The article mentioned that once on disability that the beneficiaries are afraid to give up the security of that cash flow and take a risk in holding a job. The article didn’t mention is that the total all-in impact of the tax-free or low tax welfare state benefits can be much bigger than what many people are capable of earning. Some people can get subsidized housing using Section 8 subsidies which save them $18,000 a year. Getting a combination of disability, food stamps (now called SNAP), Medicare, Section 8 housing and the tax savings from not working (and from not commuting) it pays not to work if one is a low skilled worker with a fair market wage close to minimum wage. For an anecdotal example someone could get:
Disability $13k
Food stamps $3k
Medicare premium savings over private insurance $10k
Sec 8 housing $18k
Total $44k
If the benefits are worth roughly $40,000 mostly tax free that is like getting a taxable salary of $60,000, since payroll taxes and state income tax with federal income tax could be a 33% tax in California. Of course, disability is usually not tax free. If the average wage income in the U.S. is $42,744 a year and some welfare beneficiaries get the taxable equivalent of more than that then this would explain why consumption has continued during a hard recession and it also means that people on the bottom of the employment ladder are not an objective benchmark for gauging the unemployment rate. In Britain the government required all disability recipients to get recertified that they are disabled. A third refused, another third were told by the examiner that they were not disabled, so two-thirds were on the dole incorrectly.
The unemployment rate for college graduates is 3.8%, which is less than the 4% “natural rate” of unemployment. When someone loses a job, if they seek a big vacation but want to collect unemployment benefits, then they stall for time while appearing to look for work and are thus counted as unemployed but they may be in reality temporarily withdrawn from the labor force. This boosts the unemployment rate even though the jobless person is really on vacation and is not struggling to find a job. If the average worker changes jobs every four years that is like 25% of the population quitting or get laid off each year. Suppose, for example, each newly unemployed person takes two weeks of vacation but claims he was looking for work that is a 4% unemployment rate for the unemployed person multiplied by 25% (the number of people who became newly unemployed) which adds 1% to the overall unemployment rate. Thus an 8 week vacation by this group would add 3.9% to the nation’s unemployment rate. The economists have developed the “natural rate” to deal with this, but it is subject to change and it is hard to document how much time a job seeker is using to go on vacation.
During the boom time of 1998 married men had a 2.4% unemployment rate, 1.6% below the natural rate. Using the peak year of 2007 as a benchmark we see that when the general population has an unemployment rate of 4% then this married men’s group rate of unemployment is 63% of the general population. For married women the unemployment rate was 2.8% in 2007. At the worst time in the recession in 2009 married men’s unemployment rate was 6.6%; in 2010 it was 6.8%. In March, 2013 it’s 4.3%. Since the married men index has a full employment level of 2.4% during boom times versus the “natural rate” of unemployment of 4% then that group is now 1.9% higher than its natural rate. The Fed announced a target of 6.5% unemployment as the benchmark for the Fed to back off from QE money printing. The 6.5% goal is 2.5% above the natural rate. Since the married men’s group is at 1.9% gap from full employment and the Fed’s goal is 2.5% over full employment (for a sign that the Fed will use to end QE) then perhaps the economy is much closer to full employment. Assuming the unemployment rate can be reduced by 1% a year (if add 225,000 monthly new jobs less 100,000 population growth) then for this group in 1 year by March, 2014 it will be 3.3% which is not far from the peak of 2.5%.
Since the Fed would not want to wait until the last minute to reverse course then if they were to go along with my view then in perhaps as little as 12 to 18 months they could decide that the “we’re-like-Japan-deflationary” panic is wrong and that the risks of dangerous financial bubbles outweighs the benefits of continued low policy rates and QE. The unemployment rate in March was 7.6% for high school graduates, 6.4% for those with some college, and 3.8% for college graduates. So if a high school graduate gets some college and gets a break he can cut his unemployment rate by 1.3% which is the amount that unemployment needs to be cut for Fed to raise rates. Of course part of the value of an educated worker is work experience, which is why I said “…gets a break…”.
The labor force participation rate has been dropping from 67% in 2000 to 63%. Read The Atlantic magazine article about this. This largely because as the Baby Boomers move towards retirement age some of them are fortunate enough to be able to take early retirement, however, others may have suffered from disability as they age or from loss of jobs to globalization. It has been fashionable among bearish advisors to say that a declining labor force participation rate means that there are increasing numbers of “hidden” unemployed people with the implication that high unemployment means the economy is weaker than it seems. However, much of the decline in this rate is due to normal or early retirement or disability and is not a sign of hidden unemployment. The pattern of a reduction in the labor force participation rate may continue, which will reduce the unemployment rate to 6.5% in less than a year, which would make the Fed start to raise interest rates. Since the marketplace will anticipate this, then rates may move up even before the Fed acts to raise rates.
However the actions of Japan’s Central Bank to devalue by buying foreign bonds by printing Yen means that there will be a bidder for U.S. Treasuries and this bidder could confuse global markets, making rates go down when they weren’t supposed to. This would suppress the signal from the U.S. bond markets with noise. Eventually the market would realize what is happening and rates would rise.
Think of solving the unemployment problem through an anecdotal story of a hypothetical unemployed person: Year 1 in 2008 in the crash he becomes unemployed, year 2 he decides on a career change and applies to a training program, year 4 in 2011 after waiting for admission and then getting trained and certified he is now looking for work, year 5 he does a volunteer internship, year 6 in 2013 he finally gets a break with a job in the new career. From a standpoint of measuring his progress he was off the radar screen until year six when he finally got a break. There is no way to gauge these strivers’ progress until suddenly they catch a break with an entry level job at which time the labor market will have changed before the Fed has realized it.
If the Fed decided that we are near a full employment economy and that those chronically unemployed are simply shirkers who are not relevant to the economic debate about recession versus prosperity then the Fed would raise interest rates to traditional levels. The marketplace could even do it for the Fed. This would hurt the still fragile housing market, kill off the carry trade in leveraged buying of dividend paying stock and of course hurt bonds. This would reduce economic growth since it would discourage borrowing for consumption. As house prices went down then home equity lines would be cut off and homeowners would have less access to taking cash out from refinancing, and thus less funds to spend and invest. A period of suddenly rising rates could damage hedge funds and also damage the hedge-like activities of banks that use cheap Fed funds to hold levered positions in long term bonds, causing some banks to take losses in their own portfolios.
The bottom line is that there are too many advisors and investors who take a cavalier attitude that there is need for interest rates to stay low until roughly 2018. These advisors advocate doing leveraged carry trade investments that are dependent on using ultra-low margin loan rates, which is wrong. An example would be a mortgage REIT that is levered up four to one. If interest rates suddenly rise these firms could encounter a 35% drop in value or even worse, plus their internal cash flow could decline drastically, destroying their ability to pay a hefty dividend.
I have written an article “Employment report – Will stocks crash?’
Investors should seek independent financial advice.
Posted by Don Martin on Fri, Apr 05, 2013 @ 02:15 PM
Unemployment data very complicated but ultimately the economy will recover
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Today’s employment report issued by the BLS showed only 88,000 new jobs, which are less than the 125,000 needed to keep up with population growth, so in real terms employment shrunk by 37,000 in March.
I think the best measure of employment is a six month average of the data. That shows roughly 196,000 monthly new jobs (before today’s report) or about 1,000,000 annual new jobs in excess of population growth, which is about a 0.7% annual improvement. At that rate then in mid-2014 the economy will have reached the Fed’s goal of a 6.5% unemployment rate, down from the current 7.6%. When the Fed’s goal has been reached the Fed will start to sell off their bond holdings which will raise interest rates and lower bond prices. The bond market will anticipate this as we get closer to that point, so at any time in 2014 rates could rise in the marketplace even if the Fed is not yet trying to increase rates. The reason I mention this is I have heard so many advisors claim that because inflation is low that rates won’t rise until 2018 so they want to do some risky investing that is dependent on artificially low rates. But record low rates can end suddenly. The Fed should realize that low rates don’t increase employment, instead they fool investors into making mistakes by investing in unworthy investments and thus participating in a bubble.
Distortion caused by low rates includes:
- Housing market attracts yield hungry investors fleeing bonds. These investors hope to get a net yield, after expenses, of roughly 4% on an all-cash purchase of rental houses. What they fail to grasp is that the huge number of new rental properties that are seeking tenants will put downward pressure on rents or at least keep rents from rising. Also the stagnant wages of lower-middle class people will prohibit the marketplace from raising rents. Based on reaching an equilibrium point to its long term inflation adjusted historical trendline for housing, the price still needs to go down a little, perhaps 10%, so the current inflows from investors will temporarily warp the housing market, but eventually the truth will come out that moderate income people can’t afford to pay rising rents.
- Buyers of owner-occupied homes now seek to buy to lock in low rates. When rates go up then buyers will have less purchasing power, then buyers will have to buy cheaper homes, thus putting downward pressure on the housing market.
- Yield hungry investors now may be tempted to write (issue) naked Put options in hopes of making a lucrative yield. This is dangerously wrong. But this action helps support stocks by enabling hedge funds to buy cheap Put options so that they can buy stocks with margin loans. When interest rates go up then Puts will cost more and leveraged stock investors will need to lighten their holdings, thus putting downward pressure on stocks.
- In the future corporations will pay more to borrow money and thus corporate profits will decline, pulling stocks down. Corporate buybacks of shares will be harder to do when interest rates are higher, thus putting downward pressure on share prices.
- Leveraged carry-trade strategies like mortgage REIT’s will fail and have significant price declines
- High yield junk quality investments will see an outflow as investors are no longer forced to go to them for yield. However if the economy shifts towards full employment then junk quality companies may get bailed out by a rising economic tide. This would make their poor credit quality improve and thus the value of junk bonds could increase or at least offset the downward price pressure caused by rising rates; this would be dependent upon the bond’s duration with short duration bonds having less risk.
The counter-intuitive outcome of the economy recovering (very slowly, especially today) is that it will actually make stocks go down as interest rates rise. Since stocks sometimes anticipate economic events in advance then if the Fed raises rates in mid-2014 then perhaps in early 2014 the market will anticipate it and sell off. In the meantime try to avoid being fooled by stock market bubbles even though it is very irritating to get almost no yield from intermediate term investment grade bonds.
I have written an article “Recovering economy doesn’t mean stocks to go up”. (This is especially true if stocks went up for unjustified reasons caused by the Fed’s easy money policies.)
Investors should seek independent financial advice.
Posted by Don Martin on Fri, Mar 15, 2013 @ 05:07 PM
Will the improving economy make interest rates go up to the high levels of the 1970’s?
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When the economy improves and recovers from a recession then the jobless rate returns to normal and the Federal Reserve returns interest rates to normal, according to classic theory. For several years the Fed has made interest rates artificially low to cure the economy. The risk is that a sudden surprise healing of the labor market could be grounds for the Fed to raise rates. This would hurt stocks, long term bonds, real estate, and even commodities.
There are two main types of long term unemployed: young college graduates and poorly educated high school dropouts. The young college graduates are held back from employment opportunities because people close to retirement age are holding on their jobs and delaying retirement in order to save for retirement. Eventually the older generation will finally be able to retire or will be too old to work and the young college grads will finally get a break and become gainfully employed. When they do they will have lower than hoped for wages and lots of student loans which will constrain their ability to qualify for a loan. The granting of new loans by banks is a key transmission mechanism in terms of how inflation is created. In a world where everyone has too much debt to qualify for a loan then no one can borrow extra money and thus no one (except the government) can create inflation. Thus the coming healing of the labor market does not need to be inflationary and so the healing won’t necessarily result in massive increases in interest rates. However, since rates are very low then when employment returns to normal then interest rates would need to go up both in terms of the “invisible hand” of supply and demand and in terms of the Fed trying to fine tune the economy. It could take a decade from now before the young unemployed graduates get substantial pay raises and pay down debt to the point where they can begin to engage in aggressive debt-fueled consumption. That is so far in the future that it is not even on the horizon. Based on how survivors of the Great Depression behaved after the economy returned to normal, the survivors refrained from excessive debt use for a long time. A similar experience may occur with today’s young graduates.
The other sector of hard core unemployed are those at the bottom of society with the lowest skills and education. They are hurt by globalization taking away simple jobs that will never return. Even if they get a near minimum wage job they will not be able to qualify for a loan for substantial debts and thus not contribute to inflation.
The prime potential suspects of the future causes of debt-created inflation would be the upper-middle class professionals who are already happily employed and successful businesses. But these people and businesses are being careful with their money with exception that some affluent people may be overpaying for an owner-occupied house in an elite neighborhood. Thus I don’t see much chance that the coming labor revival will result in the inflation caused debt fueled boom of the 1970’s.
Measuring the impact of unemployment, in terms of measuring the depth of a recession, used to work better when life was simpler. However, in modern times if the people at the top can earn and spend enough to make up for the lost consumption that would have been done by low skilled workers then unemployment may not be that useful in terms of gauging the right level of interest rates. When the Fed wakes up to this then they will raise rates even if unemployment is too high by traditional metrics.
The employment-to-population level which is at 58.6%, nearly the lowest in 30 years, is partly low because some fortunate baby boomers can safely take early retirement, others may have health problems that force them out of the labor force. Imagine a scenario where 25% of the population did a better than expected job of retirement planning and was able to retire early (possibly due to lucrative government employee pensions) and the other 75% needed to keep working. Then the fortunate minority actions would lower the employment-to-population ratio.
If an investor wanted to trade bonds using this article they might speculate that eventually the Fed would panic and raise rates (making bond prices drop) and then the Fed would realize inflation wasn’t coming only to find out that higher rates had shocked the speculative part of the economy (the asset traders) into a recession. Thus a future Fed rate increase might not effect jobs and GNP, etc. that much, but it would really hurt asset prices such as real estate, stocks, and of course long term bonds. This might be the final catalyst that bears look for that would lead to a cleansing crash that in turn would produce a foundation for a new 17 year bull stock market cycle.
Investors should protect their 401k by investing conservatively, avoiding bubbly assets and avoiding an excessive amount of high duration long term bonds.
I have written an article “Does jobless rate improvement mean stocks will go up?”
Investors should seek independent financial advice.
Posted by Don Martin on Fri, Mar 08, 2013 @ 04:12 PM
Will the Unemployment Problem Suddenly Be Fixed?
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Today’s Monthly Employment Report issued by the Bureau of Labor Statistics showed a 236,000 increase in jobs, significantly exceeding the consensus forecast of 162,000. The last four months were close to this range so this implies a trend is forming around this number, which is a significant improvement above the one year average.
The improving employment picture is not as good as it looks because the unchanged employment-to-population ratio. In addition stocks are too high based on the PE10 of 23 they need to drop 33% to reach fair value. Stocks went up a lot in recent years because of the Federal Reserve’s aggressive Quantitative Easing (QE) policies. The real economy (things like GNP, corporate earnings) is about the same as in the previous peak of 2007 so if anything the pattern forming looks like the previous peak of October, 2007 rather the start of a new bull market. The fundamentals don’t justify today’s stock prices. SP500 corporate earnings are 6% higher than in 4Q2006, which is an annualized gain of less than 1%, which is less than inflation. This implies stocks should be priced no higher than the highs of 2007 and actually need to go down as they did in 2007 to 2009. Typically stock market rallies last about four or five years, so this one is getting old. Stocks are not a true bubble but are merely overpriced, however, one should only buy stocks at either a fair price (roughly an SP index at 1,000) or at a discount to a fair price.
If the jobless rate problem is improving then interest rates need to rise to normal levels, which hurt both real estate and the stock market. Stocks are overpriced, so rising interest rates would be enough to trigger a bear market. Thus an improving job market does not justify buying stocks. Job growth and rising inflation tend to be lagging indicators; stocks tend to be a leading indicator. This is not a good time and price level to buy stocks.
The problem is that a reduction in the number of job seekers helped to warp this data. The best way to measure unemployment is the employment to population ratio which has been stuck at 58.6% near the lowest level in 30 years. The last time it was significantly higher was in mid-2009. It was briefly as low as 58.2% during the recession. The Economist magazine said “When all is said and done, fiscal tightening in 2012 will prove substantial, making it hard for hiring to generate much momentum.” My opinion is that since the improving employment picture is not fundamentally sound then the headwinds will mean no real employment growth. A stock market newsletter writer named Eddie Elfbein said "101 million people are unemployed or not working, it was 74 million 14 years ago.” On Twitter “The economy’s employment deficit is 8.9 million jobs (3 mln from recession and 5.9 mln from population growth since the recession started five years ago)” from a tweet by journalist @pdacosta and @Economicpolicy. That’s about 7% of the labor force, which if added to the “full employment” goal of a 4% unemployment rate implies a real rate of 11% unemployment, still less than the 14.3% U-6 rate that measures the hidden discouraged unemployed. The U-6 did come down by 0.1%.
Despite the surprise increase in jobs the bond market made the benchmark 10 year Treasury yield at 2.05% which is still in its trend line. The yield dropped from the day’s high of 2.09%.
One way that people can be fooled by employment statistics would be taking the average increase in earned income when that was skewed by the people at the top; meanwhile new jobs could be coming from minimum wage service industry jobs.
Unemployment is concentrated in either low skilled, poorly educated people or in recent college graduates who have not gotten their first job. These people will eventually get low paying jobs that won’t be enough for them to engage in much consumption or in qualify for a large loan. Recent college graduates have more debt than previous generations of young people, thus as they get a low paying introductory job they will have trouble qualifying for more loans. The ability to get a loan is how the banking system increases the money supply and creates inflation, so if the unemployed get hired at a dead end job that denies them access to loans then they can’t create inflation. This means a transition to a full employment economy may not be that inflationary. Thus bond yields may not explode upwards when recovery finally occurs. Also most long term bonds are institutionally owned where professionals manage the money and are thus less likely to engage in panic selling when rates start to go back up to “normal”.
I continue to believe even with an improving unemployment rate that the stock market is overpriced and will go down. In addition, the improving unemployment rate will not be inflationary for the next few years and will not cause a bond market rout until a few years from now.
To protect one’s 401k from a stock market crash one should invest conservatively either with investment grade bonds or if one insists on stocks then get the highest quality stocks (low debt, high corporate moat, stable and growing revenues from organic growth, high ROE, lower PE ratios than similar companies, etc.)
I have written an article “Unemployment rate fix can damage 401k’s.”
Investors should seek independent financial advice.
Posted by Don Martin on Thu, Mar 07, 2013 @ 03:34 PM
Employment report to be issued tomorrow may be bullish for stocks
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The monthly nonfarm payroll report will be released Friday. The consensus is 162,000 new jobs. If there was no population increase then that amount of increase, if annualized, would reduce unemployment by 1.5%, which would imply about 2.5 years to reach the full employment benchmark of 4% unemployment. On Friday the stock market bulls will cheer this and make stock prices go up. However, when one slows down and takes a careful look at the data and considers that 125,000 monthly new jobs are needed to keep up with population growth then an increase of 162,000 jobs will reduce unemployment by 0.03%, or 0.34% if annualized. This would require waiting for 11 years from now to bring the unemployment rate down to the 4% full employment rate.
If you want to trade stocks tomorrow then let the bond market give you guidance. If bond yields go up after the employment report is released in the morning that implies the economy is getting better. Bond investors tend to be more professional than stock investors. The interesting anomaly would be if stocks go up because employment increases by 162,000 jobs that would actually not be a reason to be bullish since at level the job market would be almost stuck in neutral. In that situation a high risk short term trader could buy a Put option on stocks at end of the day and perhaps make a small profit the next trading day when stocks come back down. Please don’t do such a short term trade because that’s too risky.
The GNP is growing at 1.6% real rate which is slightly below stall speed. This implies the economy will stall out like an airplane and go down. In this low growth mode the employment rate is likely to be trapped near a no growth zone close to the consensus of 162,000 monthly new jobs.
Investors should monitor the employment report and take action to protect their 401k from a crash. The stock market is overpriced so if you own stocks try to hold only those stocks with the best quality earnings and balance sheet.
I have written an article “Unemployment rate fix can damage 401k’s”.
Investors should seek independent financial advice.