Volume 57, Number 8 | December 3, 2010
The employment report giveth and the employment report taketh away. Last month’s exuberance that job growth was beginning to stir has been dashed on the unexpectedly very weak 39,000 increase in jobs for November. Revisions did add 21,000 jobs to October and 17,000 to September – for a total of 38,000. Still, after all the news was in, private sector job growth over the past three months was 107,000, the same as in the previous three months. Indeed, the average job growth in the past five months was 116,000 – just 1,000 higher than the average of the five months before that. Bottom line, job growth has been flat since February, though volatile month to month.
This is a trend seen in many employment related data series – like Challenger, Gray & Christmas; Monster,com; and the unemployment rate. The manufacturing ISM series, which was flat at a strong level since April, has dipped in the past two months. Meanwhile, the ISM nonmanufacturing series – which was flat since February at an unusually low level for an expansion — has ticked higher. A modest improvement in small business hiring (mostly service) is confirmed by the NFIB, while the slowing growth in manufacturing is evident in a wide range of data from factory orders, to ISM, to industrial production. Bottom line, depending on a preponderance of the evidence, there is little reason to believe that employment has improved – or slowed – in November. The reality is that the payroll report is a volatile – and coincident – indicator that the financial world relies far too heavily on in determining the direction of the economy.
Many of the key leading indicators of employment were pointing in the wrong direction this month. The household report showed a -173,000 decline in jobs after a sharper -330,000 drop last month. The household report often shows changes in direction early – although it is quite volatile. This month, both average hourly pay and hours worked were unchanged. With few new jobs created, this means there was virtually no new wage income generated in November. Solid growth in wage and salary income has been the lynch pin behind solid growth in retail sales. If income is stalling as we enter the key Christmas season – Thanksgiving through Martin Luther King’s Birthday – retail activity could slump as well. Indeed, much of the weakness in this month’s employment report was from a -28,000 drop in retail employment as stores hired fewer than normal seasonal workers for the Christmas rush.
One of the most disconcerting things about the household employment report was that the biggest rise in the unemployment rate over the past two months has been among workers with a college degree or higher. After improving all summer, the unemployment rate for this group has soared to a new high of 5.1% — up from 4.4% just two months ago. Now, the data on sub-sectors like this are quite volatile given the small sample size in the survey (about 50,000 households), but so strong a pop in this unemployment rate has rarely happened over the past twenty years. The unemployment rate for the most educated group is typically half of the total unemployment rate and it moves down faster in a recovery. The reason this group is so critical is because high income households are disproportionately important in determining consumer spending patterns. The top 20% of all households by income control over 50% of all income. A rebound in the stock market, which buoyed this group’s income and wealth, has been a key factor behind the economy’s improvement in recent months. This is particularly observable in improved consumption of luxury goods and services, like jewelry and travel. However, if job growth in this sector stalls – think teachers, financial services, state and local administrators – then the impact on consumption will be much greater than an equal loss of jobs to less educated households.
The stability in employment over the past ten months should not be surprising as it is consistent with the growth in the economy. Real GDP growth in the second quarter was up at a 1.7% annual rate. Third quarter real GDP is now estimated at 2.5% (up from 2.0% in the initial estimate.) The consensus forecast for fourth quarter real GDP growth is between 2.0%-2.5%. What would lead businesses to hire more aggressively in this environment? At no time over the past several quarters did the consensus growth expectation for this year (or next) exceed 3%. Indeed, it continues to hover around 2.5% — which is equal to productivity growth over the past year indicating no need for additional labor!
Going in the Wrong Direction
We believe the greatest risk to the economy in coming quarters is from higher long term rates which would threaten a renewed decline in home prices heading into the crucial spring selling season. Lower rates over the summer allowed a wave of refinancing for households, businesses and government which lowered interest carrying costs. Short term interest rates, where most of government and businesses debt is concentrated, are unchanged from a year ago. Five year notes (the long end of the business borrowing curve) are substantially lower than five years ago. The ten year note was near record lows this summer. Moreover, Federal Reserve purchases of intermediate term debt effectively reduce the interest rate to zero as the Fed repatriated most of the interest it earns to the Treasury. A rise in rates since the start of QE2 (buy the rumor, sell the fact) threatens to unwind that positive force. Falling home prices could renew concerns about the US banking system, just as Ireland’s over priced real estate has forced their banks into a bailout they said just weeks ago that they did not need.
The biggest plus for the economy at this phase of the cycle would be an improvement in investment. When firms shift from passive short term financial investments to longer term physical investments in plant and equipment, they stimulate economic activity by putting consumers back on the job without actually increasing the supply of goods and services available. Prices rise and profit margins fatten, encouraging other entrepreneurs to invest and the expansion gains traction. Typically, two forces drive investment, low hurdle rates and competition. Low hurdle rates are not enough if there is no threat that someone else will make the investment if your firm does not. That is the situation we find ourselves in today, as existing firms have decent profit margins despite slow growth and their potential competitors have either recently gone out of business or can’t access credit markets to exploit the low interest rates. If firms don’t invest, the economy meanders along at or below potential growth discouraging additional investment. Right now potential growth is about 2/5% — 2.5% productivity growth (as seen over the past year) and zero labor force growth. The labor force is stagnant as low growth and high unemployment leads older workers to take social security earlier than expected, younger workers to stay in school, and other potential workers to become discouraged after months of failure. The underground economy is growing as well – just ask anyone who wants a little work done around the house to improve its resale value.
With interest rates higher now than in the summer and investment still barely replacing equipment worn out by depreciation, there is little positive momentum in the economy to push growth above potential. We do not see a double dip, because business cost consciousness is still driving productivity growth at a healthy pace. However, the coming wave of improved efficiency in the state and local government sector is like to be a bigger drag on the economy than normal. Weakness in this traditionally lagging indicator is usually offset by a surge in investment – particularly residential construction. With housing still in the doldrums and the 20% of GDP that comes from government under pressure, the risks to the economy still appear to be on the downside.