The unemployment report
On Friday December 4, the Bureau of labor Statistics released its unemployment report , officially called The Employment Situation, for the month of November.
The results were surprisingly good. The unemployment rate unexpectedly dropped for the first time in a long while, from 10.2% to 10.0%. On the announcement, the S&P 500 immediately ran up 19 points, or 1.7%, before having second thoughts. The benchmark closed the day 6 points ahead, or .55%.
What the report said
1. The headline result was that the US economy lost 11,000 jobs in November. This is the best report in two years. The number compares with the average estimate from a group of 82 economists polled by Bloomberg of a loss of 125,000 jobs. The most optimistic–if you can call it that–of the economists had predicted a loss of 30,000 jobs. So the actual exceeded not only the consensus but the top end of the range of estimates.
2. The unemployment reports for September and October were revised to show 80,000 and 79,000 fewer jobs lost during those two months than first thought. The direction of the revisions is important because it tends to confirm the favorable direction of the current unemployment report.
3. Improvement was broad-based. Health care continued to add workers (21,000 last month, 613,000 since the recession began), as did temporary help agencies (52,000). Even residential construction was up slightly, although that gain was swamped by commercial construction layoffs–perhaps the sorest single spot remaining in the unemployment picture. (In fact, commercial construction layoffs accounted for more than the total job losses in the economy–although saying this with full confidence would be presuming a level of accuracy in the unemployment survey that’s higher than warranted.)
4. The manufacturing work week rose by .3 hours to 40.4 hours. Overtime rose as well, by .1 hour to 3.4 hours.
Why this is good news
Think about what you’d do about labor costs if you were running a company during a recession. As the economy began to contract, the inflow of new orders for your products/services would shrink and orders already on the books would start to be cancelled. Rather than pile up finished goods that no one was going to buy, you’d slow production. You’d cancel orders or materials from your suppliers. To keep the company from becoming insolvent, you’d eliminate overtime, cut regular working hours if you could, and finally you’d begin to lay workers off.
As the recession ends, order flow stabilizes and begins to increase. You then, and in this order:
–stop layoffs
–increase working hours for employees
–reinstitute overtime
–hire temporary workers
–hire full-time workers.
If we compare this sequence with what the unemployment report shows, we see that employers are already taking most of these steps. The revisions to the reports from September and October imply that employers have been doing so for several months already, without our being fully aware of this.
Why unemployment will likely remain higher than usual
The positive process of economic renewal described in the second half of the last section above will begin to feed on itself, aided at first by super-low short-term interest rates. If this recession were a garden-variety inventory cycle downturn, we’d be pretty much home free. Our problem is that this hasn’t been a garden-variety recession. We have two extra issues to deal with now, both of which will depress employment for some time to come:
1. The housing and financial derivatives bubbles went on for several years, creating an inflated sense of the true size of the US economy. Companies responded to elevated demand by building productive capacity–manufacturing plants, service facilities, stores, office buildings, housing…–for an economy that is, to pick a number out of the air, 5% bigger than the US actually turns out to be. On top of that, the economy has shrunk over the past two years. As a result, it will be a long time before existing productive capacity is fully employed and workers will need to be hired to add to what we have.
2. An overheated economy, a false sense of prosperity and financial derivative abuse allowed firms like Detroit auto firms to continue in business despite having bloated cost structures and producing products that few were eager to buy. During the auto bailout deliberations in Washington, for example, the government revealed that a third (as I recall) of Chrysler buyers were sub-prime borrowers who purchased the firm’s automobiles (instead of Hyundais or Kias) only because Chrysler gave them credit no one else would. But just as the bubble buoyed such firms, the financial crisis has forced such companies to restructure radically and quickly.
I don’t mean this to be a rant about Detroit. I want make the point that changes in inefficient firms that might have been managed over a decade without layoffs are instead happening all at once–and with job losses. Many of these jobs won’t come back.
In a similar vein, neighborhoods that have tolerated sub-standard education on the idea that their children will get a job at the local auto plant or construction firm after high school graduation will find that those jobs don’t exist any more.
In other words, we’re at the beginning of a long-overdue structural labor adjustment that will be more painful for having been delayed and that will result in substantial unemployment during the transition period.
Investment implications
What difference will it make for the stock market if we have a recovery that lowers the unemployment rate to 7.5% instead of 5% over the next couple of years? My guess is that we continue with the sort of stock market in the US that we appear to have been shifting to over the past few months, that is, one where overall economic expansion is sub-par and where, in consequence, the stock market is defined by growth stocks rather than value names.
There may also be important political ramifications if unemployment remains, as I think it will, uncharacteristically high. But I think it’s far too soon to be able to figure out what they might be. Given the relatively narrow focus investors typically have on the present in time like these, it’s probably also much too soon to need to build any guess about future political fallout into our portfolio strategy.