It Depends What You Mean By 'Somewhere In Between'

By: Michael Ashton | Sat, Jan 8, 2011
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Aren't December Payrolls fun?

The economy generated 103,000 new jobs in December. While upward revisions of 32k to November's data and 38k to October's data blunt the pain of the miss, the market was looking for a blow-out report as the economy built momentum and capitalized on a strong Christmas season (so the story goes). The last three months' worth of jobs generation read this way:

October: 210,000
November: 71,000
December: 103,000

Call that what you will, but it doesn't look to me like strong positive momentum. To me, it looks more like what we're seeing in the employment-condition surveys: bumping along with positive growth, but stunted positive growth. This is not a normal recovery, folks, where we see strong growth in early quarters yielding to steady growth near or above trend. And there's no sign that it is about to become a normal recovery.

To be sure, this is a December number and the seasonal adjustments are difficult to make because the sheer number of workers being added to the workforce in December and dropped from the workforce in January dwarfs the net number. To be reminded of the difficulty of seasonal adjustment, look no further than ADP. Clearly, someone missed something.

Keeping the stock market from coming completely unglued today was the fact that the Unemployment Rate, rather than falling to 9.7% as forecast by most economists or staying stable or rising as I expected, plummeted to 9.4%. That must be good news, right? I read a number of stories that tried to treat this as a "some of this, some of that" number. The Payrolls number was bad news, the Unemployment Rate good news, so "the reality is probably somewhere in between."

Well, no, not really.

The Unemployment Rate fell partly because the labor force participation rate fell to yet another 26-year low. The chart below, which I have shown a bunch of times, is truly ugly.

Labor Force Participation Rate is in an ugly trend
Labor Force Participation Rate is in an ugly trend.
We may have already seen the highs for the next 30 years!

So what has happened over the last decade to discourage people from even trying to work? Remember, when the BLS calls up, they ask if you've worked, and if you have not then they also ask you whether you have been looking for a job. If you answer "yes" to the first question, then you are employed. If you answer "no" to the first question and "yes" to the second question, then you are unemployed. If you answer "no" to both questions, then you are not in the labor force (and this makes some sense: if you are at college full-time, then are you unemployed? Not in the sense that you are competing with people who are looking for jobs. Of course, the BLS asks further questions to find out why you're not looking but that's not a topic for this column.)

Between November and December, the number of people defined as Unemployed in the household survey fell 556,000. That's great, and that leads to a healthy fall in the Unemployment Rate. But, the number of people Employed rose only 297,000. So what happened to the rest of the 556,000 people who are no longer unemployed? They left the labor force, which fell 260,000 (297k-556k≈-260k, with the 1k error there being rounding). This is not what you see when the Unemployment Rate declines for healthy reasons.

By the way, the average duration of unemployment rose back to almost match the cyclical highs from last year. The chart below gives some context. These people are looking for work, even if there isn't a lot of hope, because they're still drawing benefits while they look. Arguably, they otherwise may have dropped out of the workforce long ago, in which case the Unemployment Rate ... and the participation rate ... would be even lower. I think we can all agree that an Unemployment Rate lower for that reason would not represent health.

Average Duration of Unemployment
A long, long, long-term view of the average duration of unemployment.

Why is it such bad news that the labor force participation rate is dropping? After all, we expect that to happen eventually, once the Baby Boomers retire in large numbers. It's bad because with fewer workers, productivity will need to rise even faster to make up the downward pressure on output.

Number of people making stuff (times) amount of stuff made per person (equals) total stuff.

That is the labor, times the output per unit of labor, equals output. Simple algebra. If, because workers are discouraged or because of demographic fate, the number of workers is rising more slowly or declining, then the amount of stuff made per person needs to rise faster to cover the difference.

Maybe productivity will surge to make up the difference. But this is mere hope. If it does not, then output (that is, growth) will be lower than it otherwise would be - and there are possible inflationary implications in that. And that is why the decline in the participation rate (and the outright decline in the number of workers since 2008, which almost never happens even in recessions and even when the participation rate is declining, since the overall population tends to be growing) is bad news and in my mind outweighs the wiggle between 9.4% and 9.7%.

The equity market suffered on the data, and the bond market rallied; stocks recovered later in the day on the "it's somewhere in between" theory, to end with only mild losses. Bonds, though, never sold off, and it's the bond guys who majored in math.

A report after the data from an economist I am rapidly beginning to like, Julia Coronado at BNP Paribas, summed up very well what all this means:

"On balance the report highlights ongoing headwinds and suggests that the recovery can stay on track but is likely to remain frustratingly slow."

In my opinion that strikes just the right chord.

There is no economic data on Monday, and indeed until Thursday and Friday (when we get Claims, Retail Sales, Industrial Production, and CPI) market participants in New York are going to be almost as focused on the rumored next Nor'easter that is currently scheduled to hit the area on Tuesday. This means we will probably stay uncomfortably focused on this data for a few days and I suspect equities will have some trouble getting airborne again until there's a fresh excuse.

 


 

Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA
E-Piphany

Michael Ashton

Michael Ashton is Managing Principal at Enduring Investments LLC, a specialty consulting and investment management boutique that offers focused inflation-market expertise. He may be contacted through that site. He is on Twitter at @inflation_guy

Prior to founding Enduring Investments, Mr. Ashton worked as a trader, strategist, and salesman during a 20-year Wall Street career that included tours of duty at Deutsche Bank, Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003 he has played an integral role in developing the U.S. inflation derivatives markets and is widely viewed as a premier subject matter expert on inflation products and inflation trading. While at Barclays, he traded the first interbank U.S. CPI swaps. He was primarily responsible for the creation of the CPI Futures contract that the Chicago Mercantile Exchange listed in February 2004 and was the lead market maker for that contract. Mr. Ashton has written extensively about the use of inflation-indexed products for hedging real exposures, including papers and book chapters on "Inflation and Commodities," "The Real-Feel Inflation Rate," "Hedging Post-Retirement Medical Liabilities," and "Liability-Driven Investment For Individuals." He frequently speaks in front of professional and retail audiences, both large and small. He runs the Inflation-Indexed Investing Association.

For many years, Mr. Ashton has written frequent market commentary, sometimes for client distribution and more recently for wider public dissemination. Mr. Ashton received a Bachelor of Arts degree in Economics from Trinity University in 1990 and was awarded his CFA charter in 2001.

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