Behind the Unemployment Numbers: Demand, Wages, and Skill Levels

As all eyes, especially political ones, remain on the jobless numbers, the Employment Situation report for October, released on Friday November 4, held no upside surprise. The needle budged a hair, with a net gain of 80,000 people who found jobs during the month. The private sector added 104,000 jobs, while the government shed 24,000 of them. Overall, the unemployment rate dropped modestly to 9.0% from 9.1% in September, but did not move out of the range between 9.0 and 9.2 that we’ve seen since April 2011.

Although employment numbers are very important—and the direction in employment trends typically points to where the economy is going—we cannot lose sight of the fact that unemployment is really a symptom of much larger problems that need to be addressed: demand, wages, and skill levels.

For argument’s sake, let’s say that 1 million people find work, dropping the number of unemployed to about 12.9 million from just under 13.9 million currently, out of a total civilian workforce of some 154.2 million. Would the resulting unemployment rate of about 8.4% be the cure for all that ails us? What makes unemployment in the eights instead of the nines so significant? There have been periods in history when the American economy experienced strong growth with 9% unemployment. When I was in college, 6% unemployment was considered inflationary. The “good old days” when unemployment was under 5%, as we saw in the 1990s, was considered full employment—and was not sustainable.

The number isn’t as important as what drives it. In order for our hypothetical 1 million people to get hired, they need the right skills and experience to tap into the existing and future job demand. The educational attainment statistics (Table A-4) in the employment report should take no one by surprise: The lower the education level the higher the unemployment rate. In October, those who have less than a high school diploma had an unemployment rate of 13.8%; for a high school graduate, 9.6%; some college or associate’s degree, 8.3%; bachelor’s degree and higher 4.4%. As if we didn’t know it already, education and training matters—and yet the United States has a high school graduation rate of less than 70%.

Looking at unemployment by occupation (Table A-13) the rate is very low for management, professional, and related occupations at 4.4%, while farming, fishing, forestry, construction and extraction industries are all above 14% unemployment. Among the industries with the lowest unemployment rates are education and health services (5.6%), financial activities (5.8%), and information (6.6%). Construction tops the charts with a 13.7% unemployment rate. This is the real story of employment in the United States, one that we can’t ignore any longer. The continued development of a skilled workforce will position Americans to take advantage of the jobs that are created here. The evolution in our economy, with basic manufacturing outsourced to countries with a comparative advantage in labor costs, has resulted in displacement of jobs (the textile industry in the U.S., for one). Nonetheless, it’s an economic scenario that cannot be reversed, even in the name of “saving” or “creating” jobs in the U.S. The economics simply don’t justify manufacturing here what makes more sense to produce over there. At the same time, landing a well-paying job in the U.S. requires workers to have the requisite education, training, and skills.

Two other factors that we cannot overlook are demand and wages. With productivity at high levels, having risen by 3.1% in Q3 2011, employers are able to realize more output per worker, which is a good thing. Increases in worker productivity means companies are more efficient; they are able to do more with less, which is one of the benefits of having gone through an economic contraction. (If you’re going to endure the pain, you better have a gain, right?) At some point, productivity will max out, and if demand continues to grow companies will increase hiring. So where is the demand?

We can’t blame “the economy,” which has become a blanket excuse, without being more precise. Consumers are still cleaning up their balance sheets. Before the recession, people consumed 10 years’ worth of stuff in five years. The problem wasn’t just overconsumption, but an inefficient use of capital--selling appreciating assets to buy depreciating ones.
Demand is not the only variable, however; the cost of labor is also a factor. During the recession, while the value of assets (stocks, real estate) declined, wages did not. The price of labor, while somewhat improved, remains high, which makes investing to hire new people a risky proposition for employers who are not certain about future demand.

Making a dent in the unemployment rate is everyone’s goal these days, from politicians to picketers, but it’s not simply a matter of getting companies to hire someone--anyone--as if there is this big unfilled pool of jobs that is being kept under wraps. Demand for goods and services must increase to levels that give employers the confidence that they can hire, particularly as the cost of labor remains relatively high. And the people who are seeking those jobs must have the skills and experience to assume them.

All information contained herein is for informational purposes only. This is not a solicitation to offer investment advice or services in any state where to do so would be unlawful. Past results are no guarantee of future results and no representation is made that a client will or is likely to achieve results that are similar to those shown. Please refer to Astor's Form ADV, Part 2 for additional information and risks. Analysis and research are provided for informational purposes only, not for trading or investing purposes. Astor and its affiliates are not liable for the accuracy, usefulness or availability of any such information or liable for any trading or investing based on such information. There is no assurance that the Astor’s investment programs or funds will produce profitable returns, you may lose money. 500001-123

Gold Speaks--And the Story Is Compelling

Gold, as expected, has lost some of its luster, with prices falling by about $300 an ounce from around $1,900 an ounce in early September to just below $1,600 a few weeks later. (Keep in mind that as recently as early 2002, gold was trading below $300 an ounce, which means bullion lost more in one month than it was worth about nine years ago.) Although gold has recovered somewhat since then--currently trading around $1,681 an ounce --the recent selloff hardly came as a surprise. Previously we stated that gold is a “buy the rumor, sell the fact” commodity, which in the absence of any fears of a new crisis (old ones that resurface tend to get shrugged off) just doesn’t have any reasons to keep rising.

Beyond the price movements, however, gold seems to be telling a compelling story that’s worth listening to--or at least taking into consideration. First of all, gold is signaling that the world is not coming to an end. Yes Euro zone default concerns persist and fears of a double-dip recession are looking more likely to come to fruition. But these are not new fears, which is what gold would need to continue its climb. As far as gold is concerned, the current outlook is for no new cataclysms.

As I put the pieces of the story together, it seems clear to me that gold is also looking farther down the road than most of us, and what it sees isn’t all that bad. It might even be pretty good.

Gold seems to be giving a nod to the Fed’s monetary policies, including its latest move to buy longer-term bonds, instead of launching another round of quantitative easing (QE3). Thus, while the Fed is keeping interest rates low, it has not lowered them any further, which is why stock prices and gold got hammered in September. But that’s not all gold seems to be saying.

Gold appears to be indicating a scenario that will reverse the Fed’s practice of paying interest on reserves that banks have on deposit. Without a return on that money, it will flow out into the economy in the form of increased lending by banks, which will help fuel growth in response to demand. Gold won’t benefit from that at all and, as a result, its price has fallen.

And there’s more to this story as well. Gold’s price drop indicates that we probably will emerge from the economic contraction/recession without hyperinflation. This is where the Fed’s policies really shine. The Fed expanded the monetary base, but not money supply. (Think of the monetary base as cookie dough and the money supply as cookies that get baked. We’ve got a lot of dough in the system, but the number of cookies coming out of the oven hasn’t changed.) In financial terms, the Fed’s actions, including extremely low, accommodative interest rates, increased the monetary base (dough), but banks have not been lending money in a way that increases the amount of money (cookies) out there. The banks would rather keep their dough (pardon the pun) with the Fed to earn interest.

By constraining money supply while increasing the monetary supply the Fed was able to contain inflation. As we’ve written before, although some people complain that the Fed’s actions equate to “just printing more money,” the truth is the money supply has actually stayed at the banks.

Until now, gold has been a beneficiary of the Fed’s actions to keep interest rates low. Unless you were an institution, you had to do something with your cash other than keep it on the sidelines. You had to take a shot, which pushed the price of many assets including gold higher. If you bought gold over the past one or two years, then good for you--you made money. But now the premise for investing in gold has passed its prime.

Gold has a tale to tell these days for those who care to listen. The price is down and that’s basically good news for what could very well develop in the economy: the probability of an ordinary contraction/recession with no downside surprises, the likelihood of no hyperinflation, and an expected change in Fed policies sometime in the future to help increase the amount of money to finance new economic growth.

With gold off its highs, events may prove to be pretty uneventful (barring any sudden, unforeseen crises, that is)--and that’s a story worth listening to.

The Recession is Coming, The Recession is Coming

Fears of a double-dip recession have been swirling since the recovery began back in 2009. Economists, advisors, and investors have predicted, forecasted, rationalized and, in some cases, even hoped that a double-dip was imminent. The reality is they have been wrong. The economy actually thrived over the past two years, producing record levels of aggregate GDP at about $15 trillion, record levels of personal income at $13 trillion, and record low interest rates and inflation, along with high levels of productivity. The stock market produced double-digit returns in both 2009 and 2010. Even as the worst quarter for stock market performance since Q4 2008 nears a close, the market is still up from where it was a year ago.

Admittedly, unemployment has remained stubbornly high, and housing has yet to recover. While GDP hit record levels, the pace of growth has been below historic average growth rates. As a result, the last two years have felt less like an expansion than the statistics would support.

Looking back, to have flinched at the headlines about a weak economy at any point along the way (and believe me, there were compelling reasons to flinch) would have been a mistake. Market timing is challenging at best, and one wrong move can erase the profits of the last ten good moves. The portfolio management team and I have navigated away from market timing in our philosophy, always focusing on long-term verifiable economic trends. To that end, the data is suggesting that the next recession is here. Although it appears a recession is upon us, there’s no reason to panic.

As we sit here today, with the portfolio down on the year (albeit less than major market averages have suffered) we anticipate becoming more defensive, with possible inverse/negative exposure in the future. We believe this repositioning should reduce the overall risk and volatility of the portfolio further.

Based on the current economic climate, it appears the decline will be much more typical of garden-variety recessions/contractions, characterized by a slowing economy and declining financial markets, but within ranges that do not destroy investor wealth beyond levels that should be recouped during the next expansion. I compare it to a gloomy April day in Chicago with the temperatures at 41 degrees and a mix of rain and snow. It’s either a bad spring day or a mild winter day for Chicago. This contraction/recession could resemble that kind of day: either a slow growth period or a mild contraction.

The global economy is awash with liquidity, corporate balances sheets are healthy, and worker productivity is high. When expansion resumes and demand resurfaces (by that we mean real, sustainable demand) the labor market will be ready and willing to get back to work at fair wages. Then, the economy is going to light up like you would not believe. We cannot say what will spark demand, but the ingredients are there, and will create an expansion that will surprise even the most optimistic economist on the upside. It’s coming at some point. Unfortunately, it’s not going to happen in early 2012. Outside headwinds still exist that currently do not support necessary growth rates. When it does arrive though, we will identify it and ride it for all it is worth.

Analysis and research are provided for informational purposes only, not for trading or investing purposes. Astor and its affiliates are not liable for the accuracy, usefulness or availability of any such information or liable for any trading or investing based on such information. There is no assurance that the Astor’s investment programs or funds will produce profitable returns, you may lose money. 900001-69

When Zero Is Zero

After cruising along at a slow, but steady pace for two years, the economy seemed to stall around mid-year 2011. Q2 2011 GDP, which originally had been estimated at + 1.3%, was ratcheted back in a second estimate to a rise of 1.0%. While growth is growth, its anemic nature made one wonder if the patient would rally or sink into a relapse. The start of Q3 2011 brought with it a number that is impossible to ignore: the big goose egg, an empty basket—zero.

The Employment Situation Report released on the first Friday of September showed that no jobs– none, nada—were added in August, and the unemployment rate remained at 9.1%. The 17,000 jobs that were added were completely offset by the loss of 17,000 government jobs. Even the Bureau of Labor Statistics sounded a little disheartened when it stated, “the [unemployment] rate has shown little change since April.”

Zero job growth signals that the odds for a contraction are significantly higher than any time since the recovery began. In fact, my finger is on the trigger. At Astor, we responded to the latest data by adjusting our portfolio to protect against the possibility of a shock to the economy. We have not become maximum defensive, yet, but we did reduce equity exposure even further, and also added some non-correlating defensive positions. It’s possible that we could become more defensive and even establish an inverse position in the third quarter, but only time will tell.

As of this writing, the data are indicating GDP growth for the year of around 1%. While hardly robust, it is far better than the -6.3% economic contraction experienced in Q4 2008 and job losses of 500,000 per month. Given how far we’ve come up from the bottom, flat is okay. Not great—but okay.

The markets are taking a breather as stock returns and the economic growth of the past few years are not sustainable. Even if we stay right here for the year, the three-year economic performance will look pretty good in the rearview mirror, especially when we consider how tough the road was in 2008.

Despite some investor fears to the contrary, this is not 2008 all over again. I’ve said it before, but it bears repeating: in 2008 we had a recession on top of a financial crisis. This time around, if the economy does slip from low growth into recession it will be a garden-variety contraction.

Meanwhile, the government keeps trying to jumpstart the economic engine by focusing on jobs. Against the backdrop of an unemployment rate that persists over 9% (and with an election year approaching) President Obama unveiled a $447 billion job-creation program, which includes tax cuts and a spending plan. After the job program was announced last week, economists were all over the map with their assessments.

As for this economist, I expect job growth to be more in line with demand. Even with government assistance, businesses will not hire meaningful numbers of new workers unless demand for their goods and services pick up.

I have never been a market timer, and I don’t intend to start now. I much prefer to analyze the economic data and identify the prevailing trend, which history has shown to be a far better investment strategy than guessing which way the wind will blow next. As for now, the numbers spell out a weakening economy and a greater chance of a recession occurring. After all, it’s hard to argue with a zero in the employment report. But we need to remember we have come a long way baby, even if it doesn’t feel like it. So if we do pause or even contract from here it’s not a bad place to rest.

Gold: Losing Its Luster

There’s nothing like a little fear and loathing for putting a shine on gold prices. Indeed, concern over everything from the U.S. economy heading into recession to the possibility of sovereign debt default in Europe has been cited as the force behind gold’s meteoric price rise, reaching a record $1,917.90 per ounce on August 23. Just one day later, gold experienced its biggest one-day drop in 18 months, with prices off about 5% at $1,763 at mid-day. The reason most commonly cited for the price decline is a collective sigh of relief as the aforementioned fears appear to be somewhat alleviated--at least for now along with probability of QE3 seeing less likely.

Traditionally, gold has been viewed as the “safe haven investment;” the place to (presumably) put your money because you’re quite certain that “Financial Armageddon” is just around the corner. The fact, however, is that while fear may spark gold’s rise, when financial calamity finally strikes, it’s usually a reason to sell, hence the old adage “buy the rumor sell the fact”. Additionally, when financial calamity hits, the owners of gold, like central banks around the globe as well as large fund managers need to sell assets to cover depreciating assets and pay liabilities and this drives gold prices lower.

Gold truly is a “buy the rumor, sell the fact” commodity. Consider what happened in 2008. During the first half of the year, gold rallied to more than $1,000 an ounce on fears of a pending crisis. When the crisis hit in the second half of the year, however, gold prices actually went down, trading below $720 an ounce.

Now, with gold having made a run at $2,000 an ounce, there just doesn’t seem to be a compelling reason for it to stay at such lofty levels. Even news of fighting in the Libyan capital of Tripoli, as rebels appeared to close in on Moammar Gadhafi--a significant geopolitical development--did not keep gold prices at their recent highs. This is all the more reason to expect that gold prices may have topped. As I see it, there are more reasons for gold to continue to drop than for it to reverse course and rally significantly again. First the reasons that gold will likely sell off:

The doom that everyone has feared actually hits, whether it’s another Euro-Zone debt debacle or fresh evidence that the U.S. economy is about to go into a tailspin. As I stated, fear bolsters the rally, but when the bad news comes into fruition, investors sell and gold drops.
The threat of doom subsides. Stocks begin to trend higher, interest rates raise a touch and gold eases under its own weight. Once again, investors sell.
The only reason that gold could keep rallying is a new perception of impending doom. I don’t believe this would work for the return of an old fear, because investors tend to shrug these things off as “Oh, that old worry is coming up again?” There would have to be a new fear factor in the market to create any significant upside potential for gold from here and one that was unlikely to materialize in the near term but create fear that it could.

Looking at the three scenarios--disaster strikes for real (sell), fear of disaster fades (sell), fear of a new disaster rattles the market (buy)--I think the shine is off gold.

Signs Point Away from Treasuries…But Not Because of S&P Rating

August 10, 2011 will go down in financial history. On this day, the S&P’s dividend yield at the close was 2.17%, which was above the yield on 10-year Treasuries of 2.14%. This was only the fourth such occurrence since 1958, with 1962 and 2008 providing the only other modern-day examples. More interesting to note is what it could potentially signal.

Although the sample size is quite small, based on the three previous occurrences when the S&P dividend yield was above that of Treasures, the average return on S&Ps 12 months later was 18.5%. Even 2008, in the midst of a financial market meltdown and with equity dividend yields being quickly reduced, produced a positive return of 23.5%.

The obvious question now is will history repeat itself?

To be clear, there could be more downside in the market because no one can time a bottom very well, especially when investors are panicking and irrational behavior prevails in the short-term. But a decline in confidence is very different from a decline in financial worthiness. Fundamentals do matter, and they are not as bad as the recent market activity would indicate. In fact, if the fundamentals worsen, it appears this scenario has been priced in. Even if we do enter a recession, most of the damage to the market probably has been done already because the average market decline from peak to trough is about 25%.

No one knows for sure if history will be repeated, but the fundamentals are much more favorable now than during the last S&P dividend yield occurrence in 2008. Today, there is no liquidity crisis, as there was three years ago. Corporations are flush with cash. Corporate profits are at record levels, and more than 70% of earnings reports in Q2 2011 beat estimates. Additionally the broad economic data is still positive, admittedly slow, but positive none the less. We are adding about 150k jobs per month on average and GDP at the last look was +1.3%. These are slow but positive numbers that against the back drop of the recent equity markets moves seem to have a disconnect.

Now, enter the Fed’s latest announcement meant to assure the market in the wake of the S&P U.S. debt downgrade. The Fed took the unprecedented step of signaling future action and putting a date on it. In the past, the Fed has said it will keep interest rates exceptionally low for an extended period of time. Earlier this week, it said rates will be kept at these low, accommodative levels until at least mid-2013.

Reading the Fed’s tea leaves we arrive at two very interesting conclusions. First of all, the Fed has, in essence, thumbed its nose at S&P and its debt downgrade. Normally a reduction in credit worthiness drives up rates because investors have to be enticed to buy debt that, supposedly, is more risky. Bernanke and Company, however, have essentially told S&P: “You think rates are going up? Guess again. We’re keeping them low for two years.” No silly downgrade is going to raise rates, not on Bernanke’s watch—unless, of course, economic fundamentals deem such a move appropriate.

Further, the Fed is stating very clearly that investors will get nothing—nada, zero—in interest on short-term fixed income investments for two years, so look for something else. As investors look for other opportunities the obvious place will be stocks and the market appears to agree.

Worth Less, but Not Worthless

Markets were sent tumbling yet again, with the Dow closing down 5.5% and the Nasdaq and S&P losing more than 7%, on Monday. The latest gunshot to spook the investor herd was Standard & Poor’s downgrade of the U.S. debt rating from AAA to AA+.

The rationale for the downgrade, essentially, was the inability of Washington lawmakers to get along and come up with a debt reduction plan that the rating agency deemed acceptable. No matter how much political dissention there is, however, squabbling on Capitol Hill should have nothing to do with the U.S. credit rating. To think otherwise would be like a bank raising the interest rate on a home mortgage simply because a couple doesn’t eat dinner together most nights or argues over who left the cap off the toothpaste. It’s all about the ability to pay, which is not an issue for U.S. debt.

The irony of it is, in the wake of the downgrade, U.S. Treasuries remained the safe haven, which meant the government’s borrowing costs did not go up. In fact, they went down. Unfortunately equities, the unintended victim, were trounced substantially because investors sold first and asked questions later.

Investors had already been running scared because of worries from European debt to whether a slowing U.S. economy will slip back into recession. The real reason for their panic, I would argue, has very little to do with debt levels in Greece or Italy, or whether GDP in the U.S. will drop into negative territory. It’s all about 2008.

Investors remember all too well the great flush that occurred in the midst of the financial crisis, when huge companies that had been thought to be rock solid--Bear Stearns and Lehman Brothers, to name two--suddenly went out of business. Asset values evaporated, and investors feared a return of the Great Depression.
Now as fears ripple through the market, investors vow not to be caught flatfooted again. “I’m not going to let that happen to me” is the mantra as they head for the hills, taking their cash with them.

The good news is this is not 2008. Not even close. The economy is still growing. GDP for Q2 2011 was up 1.3%. Although that’s hardly strong growth, it’s a far cry from a negative reading of -6.8% for Q4 2008. Yes, employment is soft, but we are adding jobs, even in the midst of government layoffs. Just a few years ago, the monthly job reports were showing losses of 500,000 jobs.

Demand is weak as consumers deleverage, while the government, which can account for 20-30% of GDP, has cut its spending by mandate. This could set the stage for a soft economy to go into recession, but don’t look for things to fall off a cliff.

The simple fact is we’re two years into an economic recovery and we’ve hit a soft patch, which is to be expected. We’ll either start growing from here, or slip into a recession again. Only time--and economic data--will tell. In the meantime, assets are worth less, but they are not worthless. This is far more important than a clever play on words. It is a statement of fact that this is not 2008 all over again. We are in an economic slowdown/recession, not a crisis. No big corporations are about to implode and go out of business.

Although these are painful times to be an investor, when fear grips the market with increased volatility, but there really is no reason to panic. The economy may be wounded, but it’s been on the mend and, for the moment, there is no reason to believe the patient needs to be in intensive care. And if you are looking for the right medicine to make you feel better then look no further then the dividend yield on the S&P 500 which is yielding about as much as the US 10 year treasury. Historically when that has happened in the past equities have had a very nice rally.