Analyzing the job reports:
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The Unemployment Quandary
Show Me the Jobs
The Self-Employment Dilemma
Wall Street Meat
Up To My Chest in Snow and Sand
By John Mauldin
February 6, 2004
This week we tackle some rather odd discrepancies in the employment numbers
- are we adding jobs or losing them? Then is there a relationship between
those numbers and the stock market? Are businesses getting ready to hire
and spend money? All good questions, and I will try to shed some light on
them as we see if we can fit some rather disparate pieces of the
information puzzle together to form a picture that we can recognize.
First, there are two different sets of employment numbers. One, the
establishment survey of the Bureau of Labor Statistics (BLS), shows we have
lost about 3,000,000 jobs since the start of the recession. This survey is
a result of looking at the unemployment insurance accounts of about 160,000
businesses (establishments, and thus the name of the survey) at over
400,000 different locations, which covers about 1/3 of all employment. If
you are a Democrat presidential candidate or of that persuasion, this is
the number you feel is most important. I should point out that if Al Gore
were president, this would most certainly be the number repeated daily by
those running in a Republican primary.
Then there is the household survey. This survey is conducted by the Census
Bureau on the behalf of the BLS. They survey 60,000 homes to see who is
working and who's not. This shows the unemployment rate dropping from 6.3%
at its height to today's 5.6%, adding 1.8 million or so jobs to the
economy.
This is, of course, a huge difference. The difference between the surveys
is as wide as it has ever been and by a significant margin. Let's look at
my guess as to why.
The establishment survey looks at current businesses that are established
enterprises. They do not count new businesses within the last year or self-
employed. The household survey calls a home and asks how many people in the
home are working.
In the household survey, "People are classified as employed if they did any
work at all as paid employees during the reference week; worked in their
own business, profession, or on their own farm; or worked without pay at
least 15 hours in a family business or farm. People are also counted as
employed if they were temporarily absent from their jobs because of
illness, bad weather, vacation, labor-management disputes, or personal
reasons." (BLS)
You can see the mountains of information on the surveys and the explanation
at bls.gov. Let me go through a few
numbers with you.
First, anyone over 16 who works is counted. Your teenage kids working in
the summer are counted, which is why the actual numbers shoot up in the
summer. Looking at the actual numbers, jobs actually dropped about 800,000
from December to January. But year over year, there is job growth of about
1,000,000 from January of 2003. Without seasonal adjustments, the numbers
would look silly from month to month.
Now, since January of 2002, there have been 1.8 million or so jobs created
on the household survey, or about 75,000 per month, which is pretty anemic
as recoveries go. It is widely accepted that we need employment growth of
150,000 jobs just to make up for increases in population. Hence, the talk
about the jobless recovery.
But in the last six months, the pace has picked up. According to the
survey, we have added 599,000 jobs which is about 100,000 per month. This
month we saw an increase of about 112,000. (Given Bernanke's promise of
jobs growth in his speech yesterday, many felt he had an advance peek at
the number. Evidently, he did not. It was just the usual Fed happy talk.)
This month, health and education made up 20% of the growth in jobs. Two-
thirds of the jobs growth was in retail sales, which is a seasonally
adjusted anomaly. As I noted a few weeks ago, retail businesses did not add
workers during the last quarter, so seasonal adjustments showed them
actually dropping workers. But what about the huge gains this month? Are
they hiring? That explains part of it, but most of it is simply a seasonal
adjustment. Since retail stores did not hire lots of extra workers for the
Christmas season, it also means they did not let them go. The trend in
manufacturing jobs still remains down, but not as much, although the sector
has lost jobs for 42 consecutive months.
Show Me The Jobs
There are now 1.5 million more people who are not considered to be part of
the workforce than there were last year at this time. Part of this is due
to population increase, but much of it is what the survey calls discouraged
workers. If you are discouraged and not looking for a job, you are not
considered unemployed. Only those actively looking for jobs are considered
unemployed.
So, how do we explain the difference of three millions jobs between the
surveys? Much of it is because if you say you are self-employed, then you
are employed. Were you laid off and then decided to become a consultant?
Working part-time? Decided to start a new business? Welcome to the world of
the household survey employed. The Employment Policy Foundation tells us
that half the household survey job growth since November 2001 is self-
employed jobs.
But my friend Bill King is skeptical of that. He goes to the tax tables at
the IRS and notes that self-employed taxes rose only 2.2% for 2002, which
is less than GDP and inflation. Further, there is little in other tax
receipts to suggest a large boom in self-employment.
I called him to go over his data, and think I see a different issue.
It is not that there is not in fact a large increase in the number of the
self-employed. There is. It is just that there is not a large increase in
the profitably self-employed.
Those of us who are serial entrepreneurs know that the first year of a
business is not likely to be profitable. Thus, it is reasonable that no
increase in the tax results would show up. Further, the newly self-employed
build up carry-forward losses which cover future earnings.
Follow me here. Unless the current wave of self-employed is significantly
better than their historical forebears, 80% of them will fail within five
years. It's the business Law of the Jungle.
Now, several thoughts follow from this. First, there were a larger than
usual number of new self-employed and businesses started over the past two
years. That means that in the future, there will be a larger than usual
number of those people going back into unemployment or needing and finding
another job.
Second, some of the 20% who do end up founding real businesses will employ
many of the people who did not make it. But this is not a smooth process.
It is the transition that is difficult.
On an optimistic note, Hermann Vohs at Cales Investments notes that
business profits are rebounding. (Of course, we are not yet back to where
we were in 1998.) Corporate net cash flow is at all time highs, and
business capital investment is close to the peaks as well. He notes
commercial loans at banks are at last showings signs of stopping their
decline.
All of this should translate into jobs over the next year. But I think the
wildly optimistic projections we read are not in the cards. Treasury
Secretary John Snow staked his reputation on the economy creating 200,000
jobs a month, as an example. Others are even more optimistic that we will
soon see massive new job creation and a lower unemployment number.
The Self-Employment Dilemma
Well, maybe not. First, as noted above, there are many "self-employed" and
underemployed who will need jobs and take them, leaving the pleasures of
being self-employed to others. Further, as the economy improves, those who
are so discouraged that they are not even looking for work will once again
start the process, adding to the labor pool.
Plus, businesses are reluctant to aggressively hire. John Chambers of Cisco
noted "...as soon as we can get another 10-14% on revenue growth, then I
will start to hire again." The orders they are seeing are for replacement
or productivity. Productivity is good for business and profits, but does
not mean a lot of new jobs. Many other executives echo his sentiments. With
outsourcing available, and technology allowing for more productivity, the
number of new jobs created will continue to be less than for previous
recoveries.
I know this will shock readers (not!), but I think this year will be Muddle
Through in terms of job growth. We will be creating jobs, but not enough of
them to offset the numbers of self-employed who will want jobs with the
certainty of a paycheck to significantly dent the unemployment rate. Add in
the need for new jobs to cover the increase in population and discouraged
workers who will want a job if one can be found, and the unemployment rate
will drop more slowly than one would like. It should continue to drop for
the next few quarters, but we will not see an unemployment rate below 5%
for some time, if at all, this cycle.
But even as it drops, incomes are at risk. Unit labor costs fell 1.7% in
the fourth quarter. "All evidence shows employee benefits costs are
increasing sharply so either jobs or wages had to be cut, possibly both.
And that's not good for the economy." (Bill King.)
Hermann Vohs sums up my thoughts better than I can, so let's go to his note
from this week:
"So, while the economy is firing on all cylinders, inflation seems under
control and the upcoming elections virtually guarantee no nasty surprises
from Washington, the stock markets should be doing just fine, right?
"Let me put it this way. Stock markets climb a "Wall of Worry". In other
words, no more worries, no more climbing. The worries that this market had
to overcome during the last 4 quarters were the Iraq war, capital spending
that was virtually non-existent and last but not least the weakness in the
labor markets. Any one of these factors were at one time considered to pose
the ultimate danger to the economy and the stock market. Now that only the
labor market is left, one might get worried about the future of this
market.
"Corporate profits could rise in part because corporations were not hiring.
The increased sales were achieved with staffing levels that essentially had
not been changed for three years. However, corporations are increasingly
bumping up against capacity ceilings. If they want to increase sales
substantially above current levels, they need to start hiring and training
new employees. Training new employees costs time and money and still does
not give you the same bang for your buck like experienced workers do. The
result will be rising sales, yes, but potentially lower profit margins.
Lower profit margins automatically will engender lower Price/Earnings
Ratios which means lower valuations, even when gross profits continue to
rise.
"So let's put it this way: Once the last piece of this wall of worry
(unemployment) has been conquered, the party will be essentially over.
Falling unemployment removes the incentive for Greenspan to keep his
(current) boss happy and enables him politically to raise interest rates.
Rising interest rates and falling corporate profit margins (even when
squared off against rising overall profit levels) might put pressure on
stock prices. When will all this doom and gloom begin to occur? My guess is
that it will not be a uniform but a gradual development and that we still
have a good quarter or two ahead of us. Increasingly, however, we will have
to become more and more selective. The good news is: There is always a bull
market going on somewhere in this world. The trick is to figure out where
and when to get in and out!"
Let me give you one more quote from the bond king himself, Bill Gross. I
find his monthly work part of my "must-reads." You can see him at
www.pimco.com and I commend his entire article to you.
"As real short rates climb from negative to only slightly positive (PIMCO's
longstanding forecast), this reversal in trend will be enough to call a
halt to the higher and higher productivity of debt in a finance-based
economy. Simply put, it means that borrowers will pay more in real terms,
affecting consumption, home building and buying, business investing, and
government deficits alike. The lower real interest rate "wind" at their
backs will instead turn into a mild headwind. The economy will slow. It may
falter. The timing is uncertain. For contrary thinking, pessimistic
investment managers or economists, "someday" is often frustratingly "out
there" like some phantom force in the X-Files. Still, it suggests caution
as we move inexorably closer to our High Noon.
"Readers wishing me to get to the bottom line or even jumping ahead of me
to draw their own conclusions may find this "High Noon" parallel a little
bit hard to digest even in PIMCO terms. Have I not been preaching the
inevitability of "reflation," recommending TIPS and commodities, advocating
shorter than average durations filled with intermediate maturities to take
advantage of the carry trade? That I have - but reflationary attempts by
Fed Chairman and Presidents alike do not presuppose successful reflation in
terms of economic growth. The pace of future growth is the true conundrum,
not the obvious reflationary efforts of governmental authorities to
generate it. Believers in past Keynesian successes and promises of future
helicopter droppings [of increased money supply and cash - John] are
confident it can be done - that our U.S. and global economy can ultimately
exhibit stable long-term growth rates with the government's wind at its
back. I have my doubts. Keynes like Volcker conjured his magic in a simpler
manufacturing/agricultural based world. In a finance-based economy it is
the growth in leverage as well as its costs that call the shots. And a true
vigilante, a lender who lends money not as a participant in some money
management game or contest, but with the expectation of getting his or her
money back in inflation-adjusted terms and then some, will demand that the
growth of leverage cease and/or that its cost increase to reflect the
increased risk. Either demand will force this economy to retreat. Risk
markets will be at "risk" should we move towards this outcome. And too,
Treasury interest rates may then ultimately fall instead of rise as
reflation fails and debt deflation takes hold. But that is a story/movie
for another year and that tale's telling demands the reincarnation of a
host of vigilantes long since stripped of their common sense and their
ability to say no."
Gross has been turning rather bearish of late. But he makes a point in line
with my longer term forecast. The economy has been stimulated beyond
anything we have ever experienced. And it only produced a mere 600,000
jobs. Growth in personal income is barely keeping up with inflation and
certainly not keeping up with the growth in debt or debt service. Debt
cannot continue to grow faster than the economy or incomes, and growth in
debt is needed to keep the economy growing.
Sustainable growth will require growth in both jobs and income and less
reliance on debt. So far, this has not happened. This is still a steroid
economy. But it is difficult to see from where the next round of stimulus
comes. The markets and the economy are priced for perfection. But things
just don't look perfect to me. As I wrote last month, the markets could
continue to move sideways to up, but I think we could see this year as a
classic "Sell in May and go away" year. I would have fairy close stops on
any trading accounts.
I still think the economy is good to go for at least the first three
quarters of the year, and possibly into next year. But unless job growth
begins to manifest itself, this economic recovery is not sustainable much
over the longer term. |
