Rosy Jobs Rate Has Thorny Underside
By Barry Ritholtz
RealMoney.com Contributor
2/9/2005 9:30 AM EST
Friday's nonfarm payroll number was -- once again -- below consensus. Yet despite that disappointment, some fund managers and market watchers took solace in the newly lower unemployment rate.
They shouldn't have. If you drill beneath the headline number, you will see that the data is much less rosy than implied by the headline number. The reality is that the jobs situation is far more discouraging than it appears to be.
The Source of the Confusion
Ask the average investor (or the average economist for that matter) and they will tell you unemployment is going lower because more people have gotten jobs. Turns out, that's not the case.
In mid-2002, unemployment peaked at about 6.3%. In Friday's report, it had fallen to 5.2%. It's long been believed that a 6% unemployment rate represents full employment. How can this be anything but good news? Well, when you consider exactly how the unemployment rate is calculated, you can see why there is cause for concern.
The unemployment rate is the complementary number to the national employment rate -- the two of them must add up to 100%. The employment rate is calculated by dividing the number of people employed full time in nonfarm jobs (as defined by BLS), and dividing that by the total labor pool (the math is pretty simple).
Unfortunately, too many investors stop their research after seeing the headline unemployment number. As I have mentioned previously, headlines can often be deceiving. What many investors tend to overlook is that the labor pool has also been decreasing since mid-2002. This has occurred despite a continually rising total U.S. population. That's a rather curious phenomenon.
The math here is simple. Any percentage is just a fraction with 100 understood as the denominator. The unemployment rate is 100 minus the employment rate percentage (workers/labor pool).
Thus, there are only two ways to make the employment percentage bigger: make the numerator bigger (i.e., more people getting jobs) or make the denominator smaller (i.e., less people in the labor force).
Thus, the unemployment percentage has been decreasing not because more people are getting jobs, but because the labor pool keeps shrinking.
Some demographic observers have suggested that the labor pool is shrinking due to the retirement of the baby boomer generation. I find that conclusion premature. The oldest boomers, the group inclusive of those born from 1944-1962, are no older than 61. This group won't be retiring in significant numbers for at least another few years. Additionally, we've seen studies showing that the market's collapse in 2000 forced many in this demographic bulge to forestall retirement, continuing to work to make up for the shortfall in their portfolios. I seriously doubt retiring boomers are why the labor pool keeps getting smaller.
Beyond the Math, the Semantics
To fully understand the unemployment situation, one needs to recognize several other measures of joblessness.
Start with the augmented unemployment rate . It was created in the 1990s by Federal Reserve Chairman Alan Greenspan. He designed it to give a fuller read on the overall economy. I first mentioned the augmented measure of unemployment over a year ago in another forum, noting that it is a necessary adjunct to the terminally silly unemployment rate statistic.
According to TheStreet.com's glossary, "the augmented unemployment rate also takes into account jobless people who aren't counted among the officially unemployed because they haven't searched for work lately, but who would take a job if offered one." Call them job-wanters. At present, the augmented unemployment rate is 8.6% -- much higher than the unemployment rate.
But Mr. Greenspan's augmented unemployment rate is hardly the broadest measure of unemployed personnel in the country. For that, we need to go to U-6, found at the Bureau of Labor Statistics' Table A-12, which is the BLS' "alternative measures of labor underutilization." It is the fullest measure of unemployed persons, and it includes those people who have been looking for a job, but unable to secure one -- plus all "marginally attached workers," plus the total "employed part time for economic reasons."
What do these terms mean in English? The BLS defines "marginally attached workers" as "persons who currently are neither working nor looking for work but indicate that they want and are available for a job and have looked for work sometime in the recent past." This group includes the so-called "discouraged workers," a subset of the marginally attached. They are defined as having given a "job-market related reason for not currently looking for a job" (i.e., can't find a job, despite looking for one, and then giving up). Last, the BLS defines "persons employed part time for economic reasons" as "those who want and are available for full-time work but have had to settle for a part-time schedule."
What is the U-6 measure of unemployment? As of Friday, using January 2005 data, it is 10.2%. That's a pretty grim statistic.
Over the next few quarters, I do not expect this issue to have much impact on my intermediate-term bullishness. If anything, it will be spun positively, rationalized into a convenient excuse for Mr. Greenspan and his merry band of Fed governors to maintain their monetary policy of accommodation and the ongoing measured pace of moving toward a more neutral stance.
But it is an important concept to understand. It helps to explain why the dismal set has been so disappointingly wrong in their payroll data forecasting, as I wrote one year ago about their poor prognostications:
For more objective observers, this enormous [prediction] disappointment is revealing of two things: First, the difficulty for traditional economists to make predictions in this very untraditional cycle. Predictions are difficult enough to make under the best of circumstances, especially when they are, as Yogi Berra noted, about the future. Given our perspective that this cycle is anything but normal, it is extra-ordinarily challenging to make reliable forecasts.
That's a key if you believe (as I do) in behavioral finance and its implications for expectational analysis.
Make no mistake about it: This has very significant ramifications for the broader economy, as well as the market. Investors are well advised to ignore the economic fine print at their own financial peril.
Finally, a special thanks goes to an anonymous researcher par excellence for the initial push and invaluable assistance in the preparation of this piece. Many thanks, Lobster Girl. |
