“The jobs report was bad, bad, bad: There is no positive spin to it.” - Joseph Lake, director of global forecasting at the Economist Intelligence Unit
Last Friday the US Department of Labor offered up a shocking, and largely confusing, jobs report for the month of May. Payrolls increased by just 38,000, the lowest in more than five years and a full 120,000 below the consensus expectation of a 158,000 increase. Additionally, the March and April numbers were downgraded by a total of 59,000 between the two months. The last three months have averaged just 116,000 jobs, roughly half the pace of the preceding twelve months. There is clearly no positive spin here; these results are downright disappointing. Or in the words of Joseph Lake, “The jobs report was bad, bad, bad…”
The bad news is confirmed by the Federal Reserve’s Labor Market Conditions Index which is derived from 19 underlying indicators of labor market health. The net change in this index is now at its lowest level since 2009, and the decline has been accelerating over the past several months.
Despite the weakness in net new jobs, the May report included a perplexing twist in that the headline unemployment rate actually fell by 0.3% to 4.7%. As the chart below shows, the unemployment rate has now fallen to levels not seen since the very beginning stages of the subprime mortgage crisis in 2007.
At first glance this doesn’t make any sense. Why would the rate of unemployment be falling so rapidly in the face of decelerating job growth? There are two points I’d like to highlight in regards to this question. The first is to address the widely talked about “labor participation rate”. The second is the difference between “U-3” and “U-6” unemployment.
The labor force participation rate is defined as the percentage of the US population age 16 and older that are employed or actively looking for a job. We thoroughly dissected this statistic on our blog three years ago in Lack of Participation. As we showed, the participation rate peaked at 67.3% in 2000 and has been steadily declining ever since.
The change over time in the labor force participation rate has a profound impact on the headline unemployment rate. This is due to the fact that as participants walk away from the work force and cease looking for a job they are no longer counted as unemployed. This serves to reduce the unemployment rate not by gainfully employing those individuals, but simply by removing them from the count of unemployed persons in the calculation. This helps to explain how the unemployment rate can currently be falling so precipitously even in the face of anemic job growth in the US economy.
As a side note, there is a widely-held view that the decline in the participation rate is the direct result of bad economic fundamentals. The job market is SO bad, the thinking goes, that people are just throwing up their hands in exasperation and deciding it’s not even worth it to continue looking for a job. While there are certainly one-off examples of where this might be the case, this narrative fails to explain the decline in labor force participation. Rather, as we showed in Lack of Participation, an aging workforce is the primary driver of this trend. As the average age of our population rises so does the rate of retirement leading to a natural shrinkage in labor force participation.
I’d also like to point out that it’s important to keep an eye on the difference between U-3 and U-6 unemployment. The U-3 rate, what we refer to as the headline rate, is the most common measure of unemployment, and is simply stated as the number of unemployed workers as a percentage of the labor force. The U-6 rate, however, expands the measure of “unemployed” to include discouraged workers and those that are working part-time jobs only because full-time is not available. Thus, the U-6 rate is a truer measure of underemployment and provides additional context to the headline U-3 rate.
As the chart below shows, the U-6 rate of unemployment has not fully recovered to its 2007 levels like the headline rate has. This differential reflects the fact that many of the jobs created since the financial crisis have fallen short of what the job seeker was really wanting. It will be important to see this gap begin to close before we can consider the US economy at full employment.
We’ll see whether or not the US economy can regain some traction and pick up the pace of job growth again in the coming months, but for the time being the chief impact on financial markets is that expectations for another Fed rate hike have once again been delayed. This has put downward pressure on the US Dollar and helped fuel the recent rebound in commodity prices which has been beneficial to our current positioning in our MarketVANE HARD ASSETS strategy. While Friday’s jobs report was undeniably bad, bad, bad, there are always multiple layers to consider, and it’s important not to put too much stock in any one data point. This is yet another reminder of the importance of maintaining a well-defined investment discipline in the midst of all the economic noise.
Author David Houle, CFA is a founding member of Season Investments. He serves as the firm's Chief Compliance Officer as well as sitting on the investment committee overseeing the management of client assets. David spent nearly ten years in various roles primarily managing individual client assets prior to co-founding Season Investments. David graduated with a degree in Finance from Colorado University in Colorado Springs in 2003 and earned the Chartered Financial Analyst (CFA) designation in 2006. David and his wife Mandy have three children and spend most of their free time with friends and family.
Transparency is one of the defining characteristics of our firm. As such, it is our goal to communicate with our clients frequently and in a straightforward way about what we are doing in their portfolios and why. This information is not to be construed as an offer to sell or the solicitation of an offer to buy any securities. It represents only the opinions of Season Investments. Any views expressed are provided for informational purposes only and should not be construed as an offer, an endorsement, or inducement to invest.