“March came in like a job-creating lion and left like, well, some sort of severely disappointing animal.” – David Graham, The Atlantic
Two weeks ago in my post, Inflation Data In The Information Age, I asserted that inflation data was one of the few economic indicators that was “worth paying attention to”. My premise for making this statement was that, “Regardless of what is happening abroad, the US Federal Reserve will be heavily influenced by trends in domestic inflation, and global capital markets will be heavily influenced by the US Federal Reserve.” If we were to highlight one other data series that would most influence monetary policy here in the US it would be the labor market. This should come as no surprise in light of the Fed’s dual mandate of 1) stable prices, and 2) maximum employment. Last Friday the Federal Bureau of Labor Statistics released the jobs data for the month of March, and although the labor market entered the month like a lion, it went out like a lamb. This week we’ll unpack the current state of the jobs market by reviewing a series of charts.
First, let’s take a look at how the labor market has evolved since the financial crisis. As shown in the chart below, the economy began shedding jobs in January 2008 and didn’t stop until 8.7 million positions had disappeared. Since bottoming in 2010 the market has gained all those back plus some. The economy is now roughly 3 million jobs richer than it was heading into the crisis. This, viewed in isolation, is very good news!
Not surprisingly, the headline unemployment rate has steadily decreased over this time period, from 10% at its peak all the way down to 5.5% in March.
This would also appear to be very good news, but do we need to take this statistic with a big grain of salt? Many, and in fact most of the people I interact with, would answer that question in the affirmative. To understand why, we need to dig into how the unemployment rate is calculated. At first glance the math appears fairly straightforward…
Unemployment Rate = # of Unemployed / Total Labor Force
But we should be slow to use the term “straightforward” in describing any large scale measure of economic activity. The complications come when we begin to analyze the definition of unemployed and labor force.
A worker is considered “unemployed” if they are actively looking for work and currently do not have a job. Pretty straightforward. However, what about those who are actively looking for full-time work and currently hold down a part-time position in order to make ends meet? This person would be considered just as “employed” as a full-time worker and thus would not be included in the unemployment calculation.
When it comes to computing the size of the “labor force”, we are talking about anyone 16+ years old who is actively working or looking for work. Not included in this number are those workers who want work, have actively tried to find work but have given up the search in hopes of re-engaging once they see things improve (the government calls these the “marginally attached”). By virtue of the fact that they are not actively looking, these people would not be considered part of the labor force and again would be excluded from the unemployment calculation.
These two dynamics serve to understate, to some extent, how much unemployment actually exists in the economy. The black line in the chart below reflects what is called the “underemployment rate” (officially referred to as the U6 rate of unemployment). This measure makes adjustments to the headline unemployment rate by accounting for the two scenarios described above.
As the chart shows, the underemployment rate has also been steadily declining, but it currently stands at about twice the level as headline unemployment. There is room for continued improvement here.
While we’re on the topic of the labor force, no conversation of this nature would be complete without talking about the now infamous “labor force participation rate”. The participation rate measures the portion of the working age population that is included in the total labor force (working, or actively looking for work). As the chart below shows, the participation rate peaked around the turn of the century and has been declining steadily ever since.
What this means is that fewer citizens are participating in the work force. This lack of participation is the most commonly cited reason for sweeping the unemployment rate aside as invalid. The common argument is that if people weren’t dropping out of the labor force like flies the unemployment rate would still be sky high. (This argument assumes that those who are dropping out would otherwise be included in the total number of unemployed.) There is definitely some truth to this argument, but unfortunately rational analysis has been hijacked by political spin and this has become one of the most misused statistics in recent years.
It’s widely touted that the shrinking of the labor force is predominantly due to discouraged workers unable to find work and simply giving up due to the dismal environment brought about by the failed economic policies of the current administration. This, in my opinion, is a gross example of shameless political spin*. The fact is that discouraged workers, which make up a meager 0.3% of our working age population, don’t have much to do with the drop in labor force participation at all. Rather, it’s an unavoidable fact of aging demographics. The percentage of our working age population aged 55 or older has grown by roughly a third over the past twenty years. Simply put, the baby boomers are beginning to retire and there are not enough warm bodies to backfill them in the labor force! This trend is here to stay, regardless of who is in the White House. (See my May 2013 post, Lack of Participation, for a bit more detail on this.)
Finally, here is a visual depiction of the bombshell that was the March jobs report. Consensus forecasts were for 260,000 new jobs to be created. The actual number came in at less than half that and was the weakest monthly print since December 2013. Adding insult to injury, January and February job gains were revised lower by a combined 87,000. These numbers confirm a slew of other data points that have been pointing to a substantial slowdown in economic activity in the first quarter.
Just as disconcerting was the drop in year-over-year growth in average weekly earnings. At roughly 2% annual growth, there is simply not much ground being gained by the average worker after accounting for inflation. Growth in the number of jobs themselves is one thing, but the economy won’t be operating at “full employment” until we start see real wage growth finally kick in. That will be the sign that the labor market is tightening up and inflation might finally be around the corner.
Suffice it to say that the March jobs report was a major disappointment, so much so that it has likely moved the timetable for the Fed’s first rate hike (a topic that has been discussed repeatedly on this blog over the past couple months). The financial markets, ironically, are reacting positively, reflecting a “bad news is good news” mentality that welcomes anything that might delay the Fed’s first rate hike. While a lamb might be a bit easier to live with in the short term, I think we’d all like to see this recovery roar to new heights over the balance of this year. Over the long-term a weakening economy poses a much greater threat to risk assets than a potential rate hike, thus we’re hoping to see April usher in the lion’s return.
*NOTE: My personal politics are quite conservative, which means I’m entitled to take a jab at a conservative talking point without anyone getting offended!
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.
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