The great minds in economics can’t seem to agree whether the labor market is showing signs of tightness, or if it’s easing up. If labor is tight and tightening, why aren’t wages rising? Why isn’t inflation rising more than 2%? If labor is slack, why aren’t we seeing political and economic pressure to do ‘something’?
The data supporting a tight labor market:
- Unemployment at 5.4%
- Initial jobless claims at historical lows
- Drop in the number of part-time workers
- Average weekly hours remain close to cyclical highs, despite manufacturing/oil industry pullback
The data supporting a slack labor market:
- Labor participation rate falling
- U6 unemployment (includes marginal and part-time workers) still above previous cycle
- Jobless claims forced down by new government regulations
- Overtime dropping fast
What Unemployment Numbers Really Mean
Before we provide the Moneyball answer to the cause of this conundrum, a little mystery needs to be dispelled. It’s time to play Junior Economist.
Suppose that there are 220 people capable of working but only 200 are actually looking for work. The labor participation rate refers to the 200 looking for work compared to the 220 who are capable.
Suppose that 180 of them get jobs. The most popular measurement of unemployment (U1) would say that 200 looked for work and 20 people couldn’t find a job, therefore unemployment is 10% (20/200). Now suppose the number of jobs stays flat and of the 20 out of work, 10 keep looking and 10 give up. Then unemployment drops to 5.3% (10 out of 190 people are unemployed).
This is exactly what’s has been happening. Unemployment has been dropping largely because people have stopped looking, not because there are new jobs.
To get a sense of the impact, here is a chart of labor participation and the U1 unemployment rate that gets touted by the media.
Labor participation has fallen from ~66% pre-Recession to just shy of 63% today. That translates into 5M+ people who could be working but aren’t looking for jobs and therefore aren’t counted in the unemployment figures.
This is why the Federal Reserve under Janet Yellen began to ignore the unemployment rate and instead has been watching the participation rate.
In fact, if we used common sense and looked at the total number of capable workers actually working, we’d see a nightmarish scenario.
This undermines the first part of the labor tightness story: unemployment isn’t as tight as it would appear.
The second point is the jobless claims figure. It too isn’t all that it appears to be.
[Read: Neil Dutta: No U.S. Slowdown, Though Investment Opportunities Better Overseas]
As of January 1st, 2014, the federal government ended the emergency unemployment benefits. Jobless claims began to tank immediately. In just a few months, claims fell twice as fast as they had in the previous two years (continued claims fell 280K in the first six months of 2014 vs 670K claims for 2012 and 2013 combined). Added to the removal of federal support, states enacted tighter regulations, limiting access and payments.
Simply put, jobless claims fell because of rule changes and not because more jobs were being created.
In essence, the job market is better than it has been in years, but the picture looks a lot rosier than it really is.
Blame the Youth?
Which brings us back to the question: is the labor market tight or slack? The answer is that it is very slack for a particularly large group: young people.
Young people (16-24) account for a third of the civilian labor force and about a third of the unemployed population.
Youth unemployment rates are at Depression-era levels:
- Unemployment for persons over 25 years old: 4.5%
- Unemployment for persons under 20: 17%
- Unemployment for persons 20-24: 9.6%
It’s only a slight improvement from a year ago. Young people simply aren’t getting jobs.
The businesses that used to hire young people are not hiring. Notably, there’s an alarming lack of entry level, minimum wage jobs in construction, retail and restaurants.
Construction has an unemployment rate of 7.5% versus the average 5.4% for the total civilian work force. Retail and leisure comes in at 7.8% unemployment.
Mismatch of Skills and Lack of Pressure
Sure, we could blame the massive closures of big box retail stores and the outsourcing of US manufacturing and assembly (ahem… Apple), but a more critical problem is job skill mismatch. The market wants software programmers. Demand is off the charts, but the under-25 crowd lacks those skills.
There is no political or economic pressure, precisely because the problems are isolated to the youth demographic.
- Political pressure: Young people don’t vote
- Economic pressure: Young people are living at home, frequently enjoying free room and board
Ignoring the problem doesn’t work.
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It’s entirely possible that recent riots in Ferguson and elsewhere are less about race and more about youth employment. Unemployment in Ferguson is 13.2% (about 2.5x the national rate). If that was extrapolated to the national averages for youth unemployment, the youth unemployment rate for Ferguson is ~30%+.
Youth unemployment is behind that falling participation rate. It is severe, persistent and is dampening the inflationary pressures coming from rising purchasing power of the employed.
Moreover, this scenario is unlikely to change anytime soon.
Add to this current condition the very real possibility that wage inflation pressures may be further dulled by the slowing global economy. The last few months have seen very weak earnings growth. Manufacturing wages are responding to slower demand.
What Investors Should Consider
For investors, there are two issues: what is happening in the real economy and what the Fed thinks is happening.
The Fed is aware that the real economy is different from the one represented by 5.4% unemployment. Tellingly, the Fed under Yellen has shifted focus away from the unemployment rate and more towards the participation rate. But the Fed is eager to raise rates, perhaps because they think it’s correct or perhaps because it’s an important symbolic gesture to prove that they are in charge and can take action. Real wage inflation need not be present (the Fed believes in acting pre-preemptively!). As long as that participation rate drops, they get the necessary ground cover to move.
[Listen to: Jim Puplava’s Big Picture: Yellen Is Tellin: It Is Going to Be a Slow Slog]
To move that participation rate to more ‘normal’ levels requires at least another million jobs. At current levels of payrolls, that’s about five months away. Not coincidentally, that’s about when the market expects a rate hike.
Meanwhile, the real question is about inflation. The global economy is slowing down and that is affecting the US: GDP is less than 1% and monthly payrolls have shrunk from an average 260K at the end of 2014 to barely 200K the last four months.
From the inflation front, we have:
- Wage pressure from minimum wage hikes
- The end of deflation triggered by oil price drops
- Food inflation from California drought
- Rising CPI inflation as rent gets weighted more heavily
The rent factor is vital. Rents aren’t actually rising, but the way they get included as a component in CPI is shifting and overstating their impact. This means inflation will look that much higher and give the Fed that much more ammunition for a rate increase when, in effect, all they will be doing is hitting the consumer in the pocketbook.
In essence, a Fed move won’t tame inflation. Interest rates won’t change the drought-induced short supply or the lack of further oil price collapse. Neither will interest rates slow healthcare costs or the mandated rise in minimum wages.
[Hear also: Steven Ricchiuto: "There is no economic recovery!"]
Instead, we will see a slowing economy, higher interest rates, and higher inflation.
The Fed move in and of itself won’t trigger a panic, but it will be a contributing factor to a slowdown in consumer spending.
The US Equity markets will enjoy another bull run thanks to the Chinese stock market bubble, which will spill over into our markets as their capital seeks to exit for safer shores. That will last through the year, but as we enter 4Q consider unwinding positions and selling into this strength. Cash – not gold – may actually look like the smart move for wealth preservation.
