[“3 Things” is a weekly publication of ideas, usually contrarian, to provoke thoughtful discussions and decision-making processes. As a portfolio strategist, I am sharing things that I am considering with respect to current investment models and portfolio allocations. Please feel free to email or tweet me with your comments and ideas.]
The Claims Problem
This morning initial jobless claims plunged to the lowest level in the last 42 years. The chart below shows the weekly claims as compared to the 4-week moving average.
Surely, this must be a sign that the economy has turned the proverbial corner as full-employment has finally been obtained. Right? Maybe not.
“That really is the point that the majority of analysis misses when they point to jobless claims and the U-3 or U-6 unemployment rates. IF, and that is a big IF, employment was as strong as suggested by headlines then wage growth would be rising sharply and economic growth would be running near levels historically associated with ‘full employment rates.’
However, the chart below, which is the labor force participation rate of 16-54-year-olds as a percentage of just that age group, is representative of the real problem. Just because the BLS chooses not to “count” those individuals, it DOES NOT mean that they have ceased to exist.(The percentage of workers participating in this age group as has fallen for the past 3 months.)”
However, I am not suggesting there has been NO JOB growth. There has. However, it has been a function of hiring due to the increases in population growth, which creates incremental demand, rather than an organically driven surge in overall economic growth and prosperity.
It is there that we find the problem with the reports on jobless claims and the actual economy.
Since the end of the financial crisis, businesses have been increasing bottom line profitability by massive cost cuts rather than increases in revenue. Of course, one of the highest “costs” to any business is labor. One way that we can measure this view is by looking at corporate profits on a per employee basis. Currently, that ratio is near its highest level on record. (Scale below is inverted for clarity)
The problem that businesses are beginning to face is while they have slashed labor costs to the bone there is a point where businesses simply cannot cut further. At this point businesses have to begin to “hoard” what labor they have, maximize that labor force’s productivity (increase output with minimal increases in labor costs) and hire additional labor, primarily temporary, only when demand forces expansion.
This issue of “labor hoarding” also explains the sharp drop in initial weekly jobless claims. In order to file for unemployment benefits, an individual must have been first terminated, by layoff or discharge, from their previous employer. An individual who “quits” a job cannot, in theory, file for unemployment insurance. However, as companies begin to layoff or discharge fewer workers the number of individuals filing for initial claims decline. This is shown in the chart below which shows the 4-month average of layoff and discharges versus the 4-week average of initial jobless claims.
However, the mistake is assuming that just because initial claims are declining, the economy and specifically full-time employment is markedly improving. The next chart shows initial jobless claims versus the full-time employment to population ratio.
The issue of “labor hoarding” is an important phenomenon that is likely obscuring the real weakness in the underlying economy. Without an increase in the demand part of the economic equation, businesses will continue resorting to productivity increases to stretch the current labor force farther to protect profitability. The effect is a decline in real median incomes which negatively impacts future demand.
While massive binges in stock buybacks and accounting gimmicks have continued to blur the actual profitability of businesses, the decline in jobless claims suggests that there is little room from further reductions in body counts. However, that does not mean that businesses must begin rapidly increasing employment and wages.
The “good news” is that for those that are currently employed – job safety is high. Businesses are indeed hiring, but prefer to hire from the “currently employed” labor pool rather than the unemployed masses. The “bad news” is that for those unemployed, full-time employment remains elusive, and wages remain suppressed due to the high competition for available work.
The current detachment between the financial markets and the real economy continues. The Federal Reserve’s interventions continues to create a wealth effect for market participants. However, it is unfortunate that such a wealth effect is only enjoyed by a small minority of the total population – those at the upper end of the pay scale that have jobs.