Unemployment in Uncharted Territory

December 31, 2009

By Chris Dardaman, CPA, CFP®, CIMA®, CAIA® 

As of December 2009, the U.S. Bureau of Labor Statistics estimated that there were 15.4 million people in America unemployed, with 6.1 million of those jobless for over 27 weeks. In our view the federal government stimulus plan has not produced new jobs, primarily because most of the money went to help out state/local government deficits, and people who do not pay taxes or create jobs. Only a small percentage of the stimulus money has gone into productive job creating uses like infrastructure improvements, tax incentives for small businesses, etc. Weekly jobless claims, showing new job losses, have been going down, but fewer job losses is still not good enough to help those needing work. (See chart below). December marked the twenty-fourth consecutive month of overall job losses. The U.S. economy needs to grow by 2.5% just to stay even with the approximately 125,000 new workers coming into the job market each month. Given the massive and unique job losses of this recession, investors are struggling to understand where we go from here. What will the future of employment look like in the United States? This article explores the difficulties in understanding the unemployment picture and some of the cyclical and structural issues that may point the way forward.

Will the Real Unemployment Rate Please Stand Up?
Some of you may remember the old game show “To Tell the Truth” where imposters and the real person tried to convince the contestants that they were the real person. At the end of the show, the host would ask, “Will the real John Doe, please stand up?” When the “official” unemployment rate dropped last November, yet more people were still out of work, some of us wondered if the old game show may have found new life. In early December 2009, the reported U.S. unemployment rate dropped from 10.2% to 10.0%, likely because people who have been looking for work stopped looking. Yet the number of people without jobs did not decline, it actually increased. How does this government math work?  The U.S. Bureau of Labor Statistics actually has six different calculated measures of unemployment noted as U-1 to U-6. The U-3 unemployment rate is the monthly headline number that we hear on the news. Since 1994, this U-3 measurement does not count discouraged workers who have stopped looking for work or those who have not looked for work recently. The lesser known U-6 unemployment rate is the Bureau of Labor Statistics’ (BLS) broadest unemployment measure, including short-term discouraged and other marginally-attached workers as well as those forced to work part-time because they cannot find full-time employment. The U-6 unemployment rate was 17.2% in November 2009. Furthermore, John Williams in his shadow stats estimates that based on the pre-1994 methodology, the current U-6 total unemployment rate is closer to 22%.  Whatever the actual percentage, it is a large number.

Cyclical Issues Affecting the Short-Intermediate Term
Unemployment rates are cyclical based on the economy, and job losses happen as an economy goes in reverse. The last time unemployment in the U.S. broke 10% was 1983. As the economy recovered, the economic growth rates then were 7-9%, which is more than twice what is expected this time around. Currently, there are a number of cyclical negative pressures on employment including:

• Uncertainty about future government actions causes companies to delay hiring and expansion as they try to figure out the political lay of the land.
• Consumers spend less until they are more confident about the future. People are nesting more – spending more time at home, eating out less, shopping less and consuming less outside entertainment to save money.
• The downturn in commercial real estate will cause more job losses, along with less property tax revenue to support state and local governments and school systems.
• State and local governments are in financial distress and will be forced to lay off more workers.  The federal government stimulus plan prolonged this, but these job cuts will happen as state and local governments take in less revenue.
• Current and future Federal, State and Local tax increases take money out of the economy that otherwise could go to creating new jobs. Less reward for their efforts de-motivate entrepreneurs to take the risks that create new jobs.  

Some cyclical positive reasons employment may improve faster than we expect include:

• Companies may have cut jobs too deeply, which will cause hiring to pick up quicker than they expected once things improve.
• Inventory reductions around the globe have been dramatic. Restocking the shelves should drive a fairly substantial pickup in manufacturing.
• Home prices and investment values increasing again will help increase consumer confidence, which will help the economy recover, which could help create more new jobs quicker than expected.

Major Structural Issues Affect the Long Term Horizon
We expect unemployment rates will remain higher, over at least the next few years, than we have grown accustomed to in the U.S. This is due primarily to forced consumer retrenchment and the negative affects on employment created by the bursting of the banking and real estate bubbles. Many of the jobs lost in American industries like financial services and home building are permanent employment losses — because they were created during an era of easy credit and real estate frenzy that no longer exists. For example, many of those who lost jobs as mortgage brokers will have to change careers. It will be decades, if ever, before the job market needs that many mortgage brokers again.   

Creative destruction can be expected to generate both positives and negatives over the coming years. We’ve been through this many times in American history. A major shift occurred in the early 1900s as we moved from an agricultural to an industrial based economy. Our shift from industrial/manufacturing to more technological and service-based has been cushioned by unions and government, but it still continues. Globalization and growing markets around the world will see to that. If the simple idea on the bumper sticker saying “Buy American to Save Our Jobs” were only true. Unfortunately, we live in a much more complex global labor market now. The cold reality is that $80,000 a year manufacturing jobs have gone the way of the dinosaur. There is a human toll extracted by the change from creative destruction, and those who plan for the future will be less impacted. While the Federal government may temporarily prop up certain companies and state/local governments, ultimately the laws of economic gravity will prevail.

On the positive side (and we expect this to be very positive over time) creative destruction creates new jobs. Science, technology, energy, and health care are just a few industries that will see incredible job gains in the coming years. Going forward, the U.S. economy will increasingly become a higher-end job market that will require us to continue to train internally and import the best and the brightest workers from around the world. And it will require future American workers to have higher education, more technical expertise and a stronger work ethic.

Summary
In hindsight, it appears that the pre-2008 low unemployment rate was “juiced” through the excessive use of credit in the overall economy. It will likely take a long time to get unemployment back down to its previous 5% level. Shenkman Capital Management’s December 9, 2009 letter quotes Daniel Smick, author of The World is Curved, as stating that the U.S. economy must produce 250,000 net new jobs each month over the next five years in order to reduce the unemployment rate to 5%. This causes us to believe that the “New Normal” of high unemployment, more savings, less spending and less credit will likely mean structurally slower growth than normal from the U.S. economy. That should mean that stocks from companies that produce consistent steady growth over time will receive premium valuations. Additionally, countries with higher than normal growth will become a larger and more important part of the global economy, thus further re-enforcing the globalization of the labor market. There is a bright side, though, as the continuing downward pressure on wages will likely be one of the things that should help keep inflation under control for awhile. Overall we believe that the resiliency and innovation of consumers and businesses in the U.S. (and the global economy) will adjust to this ”New Normal”, and that while the unemployment may remain higher than we have been accustomed to, selected opportunities for making money will still be there.