The latest set of economic reports suggests the recovery, though still weak and vulnerable, is gaining at least modest vitality. The February employment report is an example of this mixture of positives and negatives. The positives include a 192,000 February rise in seasonally-adjusted nonfarm payrolls,up from a mere 63,000 rise in January. That is a better performance, but at that rate it will take years to just reverse the 8 million jobs lost in the recession, let alone create enough jobs for new entrants to the labor force. Payroll employment is up just 1.3 million over the past year, or an average 106,000 per month. That is too sluggish a pace to restore the economy to pre-recession levels any time soon.
The official unemployment rate edged down marginally to 8.9% in February. However, that still leaves 13.7 million officially unemployed. And that does not include the 8.3 million involuntary part-time workers who have sought but are unable to find full-time employment. In addition, there are still 2.7 million discouraged workers and others considered only marginally attached to the labor force that are not included in the labor force because they did not actively seek employment in the past four weeks. Including these various categories, as does the U-6 series, the unemployment rate jumps to an horrendous 15.9%, though it is down from its 17% cyclical high. Another worrisome aspect of the labor market is the continued downtrend in the civilian labor force population participation rate, now 63.9% down from 66.8% prior to the '07-'09 recession. The continuing dire state of the employment situation has led the unemployed to extreme measures such as forcing early retirement, a reversal of immigration and a return of the unemployed to school. A return to school should not be a surprising consequence of the 10.1% rate of unemployment among professional and business services workers, most of whom already have college degrees.
The markets reaction to Friday's release of the February employment report is instructive. The stock market traded off slightly while the Treasury bond market improved modestly. The likely explanation is that the markets were focused on the prospect that as a result of the employment report there would be an earlier end to Fed stimulus and no renewed Fed purchases of Treasury securities after the current Quantative Easing program's scheduled end at mid-year. That reaction assumes that speculative investment in equities would be reduced and/or corporate profit prospects would be eroded if short-term interest rates were to soon rise. At the same time an earlier end to Fed easing is likely perceived as reducing the prospect of a percipitous rise in inflation. Unfortunately, this potential market analysis is seriously flawed. The Fed is determined to see the economy far stronger than it is currently before it relinquishes its stimulative stance. That virtually assures a continuation of the present low interest policy through this year and probably well into or through next year.
Why, you might ask, am I so pessimistic on the economy that the Fed is expected to continue its low interest rate policy for such an extended period. The reason is the economy is being boosted by various stimulus programs that will end at various points over the course of this year. One of the more important of these programs is the full income tax expensing of corporate capital investment this year. As these stimulus programs end, economic growth will slow to a dissapointing pace. That day of pronounced disappointment may not come until late this year or next year. But it will come. The economy is also facing major problems. The rise in income is insufficient to maintain a rapid growth is retail sales. The US is overstored, there is too much excess office space and there is a continued and possibly an escalating home mortgage foreclosure problem. That points to a continued decline in home prices, office and retail rents, and commercial and retail building prices. Unfortunately, that also implies more losses on and writedowns of related loan assets for financial institutions. That will keep lenders cautious. State and local governments will attempt to close their budget deficits as mandated by law. That will lead to layoffs and spending reductions. The rise in energy, food and other commodity prices are also an economic negative, restraining consumer discretionary spending on products and services other than food and energy. The rise in energy prices stems in part from disruptions in the Middle East. In addition, speculative investment in commodities and the rise in emerging market economies are boosting the demand for and the prices of energy, other commodities and food. The Fed induced low interest rates and available credit in the US are a major source of that global speculation in commodities. Other potential negatives are threats to the pace of global economic growth. China is attempting to slow investment in real estate by a 60% downpayment requirement on second home purchases and despite the efforts to contain the European debt crisis, their problems have by no means been resolved.
Despite increases in oil production by Saudi Arabia and other producers, dislocations, differences in the types of crude produced and market uncertainties can keep energy prices high. Commodity and food prices are also likely to stay high. But, that is unlikely to translate into any significant rise in core consumer price inflation given the still huge excesses in unemployment and unused production capacity. Durable manufacturing capacity utilization at 76.1% is far from the typical inflation threshold near 87% where bottle-neck price pressures would be likely to emerge.
What does all this add up to for investments? The equity market may be somewhat vulnerable, but that does not justify broad scale selling until the major indices are down by at least 4.0% for a full week. In the past that has been a relatively reliable signal not only for liquidating positions, but also for going short. When the decline in equity prices or the slowdown in economic growth arrives, inflation fears will be arrested and Treasury bond prices will rise, as their yields decline. In the meantime, the tax incentive induced spur to capital investment will help boost earnings of durable goods producers. GE, for example, should be a beneficiary. That should be good for both their equity and bond prices.
There may be some few notable municipal problems as beleagured State and local governments deal with budget problems. But, the financial fallout is likely to be nothing like the market and some experts suggest. This could well be an attractive buying opportunity as any real or imagined individual local bankruptcy threat triggers a major resumption of investor liquidation of holdings in tax-exempt mutual funds. In order to meet the withdrawal of investor funds the funds will be forced to sell their holdings. For example, there are already 6% tax-exempt yields available on long-term investment grade bond investments, with relatively assured revenue streams, in New York and Puerto Rico. A new municipal bond selloff would provide increased opportunities on more intermediate-term and still higher rated bonds.
Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
This and prior reports can be accessed by going to Internet Explorer and typing the following: philipbraverman.blogspot.com
Ican be reached at philipbraverman@gmail.com
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