US labor: Is the discouraged worker bad for stocks and bonds? (Part 3 of 9)
The below graph paints a much better picture of the overall U.S. labor market to date—reflecting dramatic post-crisis recoveries in all measures of the U.S. labor force. Please remember that the “discouraged worker,” as we described in the previous article in this series, only constitutes 500,000 of the total 2014 labor force of 98 million workers. This article takes a closer look at changes in the overall labor market (the other 97.5 million workers) and considers the implications for equity investors.
For a more comprehensive review of the U.S. macroeconomic environment driving the labor market data in this series, please see Must-know 2014 US macro outlook: The crack in the debt ceiling.
Half empty or half full?
The above graph reflects the progress in the recovery of the U.S. labor market. While overall employment rates are quite poor by historical standards, it would appear that the recovery is on track. As corporate profits reach record levels and corporate balance sheets swell with cash liquidity in a low interest rate environment, it would appear that there’s ample room for investment and growth. From this perspective, the glass is half full. On the other hand, the fact that investments and, by association (to some degree), employment remain low would suggest that the glass may remain half empty for some time. As economist Paul Krugman has pointed out, the problem is not with supply—we have plenty of that. The problem is with the demand side of the economy.
Krugman: The demand side problem
As Paul Krugman points out in his New York Times column on September 26, 2010:
- “Oh, and where are these firms that “can’t find appropriate workers”? The National Federation of Independent Business has been surveying small businesses for many years, asking them to name their most important problem; the percentage citing problems with labor quality is now at an all-time low, reflecting the reality that these days even highly skilled workers are desperate for employment…So all the evidence contradicts the claim that we’re mainly suffering from structural unemployment.”
In other words, the claim that the labor force is not properly trained for jobs that are open is a political myth. Additionally, on February 9, 2014, Krugman wrote:
- “If you think the typical long-term unemployed American is one of Those People — nonwhite, poorly educated, etc. — you’re wrong, according to research by the Urban Institute’s Josh Mitchell. Half of the long-term unemployed are non-Hispanic whites. College graduates are less likely to lose their jobs than workers with less education, but once they do they are actually a bit more likely than others to join the ranks of the long-term unemployed. And workers over 45 are especially likely to spend a long time unemployed.”
The evidence has a liberal bias…
Plus, Krugman questions the orthodox supply-side economist’s doctrine:
- “But evidence has a well-known liberal bias. The more their economic doctrine fails — remember how the Fed’s actions were supposed to produce runaway inflation? — the more fiercely conservatives cling to that doctrine. More than five years after a financial crisis plunged the Western world into what looks increasingly like a quasi-permanent slump, making nonsense of free-market orthodoxy, it’s hard to find a leading Republican who has changed his or her mind on, well, anything…And this imperviousness to evidence goes along with a stunning lack of compassion.”
The overall employment data picture certainly has improved, and the sustained rally in equity prices seems to be making a significant contribution to the wealth effect, as the wealthy are now in a better position to both consume and pay capital gains taxes on equity-related capital gains. It would appear that this trend can and will continue—as long as consumption does not begin to falter—and thereby provide further support to the equity market. However, the social policies surrounding the unemployment issue will remain, and the equality debate isn’t likely to subside soon.
A note on credit: T-Mobile USA versus Verizon
T-Mobile USA (TMUS) has a market capitalization of $25.44 billion and is also a BB credit. T-Mobile USA holds $22.68 billion in debt and $7.34 billion in cash, leaving about $18 billion in debt. In contrast to Verizon’s (VZ) 9.54% profit margin and Sprint’s (S) -8.5% profit margin, TMUS has a profit margin of 0.14%. TMUS has an earnings before interest and taxes (EBITDA) of $4.78 billion to service its $18 billion of net debt, while Sprint has $5.47 billion of EBITDA to service net debt of $25.5 billion, and Verizon has $48.57 of EBITDA to service its net debt of $42 billion. T-Mobile currently has a September 1, 2018, company-guaranteed bond yielding 3.00% versus CIT Group’s February 19, 2019, senior unsecured bond yielding 3.46%, Sprint’s August 15, 2007, senior unsecured bond yielding 2.95%, Verizon’s February 15, 2008, senior unsecured bond yielding 2.00%, and Caesar’s Entertainment’s June 1, 2017, senior secured bond yielding around 11.00% (Bloomberg & Capital IQ, December 31, 2013 Quarter).
To see how the equality debate is shaped by perceptions of wealth distribution in the USA, please see the next article in this series.
Equity outlook: Cautious
Should the debt ceiling debate re-emerge after the mid-term elections in November, and macroeconomic data fail to rebound in sync with record corporate profits, investors may wish to consider limiting excessive exposure to the U.S. domestic economy, as reflected more completely in the iShares Russell 2000 Index (IWM). Alternatively, investors may wish to consider shifting equity exposure to more defensive consumer staples-related shares, as reflected in the iShares Russell 1000 Value Index (IWD).
Plus, even the global blue chip shares in the S&P 500 (SPY) or Dow Jones (DIA) could come under pressure in a rising interest rate environment accompanied by slowing consumption, investment, and economic growth. So investors may exercise greater caution when investing in the State Street Global Advisors S&P 500 SPDR (SPY) or the State Street Global Advisors Dow Jones SPDR (DIA) ETFs. Until there’s greater progress on the budget and federal debt issue, and consumption, investment, and GDP start to show greater signs of self-sustained growth, investors may wish to exercise caution and consider value and defensive sectors for investment, or individual companies such as Wal-Mart Stores (WMT).
Without sustained improvement in economic growth data, there’s little doubt that the debt level issue and tax reform will be a big issue later in the year. Current economic data noted in this series suggests that the probability of the 2013 sequester issue returning—in one form or another—could be higher than many think. The data is simply not that robust—yet.
Equity outlook: Constructive
However, if investors are confident in the ability of the USA to sustain the current economic recovery as a result of the improving macroeconomic data noted in this series, they may be willing to take a longer-term view and invest in U.S. equities at their current prices. With the S&P 500 (SPY) price-to-earnings ratio standing at 19.65 versus the historical average of around 15.50, the S&P is slightly rich in price—though earnings have been solid. However, with so much wealth sitting in risk-free and short-term financial assets, it’s possible to imagine that a large reallocation of capital that is “on strike,” including corporate profits, into long-term fixed investments. This could lead to greater economic growth rates and support both higher equity and housing prices as well. In the case of a constructive outlook, investors should consider investing in growth through the iShares Russell 1000 Growth Index (IWF) or through individual growth-oriented companies such as Google (GOOG).
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