The real US unemployment picture and our future

Market Realist

Sam Madden, CFA, founder, and CEO of Interactive Buyside, analyzes the U.S. unemployment picture on the eve of elections in September 2012

I wanted to analyze the U.S. unemployment picture in an effort to look at all the data in front of me, and come to a relatively unbiased opinion about the current state and direction of the U.S. labor market. I’ve tried to structure this in a very simple fashion, as with election season upon us, I need to block out all the noise coming from political parties about the domestic unemployment situation, and just focus on a few simple questions:

  1. How bad is it?
  2. If it’s really that bad, then why is it so?
  3. How will the unemployment picture change?

So, let’s take each of these questions one by one and attempt to find a real answer to them:

1. The details: How bad is it?

This is probably the most commonly asked question, so to no one’s surprise (I hope), the answer is the unemployment picture is pretty bad. Headline unemployment is a reported 7.8%; now to be clear, this headline number is the % of the total labor force that is unemployed but actively seeking employment (or willing to work). The unemployment rate as of August 2013 is 7.3% as shown below:

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We all know that this “unemployment rate” has been trending down, albeit very slowly. If we look at the “employment-to-population ratio” (also produced by the Bureau of Labor Statistics or BLS), this analyzes the percent of those currently employed against the total working-age population of the U.S. (age 16 to 64 for men; age 16 to 59 for women). This employment-to-population ratio stands currently at 58.7%, and unlike the unemployment rate, this ratio has not recovered from its recession depths:

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2007

2008

2009

2010

2011

2012

September

62.9%

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61.9%

58.7%

58.5%

58.4%

58.7%

The BLS also releases a “U-6 unemployment rate” which includes (a) part-time workers who desire full-time employment, and (b) short-term discouraged workers out of the labor force for less than one year. This U-6 unemployment rate is 14.7%, down from its 17.2% peak during the Great Recession. Now if you factor in long-term discouraged workers, then this revised U-6 unemployment rate has actually increased from 21.8% (in October 2009) to 22.8% currently. These numbers show you more of a realistic percentage of maybe not the fully unemployed, but the seriously underemployed people in the U.S.

The traditional unemployment rate obviously has a numerator (employed U.S. citizens) and a denominator (total labor force). However, what the below chart clearly outlines (per BLS.gov) is that the number of U.S. citizens not in the labor force is increasing at a much faster rate than the U.S. is adding jobs.

Sep 2011

May 2012

June 2012

July 2012

Aug 2012

Sept 2012

Civilian Labor Force

154,004

155,007

155,163

155,013

154,645

155,063

Participation Rate

64.1%

63.8%

63.8%

63.7%

63.5%

63.6%

Employed

140,107

142,287

142,415

142,220

142,101

142,974

Empl/Pop Ratio

58.4%

58.6%

58.6%

58.4%

58.3%

58.7%

Unemployed

13,897

12,720

12,749

12,794

12,544

12,088

Unempl Rate

9.0%

8.2%

8.2%

8.3%

8.1%

7.8%

Not in labor force

86,067

87,958

87,958

88,340

88,921

88,710

People who want a job

6,240

6,291

6,520

6,554

6,957

6,727

 

Some economic bulls claim that the reason this is such is because baby boomers are retiring, and this is simply a natural progression of the economy as one generation gets older (thus participation rate trends down). This sounds like a reasonable theory, and the Chicago Fed actually issued a report stating that the baby boomer generation retiring represents about half the decline in labor participation rates. The other half is something more structural in nature. The Fed is usually more optimistic than it is pessimistic (e.g., its prior estimates for GDP growth for each of the past four years), but let’s be conservative and assume that half of this reduction in the labor force (thus the unemployment rate) is a natural societal progression. However, that only explains half the story, and the table above clearly outlines that domestic unemployment stats are quite poor. Now, let’s try to figure out why that is…

2. If it’s really that bad, then why is it so?

No one economist or politician has a clear-cut answer and/or solution to this question; if they did, then our unemployment situation would not be as bad as it is right now.

The definition of “structural unemployment” is the amount of unemployment that cannot be affected by changes in monetary policy. Thus, most would argue that with interest rates having been at zero for four years, and with the Fed having pumped in hundreds of billions of dollars of liquidity into the financial system, then our current unemployment picture is structural (by definition). So why hasn’t monetary policy worked? Some folks argue “geographic immobility” where citizens are unable to move to where jobs are because their homes are underwater. Others argue a cross-sector skills mismatch of our workers, where certain industries have grown by multiples while others have shrunk considerably. There might be some truth to both of these theories to some extent, but Fed papers have been released talking about these reasons, and their main conclusions are that these theories are not the main driving forces to structural unemployment. The most reasonable answer, in my opinion, is the economic theory of hysteresis.

Hysteresis in economics and the labor market works the following way:

  • A negative shock hits an economy, firms are forced to fire employees, and thus fewer employees are left per firm. Workers who lost their jobs miss out on job training and skill acquisition while they remain out of the workforce. As the economy rebounds and begins to grow again, there are fewer skilled workers available to hire. The supply of skilled laborers has decreased, thus those benefitting are the employees who made it through the economic shock, which will then lead them to better wages (supply/demand dynamics).
  • The issue that we face as a nation currently is that the economic shock that we experienced was so deep and so severe, that it simply magnified all the effects that drive structural unemployment—the number of jobs lost, and the amount of time it takes to get out of our hole. Currently the amount of people unemployed 27 weeks or longer is >40%; for reference, all previous recessions since the Great Depression peaked at 25%. What is also shocking is an article last month, analyzing September BLS data, details how out of the ~2.7 million people who left the labor force in the last year, 81% of them (or 2.2 million) are not interested in finding a job. We know that about half of this 2.7 million people are baby boomer retirees (per the Chicago Fed), but what about the other 850,000 citizens in prime working age who apparently don’t want a job? I’m guessing this is one of the main drivers of the number of individuals receiving food stamps, growing from 35 million in July 2009 to 47 million in July 2012. If working-age Americans aren’t interested in finding a job, then the government must have a hand in perpetuating this de-motivation (e.g., unemployment benefits eligibility).
  • We dug ourselves into a big hole, and we’re not climbing out of it because our labor force is either unskilled or unmotivated, so what happens next?

3. How will the unemployment picture change?

I’m putting politics aside when I attempt to give some color around this question. Monetary policy clearly is not improving the unemployment picture as we would have liked. As we currently stand today, the Federal Reserve Bank of San Francisco (here) has stated that its estimate of the new “natural” rate of unemployment for the U.S. is 6.7%, versus the 5% natural unemployment rate prior to the Great Recession. Once again the Fed is usually optimistic, but even a 170 bps increase to natural unemployment means multiple millions of Americans never going back to work again. How do we expand GDP growth rates with this extra drag on consumption levels?

The onset of a coming artificial intelligence boom details a much more depressing outlook for the labor market. Certain futurists such as Thomas Frey and Patrick Winston estimate that robotic manufacturing and 3D manufacturing printers will replace 2 billion jobs (globally) by 2030. This is clearly quite pessimistic and some would argue extreme, but this is simply an example of another headwind to the employment picture the U.S. is facing today.

So is there a more positive outlook for our domestic labor market? Of course we need monetary and fiscal policies that spur employment, but those two actions on their own won’t return average unemployment to 5% (as detailed by the SF Fed). Simply put: we need innovation. I’m not talking innovation in financial products (like the most recent boom) or another Google, which is purely cannibalizing traditional advertising media. The trend in real GDP growth since 1950 is staggering, and it truly tells a story about how crucial innovation (e.g., the transatlantic phone cable, the PC, the Internet, etc.) is to economic growth:

1950–1980

1980–2000

2000–today

Real U.S. GDP Growth (approx. avg.)

+5%

2.5-5.0%

 

Unfortunately, I don’t have the solution to these structural problems. As investors, the best we can do is analyze the trends and data in the most unbiased way possible, come to our own conclusions as to the reasons why things persist the way they do, and then make investment decisions with this backdrop in mind. As entrepreneurs, the task is much more difficult.

The Market Realist Take

The unemployment rate dropped to 7.3% in August 2013 from 8.1% in August last year, according to the latest jobs report from the Labor Department. The economy added 169,000 jobs but the pace of hiring remained slow. The disappointing jobs data forced the Fed to pull back on its $85 billion bond buying program last month. The U.S. economy grew at a rate of 2.5% in the April–June quarter, but that was considered to be slow enough to boost hiring. Economists are forecasting 1.5% to 2% growth in the third quarter, but the partial government shutdown announced at the end of September could further reduce the pace of growth.

Economic growth could encourage a rise in hiring and wage increases. This in turn would boost consumer spending, which accounts for 70% of the U.S. economy. As pointed out in the article Do asset bubbles and government spending sustain consumerism?, broad-based indices with significant exposure to large U.S. blue chip companies—such as the State Street Global Advisors SPDR S&P 500 ETF (SPY), the Blackrock iShares S&P 500 Index (IVV), or State Street Global Advisors SPDR Dow Jones Index (DIA)—may outperform indices with greater exposure to more domestic economy–sensitive shares—such as the Blackrock iShares Russell 2000 Index (IWM), Blackrock iShares Russell 1000 Growth Index (IWF), and smaller market capitalization companies found in the State Street Global Advisors SPDR S&P MidCap 400 (MDY). The Blackrock iShares Russell 1000 Value Index (IWD) may also provide a more defensive exposure to U.S. equities should valuations remain attractive and stable in the face of softening economic data.

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