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How capacity utilization and the jobs gap predict unemployment

Brent Nyitray, CFA, MBA

San Francisco Fed unemployment study (Part 3 of 5)

(Continued from Part 2)

Capacity utilization is a bellwether of economic activity

Capacity utilization is a good top-down macroeconomic indicator that helps forecast the labor market, final demand, consumption, and inflation. While manufacturing is no longer the primary driver of the US economy, it still influences the economy to a large degree—particularly for unskilled workers. US manufacturing has been undergoing a bit of a renaissance lately due to cheap energy prices. While there’s still a difference between wages overseas and here, low natural gas prices are offsetting that difference. Also, as wages rise overseas, the cheap labor arbitrage (taking advantage of lower wages) is fading away. The Fukushima nuclear disaster also showed how elongated supply chains are vulnerable. Increases in capacity utilization is bullish for homebuilders like KB Home (KBH), Lennar (LEN), Toll Brothers (TOL), Standard Pacific (SPF), and PulteGroup (PHM)

Generally, an increase in capacity utilization signals that firms will have to expand production and hire more workers. In fact, increases in capacity utilization have often been associated with increasing inflation. Capacity utilization is the third-strongest indicator, with a current correlation of 0.55 and a momentum indicator of 0.4. However, at the moment, it’s not predicting any strength in the labor market

Jobs gap

The jobs gap derives from the Conference Board Consumer Confidence Index. It’s probably the least familiar of these momentum indicators. It measures the difference between the percentage of households that consider jobs hard to get and the percentage that considers jobs plentiful. The Conference Board Consumer Confidence Index is an important indicator of the consumer’s perception of the US economy. Similar to other consumer confidence measures, it asks consumers about their views on the current economic conditions and their expectations for six months out. The CCI is one of the oldest consumer surveys, originally started as a mail-in survey in 1967. It asks respondents whether the following conditions are positive, negative, or neutral: current business conditions, current employment conditions, expected future business conditions, expected future employment conditions, and expectations for family income. The index is then the average of the five questions.

The jobs gap was the fourth-strongest momentum indicator, with a correlation coefficient of 0.63 and a momentum indicator of 0.36. However, it’s one of the indicators most strongly signalling an improvement in the labor markets.

Continue to Part 4

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