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The Recessionary Signals Of A 5% Unemployment Rate
Submitted by Lance Roberts via STA Wealth Management,
This past Friday, the Bureau of Labor Statistics released the unemployment data for October which surpassed even the most bullish Wall Street forecasts. The news that the economy added 271,000 jobs for the month (vs expectations of 182,000) sent predictions of a Fed rate hike in December soaring as the unemployment rate fell to 5%.
As Akin Oyedele via Business Insider wrote:
"After months of guessing, Friday's October jobs report jolted the market's confidence that the Federal Reserve could — and perhaps would — raise rates next month.
This looked like the kind of data that the "data-dependent" Fed needed to argue that the labor market had shown 'further improvement.'"
Akin is correct and the market agreed as the probability of a Fed rate hike this year soared above 70%.
The support provided by the increase in employment, the drop in the unemployment, falling jobless claims and rising asset prices all suggest that the economy is, at long last, on the verge of acceleration. Right?
Maybe not?
Records Are Records For A Reason
Think about the following statement for a moment.
"Jobless claims recently reached the lowest level in 42 years."
That is certainly a very "bullish" economic data point. However, when not put into some form of "context" it is really fairly meaningless. The chart below provides the "context."
Notice that each of the "lowest levels of jobless claims since..." was set just prior to the onset of the next recession.
Since the economy is driven by "full cycle" patterns of growth, to peak, to trough, any data point that reaches a "record" level should be viewed within the context of the economic cycle. As with jobless claims, a recovery from a record high in jobless claims to record lows suggest a completion of the economy recovery from trough to peak. Importantly, the economy can not remain indefinitely at a peak, the other half of the normal economic cycle will ensue at some point.
This is the point made by James Paulsen of Wells Capital Management in a recent analysis of what "5% unemployment rates" tell us about future stock and bond market outcomes. To wit:
"Historically, the stock and bond markets have done much better when the labor unemployment rate is above 5% (i.e., above full employment). Indeed, since 1948, annualized stock returns have been nearly twice as strong and long-term government bond returns have been almost four times greater compared to their respective returns when the unemployment rate is at or below 5%.
Moreover, both stocks and bonds have tended to suffer more frequent monthly declines in fully employed economies. Finally, on average during the post-war era, once the unemployment rate reaches 5%, a recession has been less than two years away."
Paulsen provides a series of charts documenting when the unemployment rates were 5% or less as provided in the full PDF version below. However, I want to bring your attention to the points he makes about the relationship between unemployment rates and recessionary onsets.
"Moreover, Chart 3 illustrates the increased risk of recession once a 5% unemployment rate is reached. On average in the post-war era, a recession is less than two years away once a 5% unemployment rate is reached compared to about 4.2 years when the unemployment rate is above 5%."
Importantly, just because the unemployment rates is at 5% does mean that a stock market crash is at hand. However, it does suggest that the inherent returns received by stock market participants will likely be substantially different in the future as compared to those seen during the recovery from the post-financial crisis lows.
"Historically, as Chart 6 shows, the entire financial market risk-return frontier (which relates historic returns and risks associated with all stock-bond portfolios shown in 10% allocation increments) shifts significantly downward at full employment. The large black squares illustrate the annualized stock/bond frontier for all months since 1948 when the unemployment rate was above 5% while the smaller gray triangles illustrate the frontier only for those months when the unemployment rate was 5% or less. Several observations are noteworthy."
"First, returns from either an all stock or an all bond portfolio (or any combination thereof) is significantly less once the economy reaches full employment.
Second, the lower returns offered by financial assets in a fully employed economy also have less volatility.
Third, the portfolio diversification offered by combining stocks with bonds is far greater before the economy reaches full employment.
Fourth, because portfolio diversification is not as effective once the economy reaches full employment, the return per unit of risk (i.e., the slope of the frontier or the additional total return per unit of risk achieved by increasing the allocation toward stocks) has historically risen much faster before the unemployment rate reaches 5%.
Finally, the degree to which the mathematics surrounding the financial markets is altered by an economy reaching full employment is perhaps best highlighted by the following fact. The all bond portfolio in an economy with an unemployment rate above 5% has yielded investors about 8.6% total annualized returns with only 10.4% risk. By comparison, once full employment is reached in the economy, the all stock portfolio has only produced an 8.0% total return for investors with a much higher risk of about 13.9%!"
Mr. Paulsen's view support many of the points I have made recently about the lateness of the current market and economic cycle. To wit:
"It is becomingly increasingly clear from a variety of inputs that deflationary pressures are mounting in the economy. Recent declines in manufacturing and production reports, along with the collapse in commodity prices, all suggest that something is amiss in the production side of economy.
While increasing interest rates may not 'initially' impact asset prices or the economy, it is a far different story to suggest that they won't. In fact, there have been absolutely ZERO times in history that the Federal Reserve has begun an interest-rate hiking campaign that has not eventually led to a negative outcome.
The Federal Reserve clearly should not raise rates in the current environment, there is a possibility they will regardless of the outcome. The Fed understands that economic cycles do not last forever, and we are closer to the next recession than not. While raising rates would likely accelerate a potential recession and a significant market correction, from the Fed's perspective it might be the 'lesser of two evils. Being caught at the 'zero bound' at the onset of a recession leaves few options for the Federal Reserve to stabilize an economic decline."
Of course, it is also worth mentioning that there is a significant difference between real "full employment" and "statistical" full employment.
Despite a strong headline in the most recent jobs report, the actual employment rate of individuals that should be working (excluding all those over the age of 55) has been falling in recent months. It is hard to suggest that the economy is running near full-employment with more than 54% of the working-age population sitting at home.
As Mr. Paulsen concludes:
"Historically, the statistical or mathematical properties of the financial markets have shifted as the economic recovery nears full employment (i.e., at about the 5% unemployment rate the contemporary recovery has reached). Traditionally, at this point in the recovery, the stock market suffers more frequent declines, bond yields rise more often, average annualized returns from both asset classes are lower, diversification benefits tend to diminish, and recession risk is enhanced."
I agree with Mr. Paulsen's point. With the actual economy, as witnessed by the plunge in imports, weaker than headlines suggest, the risk of recession has risen markedly.
Paulson - 5% Unemployment & A Shift in Market Mathematics
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It is scary, but a large proportion of the working population has never seen an ordinary business cycle recession. Even one of those (previously normal) downdrafts will hit them unaware and unprepared.
LOL! Are you suggesting that the normal pricing mechanisms are still at work? LMFAO!!!
The "official" propaganda will be that everything is awesome. Likewise, "official" prices will be very attractive, however, taking delivery at that price or getting the promised service at that price will be something else altogether. Just look at healthcare.
Soviet Union 2.0...
I was gonna mention................
Since WHEN is the unemployment figure (or any other figure) really a indicator of what's really going on in reality?
This is depressing. Maybe is better we are distract with Global Warming humor?
How is "Climate Change" (in case you didn't get the memmo) humor go?
I know Putin says it's a good thing, his people will need less fur coats.
Humor of Global Climate Change argument is ageless historical:
In cave in rural France is painting circa 5000 BC, and is tell story. One day is rain much and lightening is loud and scary. Leader of cave community is explain danger of lightening and is predict end of world if citizenry is not work hard for stopping of lightening. Every citizenry of community must bring it portion of berries and meat for sacrificial god and make incantation. Leader of cave community is so very smart, is not help hunt and gather, but is must make strategy and “guide” community for self-preservation technique. One day, citizen is look up and see is still lightening, but is look around and is still alive. Other is still alive. Lightening is come and go, and community is survive. Citizen is make comment at cave meeting and next day is fall in tar pit.
Next cave meeting is deal with peril of tar pit and how is so important for cave leadership to address with "War on Tar Pit".
Never let crisis going to waste.
Understand that story, and the rest of history is an open book.
Seriously, why the U3 unemployment rate is even talked about is a joke in itself. The U6 rate that counts those who have given up looking for work is much more accurate, and is nowhere near 5%...
Full employment, baby!
How about measuring parent's basement availability/utilization rate instead of unemployment. We can call it UB instead of U6.
Eventually Shadow Facts founder will be attached by nailguns
If were at true 5% unemployment, Cauitlyn Jenner is a true dickless woman! With 95 million emplyable people out of work, Ameika has reached top banana republic status. We are in a recession you dumb ass statistiion's in the beltway bunghole.
Oh, do you mean Bruce, some guy who likes to dress-up ... in women's clothing?
History. Meh.
this would mean something if the 5% unemployment rate was a genuine figure. since the rate is not genuine this analysis is not genuine. given the proper adjustment the rate would probably have to be much lower if the current bls numbers are used.
"... as the unemployment rate fell to 5% ..."
Yes, it's true that the jobless rate fell to 5%.
Why does Tyler publish steamers like this?
It's.all.a.lie
Most transparent administration evah!
-Obozo
A long meaningless story since the unemployment isn't 5% and could go to 0% in this system. It's hilarious.