Submitted by Lance Roberts of STA Wealth Management [7],
Last week, the number of first-time jobless claims dropped below 300,000 which has not happened since before the onset of the financial crisis. Not surprisingly, the media and economic analysis exploded with commentary that this is a sure sign that the economic recovery is afoot. Such a recovery will lead to stronger employment, higher wages, rising interest rates and a continuation of the bullish stock market cycle. However, is that really the case?
[8]
[Side Note: Just a quick observation suggests that when initial claims have previously been at these levels the economic cycle was closer to its end than its beginning.]
First, let's review exactly what constitutes an "initial" jobless claim. Each week the Department of Labor (DOL) releases the number of newly unemployed seeking jobless benefits from public institutions. In theory, only individuals who have been terminated by employers are eligible to file for an initial claim, although in recent years even employees voluntarily quitting employment are being approved for claims as well. The claimant receives a temporary source of income from the government while transitioning to a new job as a substitute for lost wages.
Historically, falling jobless claims have resulted in increased employment and is currently viewed as an important leading indicator of employment recovery. The chart below is a historical look at jobless claims (inverted) and full-time employment relative to the population from 1968-2007. Since all jobs created are not equal, I am using full-time employment which leads to household formation and sustainable economic growth.
[9]
As shown, historically when jobless claims have fallen to 300,000 or less full-time employment has been at 50%, or above, for the working age population. However, since the financial crisis that is no longer the case.
[10]
Despite falling jobless claims, full-time employment has remained a limited commodity. The good news is that there has been a relative pickup in full-time employment as a percentage of the population as of late. However, the bad news is that the ratio is increasing because the working age population is declining.
[11]
As I have discussed previously, much of the effect of the decline in jobless claims is not due to substantial increases in actual employment but rather to the effect of "labor hoarding." [12] Since "initial" jobless claims are a function of "newly" terminated individuals filing for benefits it is logical that when companies cease terminations, and "hoard" their existing labor force, claims will fall. This is shown clearly below in the number of layoffs and discharges as compared to the level of initial jobless claims.
[13]
Despite many hopes that corporations will ramp up hiring, thereby reducing the excess slack in the labor force, it has failed to materialize to any great degree. As I stated above, the rate of employment remains closely tied to population growth. The chart below is the ratio of total non-farm employment growth to the growth of the working age population 16-64 years of age. A ratio of 1.00 means that employment growth is equal to population growth.
[14]
As you can see, the ratio has failed to climb above 1.00 since the turn of the century. Much of this has to do with the drive to manufacture corporate profitability in an environment of weaker topline revenue growth. During the recession businesses slashed costs, wages, and employment while boosting productivity. However, what businesses learned was that even as the economy began to recover they could continue to increase profits by focusing on productivity minimizing employment. One way that we can measure this is by looking at corporate profits on a per employee and wage basis. Currently, those ratios are at the highest/lowest levels on record.
[15]
As I said, business owners have learned their lesson. Productivity increases through technology is far better than hiring physical employees in excess of current demands. As such, there is currently little incentive to increase employment beyond current needs. This suggests that hopes of declining jobless claims leading to sharp ramps in employment and economic growth may be disappointing. More importantly, advances in technology are continually reducing the need for labor in the economy which increases the drag on both employment and wages. This is the dark side of e-commerce. In the retail world businesses need numerous employees to service physical customers. However, companies like Amazon can service thousands of customers instantaneously with no human interaction whatsoever - this is part of the "structural shift" in employment and remains focused on lower wage paying jobs.
As I stated previously [16]:
"This is why the majority of hiring continues to focused on services related jobs and generally never exceeds the rate of population growth. As the population grows, demand on services increases incrementally. However, low wage paying and temporary service jobs do not foster higher levels of spending in areas that promote sustainable economic growth."
There is one other issue that is very critical to this analysis. As with investing, getting back to "even" is not a growth strategy. Each passing month is filled with analysis of the employment data and how close to pre-crisis levels the economy is. Yet, the damage is truly greater than realized. The chart below shows the "real" employment situation that currently exists in the U.S that is simply the deviation of employment from the long term growth trend.
[17]
The structural shift in the need "for" employment has caused a massive deviation from the long term employment trend in the economy. This is unlikely to be repaired during our lifetimes and has major implications for the economy in the long term.
The issue of "labor hoarding" is an important phenomenon that is likely obscuring the real weakness in the underlying economy. Without an increase in the demand part of the equation businesses are likely to continue resorting to further productivity increases to stretch the current labor force farther to protect profitability. Furthermore, we may be witnessing businesses reaching the limits of what they can do to continue increasing profits at the bottom line as topline revenue has begun to stagnate. (This also creates implications for the financial markets which are clearly negative.)
The "good news" is that for those that are currently employed - job safety is high. Businesses are indeed hiring, but prefer to hire from the "currently employed" labor pool rather than the unemployed masses. The "bad news" is that for those who remain unemployed, full-time work remains elusive and wages suppressed due to the high competition for available jobs.
The current detachment between the financial markets and the real economy continues. The Federal Reserve's interventions continue to create a wealth effect for market participants, however, it is unfortunate that such a wealth effect is only enjoyed by a small minority of the total population - and it is primarily those at the upper end of the pay scale that have jobs.