Labor Market Weakness Is A Warning for Stocks

 

The weakness in the labor market is in the middle-skill non-college graduate area. This sector is losing jobs to lower wage Emerging Market countries. The U.S. economy is like a big ship that hit a small iceberg and was taking on water but the compartments have been shut to seal off the rest of the ship from the leak. The ship is sound and will survive. The “leak” is the loss of blue collar middle skill jobs to EM countries. This problem has no solution. It will continue until wages for this sector have become as low as the competing EM countries. Politicians say that workers should get retrained to become more highly skilled, but not everyone is bright enough to become a more sophisticated, well paid, highly productive worker.

The reason there are plenty of unfilled job openings is that employers want too much; they don’t want a mediocre generic worker. Regarding the recent improvement in the “quit rate” where employees show confidence by quitting their job, that is good news, but one must remember that this may only be happening among the most skilled sector of workers. Also the data is warped by the absence of the missing 3.5% of workers who dropped out in 2009 and became the hidden unemployed.

The upper middle class with sophisticated skills are in demand. However they tend to save more than moderate income people so the affluent classes won’t do enough consumption to offset the reduction of consumption from the weak blue collar community. Thus the economy will continue to experience deflationary pressures mixed in with inflationary forces with the net result of very low inflation.

The EM countries, Japan, the EU all urgently need to boost exports by devaluing their currency. The EU and Japan have trade treaties with the U.S. that prohibit export subsidies so the only way for them to get an advantage is through devaluation. The EU’s Central Bank lacks authority to aggressively reflate the economy and it may take several more years of hardship before legislative and judicial authority is granted to the ECB to get aggressive to fix Europe’s problems.

The stage is set for a global economic slowdown that fully justifies today’s low yields. An attempt to escape low yields by recklessly speculating in junk bonds, naked option writing, bank preferred stock, etc. is too risky and could result in severe permanent loss of principal as happened in the 2008 crash.

Labor indicators can be warped by behavioral issues such as hard core long term dropouts who don’t bother to register with the government and are thus not counted. Data can be warped by people who cheat on welfare rules and find ways to go on disability, get nearly free HUD section 8 housing vouchers, free food stamps and medical care, etc. Stock prices and corporate earnings can be warped as I described in many articles on this website. The data that is most reliable is GDP and corporate gross revenue. Corporate revenue per share of stock has been flat since the economic top in 2007 despite growth in real GDP. And real GDP has grown very slowly in the past decade at only 1.8% a year which is below the stall speed of the economy.

The explanation for how consumption remained steady despite the 2.7% median drop in real wages since 2007 is that interest rates dropped, loan terms were extended to stretch out payments, and more people took out student loans.

In a low growth economy where risk of falling back into recession is greater than it is important that investors avoid overpaying for stock prices. The PE10 indicates the SP is worth roughly 1200 but it trades at 2000, a 67% over-pricing. The reason bond yields are low is that they are determined by professional investors who worry that the economy and stocks may be headed into a less than positive outcome, so in anticipation of a flight from stocks to bonds the bond market has received a bid from the marketplace (meaning the price has gone up/yields have gone down).

There is no guarantee that bond prices will move higher, but I feel highly confident stocks are very overpriced and should be avoided by those who respect fundamental valuation principles. It is too risky to pick the exact top for stocks, so it is better to avoid them now. There is an old saying that one should take profits by selling into a rally instead of waiting for a crash to trigger a stop loss. In modern times so many over levered speculators have set up hair trigger stop losses and program trading that it doesn’t take much to trigger another May, 2010 Flash Crash where some people lost 40% in a day. During those times a stop loss order won’t get filled until the market has dropped far below the trigger price.

There are many wonderful long term future possibilities for the economy in terms of new technology but it may take decades to fully implement them and there is no guarantee that a particular company will be able to profitably implement new technology. Lots of new technology was implemented since 2000 but since then we have had lots of deep crashes, high unemployment, low GDP growth, etc. For the next ten years we still have deal with a world where stock prices are too high and will crash, corporate earnings are inflated, investors are too bullish and speculate too much, causing stocks to be overpriced and then crash.

Investors need independent financial advice about the risk of a stock crash. I wrote an article “Pent up wage deflation to make stocks crash”.

 

About the author

Don Martin, CFP®

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