Rising Employment Implies Investment Paradigm Shift

Last week, the monthly employment report was released by the BLS showing a shocking 204,000 increase in jobs, instead of a consensus estimate of 120,000. At this rate the economy is well on the path to return to normal. The difference between 120,000 new jobs versus 204,000 is huge because after adjusting for the population increase of 120,000 new job seekers every month (from becoming an adult or immigration) then the “real” job increase should be 204,000 less 120,000 which is 84,000. If the consensus forecast of 120,000 was correct then the “real” increase in jobs would have been zero. Investors should seek independent financial advice regarding how to understand the impact of the employment report.

Most of the new jobs created are lower paying food and hotel jobs, however these lower paying entry level jobs are what is needed so as to provide a break for a hard core long term unemployed person to get a job. The higher skilled, higher paid workers are very much in demand to the point where it is hard to hire them, so to fix unemployment the solution is to create more entry level low skilled work. Further, the creation of more jobs in dining and hotels implies a growing economy where busy, employed people can afford to eat out or travel for business and vacation. The dining and hotel industry gets eliminated from consumers’ budgets during a recession, so now it is catch-up time for consumers to enjoy life, thus more jobs are getting created in these fields.

An interesting speculation is to wonder whether the opportunity to get an ACA mandated company paid health plan is pushing workers in the low wage industries to change from a tiny employer and seek employment in a large company where employment is strictly reported using a W-2, etc., instead of working at a tiny restaurant illegally “off the books” for cash? If yes, then that will eventually capture more data about the “hidden employed” and opposed to the cliché of the “hidden unemployed”. Economists need to spend more time studying “hidden employed” instead of unemployed.

One big problem with calculating unemployment is that people at the lowest income levels may be have a conflict of interest or be corrupted in their goal of seeking employment if they have lucrative welfare benefits.  The more that entry level employment can be created the more that this will fix the problem of a skewed data base of unemployed people who are tempted to prolong their unemployment so as to enjoy welfare benefits.

The worry about the recovery is that formerly well-paid workers were forced to accept a new job in a low paid field. However, as time goes on, the low paid fields may become more sophisticated and complicated thus requiring better paid, higher skilled workers to handle new automated processes. The ones who took an entry level job at a restaurant and who used to work at a higher skilled job will eventually get a better job working with a more highly automated workplace.

Another concern about the recovery is that high wage jobs were replaced with low wage ones. If roughly 6% of the population lost their job and half of them had to accept a huge pay cut that would mean 3% of the population will have less purchasing power. Surely the enormous career and income gains for the top 10% of the population in the last decade would in the aggregate offset the loss of purchasing power by the less skilled workers.

The bottom line is that the recovery of employment is real and that means a paradigm shift away from low or declining costs and high profits for corporations, and away from low interest rates used to fuel speculative bubbles. The combination of those two items will make stocks go down to where the PE10 formula implies, which would be about 1050 for the SP500.

If any further evidence of an improving labor market is needed look at the initial claims for unemployment at 336,000 are near a cyclical low (it recently went as low as 300k) that comes close to matching with other lows even going back to the “full employment” 1960’s and 1970’s (after adjusting for population). However, part of that is that initial claims can only be filed by workers who are “insured” meaning they are eligible for unemployment insurance. So that data doesn’t capture new labor entrants or people who have been long term unemployed then just recently got a job and then lost there job soon thereafter.

An improving job market is inflationary and will hurt bonds, except that it will happen very gradually. Despites decades of low interest rates during the 1930-1951 era inflation didn’t explode until 1965, a whole generation after the Great Depression. (However, there was a brief post WWII period of high inflation). I expect the deflationary aspects of the Eurozone and Japan and the EM commodities bubble cool down to help suppress U.S. inflation. Further, I expect continued use by the rest of the world of our Treasuries as a form of money, even if they don’t yield a fair “real” yield. This will keep Treasury prices high even if rates have a “need” to go up because of increased prosperity and inflation. Thus the greatest risk of an investment surprise is that the recovery would actually hurt corporate earnings and stock prices, rather than that the much anticipated increase in interest rates would somehow instantly lead to a Volcker moment like October 6, 1979 when the Fed made rates explode upwards, severely damaging the bond market.

The newly empowered workers in their burger flipping jobs are not going to have enough power to get loans (getting a loan increases the money supply, thus contributing to inflation) and to engage in buying high margin goods. In addition they will be coming off welfare and into taxable work, so their spendable income won’t increase that much and their activities won’t contribute much to inflation.

Investors should seek independent financial advice. I wrote an article “Full employment economy ready to surprise investors.”

About the author

Don Martin, CFP®

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