Insight Line—January 21, 2008

As I see it, no single economic indicator affects the stock and bond markets as much as the jobs report. The reason? The report, derived from information literally only weeks old, is rich in detail about the job market, wages, and arguably, the current state of the economy. And, because the perceived direction of the economy factors heavily into investors’ expectations for stock and bond returns, one can see why the investing community pays such close attention to the jobs report.

Some economists and pundits would have investors believe the pace of job creation in the current business cycle is symptomatic of a struggling economy. While at first glance such an argument may seem plausible in an historical context, one must always consider that in a dynamic economy such as ours, history may not always be the best guide for interpreting contemporaneous economic data.

You see, history would have investors expect that as job creation slows, as has been the case for most of this decade, the unemployment rate should be far above that of past years when job creation was substantially greater. However, this isn’t the case. In fact, the average unemployment rate in this decade—5.03 percent—is more than two percentage points below the average of the 1980s and three-quarters of a percentage point below that of the 1990s. Moreover, I have reason to believe that in the years ahead the unemployment rate may remain lower than once believed.

For years, accepted wisdom in economic and political circles has been that in a growing economy, employment growth should roughly equal population growth. This view may be changing, however.

A little less than three years ago, Julie L. Hotchkiss, an economist at the Federal Reserve Bank of Atlanta, challenged conventional thinking by suggesting that while employment growth remains an important factor in assessing the overall health of the economy and the business cycle, the headline monthly numbers are only part of the analysis¹. By her way of thinking, the actual number of jobs created is little more than an interesting number, unless one views it in the context of the size of the population, the labor force and lastly the participation rate of the population in the labor force.

Though her research was an attempt to address concerns over the so-called job creation and unemployment paradox—where (as in 2003) job creation slows concurrent to a declining unemployment rate, I believe her findings are applicable to today’s worries over recent trends in the monthly employment data. You see, her conclusion, based on the actual and expected demographics of the nation’s labor force, essentially argues that the economy does not need to create the same number of jobs as in years past to keep the unemployment rate from rising. In fact, according to her data projections, the rate of job creation necessary to hold the unemployment rate constant appears to be roughly two-thirds of that necessary in the 1980s and 1990s or approximately 93,000 a month.

Indeed, if her calculations hold, it is not really the population growth that the labor market needs to absorb, but rather the growth in the labor force—an important and critical difference to those focusing only on the monthly headline data.

All of which leads me to suggest that, to a point, month-to-month employment changes may no longer carry the same economic message from years past.

¹ Hotchkiss, Julie L., “Employment Growth and Labor Force Participation: How Many Jobs Are Enough,” Economic Review, Federal Reserve Bank of Atlanta, First Quarter, 2005.

Factors Driving the Economy

Economic Acceleration

Economic Deceleration

Latest Available Information
(as of 1/18/08)

Employment
^{(Source: Bureau of Labor Statistics)}

Up^*

Down

The release of December 2007’s employment data sent waves of worry across the financial, economic and political spectrum. Payroll employment slowed to a meager 18,000. Though far short of expectations, the payroll data shined in comparison to the yet-to-be-explained decline of 436,000 in the household survey that produced a 0.2 percent rise in the nation’s unemployment rate to 5 percent. Might this be a point of inflection with respect to economic growth? Perhaps, but the concurrent claims, hours worked and wage data argue the headline numbers may not be reporting the entire picture. Thus, I suggest the appropriate action on the table remains, circling Up, but with an asterisk.

Personal Income
^{(Source: Bureau of Economic Analysis)}

Up

Down

November 2007 personal income data was in sharp contrast to other, less upbeat data points over the course of December 2007. The overall income total grew 0.4 percent to $11.868 trillion. Perhaps more telling is that the year-over-year inflation adjusted growth rate of 4.5 percent suggests the purchasing power of the consumer remains a viable contributor to economic activity. Therefore, I suggest Up remains the appropriate circle on the table.

Retail Sales
^{(Source: Department of Commerce, U.S. Census Bureau)}

Up

Down

December 2007’s retail sales data clearly reflects the calendar effect of an early Thanksgiving and one less shopping day compared to 2006. The monthly total of $383 billion was weaker than forecast. When viewed over a two-month period the data is somewhat better, but does not alter the trend of declining year-over-year growth. I suggest the continued appropriate circle on the chart remains Down.

Durable Goods
^{(Source: Department of Commerce, U.S. Census Bureau)}

Up

Down

New orders for durable goods confirmed recently published reports from the nation’s manufacturing sector that overall growth rates shifted markedly lower in the month of December. However, activity in manufacturing goods posted a stronger than forecast gain, thereby enabling the all important shipments data to once again contribute to overall economic growth – albeit not as rapidly as in the third quarter of the year. Nevertheless, the overall picture in the nation’s manufacturing sector continues along the lines of inventory and sales replacement rather than business expansion. As such, I continue to position the durable/manufacturing goods activity levels are not meaningfully contributing to economic expansion. Please continue to circle Down.

Inflation
^{(Source: Bureau of Labor Statistics)}

Low

High

Inflationary pressures inched modestly higher over the course of the last quarter, due in no small measure to a dramatic rise in energy prices. The Federal Reserve’s preferred measure, Personal Consumption Expenditures ex- food and energy price changes, as of November 2007 registered above the Fed’s comfort zone of 1 to 2 percent at 2.2 percent year-over-year. Nevertheless, in that Federal Open Market Committee (FOMC) members do not seem overtly concerned over the recent uptick, I suggest keeping the circle as Low on the chart until public utterances to the contrary from voting FOMC members is commonplace. Please circle Low.

Government Spending
^{(Source: Congressional Budget Office, U.S. Treasury)}

$In

$Out

A calendar quirk enables the federal budget to record a larger than forecast surplus in the third month of the fiscal year. As such the rolling 12-month deficit when measured as a percent of GDP fell slightly to 1.3 percent. Nevertheless, the early trends appear unscathed, thereby suggesting a slightly rising budget deficit over the course of the fiscal year.
As this commentary was being prepared, members of Congress and the Administration are publicly discussing the need for some type of fiscal stimulus package in 2008. If this is to be the case, the deficit, expressed as a percentage of GDP, will more than likely reverse the downward trend recorded in the last two fiscal years. The appropriate circle on the chart remains $In.

Monetary Policy
^{(Source: Board of Governors, the Federal Reserve System)}

$In

$Out

The FOMC reduced the overnight lending rate to 4.25 percent on December 11, 2007. The committee next meets on January 29-30. Barring a reversal of fortune in the nation’s financial system, public inferences from FOMC members suggest to me the committee favoring an aggressive reduction in short-term interest rates to offset the ongoing credit contraction in the nation’s short-term funding markets. Therefore, please continue to circle $In.

Yield Curve
^{(Source: Bloomberg, LP)}

Positive

Negative

The difference between the three-month Treasury bill yield and the 10-year Treasury note yield was 68 basis points on January 18, 2008.
Please Circle Positive.

Gross Domestic Product
^{(Source: Bureau of Economic Analysis)}

Above

Below

The nation’s third quarter annualized GDP growth of 4.9 percent more than likely bears little resemblance to that recorded in the last quarter of the year. Mixed readings on personal consumption, inventory builds and trade came together, as I see it, to produce an annualized growth rate of around 2 percent. While I believe calls for a recession are highly suspect, the prospect of slowing growth in the first half of 2008 is all but certain. Therefore, please circle Below.