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Labor Market Continues to Struggle
The employment report released on Nov. 6 continued to showcase a weakening in
the labor situation, showing a 190,000 drop in payrolls and an increase to a
10.2% unemployment rate. However, the market shrugged off the news as stocks
moved horizontally throughout the day.
A CNBC reporter made comments after the initial release that the market
shouldn't care about the employment situation. Earnings reports from Q3 showed
that firms were positioned so that they could make a decent profit regardless of
a 9.6% unemployment rate. The CNBC report suggested that firms can continue to
profit even though the unemployment rate has edged up beyond 10% to 10.2%.
The idea that firms can remain profitable is very strange to us. In order for
firms to obtain revenues, they need people to buy from them. The increase in
unemployment will continue to pull down wages and eventually cause a further
drop in demand. There is no technical, statistical, or empirical evidence that
suggests a drop in income will lead to higher consumption!
Given that income has to fall as unemployment rises, it is asinine to believe
firms can continue to make a profit without further cost cuts. Of course further
cost cutting involves laying off more workers, which increases the effects of
the negative feedback loop the economy is currently in.
There are two main ways out of this vicious negative feedback cycle. One method
would be if long term expected demand starts rising, which causes firms to ramp
up production and, with it, increase wages. The second method would be for the
government to provide a direct consumer stimulus which artificially inflates
current demand. Firms would have to replace purchased goods by increasing
production, which in turn, leads to higher income.
The government has already enacted multiple stimulus plans that have directly
affected the consumer including income tax cuts, homebuyer tax credits, and an
auto stimulus program. So far the stimulus has done wonders by pushing up
consumer spending in Q3. However as these program fade, the pullback will be
noticed with a sharp decline in spending in the following quarters.
Companies understand that the Q3 data is not due to a rise in consumer demand
but from government spending. Firms have not changed their forecasts for future
consumption and production is likely to stall in many sectors. This has led to
higher unemployment forecasts.
The picture of the labor situation is even worse when the details of the report
are examined.
Where Oh Where Is My Income Coming From? Oh Where Oh Where Can It Be?
The increase in the unemployment rate to 10.2% wasn't so shocking. Most
economists have believed that unemployment won't top out until about 10.5%.
However, what made the jump so severe was that the increase in the unemployment
rate was not due to workers reentering the job market but due to more people
losing their jobs. The number of unemployed increased by 589,000 in October and
at the same time the labor force contracted by 31,000. In fact, 259,000 workers
left the labor force as they became so discouraged at finding a job.
The labor force participation rate has been steadily falling since the beginning
of the recession and is now at 65.1%. This is the lowest level the rate has been
since 1986!
The unemployment rate was expected to rise as more of the previous discouraged
workers moved back into the labor market. This would push the rate up, but at
the same time signal a strengthening in the labor sector as worker confidence in
finding jobs also increased.
Our forecast of the labor market made at the beginning of the year, which we
continue to stand by, shows unemployment peaking to almost 11% by the end of
2010 with mediocre economic growth through most of next year.
Our peak unemployment rate doesn't look too far off considering the unemployment
rate including all discounted and marginally attached workers as part of the
labor force has jumped 0.5 percentage points to 11.6%.
With an unemployment rate of 11.6%, how can the market truly believe firms can
make a profit under these conditions?
The fact is, the increase in unemployment is going to continue draining worker
savings and push down available income for spending.
Income is Not Coming From More Jobs
Many people discount the unemployment rate based on the survey method that is
used to calculate it. The criticisms are fair. Instead, these people tend to use
the payroll data to get a better understanding of the labor situation.
Here, the headline numbers look strong. Nonfarm payrolls declined 190,000 for
the October and the payroll decline in both August and September were revised
lower. It seems firms are steadying themselves at the current employment levels
and do not need to institute more layoffs.
On the surface this is true. However underneath the headline number lies a very
disturbing possible new trend.
Firms hired 34,000 temporary workers to fill positions that used to go to
full-time workers.
The hiring shows up, not only as an increase in payrolls, but their wages are
evaluated no differently than the other full-time employees.
There are two problems with this. First, the temporary workers may not last long
if the economy doesn't right itself quick enough. Therefore, the increase of
34,000 workers could evaporate next month and pull down payrolls.
Second, temporary workers have a different marginal propensity to consume than
full-time workers. This means that they tend to save at a higher rate. The
income these workers receive is going to be used for consumption at a lower
rate.
Both of these problems points to a drop in aggregate spending over the last
month even though the payroll decline suggests an increase in consumer demand.
Where Does This Lead Us?
Unfortunately the conclusions about this month's payroll don't leave us with
much to look forward to in terms of economic well-being.
Both the unemployment rate and payroll numbers are signifying lower aggregate
spending.
While the market may believe this will have no effect on the profits of
companies, there is no way revenues can be maintained given the continued
severity of the job losses and, with it, income declines.
The U.S. seems to be stuck in a negative feedback loop where increased
unemployment today begets more unemployment tomorrow.
Unfortunately, expected demand and government spending have thus far been unable
to break the cycle.
Feeds!