So, the data is in and we got another decent jobs report. Not only did nonfarm payrolls increase by over 200,000, there were also net revisions upward to prior data. The consistent net revisions upward demonstrates that momentum in the labor market in the US is to the upside and that previous months’ data underrepresented the net addition to payrolls.
The number everyone is looking at is the labor force participation rate. Even though the data have started to turn up, the labor force participation rate is lagging. It has stalled and even declined in recent months. Last month it hit a 30-year low. This rose to 63.9% from 63.7% with the employment population now at 58.6%. A rising labor force participation rate is always seen as a sign of a more robust economy, while a falling rate is a sign of weakness.
Last month in the labor force participation rate article I said there were three factors suppressing the rate:
- Cyclical: Low participation is a negative signal.
- Structural: The jobs market is weak and that puts downward pressure on the participation rate as people drop out of the labor force. The difference here is that if the problem is structural and not cyclical, the so-called output gap will continue to be large as throngs of people remain out of the labor force.
- Secular: The first cohorts of boomers started to retire last year. I know many people that were close to retirement when the recession began in 2007 that have had to change plans. Some have delayed retirement because of financial turmoil. But many others have accelerated retirement unwillingly because they were forced out of the labor force. Expect the loss of boomers to put downward pressure on the labor force for years to come.
There has been a lot of talk about the structural weakness and I think this is a major factor in the US jobs market. But I also think the secular trend is going to becoming increasingly important. And that is significant because it will act as a break on demand. The older cohort will see the tail end of its business career’s earning potential unexpectedly curtailed while returns from investment are reduced due to financial repression and stock market volatility. This makes for an uncomfortable combination as people enter retirement and will cause a lot of precautionary savings for years to come. Demand growth will be exceedingly slow even in the best case scenarios because of this dynamic. Only increased government spending can fill in this gap, and we are at the politically feasible extent of this kind of policy support.
Therefore, over the longer-term I remain cautious about the prospects for risk assets like stocks. An investor with a longer-term horizon is best advised to stick to the highest yielding high quality assets she can find: Utilities, oil and gas, consumer staples, etc. Meanwhile, the precautionary savings of the older cohort will act as a drag on the fiscal side because the financial sectors must balance (increased private sector savings translates into reduced current account deficits and increased government deficits). That suggests to me that in expansionary phases of the business cycle, government bond yields, already artificially low due to Fed policy, will underperform higher grade corporate bonds. I see a scenario in which either the government debt trajectory worsens as we have a cyclical rebound or cuts are made and the economy stalls. To me that speaks to an underweighting of US government bonds and an overweighting of foreign government bonds/US corporate bonds.
Over the short-term, the cyclical bull market remains intact but it is considerably weakened. The initial spurt after March 2009 was the time to get into risky assets like cyclicals and bank stocks. Now, while one wants continued equity exposure to participate in the cyclical bull, a rotation into more defensive areas is warranted, the jobs data notwithstanding.
Ultimately, I think the fundamentals in the US are still relatively weak such that any large exogenous economic shock will cause the US to tip into recession and have a very negative impact on stocks. In Europe, where policy makers are trying their best to overcome a truly frightening macro environment, stocks are cheaper and therefore more interesting for a value-oriented investors – same sectors, more upside potential.