Economic Commentary -- August 2011By Christopher Bremer, Director, Private Client Services Portfolio Management
This is the story of Louie Zamperini, a record-holding Olympic runner, as told by Laura Hillenbrand in her bestselling book, Unbroken: A World War II Story of Survival, Resilience, and Redemption. Metaphorically, it’s also the story of the state of the labor markets in the United States from 2007 to 2011 and beyond. What factors are contributing to unemployment? How are the employment challenges impacting the rest of the economy? At what point will the labor markets improve?
Zamperini’s journey has three phases:
Adrift at Sea: The Unemployment Situation Just recently, July’s non-farm payroll report was a disaster. Economists expected gains of 125,000 jobs, but only 18,000 were created (Fig. 2). In addition, June’s expected employment The average workweek duration was down and average earnings were flat, according to the U.S. Bureau of Labor Statistics. The number of hours worked in the economy in June 2011 was roughly equal to the hours worked in February 1999, revealing how much slack truly remains in the current economy. In short, most employees in most industries are working fewer hours today than they were 11 years ago. Since productivity hasn’t fallen, it’s only reasonable to conclude that there is a lot of unused capacity. The unemployment rate has fallen very slowly and actually bounced up a bit in July from 9.1 percent to 9.2 percent. Economists surveyed by the Wall Street Journal in July expect an average growth of 170,000 jobs per month over the next 12 months. To merely keep pace with population growth, the U.S. needs to create at least 100,000 jobs a month. Robust hiring would exceed 300,000 jobs per month, a level of growth the economy is nowhere near creating at this time. While there is some mismatch between labor demand and labor availability, the problem isn’t as much structural as it is economic weakness. Even if all current job vacancies were filled immediately, there would still be 11 million people out of work, according to the U.S. Bureau of Labor Statistics Job Openings and Labor Turnover Survey. The number of job openings is certainly higher than it was at the bottom of the Great Recession, but it is still far below the number of pre-recession openings, which stood at 4.5 million in 2008. A disturbing development occurred in July – and for the first time since the government began collecting unemployment data via its household survey. The survey saw its worst performance in the number of people employed full time since the survey began in 1968. The increase between 2010 and 2011 was 637,000, which is lower than the previous worst number, a 931,000 increase in June 2009.
In a report published by the San Francisco Federal Reserve in July, long-term unemployment was identified as one of the biggest challenges for the U.S. economy. “The deterioration in skills among the long-term unemployed limits their future ability to find jobs and puts the economy at risk of relying on a far smaller number of workers to support living standards,” the report noted. The official unemployment rates don’t include the portion of the long-term unemployed who have given up actively looking for work. If you include those so-called “discouraged workers” and others who aren’t counted in the labor force, unemployment rose to 16.4 percent in July from 15.4 percent in June. While this number typically goes up in the summer, this was the largest increase since 2001.
For Louie Zamperini, beatings were a regular occurrence during his internment at the prisoner of war (POW) camps. Similarly, the problem with the economy is a lack of demand. A number of forces are conspiring to beat down demand, including deleveraging, low housing prices and consumer confidence. Just as it took many years for consumers to build unsustainable levels of debt from credit cards, home equity loans and student loans, it could very well take decades for consumers to deleverage, or pay off debt, and get to the point where they feel comfortable spending again – or at least have the resources to do so. For now, in an effort to deleverage, consumers are instead directing more of their income towards paying down their debt. Tax cuts meant to stimulate the economy haven’t had their intended effect as consumers are either saving money or paying off loans. In a survey conducted by Gallup in June, consumers disclosed that they are spending significantly less now per day than they were three years ago. For example, in May of 2008, a family earning less than $90,000 per year spent $105 per day. In the subsequent three years, that same family spent about $59 per day, a decrease of 44 percent. That figure essentially hasn’t budged at all, even during the economic recovery. Consulting firm McKinsey reports that, following an extended period of unemployment, workers typically earn 20 percent less during the next 15 to 20 years than workers who did not suffer an interruption in employment. Another reason spending is depressed is that, as home values have fallen, Americans haven’t been able to borrow from home equity or count on their homes increasing value. Not only do consumers not have money to spend from those potential sources of income, but many are also underwater, owing more money on their mortgages than their homes are worth. Business confidence also remains weak. When businesses, especially small ones, don’t feel confident that economic conditions will improve, they aren’t willing to hire. The most recent survey by the National Federation of Independent Businesses reveals that small business owners continued to be concerned about the lack of demand, which manifests itself as weak sales growth. A quarter of those surveyed cited poor sales as the most important problem facing their businesses. Re-entry into Civilian Society: Causes of Unemployment Wage growth has been stagnant while corporate profits have been increasing. Even employed consumers are not in a position to spend much, especially since commodity inflation has been increasing. Money that could be used for other purchases is being diverted to the gas pump and the grocery store. Before the Great Recession, consumer spending made up two-thirds of GDP. Without robust participation from consumers, it’s extremely difficult for the economy to find its footing and begin growing on a consistent basis again. In the absence of consumer spending, business sales growth is lackluster, leading to anemic growth in employment. Each stage reinforces the other, leading to a vicious cycle of economic weakness. While unemployment typically bounces back quickly after a garden-variety recession, that’s not the case after a severe recession like the one the U.S. experienced from 2008 to 2010. It takes years for an economy to work through a severe financial crisis. Unemployment usually remains stubbornly high for many years due to weak growth and deleveraging, prolonging the pain for the entire economy and the unemployed in particular. In an essay published on Bloomberg.com in July, Peter Orszag, the former director of U.S. Office of Management and Budget, noted that other advanced economies moving out of severe recessions experienced high unemployment for decades. Unemployment in these situations, which occurred in Norway, Finland, Sweden and Japan, didn’t peak until three to 10 years after the financial meltdown. In addition, the median increase in the unemployment rate in the decade that followed was more than five percentage points. The implications of high unemployment rates continuing for a decade or more are potentially staggering. Not only does high unemployment depress overall economic growth, it also adds to the budget deficit, as deficit predictions are based on unemployment rates moving rapidly back down to pre-recession levels. Continued high unemployment will likely lead to continued low economic growth. On the positive side, initial claims for unemployment benefits declined by 14,000 to 418,000 on a seasonally adjusted basis in July. ADP, a payroll provider for businesses, reported that the private sector added 157,000 jobs in June. Staffing provider Manpower also reported larger hiring numbers than the federal unemployment figures.
Many economists are optimistic that unemployment is headed in the right direction, albeit with many fits and starts. The decline in oil prices following the release from the strategic petroleum reserve has provided welcome relief for consumers, as has the decline in other commodities. As a result, inflation is still quite low. Rainy weather in May and June sidelined consumers, who may spend more now that more regular summer weather patterns have resumed. A recent survey of economists by the Wall Street Journal confirmed that the major problem with employment is an economy-wide lack of demand. Of the 51 economists surveyed, nearly two-thirds cited a lack of demand as the chief reason for the lack of hiring. A little over a quarter of them ascribed lack of hiring to uncertainty surrounding government policies, specifically over the raising of the debt ceiling. What to Watch For Needless to say, the lower the unemployment rate the better. There’s a pretty big gap between the traditional measure of “full” unemployment, defined as five percent unemployment, and our current 9.2 percent unemployment rate. If the U.S. can close the rate gap even somewhat by the end of the year and move closer to eight percent, it would be a sign that job creation is sustainable and headed in the right direction.
On the economic growth front, GDP growth needs to consistently come in at or above three percent to show that growth, rather than stagnation, has the upper hand. Increases in consumer spending in the form of retail sales would also demonstrate economic growth. Increases in both consumer and business confidence would signal that businesses are preparing to hire as consumers gear up to spend, lifting overall economic growth and employment. Over the long term, the U.S. economy would need to create 21 million jobs by 2020 to return to full employment, according to McKinsey. Where We Are Headed The employment situation, however, will continue to be challenged. Companies in several sectors are laying off more staff. Cisco, Goldman Sachs and Lockheed Martin have all announced job cuts recently. Behind the cuts are jittery employers whose faith in the recovery – and, by extension, consumers’ willingness to spend – has been shaken, reports the Wall Street Journal. Taking “jittery” a step further, Steve Wynn, founder, chairman and CEO of Wynn Resorts, lashed out, “I’m afraid to do anything in the current political environment in the United States…And I’m saying it bluntly, that this administration is the greatest wet blanket to business and progress and job creation in my lifetime. And I could prove it and I could spend the next three hours giving you examples of all of us in this marketplace that are frightened to death about all the new regulations, our healthcare costs escalate, regulations coming from left and right. Well, my customers, and the companies that provide the vitality for the hospitality and restaurant industries in the United States of America, they are frightened of this administration. And it makes you slow down and not invest your money.” Back to our storyline. In the years after his return home, Louie struggled with alcoholism and a burning desire for revenge. Eventually, he liberated himself from his internal adversaries and went on to live a productive and fulfilling life. Shortly after his release from the POW camps, Louie told a reporter, upon inquiring about his running career, “It’s finished, I’ll never run again.” He did not keep his pledge, and in his sixties, he could still run a mile in under six minutes. Employment feels like it may never run again, but at some point it will. It’s just the how and when that remains to be discovered. Christopher Bremer is the Director, Private Client Services Portfolio Management with The Northwestern Mutual Wealth Management Company. The opinions expressed are those of Christopher Bremer as of the date stated on this report and are subject to change. There is no guarantee that the forecasts made will come to pass. This material does not constitute investment advice and is not intended as an endorsement of any specific investment or security. Information and opinions are derived from proprietary and non-proprietary sources. Northwestern Mutual Wealth Management Company, Milwaukee, WI is a subsidiary of The Northwestern Mutual Life Insurance Company, Milwaukee, WI (NM) and a limited purpose federal savings bank authorized to offer a range of financial planning, trust, fiduciary, investment advisory and investment management products and services. Securities are offered by Northwestern Mutual Investment Services, LLC, subsidiary of NM, broker-dealer, registered investment adviser, member FINRA and SIPC. Please remember that all investments carry some level of risk, including the potential loss of principal invested. Bond or debt investors should carefully consider risks such as interest rate risk, credit risk, securities lending, repurchase and reverse repurchase transaction risk. Greater risk is inherent in investing primarily in high yield bonds. They are subject to additional risks, such as limited liquidity and increased volatility. There is an inverse relationship between interest rates and bond prices. Government debts are guaranteed by the full faith and credit of the U.S. government as to the timely payment of principal and interest when held to maturity. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment. Diversification and strategic asset allocation do not assure profit or protect against loss. All index references and performance calculations are based on information provided through Bloomberg, a provider of real-time and archived financial and market data, pricing, trading, analytics and news. The Bureau of Labor Statistics of the U.S. Department of Labor is the principal Federal agency responsible for measuring labor market activity, working conditions, and price changes in the economy. The Bureau of Labor Statistics Job Openings and Labor Turnover Survey (JOLTS) program produces data on job openings, hires and separations. The Great Recession describes the U.S. recession that began in December 2007 and ended in June 2009. Gallup, known formally as the Gallup Organization, provides management consulting, human resources and statistical research services. McKinsey & Company, Inc. is a global management consulting firm that focuses on solving issues of concern to senior management. McKinsey serves as an adviser to many businesses, governments and institutions. The National Federation of Independent Business is a small business association representing small and independent businesses. A nonprofit, nonpartisan organization founded in 1943, NFIB represents the consensus views of its members in Washington and all 50 state capitals. Automatic Data Processing, Inc. (ADP) is a national provider of payroll-related services. Manpower is a workforce solutions and services provider company headquartered in Milwaukee, Wis. The U.S. Department of Labor is a Cabinet department of the United States government responsible for occupational safety, wage and hour standards, unemployment insurance benefits, re-employment services and some economic statistics. The gross domestic product (GDP) is the amount of goods and services produced in a year, in a country. Sea image by Joel Sartore, National Geographic Stock. 92-0381 (0811)
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Employment: Broken or Unbroken?
In this month’s commentary, we’ll address these questions and look at the issues that are prolonging the unemployment crisis in the context of Louie Zamperini’s storyline.
Out of all of the unemployed, 45 percent are classified as part of the long-term unemployed, or those who have been without a job for six months or longer (Fig. 3). In a strong economy, that number is likely to be in the teens. The fact that it is this high and has remained high indicates that a large number of people will continue to be unemployed for a long time.
Retail sales numbers look favorable, which could signal that demand is rising (Fig. 4). Rising demand will favorably impact employment at some point. Recent auto sales have been poor, and when consumers aren’t buying cars they have more disposable income for other purchases.
The four-week moving average of unemployment claims is another important indicator (Fig. 5). Claims need to drop below 400,000 for a sustained period of time – and stay there – to indicate that layoffs are abating and that job creation is gaining traction.| John Burton : Northwestern Mutual |
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