February 2011invisible

Laufenberg Economic Quarterly

Daniel E. Laufenberg, Ph.D.
Economist

The views expressed here reflect the views of Daniel Laufenberg as of the date referenced. These views may change as economic fundamentals and market conditions change. This commentary is provided as a general source of information only and is not intended to provide investment advice for individual investor circumstances. Past performance does not guarantee future results.

Executive summary

  • According to the advance estimate from the Bureau of Economic Analysis, real gross domestic product (real GDP) in the fourth quarter of 2010 climbed to a level that was finally above the pre-recession high. This means, at least by this measure, that the recovery is over and the expansion has begun.

  • More importantly, solid gains in consumer spending, international trade, and business fixed investment have replaced rebuilding of business inventories and strong federal government spending as the primary sources of real output growth. The implication is that the expansion now underway has the upward momentum necessary to sustain economic growth without additional government stimulus.

  • Real personal consumption expenditures surged in the fourth quarter, contributing 3.0 percentage points to real GDP growth. Also, the international trade deficit narrowed markedly in the fourth quarter as imports plunged and exports climbed, contributing another 3.4 percentage points to fourth-quarter real GDP growth.

  • Consumer spending growth is expected to remain solid in 2011. On the other hand, net exports are not expected to contribute as substantially to growth this year as they did in the fourth quarter of 2010. Indeed, real final sales in the fourth quarter grew at their fastest pace since 1984, something that is not expected to be repeated in 2011. That being said, the change in business inventories, which detracted nearly 4.0 percentage points from real GDP growth last quarter, is not expected to be repeated in 2011 either.

  • On balance, the Laufenberg forecast is little changed from November. In particular, given that the tax increases scheduled to go into effect in 2011 were delayed, the concern about a substantial retrenchment in consumer spending in the first quarter of 2011 has been removed. As a result, real output is expected to grow 3.9 percent over the four quarters of 2011 versus 3.4 percent in the November forecast.

  • For the most part, the current forecast for 2011 is now only slightly more optimistic than the consensus, owing to a substantial upward revision to the consensus since November. Indeed, according to the 49 economists surveyed recently by the Blue Chip Economic Indicators, the consensus real GDP forecast is 3.2 percent year-over-year versus the Laufenberg forecast of 3.5 percent year-over-year.

  • However, one major difference between the Laufenberg forecast and the consensus forecast remains; the outlook for the unemployment rate. The consensus continues to expect unemployment to remain elevated throughout 2011 and 2012, whereas Laufenberg is far more constructive on unemployment this year and next.

  • Inflation is tame but not dead. For this reason, the Federal Reserve will be more sensitive to inflation concerns in 2011 than most analysts currently anticipate. After all, Fed officials have long argued that monetary policy operates with a considerable lag. For that reason, they soon will need to start anticipating the adverse consequences of an overly accommodative monetary policy.

  • At this stage of the business cycle, interest rate risk is more of a concern than credit risk. Investors should be cautious but not afraid.

Forecast details

Forecast Details

The expansion continues

On balance, the Laufenberg forecast is little changed from November 2010. That being said, given that the tax increases that were scheduled to go into effect in 2011 were delayed until 2013, the concern about a substantial retrenchment in consumer spending in the first quarter of 2011 has been removed. Recall that in the November forecast, it was assumed that even if any tax increases were allowed to occur in 2011, they would be quickly reversed. For that reason, the adverse effect on consumer spending in the first quarter was expected to be largely offset by a rebound in spending in the following quarters. Now the forecast shows consumer spending growth remaining relatively solid throughout 2011, as consumers continue to acquire the wherewithal to spend and the increased willingness to do so.

Another change to the forecast is that government spending is expected to grow at a slower pace in 2011 than shown in the November forecast, owing to weaker spending outlook for state and local governments. Ongoing pressure on state and local tax revenues will force local governments to raise taxes or cut spending to meet their statutory or constitutional requirement to balance their operating budgets.

Imports are also expected to be a bit more robust over the four quarters of 2011 than shown in the previous forecast, reflecting a better consumer spending outlook early in the year, as well as a response to the sharp slowdown in inventory accumulation at the end of 2010. According to the Bureau of Economic Analysis (BEA), real gross domestic product (real GDP) grew at an annual rate of 3.2 percent in the fourth quarter of 2010, but real final sales, which excludes the impact of the change in business inventories on real GDP, surged at a 7.1 percent annual rate. In other words, the change in real business inventories detracted 3.7 percentage points from real GDP growth last quarter. The conclusion is that net exports will not contribute as much to growth in 2011, but then the change in business inventories will not detract as much either.

Finally, the outlook for the price of imported oil to refiners shown in the forecast has been bumped up somewhat from the trajectory shown in the November forecast. This price of oil is expected to average $88.3 a barrel this year versus an average of $75.9 for all of 2010. This implies that overall consumer price inflation will be a tad higher in 2011 than shown in the November forecast; it is now expected to be 2.2 percent over the four quarters of 2011 versus the 1.7 percent shown in the November forecast. Despite this slight uptick in inflation, it will not be enough to threaten the expansion.

For the most part, the Laufenberg forecast for 2011 is now only slightly more optimistic than the consensus forecast, owing to a very substantial upward revision to the consensus outlook since November. According to the 49 economists surveyed by Blue Chip Economic Indicators, real GDP is expected to grow 3.2 percent year-over-year in 2011 versus 3.5 percent year-over year in the latest Laufenberg forecast.

However, one major difference between the two forecasts that remains in place is the outlook for the civilian unemployment rate. The consensus continues to expect the unemployment rate to remain much higher throughout 2011 than shown in the Laufenberg forecast. This was the case in November and it remains so. The Laufenberg forecast continues to show the civilian unemployment rate falling dramatically this year and next, despite sluggish gains in payroll jobs, owing to changing demographics. For a more detailed discussion of this, see the essay in this issue of the Quarterly. 1

Nevertheless, with the economy growing at a solid pace, the unemployment rate falling sharply, and consumer price inflation within the Federal Reserve’s target range, the Quarterly expects the Fed to start moving away from its very accommodative policy stance sooner than most. In fact, the Laufenberg forecast actually shows the Fed bumping up their federal funds rate target before the end of this year. This too is not a consensus view. Most economists do not expect the Fed to start reversing its current policy stance until 2012.

A massive gain in real final sales last quarter

Although the November 2010 issue of the Quarterly expected a very robust increase in fourth-quarter real final sales, they were far more robust than my above-consensus estimate of 3.6 percent at an annual rate. Indeed, real final sales surged 7.1 percent at an annual rate last quarter, which was fastest growth rate in real final sales since the second quarter of 1984. The bulk of the upward surprise came from foreign trade. In particular, net exports added 3.4 percentage points to real sales in the fourth quarter, which accounted for nearly half of the spike in real final sales in the fourth quarter. According to the BEA’s advance estimate, real imports declined 13.6 percent at an annual rate, while real exports gained 8.5 percent, causing the real trade gap to narrow by a whopping $112 billion annualized in the fourth quarter.

Another surprising source of real final sales growth in the fourth quarter was personal consumption expenditures, which surged at 4.4 percent annual rate in the fourth quarter (see Chart 1). The November forecast showed real consumer spending increasing at a 3.0 percent pace in the fourth quarter, but the consensus at the time was expecting real consumer spending to increase at a mere 2.0 percent annual rate. The bulk of the gain in consumer spending last quarter was in goods, which increased an oversized 10.1 percent, led by spending on durable goods. Spending on services rose only 1.7 percent in the fourth quarter, only marginally better than the 1.6 percent gains in each of the preceding two quarters.

That being said, I continue to believe that the key to a sustained economic expansion and job growth will be “a shift in final demand growth away from goods and toward services, the latter of which are more likely to be produced domestically.” 2 Recall that a large share of consumer goods is imported, whereas consumer services are not. Thus, any slowdown in demand for consumer goods would be at least partially offset in the national income and product accounts by a corresponding slowdown in imports. Domestic demand would not necessarily have to grow faster for real GDP growth to accelerate as shown in the forecast. The only thing needed would be a shift in spending away from goods and toward services.

Unfortunately, the evidence in the BEA’s advance estimate of third-quarter GDP that this shift was already underway was largely revised away, and the BEA’s fourth-quarter estimate was only marginally encouraging in this regard. Nevertheless, there are other signs that spending on services is approaching a turning point. In particular, the business activity index of the Institute of Supply Management non-manufacturing survey was 64.6 in January versus 62.9 in December, suggesting that the level of activity in the service sector is rising at a very solid pace. Also, service-producing jobs increased an average of 95 thousand a month in 2010, reflecting the modest improvement in service spending that has occurred so far during the current recovery. Finally the wealth effect from higher stock prices most likely will spur consumer spending on services and durable goods more so than on nondurable goods. In fact, the largest impact of wealth on consumer spending may be on services.

chart 1

Another area of the forecast that seems to be at odds with the consensus is housing. In particular, I am confident that housing starts will rise once the labor market improves more dramatically. The argument is that as the unemployment rate falls and employment improves, more households are formed. And the more households that are formed, the more housing demanded. It seems that household formation was postponed sharply during the recession and during the jobless recovery that followed. Since I expect the labor market to improve more than the consensus, it follows that I also expect housing to improve more than the consensus. In fact, housing starts are expected to climb steadily this year, reaching one million units by yearend. At the moment, this is far more optimistic than the consensus outlook for housing.

Government spending will slow over the next year, but it will not slow enough to derail the solid hiring and spending gains expected in the private sector. Budget pressures will restrain state and local government spending considerably in the near term, but federal spending most likely will offset most of the slack. Although the Congress and the Obama administration will talk tough about deficit reduction, any plan to cut spending will be backend loaded. For example, President Obama released his proposed $3.7 trillion budget for fiscal 2012, which starts October 1 of this year. Although the Obama administration proposed trimming the deficits by $1.1 trillion over a decade, his budget actually adds to the deficits this fiscal year and next. Obama is projecting the deficit will hit an all-time high of $1.65 trillion this year and then drop sharply to $1.1 trillion in 2012, with an expected improvement in the economy and as reductions in Social Security withholding and business taxes expire. The bottom line is that it federal spending is not expected to decline in the current fiscal year and very little next year. For the most part, it is not sharp declines in projected federal spending that will improve the budget deficit in 2012 as much as much higher projected revenues.

Real output has recovered

After a year and a half of recovery, the level of real GDP in the fourth quarter of 2010 rose to an all-time high, exceeding its pre-recession level in the fourth quarter of 2007 (see Chart 2). The level of real GDP stood at $13.382 trillion in the fourth quarter of 2010 versus $13.363 trillion in the fourth quarter of 2007. Technically, the recovery is over and the expansion has begun. However, the two terms are often used interchangeably to describe the positive phase of the business cycle. This makes sense given that not all measures of economic performance have recovered. Payroll employment and the unemployment rate are both recovering but are still a long way from a full recovery.

chart 2

One interesting aspect of the last expansion was its longevity, lasting for six years when the average length of expansions since WWII is closer to four and a half years. Moreover, as shown in Chart 2, the 2001 recession was extremely mild by historical standards as measured by real GDP; real GDP was roughly flat during the 2001 recession, as opposed to the substantial decline in real GDP registered during the 2007-09 recession.

An interesting aspect of the current expansion is whether it will be as long as the last one. At the moment, I am concerned that it will not. Indeed, the risk is that the current expansion may be closer to average in length. Given that we are already in the seventh quarter of the current expansion, this would imply that we only have something like twelve quarters to go before we have another recession. The cause of the next recession is increasingly likely to be inflation. Current fiscal and monetary policies, accelerating inflation in developing economies, a weaker dollar ahead and the prospect of a more highly regulated U.S. economy favor inflation becoming a problem in the future. Of course, after nearly three decades of disinflation, it will not take a great deal of inflation to derail the expansion. But as I noted above, this is still a few years off.

Inflation tame but not dead

Inflation has been very tame on average over the last few years and there is no reason to expect that to change anytime soon. As shown in Chart 3, the overall consumer price index (CPI) was up a scant 1.5 percent over the twelve months of 2010, whereas the CPI excluding the very volatile food and energy components increased an even less 0.8 percent over the same period. Food prices in December were 1.3 percent above a year earlier, while energy prices were up a more disturbing 7.7 percent. Clearly the impact of the commodity inflation late last year was confined to the energy component of the CPI. Prices of goods excluding food and energy commodities actually fell 0.4 percent over the twelve months of 2010, whereas prices of services less energy services increased 1.3 percent. The latter was led by a 3.4 percent gain in prices of medical care services.

chart 3

The outlook for the CPI in 2011 is not as tame as it was last year, but it is not expected to be a problem either. The Laufenberg forecast now shows the overall CPI increasing 2.2 percent over the four quarters of 2011, which is up from the 1.1 percent advance over the four quarters of 2010. At first blush, this looks troubling, but it is important to remember that 2.0 percent inflation is roughly in line with the Federal Reserve’s unofficial inflation target. Moreover, core CPI inflation is once again expected to be well below overall inflation, albeit higher than it was in 2010. Not until resource utilization improves dramatically will inflation be more of a risk. Although I expect this to eventually be the case, I doubt it will be anytime soon.

Implications of a steep yield curve

Stating the obvious, short-term Treasury yields are unsustainable at their current levels. The steep yield curve currently in place concurs. Recall that longer-term rates can be construed as geometric averages of current and expected future short-term rates. For example, the yield on the two-year Treasury note reflects the average of the current yield on the one-year Treasury note and the expected yield on the one-year note next year. Using this relationship, a two-year yield of 0.61 percent and a one-year yield of 0.27 percent in January 2011 suggests that the one-year yield expected next year is 0.95 percent. In other words, a steep yield curve implies that short-term interest rates will be higher in the future.

As shown in Chart 4, the yield curve is currently steep and has shown similar steepness at this stage of each of the last four business cycles, but clearly at different overall levels of rates. The flattest yield curve of the five shown in Chart 4 was in the nineteenth month of the 1982 recovery, which was June 1984. This makes sense, since the overall level of rates was already very high and both short and long rates had already increased from their recession lows by then. In contrast, the steepest yield curve of the five shown in Chart 4 was in the nineteenth month of the current recovery. This makes sense as well given that short-rates are still near zero, while long rates have moved up slightly from their recession lows.

Of course, for the most part, when the yield curve is as steep as it has been, especially in an environment of low short-term rates, it generally correctly anticipates higher short-term rates. As shown in Chart 5, the trend in both short and long interest rates over the last 30 years has been downward. However, in each business cycle, short-term yields do eventually turn upward. Could it be different this time? I see no reason why it could. At some point, short-term interest rates will rise. The Laufenberg forecast shows that this uptick in short rates actually will start before the end of this year. The consensus is more conservative in its expectations. They do not expect the Fed backing away from its very accommodative policy stance currently in place until 2012. In fact, some analysts are still taking about the possibility of another round of quantitative easing by the Fed later this year.

chart 4

chart 5

Regardless of when it happens, rates do rise. For example, despite the downward trend in Treasury yields since 1982 shown in Chart 5, short-term interest rates have always backed up in each business cycle. In fact, as recently as the previous expansion, the yield on the three-month Treasury bill climbed from 0.9 percent in January 2004 to 5.2 percent in February 2007, while the yield on the 10-year note rose from 3.8 percent to 5.1 percent over roughly the same time period. Clearly, short rates rose more aggressively than long rates. The expectation is that a similar scenario will play out over the next few years. A major difference, however, is that the downward trend in yields since 1982 may be at an end and that the current interest rates cycle will actually see both short-term and long-term yields at levels higher at their peaks than in the last expansion.

Large budget deficits, but also the ongoing shift of outstanding Treasury debt into the hands of the public, will cause Treasury yields to be higher at their next peak than they would be otherwise.

First look at 2012

I have extended the forecast horizon to include 2012 for the first time. For what it might be worth at this point, 2012 is expected to be another solid year of real growth with relatively benign inflation. However, there will be increasing signs of pending problems on the inflation front before 2012 ends. In particular, the unemployment rate is expected to fall dramatically in 2011 and again in 2012. Indeed, by the end of 2012, the Laufenberg forecast expects the unemployment rate to be down to 6.5 percent. Although this is still higher than what most economists considered full employment or the NAIRU (the non-accelerating inflation rate of unemployment), it will be moving in a direction that will start to generate some cost pressures for firms.

Also in 2012, the payroll tax reduction that was implemented this year is scheduled to expire. This is expected to have a small negative impact on consumer spending, primarily because I doubt it will have much of a positive impact on consumers this year. Recall that if consumers know that the tax cut is temporary, the gain in disposable income generated by the tax cut is likely to be treated more like transitory income than permanent income. And consumers tend to spend permanent income more so than transitory income.

Investment implications

This year will prove to be very challenging for investors. Interest rates across all maturities are expected to be higher on average in 2011 than they were in 2010. This will create some anxiety among bond investors, who have turned to U.S. Treasury obligations as a safe haven. Credit risk will not be as much of an issue, although concern about the credit rating of the U.S. government and some municipal general obligations may surface at times this year. Indeed, because of the fundamental strength of the economy, I favor high-yield corporate bonds and many municipal revenue bonds more so than U.S. Treasuries or municipal general obligations.

Higher interest rates will not be confined to the U.S. As such, I would be cautious about foreign sovereign debt given the increased likelihood of higher interest rates going forward. In fact, some countries have already started to push interest rates higher. Moreover, do not anticipate a weaker U.S. dollar this year to bail out investors in non-dollar denominated sovereign bonds. All of the dollar weakness expected this year is already behind us.

Equities continue to be preferred over bonds in 2011. But even here, be careful not to get overly exuberant about expected returns. Stock prices will be up this year, but they most likely will not deliver stellar returns in an environment where the Fed is expected to start removing the very accommodative monetary policy stance currently in place.

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1. See “Help not wanted?,” this issue, pp. 13-20.

2. See Daniel E. Laufenberg, “The current expansion: Sustainable but uneven,” Laufenberg Economic Quarterly, November 2010, pp. 4-12.

Help not wanted?

Over the first nineteen months of the current U.S. economic recovery/expansion, the unemployment rate has remained stubbornly high and total nonfarm payroll employment has actually declined 228 thousand. From everyone’s perspective, these have been frustrating times. After all, the term “recovery” implies that the economy is recovering all that was lost during the downturn. While that has been true of real output, which in the fourth quarter exceeded its high at the end of the previous expansion, it has not been true of the labor market. Unfortunately, this has been the trend in recent recoveries. That being said, a full recovery of the jobs lost in recessions always takes longer than a full recovery of the output lost, but more recently it seems to take even longer for jobs to rebound.

The household survey

The unemployment rate is calculated from data collected in the household survey, which is a sample survey of about 60,000 households selected to represent the entire civilian noninstitutional population. As shown in Chart 1, the civilian unemployment rate rose dramatically during the previous recession, reaching a level of 9.5 percent in the month the recession officially ended but did not peak until October 2009 at 10.1 percent. Not only was the unemployment rate in the last recession higher than in either of the previous two recessions, it was the highest reading in 26 years. As frustrating as this was, the slow pace of improvement so far during the recovery has proven to be even more frustrating. For example, the unemployment rate in January (the most recent data available) was 9.0 percent, which is only a half a percentage point lower than its level when the recession officially ended. Indeed, the bulk of the improvement in the unemployment rate from its peak has occurred in the last two months of data. The bottom line is that this may be the start of a more pronounced improvement in the unemployment rate over the next few years.

chart 1

In this regard, the Laufenberg forecast continues to expect the unemployment rate near 8.0 percent by the end of this year. Moreover, this cyclical improvement is expected to continue. At the moment, the Laufenberg forecast shows the civilian unemployment rate at 6.5 percent by the end of 2012. This is far more optimistic than the consensus forecast. The difference seems to be that the consensus expects the civilian labor force participation rate, which fell rather dramatically during the recession, to rebound to its previous level. If people stop looking for employment, they are no longer considered part of the labor force—they are neither employed nor unemployed. However, as the economy improves and jobs increase, more people start looking for jobs again, pushing the participation rate upward. As a result, even more new jobs are needed to lower the unemployment rate. Most economists contend that job growth, although expected to improve, will only slightly exceed the expected surge in labor force growth due to reentrants, causing the unemployment rate to remain elevated.

I contend that the civilian labor force participation rate will not rebound anywhere near as much as the consensus seems to expect. As shown in Chart 2, the participation rate over the last thirty years has a slight cyclical pattern, but the bulk of the sharp moves up and down seem to be longer-term trends. In particular, the participation rate rose sharply in the 1980s, edged even higher on average in the 1990s, but then started to trend lower from 2000 to 2007. Since 2007, the participation rate has plunged, reachingits lowest level in 25 years. Obviously, to have a better feel for what might be ahead, it is imperative that we find an explanation for the past. At least a partial explanation may be in Chart 3. I believe that the pickup in labor force participation of the 1980s and less so in the 1990s reflected households having more than one member look for employment (the rise in the female participation rate). This continued in the 1990s but at a slower pace until it peaked at about 60 percent in 1999. Since then it has gradually fallen.

chart 2

chart 3

 

Over this same period, the participation rate for men has trended downward, including the more dramatic drop recently. Unlike the consensus, I do not expect the participation rate for males to suddenly start to climb—the aging population does not favor such a move. There may be a mild cyclical bounce, but it will be overwhelmed by the downward trend. Moreover, I doubt that the participation rate for females will rebound dramatically either, given that this segment of the labor force is also getting older. After all, when someone retires, they are no longer considered employed or unemployed (they no longer participate in the work force) in the household survey.

The establishment survey

Monthly nonfarm payroll data is collected from the records of a sample of nonagricultural business establishments. The sample includes about 140,000 businesses and government agencies representing approximately 410,000 worksites. The active sample includes approximately one-third of all nonfarm payroll employees. This survey represents a completely different sample from the household survey and is designed for the purpose of counting payroll employees rather than the percent of the labor force unemployed.

In Chart 4, I have plotted total nonfarm payroll employment from January 1990 to present. Clearly the decline in jobs during the last recession was far more severe than in either of the previous two recessions. Indeed, payroll jobs fell a whopping 8.7 million from their peak in January 2008 to their trough in February 2010. As such, it most likely will take longer for jobs to recover. The more interesting question is whether jobs will recover completely from the last recession before the next recession hits. My expectation is that they will, but only marginally. The issue is whether the relatively sluggish job growth of the previous expansion is the new benchmark or will job growth revert to its more rapid pace of earlier expansions. It seems that demographics suggest that the pace will be slower rather than faster.

chart 4

Jobless recoveries have become the standard rather than the exception in recent business cycles. To illustrate this point, I constructed indexes of nonfarm payroll employment for the first nineteen months of the last nine recoveries, setting the level of employment at the start of each recovery equal to 100. I did nineteen months because as of February, the current recovery is nineteen months old. As shown in Chart 5, I plotted the average index for the six recoveries from 1954 to 1982 over this nineteen month period and then plotted each of the three more recent recoveries (1991, 2001 and 2009) individually. The remarkable feature of this chart is how similar the last three recoveries have been and how jobless they have been early.

Because each of the prior two recoveries were jobless well after the recessions officially ended, I went to my files to see what I had written about past jobless recoveries. I found several essays on the topic, including one I wrote in April 1993 and another I wrote in September 2003. In April 1993, I said the following:

Sluggish employment growth has been a disturbing feature of the current economic upturn. During the nearly two years since the recession officially ended, payroll jobs have expanded a meager 35 thousand per month and civilian employment has increased only 75 thousand per month. In both cases, these gains are well below the same two-year period of the four preceding economic recoveries (The 1980 recovery lasted only six months so it was excluded for purposes of calculating the average job gain during the first two years of the previous four recoveries.). Several factors likely have contributed to this slower-than-usual pace of job growth, including restructuring at large U.S. corporations, cuts in defense spending, and budget-problem-plagued hiring plans of state and local governments. The concern is that without meaningful job gains—and the associated income growth—the strength in consumer spending needed to make the economic expansion self-sustaining may not materialize.

A major element—probably both a cause and an effect—of the sluggish labor market following the end of the 1990-91 recession was the “slow-motion” pace of the recovery; that is, real output grew at such a slow pace that productivity gains alone accounted for increased output without the need for hiring additional workers. Several factors have been identified as contributors to the slow-paced recovery, including the real estate crisis, the financial sector debacle, sharply lower interest rates, the consumer retrenchment, and defense spending cuts.

Although further job loss in defense-related industries is very likely, a modest revival in overall job growth may have begun. In fact since the unemployment rate began its latest decent, civilian employment has increased an average of about 125 thousand a month, still below the average of past recoveries but nevertheless a substantial improvement from early in the recovery.

Unfortunately, even this improvement in job gains is considered suspect by many. Such pessimists contend that these employment gains reflect a shift toward contingent workers, such as temporary workers and part-time employment, rather than permanent, full-time jobs. As such they are generally viewed as low-wage, no-benefits jobs that take advantage of workers at a time when job alternatives are scarce.1

In the eight years that followed, payroll employment grew a very solid 22.5 million. Clearly the slow start to job growth and the use of temporary and part-time workers early in the recovery was far less ominous to future job growth than offered by the media at the time.2 Moreover, the slow-motion start to the expansion may have contributed to the expansion lasting as long as it did, which was the longest expansion on record (ten years).

The U.S. economy experienced another jobless recovery following the 2001 recession. Looking back, I wrote an essay in September 2003 that discussed this disturbing feature of the recovery. Here is what I said:

Why, with the economy growing seven consecutive quarters, have businesses been so reluctant to hire? It appears that in response to improved demand for their products, employers have been able to satisfy that demand with productivity gains and longer workweeks rather than new hires. Some economists contend that this development reflects a structural shift in the labor force.3 They argue that any new jobs added during the recovery have been new positions in different firms and industries, not rehires. As such, creating jobs takes longer and is riskier than recalling workers to their old positions. This may explain the delay in hiring.4

In the four years that followed, the U.S. firms added 8.2 million to their payroll. Clearly, the economy eventually saw some job growth. However, that does not guarantee that the economy will repeat its past performance. In fact, there are several reasons to expect that job growth, although solid, will not be as robust as it has been in past recoveries.

First, I agree that there have been structural shifts in U.S. employment that may explain why jobs have been so slow to arrive in recent recoveries. In particular, service jobs have steadily increased in importance over the years and now represent a whopping 83.5 percent of all private-sector jobs (see Chart 6). In the early stage of recovery, consumers tend to focus on consumer goods, which have increasingly become imports rather than domestically produced over the years. It is not until consumers start to spend on services that domestic employment really starts to recover.

chart 6

Second, the pace of the last three expansions, the current one included, has been slower than in prior expansions. Hence, productivity gains alone have accounted for much of the increased output, eliminating the need for hiring additional workers early in the recovery.

Third, I tend to agree with the conclusion of the study by the two economists at the Federal Reserve Bank of New York published in August 2003 that the types of jobs being created matter.5 In particular, any new jobs added during the last three recoveries (including this one) increasingly have been new positions in different firms and industries, not rehires. As such, creating jobs takes longer and is riskier than recalling workers to their old position.

Finally, the U.S. work force is getting older on average, which means that a larger percentage of the labor force will be eligible to retire. It is not that the labor force participation rate for the population aged 65 years and over has fallen, because it has not. The more important factor with regard to the overall participation rate is that a larger share of the population is falling into the older age groups. After all, participation rates tend to decline as the population ages. For example, for the population aged 40-45 years, the participation rate is 83.1 percent, but for the population aged 60-64 years, the rate falls to 53.8 percent. As boomers age, the participation rate should fall, although maybe not as much as the current participation rates for age groups suggest. After all, boomers may decide or may be required to stay in the labor force longer than past generations. Nevertheless, I estimate that the aging of the “boomers” contributed roughly 0.2 of a percentage point to the decline in the overall participation rate for the twelve months ending in January 2011, despite slightly higher participation rates for some of the older age groups. Obviously, there was more to the story than just the aging boomers, since the overall participation rate fell 0.7 of a percentage point over the same twelve-month period.

The bottom line is that the labor market is expected to improve. Barring an overly zealous regulatory policy or a counterproductive trade policy in the name of risk containment or job creation, the U.S. economy seems destined to enjoy a solid-paced, self-sustained economic expansion over the next two years. And associated with this continued expansion should be a meaningful revival in employment and an even more spirited decline in the unemployment rate.

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1. See Daniel E. Laufenberg, “Where are the jobs?,” Economic Perspective, IDS Financial Services, Inc., April 2, 1993, pp. 17-23.

2. For example, see Clare Ansberry, “Hired Out: Workers Are Forced to Take More Jobs with Few Benefits,” The Wall Street Journal, March 11, 1993, p. A1. Not only did the concern expressed in this article not play out, the statistics quoted were suspect. Also, see “Jobs, Jobs, Jobs,” Business Week, February 22, 1993, pp. 68-74. This article noted that “corporate America has developed a deep, and perhaps abiding, reluctance to hire.”

3. See Erica L. Grosben and Simon Potter, “Has Structural Change Contributed to a Jobless Recovery?,” Current Issues in Economics and Finance, Federal Reserve Bank of New York, Volume 9, Number 8, August 2003, pp. 1-7.

4. See Daniel E. Laufenberg, “Jobs ahead?,” Economic Perspective, American Express Financial Advisors Inc., September 2003, pp. 13-16.

 

LQ Stock-allocation indicator

In the August 2010 issue of the Laufenberg Quarterly, I introduced the LQ stock-allocation indicator.1 The purpose of this indicator is to provide a signal of when to overweight or to underweight equities in well diversified investment portfolios. In each of the prior two reports, the indicator has suggested that investors should overweight equities in their portfolios. Based on three more months of data (see Chart 1), it continues to suggest the same.

Recall that even though the S&P 500 stock price index has increased 23 percent since August 2010, signaling such short-term moves in the stock market is not the purpose of this indicator. The LQ indicator is not a trading tool. Its purpose is more long-term. In other words, if the signal provided by this indicator is followed, well-diversified portfolios should outperform the buy-and-hold strategy, as well as the dollar-cost-average strategy, over a decade and not a week, month, or even a year.

chart 1

As noted before, the LQ indicator seems to move counter to the S&P 500 stock price index—when the indicator is low, stock prices are high, and vice versa. But there is more information in this indicator than the obvious. For example, when the indicator pushes above a reading of 100, it signals a time to overweight equities in your portfolio. This was true in 2002 and again in 2009, when in both cases the indicator moved through 100 just a few months before the S&P 500 stock price index bottomed. In addition, the indicator provides a signal to investor to underweight equities. This signal is not as defined as the signal to overweight. It occurs when the value of the indicator has stabilized over an extended period following a pronounced decline. Certainly, investors could sell equities as the indicator falls, but they would be better served to wait until the indicator has leveled off at a lower level. This signal was provided by the indicator twice over the last twelve years, once in 1999-2000 and again in 2007. Based on its latest observation, the indicator suggests that investors can still get paid to be overweight equities.

It goes without saying that there are no guarantees this relationship will hold in the future. Indeed, a major concern may be that there are too few cyclical observations (only two business cycles shown) to claim that the indicator accurately signals the cyclical element of the stock market. For this reason, I would caution readers not to rely on this indicator without reservation. On the other hand, do not dismiss it either. In analysis of this sort, the signal from one indicator should be verified using the signals of other indicators that attempt to measure the same event in a different way. It should be viewed as another tool to assist investors in making their asset allocation decisions.

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1 See Daniel E. Laufenberg, “The economic expansion continues—really!,” Laufenberg Economic Quarterly, August 2010, pp. 10-11.

 

The views expressed here reflect the views of Daniel Laufenberg as of the date referenced. These views may change as economic fundamentals and market conditions change. This commentary is provided as a general source of information only and is not intended to provide investment advice for individual investor circumstances. Past performance does not guarantee future results.


ARCHIVES OF LAUFENBERG ECONOMIC REPORTS

November 2009 - LEQ (PDF)
February 2010 - LEQ
May 2010 - LEQ

August 2010 -LEQ
November 2010 -LEQ


INDEX TO CURRENT EDITION

Executive Summary

Forecast Details

The expansion continues

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LQ Stock-allocation indicator

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INDEX TO CURRENT EDITION

Executive Summary

Forecast Details

The expansion continues

Help not wanted?

LQ Stock-allocation indicator

~ ~ ~ ~

 

INDEX TO CURRENT EDITION

Executive Summary

Forecast Details

The expansion continues

Help not wanted?

LQ Stock-allocation indicator

~ ~ ~ ~

 

 

 

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