Basepoint's Chief Investment Officer (CIO) presents valuable insights into recent job numbers, adding depth to our recent discussion in the inaugural episode of The Point Podcast. Similar to the harmonious notes in a well-played symphony, these details contribute to the overall richness of the conversation. Discover more in episode one of The Point Podcast.
"If you torture the data long enough, it will confess to anything."
-Ronald Coase
Dear Family, Friends, and Clients,
As an accompaniment to our newly and belatedly issued first podcast, I want to take an opportunity to walk you through the recently released jobs numbers for December, and how they relate to evaluating what is going on in the economy. There is great danger in terminating our journey toward understanding reality with headline numbers. The randomly selected topic of our first foray into the already saturated market of podcasting just happened to be about the unemployment rate. The discussion we had around unemployment naturally gravitated to the importance of digging into economic data releases, and the limitations of using statistical data to make assessments about the economy and investment markets. It is from these data that we must formulate hypotheses about where we are in our endeavor to protect your money.
Economic data is a valuable commodity in some financial circles. Many trading strategies revolve around predictions about future statistical releases, and fortunes are made and lost gambling on whether certain figures will meet or miss the expected target. We do not participate in this type of activity because it is inherently speculative. These trading strategies exhibit what we call “negative skewness”. This is a pedantic way of saying that participants are likely to experience frequent small gains and infrequent catastrophic losses; more simply still, “the juice isn’t worth the squeeze”. We cannot, however, ignore these traders because they can cause significant temporary changes in asset prices. The most violent volatility occurs when many people expect a certain outcome, and the opposite happens. We must be mindful of what is going on around highly anticipated data releases to determine whether market moves are simply transitory fluctuations caused by the pain of traders, or if fundamentals really have changed significantly.
There are hundreds of varying statistics released by multiple government agencies and private think tanks in both the United States and abroad. Each of these individual statistics contribute a single brush stroke toward creating a picture of the health of our economy. No single statistic is all powerful, but some are more important than others, and the changing seasons of the business cycle can determine the relative importance of different measures. Some data are important during expansions and other data are more meaningful in anticipating a recovery. In the late stage of an expansion, where we most likely stand now, the yield curve and employment become very important. The timing of a recession normally follows a yield curve inversion, followed by a yield curve un-inversion, and then finally a souring of the employment market. There are other factors that need to be evaluated, but the important signs that mark the road to recession given our current location are the unemployment rate and the jobs market.
Unemployment Rate:
While jobs numbers and the unemployment rate are not synonyms, they are cousins. The most logical place to begin is with the unemployment rate (U), which is calculated as:
This figure is calculated by the Bureau of Labor Statistics each month and is then revised each month after release for two months. The figures are also “seasonally adjusted” to smooth out the data for things like weather, holidays, and school closing (if you fancy yourself an intellectual masochist, the process for seasonal adjustment can be found here). Seasonal adjustments continue for 5 years, gradually declining in magnitude until 5 years after the fact when we reach the final historical figure. At first glance, it seems like a relatively simple calculation, but as is true with anything involving economics, beneath the surface complexity lurks. Once we dig deeper into these numbers, we will start to paint a picture of why careful consideration needs to be exercised before entering the data into our evaluation process.
The first step is to determine who is unemployed. Since there is no omniscient being looking down on us, at least not one who publishes economic updates, data must be gathered, analyzed, and conclusions must be inferred. The Current Population Survey (CPS), also called the Household Survey, is conducted monthly by the U.S. Census Bureau for the Bureau of Labor Statistics. The CPS is a sample survey of 60,000 eligible households and is conducted via telephone and in-person interviews. It provides state level data and data for the 12 largest metropolitan areas. The average response rate is approximately 75%, which is the highest response rate of any government survey. The CPS gathers demographic data to determine whether members of a household are employed or not, or if they are not in the labor force. It also gathers other data about age, sex, race, education, foreign born or native status, employee tenure, military disabilities, and worker displacement. These data are then magically extrapolated into national numbers.
Next, we calculate Labor Force, also using the CPS data. The Labor Force is defined as people ages 15 and older who are either employed in providing goods and services or looking for work (including first time job seekers). Once the variable data has been estimated we divide the numerator by the denominator and multiply by 100 to get a percentage unemployment rate. Simple so far. Here is where it gets a little hairy.
Unemployment is measured in 6 different dimensions, uncreatively named U-1 through U-6. The number you see on TV and in the Wall Street Journal is U-3. The following definitions are courtesy of the BLS:
U-1, persons unemployed 15 weeks or longer, as a percent of the civilian labor force;
U-2, job losers and persons who completed temporary jobs, as a percent of the civilian labor force;
U-3, total unemployed, as a percent of the civilian labor force (this is the definition used for the official unemployment rate);
U-4, total unemployed plus discouraged workers, as a percent of the civilian labor force plus discouraged workers;
U-5, total unemployed, plus discouraged workers, plus all other marginally attached workers, as a percent of the civilian labor force plus all marginally attached workers; and
U-6, total unemployed, plus all marginally attached workers, plus total employed part time for economic reasons, as a percent of the civilian labor force plus all marginally attached workers.
Also from the BLS:
“Definitions for the economic characteristics underlying the three broader measures of labor underutilization are worth mentioning here. Discouraged workers (U-4, U-5, and U-6 measures) are persons who are not in the labor force, want and are available for work, and had looked for a job sometime in the prior 12 months. They are not counted as unemployed because they had not searched for work in the prior 4 weeks, for the specific reason that they believed no jobs were available for them. The marginally attached (U-5 and U-6 measures) are a group that includes discouraged workers. The criteria for the marginally attached are the same as for discouraged workers, with the exception that any reason could have been cited for the lack of job search in the prior 4 weeks. Persons employed part time for economic reasons (U-6 measure) are those working less than 35 hours per week who want to work full time, are available to do so, and gave an economic reason (their hours had been cut back or they were unable to find a full-time job) for working part time. These individuals are sometimes referred to as involuntary part-time workers.”
The current unemployment numbers are as follows:
As we can see in the chart, unemployment has been increasing over the last year, but a big determining factor is that to be included in the official U-3 Unemployment figures, you have to be looking for work.
A derivative calculation, which has its own nuances, is the Labor Force Participation rate (LFPR), which tells us whether the denominator is increasing or decreasing as a percentage of total population.
Here is the data from the Federal Reserve:
As illustrated, the LFPR rose steadily from the mid-1960s until the tech bubble in 2000. The increase was most likely from women moving into the work force instead of staying home, and the large population of the boomer generation. We also saw an increase in single earner households during this period. As the oldest boomers reached their mid-fifties in 2000, and the GenX’ers started entering the labor force, we saw a long, steady decline in the LFPR. The LFPR peaked at 67.3% in 2000, and currently stands at 62.5%.
“The BLS lists the following factors as primary drivers of the decline in the LFP rate since 2000: (1) the aging of the baby boomer cohort; (2) the decline in the participation rate of those 16-24 years old[increase in college enrollment]; (3) the declining LFP rate of women (since its peak in 1999), and (4) the continuous decline of the LFP rate of men (since the 1940s). The main factors that keep the aggregate LFP rate from falling further are the increase of the LFP rate of those 55 and older and the strong attachment to the labor force of Hispanic and Asian people, who constitute the main share of the immigrant population.” Source BLS
We are just now returning to the pre-Covid LFPR, but it is expected to fall all the way to 58% by 2050. So even when we see that unemployment is low or declining, we need to evaluate the labor force participation rate to see if the change in unemployment is due to more people working, or less people being considered part of the labor force. It is possible for more people to be getting work while the unemployment rate rises if more people are entering the labor force due to positive expectations about the economy. Conversely, it is possible for the unemployment rate to drop even when people are out of work if they give up and stop looking.
Jobs Data:
Jobs data is also released each month by the BLS and is supposed to be a measure of how many new jobs are being created by the economy. Politicians like to take credit for creating jobs as a signal of effectiveness in managing economic policy. This is not a partisan issue; they all play the same game. The headline number here is called “nonfarm payroll employment”. Non-farm payroll data is based on the Establishment Survey (CES), a different survey conducted by the BLS. The CES is a survey conducted by taking a representative sample of businesses in the US, as opposed to individual households. The CES has the unique characteristic of not removing duplicate entries like the Household survey does. In other words, data based on the CES counts a person working 2 jobs twice, whereas the household survey only counts each worker once. When you see the CES job numbers, people getting a second job count as two jobs. In addition, the CES does not measure job quality. A part-time job is still counted just the same as a full-time job. The household survey adjusts for full time employment vs part-time employment.
Here is a comparison of the two reports provided by the BLS:
The Jobs Report:
Now I will finally get to the point. The Jobs report (based on CES) released on January 3, 2024, covered data through the last business day of November 2023. Total job openings held steady at 8.8 million. New people hired were 5.5 million and separations were 5.3 million. Of those separated 3.5 million quit and 1.5 million were involuntarily terminated (numbers do not tally due to rounding). Here is a sample of headlines:
“December jobs report: US economy adds 216,000 jobs, shocking Wall Street”
“U.S. Added 216,000 Jobs in December, Outpacing Forecasts”
“Global shipping delays cast shadow over strong December jobs report”
“Hot jobs report gives Biden a boost”
Let’s dig in.
Full report here. https://www.bls.gov/news.release/pdf/empsit.pdf
Household vs Establishment survey: While the CES showed 216,000 new jobs were filled in November, the most recent household data showed that 683,000 less people were working. Remember, the CES does not adjust for part-time work vs full-time work and does not adjust for people having multiple jobs. The Household report shows that the number of full-time jobs is down 1.5 million to 133 million, which is the biggest drops since the Covid layoffs of April 2021. Part-time jobs went up by 762,000. Part-time jobs are the highest they have been since early 2018. Those with multiple jobs increased by 222,000 to a total of 8.6 million, which is the highest it has ever been. It was also quoted that total wages per hour was up by 4.1%, but total hours worked has declined to 34.3, which is the lowest level since pre-Covid. Keep in mind that people working less than 35 hours who would work more hours if offered are not included in U-3.
Foreign Born vs US Born: The number of foreign-born workers has increased to an all-time high, while the number of native-born workers has declined. The number of native workers has not increased since September 2017, which means that all additional employment since 2017 has been created by immigration. Data indexed to 2017 shows that foreign born employes have grown by 12%, while the number of natural born workers has remained the same. Total documented immigration since the beginning of the Biden Administration is estimated at 4.5 million. This commentary is not meant to express an opinion on immigration policy; however, it is important to note that most of our recent expansion of jobs has been cause by immigration, and if political regime change significantly changes immigration policy there may be economic consequences of unfilled jobs.
Types of jobs: Of the 216,000 jobs created: 73,000 were in government and social assistance, 38,000 were in health care, 17,000 were in construction (due to unseasonably warm temperatures), leisure and hospitality comprised 40,000, and retail was 17,000, professional and business services were 13,000. Most of the other categories comprised the remainder and include mining, quarrying, oil and gas extraction, manufacturing, wholesale trade, information, financial activities and other. It is important to note that in his General Theory of Employment, Interest, and Money, Lord Keynes noted that government jobs are not as productive as private sector jobs because they may cannibalize private sector activities.
Revisions: The CES has been consistently high when initially reported over the past year. Total downward revisions for 2023 have been more than 400,000 jobs. Over 90% of the jobs reports for last year were eventually revised downward. We may find that the 216,000 reported increase is revised away as time passes and the report quietly departs from the news cycle- especially given the large decrease shown by the more accurate Household Survey.
As can be seen, there is much more than meets the eye when evaluating economic data. There are thousands of data points released each year that all need this type of analysis to determine their significance and accuracy. Conflicting data needs to be consolidated to search for possible errors and differences in magnitude. They then need to be considered in context as a reflection of an entire world economy to make any meaningful decisions about where we are in the economic cycle. It would be a grave mistake to base any investment decisions on a single statistic at a single point in time. It is rarely effective to make any changes to your portfolio based on recently reported economic data. We only use these data to determine trends, and to help us formulate the appropriate amount of risk to take to ensure that you are being adequately compensated while trying to earn a sufficient return to reach your goals.
The investment markets have been increasing over the past few months and it may feel like the sky is clear and that we should press the accelerator, especially when we read positive headlines. It is important to note that many signs are still pointing in the direction of a late-stage expansionary environment, which means that we should continue to exhibit caution and focus on managing risk. We do not attempt to eliminate volatility, but we do insist that the investments that we buy are offering a fair return on capital and exhibit enduring earnings potential. At this stage of the cycle, it is incredibly dangerous to own overpriced securities, especially securities that are widely owned passively by much of the population in their 401(k)s and other investment accounts. We will continue to be careful and mindful of the risks that lie beneath the surface. It isn’t the tip of the iceberg that sinks the ship, it’s the part that you can’t see that gets you.
While the news reports are singing praises of a strong jobs market, there is conflicting data that is not being reported showing the opposite impact, to a much higher degree. We need to evaluate both positive and negative economic data to determine whether the reports are being misconstrued to shift our conclusions in a certain direction, especially in a contentious election year when both sides of the political aisle are trying to champion their own agendas. Based on history, it is possible that 2024 will be a symphony of cherry-picked data and accelerated monetary and fiscal stimulus promising a green future that will coast us into November. It is also possible that these efforts will fail. We are taking adequate risk to benefit if the markets continue to rise, and we are cautious enough to survive if the economy turns sour. If you have questions about this data or its relationship to our investment process, please feel free to contact your Wealth Advisor, or me personally.
Warm Regards,
Allen
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