Alice…where are you?
It seems that Alice in Wonderland may be the only one in a position to understand what’s happening with interest rates, unemployment and the overall U.S. economy in light of the Fed Meeting on Wednesday and recent data.
Much like in Lewis Carroll’s Through the Looking Glass, where the clock runs backwards and memories flow in reverse, things in the U.S. economy may not be quite what they seem. While the equity market seems to have fallen down the rabbit hole, we have been busy looking for the source of this distortion. Perhaps we have found it…
At the end of October, the value investor Mohnish Pabrai gave a presentation and took part in a Q&A session at Boston College and Harvard Business School on the Uber Cannibal Investor Framework, which he has developed over the past decade. Uber Cannibals are the businesses “eating themselves by buying back their stock,” the value Read More
The Old Reality
I’ve read a few reports about reactions and thoughts on Yellen & Co.’s decision to hike U.S. interest rates again. If we look at traditional wisdom, which many analysts do, the rate hike was the right thing to do.
The old reality is that when unemployment rates are low – and at the May rate of 4.3%, the lowest unemployment rate since the days of George Bush’s presidency in 2001 – the economy is assumed to be operating at near full capacity. With all the U.S. workers gainfully employed, those U.S. consumers are more willing to spend money and take on more debt because they feel financially confident. This is when inflation can start to show its face and increasing interest rates help to ensure that inflation doesn’t run rampant and spoil the fun.
But, with unemployment rates so low that even ex-convicts and high school drop outs are getting job offers, inflation is still under 2%. The Consumer Price Index (CPI), which is the standard used to measure inflation, has remained nearly flat over the past three months. Something has changed.
The Paradigm Has Shifted
The Fed acted to raise rates based on what it believes full employment should means to the overall economy, yet, raising inflation is nowhere to be found. The question we must answer is why. To do that we have to look much deeper than the pandering news headlines that shout about the lowest unemployment rate in 16 years.
Together with Jeff Opdyke, an independent analyst and investment writer, I looked at the most recent jobs data in America to find out exactly where the jobs have come from and how America has reached this 4.3% unemployment level.
At first glance, dissecting these data points may seem unrelated to study of the investment markets, but at 1291, we believe you have to connect the dots in order to see the entire financial picture.
Not All Employment is Created Equal
There are 12 categories that jobs fall into and they are large broad categories such as leisure and hospitality, retail trade, professional services and the like. Often, the main stream media talks about the number of new jobs that have been added or lost. It doesn’t look at the quality of those jobs – what do these jobs pay?
There’s a big difference between a $75,000 executive who needs to find a job and accepts a new position for $79,000 versus having to take a job paying $50,000 a year. That executive has a job, so they are “fully employed” according to the data that the government collects, but they aren’t living the same quality of life. They’ve lost a third of their prior income.
The New York Times had an interesting story on this point last month.
Mirella Casares has what used to be considered the keystone of economic security: a job. But even a reliable paycheck no longer delivers a reliable income.
Like Ms. Casares, who works at a Victoria’s Secret store in Ocala, Fla., more and more employees across a growing range of industries find the number of hours they work is swinging giddily from week to week — bringing chaos not only to family scheduling, but also to family finances.
And a new wave of research shows that the main culprit is not the so-called gig economy, but shifting pay within the same job.
This volatility helps unravel a persistent puzzle: why a below-average jobless rate — 4.4 percent in April — is still producing an above-average level of economic anxiety. Turbulence has replaced the traditional American narrative of steady financial progress over a lifetime.
“Since the 1970s, steady work that pays a predictable and living wage has become increasingly difficult to find,” said Jonathan Morduch, a director of the U.S. Financial Diaries project, an in-depth study of 235 low- and moderate-income households. “This shift has left many more families vulnerable to income volatility.”
The May jobs report showed that areas with the largest growth were professional and business services, education and health services, and leisure and hospitality. Together these three sectors make up 40% of the job market. While these sectors showed the largest gain in jobs, the average income these new jobs provide are below or deeply below the national median household income of $56,000 per year.
In the professional and business sector, 66% of the new jobs created were for administrative and support services which pay around $37,500 per year. And to make it slightly worse, more than half of the 25,200 new jobs in the administrative service area were for temporary help.
Education and health services added nearly 47,000 new jobs. However, less than half the jobs create pay more than the national median income.
The worst of the bunch, however, are the 31,000 new jobs in leisure and hospitality. While the number of new jobs is large, the reality is that the vast majority of these jobs – food prep, cashiers, building services, etc. – pay only half or less of the national median. Trying to care for a family on $28,000 a year or less is nearly impossible.
And on the other flip side, the May jobs report saw the retail trade sector that employees nearly 16 million Americans have a negative number of new jobs. While jobs were gained and lost in this sector, general and miscellaneous store retailers lost 7,500 jobs while food and beverage stores lost 5,300 more. With retailers struggling and many declaring bankruptcies thanks to stiff online competition, job losses in this area may well continue to mount.
Lower Quality Jobs Mean Weaker Economy
If the Fed looked past the simple math calculations, they would have seen that a majority of new jobs that have been created since the Great Recession of 2008 have not been solid, reliable white collar jobs. Jobs that paid $75,000 a year or more have vanished…to be replaced with more modest job openings paying at or below the $56,000 average. It’s no wonder that inflation has gone missing. There are fewer willing consumers.
The lack of a solid U.S. job recovery means that economic risk is alive and well, regardless of what the Fed’s rate hike might signal.
The U.S. equity market is lost in Wonderland and it believes the Federal Reserve is the Queen of Hearts. It is still buying into Trump’s promises of better tariffs, lower taxes and infrastructure spending…all while nothing has materialized.
The gold and bond markets, on the other hand, are well aware of the new reality. Yields in the bond markets are coming down as they realize that the expectations of a U.S. economic recovery aren’t what they are cracked up to be. Gold seems to be clear on the risk at hand as well. The gold market has not sold off – the metal continues to bounce in the $1,200 to $1,300 range. If the U.S. economy was truly as strong as the Fed and the latest unemployment rate implies, inflation would be on the move and gold prices would be dropping.
For now, we continue to believe that Europe is in a better place than the U.S. Elections in France have stabilized the geopolitical situation and the euro has strengthened verse the U.S. dollar.
In light of the current environment, our 25/4 Portfolio strategy is well positioned for the current environment. Gold, foreign currencies, and bonds, as well as our exposure to European equities and alternative assets will be positions of strength for any U.S. weakness that may appear once the impact of the latest interest rate hike is felt.