A Tortoise on a Lunch Break
From its very start, this expansion has been a tortoise, plodding along at the
slowest pace of any post-war recovery. The May employment report suggested the
tortoise is now on a lunch break, with a measly 38,000 payroll jobs added, far below
consensus expectations, with 458,000 people leaving the labor force.
Investors should not freak out about the lunch break. The slide in job growth was
likely exaggerated and should mostly be reversed in the months ahead. However, they
should think carefully about the tortoise. This economy is quickly absorbing
whatever slack remains and, barring major policy changes, will likely see an even
more subdued growth rate in the years ahead, underlining the importance of a more
global approach to investing.
First, on the jobs report, it is important to recognize that it wasn’t quite as
shocking as portrayed in media commentary. A gain of 38,000 jobs was well below the
consensus expectation for a 160,000 increase compiled by Bloomberg a week earlier.
However, it may well be that the consensus estimate did not fully capture the 35,100
Verizon workers that were absent from payrolls due to a strike. In addition, key
leading indicators of employment, such as the employment indices from the ISM
surveys and the labor market conditions components of the Conference Board’s
consumer confidence index, all of which were on the weak side, weren’t available a
week earlier. In hindsight, with those data, my own model of private sector
employment would have predicted a private sector gain of 89,000 – still well above
the reported private sector number of +25,000 – but not shockingly so.
It also needs to be stressed that any estimate or forecast of payrolls has a degree
of error attached. My own model, which explains 89% of the variation in monthly
payroll job gains since 2005, still has a standard error of 86,000. In other words,
under normal assumptions, the forecast should be within 86,000 of the actual number
two-thirds of the time. In this case, the forecast would have been off by 64,000 –
just not that big a deal.
Moreover, this size of forecast error is entirely understandable. As just one
issue, consider that not-seasonally-adjusted private sector employment grew by
697,000 in May following a gain of over a million jobs in April. In a fast-evolving
economy and labor market, it is very difficult for the Bureau of Labor Statistics to
figure out how many jobs should have been added in May for seasonal reasons alone.
In June, the settlement of the Verizon strike should add to payroll job gains and
assuming not much other movement in labor-market conditions, a gain of
140,000-150,000 private sector jobs would not be surprising.
Moreover, demand conditions in the economy appear to be strengthening following two
very weak quarters. Data last week on real consumer spending for April and vehicle
sales for May suggest that real consumer spending could grow by more than 3% in the
second quarter, boosting real GDP growth to 2.0%.
However, in a broader sense, the May jobs report reinforced some of the key themes
that have dogged this slow expansion and which will be important in shaping economic
and financial conditions over the next few years. First, while the May slowdown in
job growth was probably exaggerated, a slowdown was likely coming anyway. In the
fourth and first quarters combined, real GDP growth amounted to just 1.1% annualized
while payroll job growth ran at over 2% annualized. The trend in productivity is
weak but it isn’t that weak and if the economy isn’t going to grow by more than 2%
going forward, it is reasonable to expect monthly job gains of only half that
amount, or roughly 100,000 to 150,000 per month.
The second theme is that, soft as demand growth is, supply growth is even worse.
The unemployment rate fell to 4.7% in May from 5.0% in April as a result of a small
gain in jobs and a 458,000 fall in the labor force. The usual commentary on this is
that workers became discouraged and dropped out of the labor force.
However, this just doesn’t pass the smell test. First, the actual number of
self-reported discouraged workers in May, (that is those who had given up looking
for a job because they assumed no job was out there for them) was just 0.21% of the
working-age population, the lowest percentage since September 2007. Second, the
actual unemployment rate, at 4.7%, was also the lowest since September of 2007 and
is far below the 50-year average unemployment rate of 6.2%. In fact, the U.S.
unemployment rate is now lower than it has been over 80% of the time in the last 50
The truth is, the decline in the labor force in May (and a 362,000 decline in the
prior month) was very likely just payback for an unusual surge in labor force in the
prior six months. That surge, amounting to 2.4 million people, had boosted the
labor force participation. However, the trend on the labor force participation rate
remains firmly downwards as millions of baby boomers reach 65 each year with many of
them retiring. The most likely scenario is that dismal labor force growth will
persist and that even 2% economic growth will likely cut the unemployment rate
In the week ahead, there will be only a few data points to confirm or challenge this
picture. Revisions to First-Quarter Productivity data should show a continued
pickup in unit labor costs while numbers on Job Openings for April and Unemployment
Claims for last week, should continue to portray a very tight labor market, albeit
lacking recent momentum.
For the Federal Reserve, provided they recognize that the trend in demand growth in
the economy still remains faster than that of supply and provided they see no sign
of an imminent collapse in demand, they should be willing to raise interest rates
next week. But while one number doesn’t make a trend, one number is enough to scare
this Fed, making such a move now highly unlikely.
For investors, provided growth picks up in the second quarter, the outlook should
still be one of slowly rising interest rates and rebounding earnings in the short
run. But in the long run, regardless of Fed policy, the U.S. economy is running out
of room to grow, and it will be more important than ever to invest globally to find
some foreign hares that will outpace the American tortoise even as it gets back on
Chief Global Strategist