After great progress throughout the spring, the labor market seems to be cooling again. Friday’s jobs report was yet another head-scratcher in a long series of baffling numbers.
Where June’s jobs report was a mix of a stellar non-farm payrolls number, upward revisions to prior months, and a rise in the unemployment rate, July’s numbers released last week baffled the other way, with a worse-than-expected new payrolls number of 162,000, downward revisions to May and June, yet with a 0.2% improvement to the unemployment rate, which fell to 7.4%.
A cooling labor market could be a portent of slowing economic growth going forward. What’s going to happen to the Fed’s bond tapering now? Is your portfolio prepared?
Worse Than It Looks
The unemployment rate at 7.4% may have fallen to its lowest point since December 2008, but it doesn’t give a true picture of the overall employment scene.
2.4 million unemployed were not counted in the tally because they hadn’t looked for work in the 30 days prior to the survey. If they had been counted in with the 11.5 million officially unemployed, the unemployment rate would actually be 8.9%. The all-encompassing under-employment rate – which includes part-timers who can’t find full-time work as well as those unemployed who have simply stopped looking for work – comes in at an uglier 14% job shortfall.
Several indicators point to even slower job growth ahead, including an increase of discouraged workers no longer looking for work, a 35-year-low participation rate of 63.4%, a shortened work-week of 34.4 hours from the previous 34.5, and a lower average wage by 2 cents at $23.98 per hour. Reduced work hours and falling wages are signs that employers can’t afford to keep people working as much, which lowers the expectation of new job creation in the near future.
Gus Faucher, senior economist at PNC Financial, believes federal spending cuts have begun impacting jobs. “They may be a drag (on job growth) for another few months,” he predicts to USA Today.
Federal Reserve Policy Expectations
The Federal Reserve seems to be contending with two foes at once.
On the one hand, the Obama administration’s focus on reducing the deficit – which is expected to fall from $1.4 trillion in fiscal year 2009 to $744 billion by the end of FY 2014 through a heavy reliance on taxes and the sequester – has long frustrated the Federal Reserve, which has repeatedly stressed in its press releases that “fiscal policy is restraining economic growth”.
On the other hand, the Fed has also been grappling with a sluggish jobs recovery punctuated by a high unemployment rate, which has persisted above the Fed’s 6.5% target since October 2008, near the start of the crisis.
The FOMC’s entire purpose hinges on those two key objectives: coaxing a strong economic recovery supporting maximum employment. Do we have those yet? Not by a long shot.
“This isn’t a disaster of a report, but it shows the U.S. remains vulnerable to a slower economic-growth performance,” Julia Coronado, chief economist for North America at BNP Paribas, expressed to Bloomberg. “This isn’t the kind of progress the Fed would like to see. At the margin, it keeps them cautious.”
With a 1.7% annualized GDP and a 7.4% unemployment rate well above the Fed’s target, a September reduction of Federal Reserve monthly bond purchases is no longer a done deal.
Friday’s jobs report will “keep the debate alive over the prospects for a September tapering,” expects William O’Donnell, head U.S. government bond strategist at RBS Securities. “Another weaker-than-expected employment number in September might delay it.”
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Market Expectations
Knowing, then, that the Federal Reserve will use everything in its power to counter the government’s fiscal policy of taxes and spending cuts as well as to stimulate job creation, we can expect low interest rates for years to come and continued monthly bond purchasing for at least a few more quarters. Equities will thus remain well supported by highly accommodative Fed policies until at least rate normalization by 2017-18.
Yet equity traders are bracing their portfolios for that all-important and heavy-hitting first tapering announcement. Whether it comes in September, December, or even early 2014, that first tapering call will send equities back as they adjust to a new lower level of stimulus.
Even now, a shift toward defensive sectors has already driven up the PE ratios of staples stocks to over 15, while discretionary stocks average near 8. Though discretionaries look more attractive, the market could be telling us it’s time to look for the cover of the large caps and staple goods providers, which generally ride out the storms better.
Food producers like Kellogg (NYSE: K), the old Kraft Foods now known as Mondelez International (NASDAQ: MDLZ), and Warren Buffett’s choice Coca-Cola (NYSE: KO) are basic foods and drinks consumers don’t skimp on.
Bond traders are not waiting either, as a rising 10-year Treasury yield back above 2.6% shows. To long-term bond holders, the 3-month difference between September and December is insignificant, and they’re preparing themselves now.
After all, if you can see the dark clouds approaching, you don’t have to wait until you’re soaking wet to starting heading indoors.
Joseph Cafariello
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