Shortfalls in the Economic Recovery

Friday’s belated October jobs report delivered some mixed signals. 204,000 new jobs were added to non-farm payrolls last month, much higher than the 120,000 analysts expected. There were also upward revisions to August’s and September’s numbers by a combined 60,000 additional jobs. This raises the 12-month average to 194,000 new jobs per month, very close to the 200,000 monthly gain the Federal Reserve is looking for.

So you would think the Fed will now move ahead with tapering its monthly purchases, right? Maybe not. Other data from Friday’s report weren’t so hot, such as the unemployment rate, which rose from 7.2 to 7.3% despite the gain in new jobs.

This and other data are leading economists to seriously question America’s economic recovery. Peering into the all-important holiday shopping season, they see trouble ahead.

Mixed Market Reactions

For the most part, the markets reacted to Friday’s data with optimism. Not because the jobs data was good, but because the unemployment rate was bad. The unemployment rate is the chief bit of data to which the Federal Reserve is linking its stimulus plans, aiming for a recent historical average of 6.5%. An unemployment rate above that number means interest rates simply will not budge from their current all-time lows.

For this reason, the equity markets rallied, with the broader S&P 500 index rising over 23 points to 1,770.61 for a 1.34% gain on Friday, just shy of the 1,775.22 all-time high set the week before.

But bond traders looked the other way, with the 10-Year U.S. Treasury falling and its yield rising a hefty 15 basis points to close at 2.745% on the expectation of Fed purchasing reductions. Gold seemed to expect the same, falling $23.90 to $1,284.60 for a 1.8% loss in a move that was compounded by a stronger U.S. dollar, which rose a sizable 0.7 on the DXY dollar index versus foreign currencies.

And herein lies the reaction – where the still high unemployment rate supports continued Fed assistance through low interest rates, the pick-up in job creation seems to indicate the Fed will move ahead with bond purchasing reductions after all.

But one member of the Federal Reserve – Atlanta Fed President Dennis Lockhart – acknowledges the data could be a little misleading, made somewhat unreliable due to incomplete data collection during the recent government shutdown. “The context of policy making is murkier than I would like,” he confessed to Market Watch. So don’t be surprised if we get some stark revisions to these numbers over the next couple of months.

The True Employment Picture

Yet Friday’s market activity goes to show just how short-sighted participants have become. Digging a little deeper into the numbers shows a sadder truth.

While the number of unemployed looking for work stayed the same at 11.3 million, the unemployment rate rose because many people simply stopped looking for work and are no longer counted as unemployed but as “discouraged workers.” But we all know they are still unemployed.

In fact, there are a total of 2.3 million unemployed workers who were simply not counted for various reasons, including not having looked for work in the last 4 weeks. Separated from the unemployed into a group called “marginal workers,” they too are still unemployed. Add them all together and the real number of unemployed comes to 13.6 million, with 8.78% being the real unemployment rate.

A more accurate snapshot of the American labor recovery is the labor participation rate, or the amount of employed persons out of the entire workforce which includes the 11.3 million unemployed and the 2.3 million marginal workers. In October, that participation rate fell by 0.4% to 62.8%. Total employment fell by 735,000 jobs, while federal government employment was down by 12,000. The ratio of employed persons to the overall population also fell by 0.3% to 58.3%.

Grinch Alert

More bad news came from the Thomson Reuters/University of Michigan November Consumer Sentiment Report also out on Friday. Where economists were expecting a rise of 1.3 points, the consumer sentiment index actually fell 1.2 points from October’s 73.2 to November’s 72.0 – the lowest since December of 2011.

Two other gauges of the index also came out lower this month from the last, with “consumer expectations” falling from 62.5 to 62.3, and “current conditions” shrinking from 89.9 to 87.2.

“Following the end of the [government] shutdown, consumers were somewhat more optimistic about the outlook for the economy, but thus far the rebound has been lackluster,” survey director Richard Curtin assessed to Reuters.

This has potential for weakness looking ahead, as we are already in the holiday shopping season when most businesses expect to make most of their profits for the year. A higher number of shoppers lacking confidence, a larger temporary workforce who can’t find full-time work, a growing number of unemployed, and an increasing number of discouraged workers who have simply given up spell trouble heading into year’s end.

The rising cost of education is compounding the problem, as fewer workers qualify for the increasing number of skilled jobs. Labor Secretary Thomas Perez noted to the Washington Post, “I’m heartened by the numerous conversations I have with employers who say, ‘I want to grow my business.’ But they often add that ‘too many people coming through the door don’t have the skills that I need.’”

As a result, “the job market is actually narrowing,” John Silvia, chief economist at Wells Fargo, confirmed to the Washington Post. “There’s a smaller group of people working, but they are prospering.”

Some indeed may be prospering, but the consumer sentiment report showed a growing divide between the haves and have-nots, where sentiment improved for wealthy Americans earning more than $75,000 a year but worsened for all the rest.

Trouble Ahead?

Unless that sentiment picks up – and quickly too, with just 7.5 weeks remaining to the end of the year – the fourth quarter could look pretty ugly. While GDP figures out last week showed a 2.8% annualized rise in Q3 for the largest gain so far this year, much of that increased production was due to preparations for the holiday season, as businesses built-up their inventories. It’s one thing to produce, but it’s an entirely different thing to sell that production.

In fact, stripping out inventory restocking leaves just 2% annualized growth for Q3, which is actually lower than Q2’s inventory-stripped 2.1%. Q4, for its part, is not expected to be pretty, with the half-month government shutdown falling entirely within its three-month window.

Moreover, worries of yet another government shutdown coming at us over the horizon in January are causing businesses to reduce their capital spending; too many unknowns are making business investment riskier. “Uncertainty is not the friend of investment,” Keith Nosbusch, chief executive of Rockwell Automation Inc., underscored to the Wall Street Journal.

America’s economic recovery could drag on longer than expected as business expansion plans have been placed on hold since last month, when corporate executives “didn’t know what the future was going to be,” Nosbusch summarizes, “and that causes people to take pause.”

Economists are now expecting a dismal 2.2% annualized growth for Q4 from the combined negative effects of the shutdown and falling consumer sentiment. That may not seem all that bad – until we compare it to recent Q4 growth of 3.9% in 2009, 2.8% in 2010, and 4.9% in 2011. Looked to as the most important quarter of the year, Q4 this year may fail us for a second year in a row, as it did in 2012 when it registered an abysmal 0.1% annualized growth.

So what do we have in front of us, then? Both businesses and consumers taking a pause during the most important quarter of the year, sandwiched between one of the longest government shutdowns behind us and the potential for another one ahead.

Still, it’s not like there are better places in which to invest. While Canada’s unemployment is a little better at 6.9%, two years of lower commodity prices have reduced the growth potential of its resource-heavy economic output. Last week’s decision by the European Central Bank to lower interest rates to 0.25% is a symptom of a struggling region in need of continued government assistance. Meanwhile, the Japanese Nikkei index of 225 stocks is still struggling near a 6-month upper resistance barrier that it just can’t seem to penetrate despite talk of continuing government stimulus.

Rough as the going may get over coming months, investors in America still have the best investment situation in their own backyard. If a slow Q4 and sluggish holiday shopping season draw markets down, consider it a buying opportunity. Once we get over the expected slower sales, government infighting over the debt limit, and first announcement of Federal Reserve purchasing reductions, 2014 should prove to be another up year for equities – all on the back of continued Fed support. They won’t let go of toddler’s hand all too abruptly.

Joseph Cafariello

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