Income and GDP

March 30th, 2014

Business Activity

The Institute for Supply Mgmt (ISM) and Markit Economics are two private companies that survey purchasing managers and release the results in the first week of each month. Toward the end of each month Markit releases what is called a “Flash PMI”, an early indication of activity for the month.  This month’s flash index of manufacturing activity declined slightly but is still showing strong growth.  New orders are showing strong growth at a reading of 58.  The Flash reading of the services sector rose to over 55 but this is a mixed report, with only tepid growth in employment and backlogs actually in a slight contraction.  The most remarkable feature of this report was the 78.1 index of business expectations, an outstandingly optimistic reading. This Flash index gives investors a glimpse of the full survey reports from ISM and Markit that will be released in the first week of next month.


On the other hand…

The monthly report of durable goods indicates a rather tepid 1-1/2% year over year growth.  This excludes planes, autos, and other transportation orders.  Including those components, there has been no yearly growth.


Stick with the plan, Stan…

Rising equity and real estate markets have been good for a lot of people. A blog noted the number of people entering the ranks of millionaires in 2012.  Toward the end of this report was an important lesson: “60 percent of investors worth $5 million or more say they’ll invest in equities this year, while 31 percent of those worth $100,000 to $1 million plan to do the same.”  Hmmm…rich people are not buying into the prophecy prediction analysis that the market will crash this year.  Could they be sticking with a plan that  allocates investments across a variety of assets, including stocks?


Personal Income

This week, the Bureau of Economic Analysis (BEA) released February’s estimate of personal income.  Real, or inflation adjusted, disposable personal income (DPI), rose 2.1%, a decline from January’s 2.75% increase but above the 1% that has historically led to recessions.

A few weeks ago I noted that annual DPI had dropped below 1% in 2013.  Contributing to the weak year over year comparison was the high spike in income in the fourth quarter of 2012 when many companies “paid forward” both dividends and bonuses in December in advance of tax increases scheduled for 2013.

While this may have been a contributing factor to the decline, it would be a  mistake to give it too much weight.  The growth in personal income has been relatively weak and it shows in the consumer spending index released this week.  The .1% year over year increase – essentially zero – indicates consumer demand that is too weak to put any upward pressure on prices.  Sensing this, businesses are less likely to invest in growth.  Less investment growth means that employment gains will be modest, which further reinforces modest economic growth.

The stock market trades on profit growth.  Standard and Poors reports that 4th quarter earnings for the companies in the SP500 rose 9.8%, accelerating from the 6.0% growth in the 3rd quarter of 2013.  A moderately improving economy and only modest growth in investment has helped boost profits.  Profits are expected to rise 11% in the second half of 2014.



The third estimate of GDP growth in the fourth quarter of last year was 2.6%, in line with consensus estimates.  In her testimony before Senate Finance Committee two weeks ago, Fed chairwoman Janet Yellen noted that we may be in for an extended period of slow growth below the fifty year average of 3%.

Three weeks ago I looked at GDP and the personal savings rate.  This week I’ll look at per hour GDP.  Readers should understand that this is what some economists would call a messy data set.  I have made some assumptions about the number of hours worked per employee.  The BLS publishes average hours worked for manufacturing employees and I made a guesstimate that the average for all workers is about 90% of that.  The number of part time employees who do not work this amount of hours offsets the unreported hours of the self-employed.  I am less concerned about the absolute accuracy of the GDP output per hour worked but that any inaccuracies be fairly consistent.  The trend is more important than the actual numbers.  What can we learn when output per hour flattens or declines?  Below is a graph of sixty five years.

We can see that flat growth tends to precede recessions but there is no definite pattern where we can say with any confidence that a flattening or decline in per hour GDP necessarily precludes a recession.  If we zoom in on the past thirty years, we do notice that the preceding decade has been marked by long periods of flat growth.  More importantly, the recovery from this past recession is marked by the longest period of flat growth in the history of the series.

The summer of 2009 marked the official end of this past recession.  For five years there has been no increase in real GDP per hour worked.  For a few years following a recession in the early 1990s, per hour GDP flattened before taking off in the late 1990s.

Does this flat growth represent a pruning of the economic tree before a surge of new growth? Or does it presage an even worse recession? Is the economy locked inside a limbo of limp growth for years to come, echoing the two decades of little growth in Japan’s economy?  Whatever happens, we can be certain of one thing – the trend and pattern will be so much more obvious in the future simply because we will disregard some past data based on what happens in the future.

As we make investment decisions, we should remember that the “obvious” patterns we see when we look back were much less clear at the time.  Sure there will be investment gurus who tell us that they saw it coming.  We forget that they also saw the depressions of 1994, 1998, 2000, 2004, 2006 and 2011 – the ones that didn’t happen.

Let’s look a bit more closely at recent periods of flat growth.  The recovery from the recession of 1991 was marked by a painfully slow recovery in the job market.  After a 30% rise over three years, the market stumbled.

There’s a story to be told when we look at the growth in the market index and per hour GDP.  Whether it is by coincidence or not, there is a loose response of the market to changes in output.

After another slow recovery from the recession of 2001, the market began to climb in 2004.

But this time the market was not responding to the flattening growth in per hour output.

In the past four years, there has been little growth in output per hour.

But the market has doubled over that time.

Part of that recovery can be attributed to the market simply reversing the decline of 2008 and early 2009, but a good 40% increase in market value can be attributed to the greater share of output that companies have been able to convert to profit. (See last week’s blog)  How long that trend can and will continue is anyone’s guess but we know that it can not go on forever.  Flat revenue growth makes growing profits an ever more difficult task.

The flat growth in per hour output gives us perhaps another insight into the so-so growth in employment.  Without a clear vision of a stimulus that will spur growth, companies are reluctant to commit to plans for an expansion of their work force.

Productivity & GDP

March 23rd, 2014

Industrial Production

The week opened with a positive report on industrial production.  The .8% rise offset Janary’s decline and was the 4th month in which this index has been above the level of late 2007, the onset of the last recession.  To give the reader a sense of historical perspective, this index of industrial production has been produced for almost hundred years.  The average recovery period of civilian production is 2-1/2 years.  This recovery period of this past recession, 6 years, is second only to the  7-1/2 year recovery of the 1930s Depression.  I have excluded the 6-1/2 year post WW2 recovery period from war time production, which doubled production to produce goods and armaments for the war.  If that period is included, the average is 3 years.

Here is a comparison of the recovery periods since 1919.  The back to back dips of 1979 and 1980-83 were, in effect, one long dip lasting 4 years, making it the third worst recovery period of the past one hundred years.

When industrial production takes several years to regain the ground lost during a recession, it is vulnerable to even minor economic weaknesses.  As production recovered from a 7-1/2 year dip during the 1930s Depression, the Federal Reserve tightened money and production slid once again before reviving to produce arms to ship to British and European forces in the early years of World War 2.  Outgoing Federal Reserve chairman Ben Bernanke, a noted scholar of the 1930s Depression, understands the inherent weakness of an economy when production takes several years to recover.  For this reason, he was reluctant to ease up on monetary support until production was clearly and securely recovered.

The new Federal Reserve chairwoman, Janet Yellen, has decades of experience and is well aware of the fragility that is inherent in an economy that experiences a long period of industrial recovery.  This will be one of several factors that the Federal Reserve watches closely for any signs of faltering.  Those who think that the Fed will make any abrupt changes in monetary policy have not been reading the footprints left by the past.



Last August I wrote about the rather slow growth of multi-factorial productivity (MFP) since 2000.  The Bureau of Labor Statistics (BLS) calculates a meager 1% annual rate of growth in that time.  Far down in their historical tables is a revealing trend: Labor’s contribution to production has declined dramatically in the past ten years while capital’s share of inputs has increased.  Capital inputs include equipment, inventories, land and buildings.  In 2011, the most recent year available, labor’s share of input had decreased to 63.9%, far below the 60 year average of 68.1%.

Capital’s share of input had increased to 36.1%, far above the average 31.9%

As I mentioned last August, the headline productivity figures are misleading because they simply divide output by number of hours worked and ignore the contributions of capital to the final output.  As capital’s share of input increases, the contributors of that capital want more return, i.e. profit, on their increased contribution.

In the twelve years from 2000 – 2011, capital’s share of input has increased 20%, from 30% to 36%.  In that same period, after tax profits have grown by 130%, a whopping return on the additional 20% capital invested.  While overall MFP growth has slowed, the mix has changed.

Given such a rich return, we can expect this trend to continue until the growth of profits on ever larger capital investments reaches a plateau and slows.  Until then, labor’s share of productivity gains will be slight, acting as a continuing restraint on family incomes.


Existing Home Sales

The 5 million sales of existing homes in 2013 was 9% above 2012 levels but the percentage of cash buyers has increased as well, now making up almost 1/3 of existing homes sales. (National Assn of Realtors).  The percentage of first time buyers declined from 30% in December 2012 to 27% in December 2013. For the past half year sales of existing homes have declined and the latest figures for February show a 7% decline from 2013 levels.

In May 2013, the price of Home Depot’s stock hit $80, a 400% rise from the doldrums of the spring of 2009.  Since then, it has traded in a close range around that price.  In May 2013, the price of the stock was 200% of the 4 year average, an indication that all of the optimism had been baked into the stock price.  It now trades at 160% of the 4 year average, rich but more reasonable if expectations for a continued housing recovery materialize.

In January 2000, the stock broke above $50 and was also trading at almost 250% of it’s 4 year average.  After trading in a range in the high $40s for several months, the stock began to fall.  By mid-June of 2000, the stock traded for 150% of its 4 year average.

The range bound price of Home Depot’s stock price for 8 months now is a good indication that investors have become watchful of the real estate sector, particularly the existing home market.  The percentage of cash buyers has risen 10%, replacing the similar decline in the number of first time home buyers.  Remember that this stalling is taking place at a time when interest rates are near historic lows.


Reader questions

A reader posed a few questions about last weeks blog.

When annualized sales rates are down, but annualized inventory rates are up, is that usually because of prior contracts that businesses must accept?  Or is it usually hope for their future?  In other words, is a higher inventory rate a positive sign or a negative one?

When sales are going down and inventories are going up, it means that businesses were not prepared for the change in sales. This ratio measures the amount of surprise.  Businesses will then reduce their orders to factories, wholesalers, etc.  They may decide to reduce any hiring plans.  On the other hand, they might increase their marketing expense.  Look closely at the Inventory to Sales Ratio (ISRATIO) graph from the Fed.  In the early part of the recession in the first quarter of 2008, the ISRATIO moved up a bit, then down in the 2nd quarter but it was still in the subdued normal range of 1.25 to 1.30 established since 2006.  During the summer of 2008, the ISRATIO rose again but it was not until September 2008 that this ratio began it’s several month upward spike as sales crashed.

Re:  Decline in real personal consumption below 2.5% has ALWAYS led to a recession within a year.  Are there any substantive changes in how the economy is run now than in the past?  For example, has the Fed always been involved with quantitative easing like it is now?  Could that easing create a better economic climate despite personal consumption decline?  When we look at the past, are we generally comparing apples to apples?

The fact that a recession has always happened when inflation adjusted personal consumption falls below 2.5% does NOT mean that it will happen this time.  These are indicators, not predictors and we must remember that indicators of past trends are with revised data.  Investors and policy makers must make decisions with the currently available data, before it is fully complete. Personal consumption for 2013 could be revised higher in the coming quarters.  Some revisions happen as much as three years later.  What it does mean is that the Fed will be watching this sign of weakness in the consumer economy and is unlikely to make any dramatic policy changes.

So how do you think our leaders should lead in regards to SS?  Do you think the age should be raised to say 70?  Do you think we will not be able to depend on SS being there throughout our lifetimes?  It must be of great concern to your kids that it may not be there for them, esp. after having contributed over the years.

I think politicians will have to spread the pain on Social Security.  These suggestions are not new.

1) Raise the salary level that is subject to the tax so that more tax is captured from higher salaries.  This years maximum is $117K. (SSA) This is a tough sell.  The ratio of the maximum taxed earnings to the median household income (Census Bureau Table H.6) has gone up from 150% in 1980 to almost 220% in 2012.

Well to do people feel like they are already paying their “fair share.”  Senator Bernie Sanders and other Democrats use the ratio of the maximum taxed earnings to the top 10% of incomes to make the case that the maximum should be as high as $175K.  Computers and the availability of so much data enable policy makers and think tanks to produce whatever data set they want in order to support their conviction.

2)  Raise the employee and employer share of the tax .1% each year for the next five years.  Democrats will not like this one because it raises the burden on lower income families.

3)  Initially raise the social security age by two months each year over the next five years and index it to the growth in the life expectancy of a 65 year old so that the official retirement age is 15 years less than the life expectancy.  In 2025, if the life expectancy is 85 years, then the official retirement age would be 70.  Early retirement should be set at 3 years less than full retirement age.  In this case, early retirement would be 67.

All of these are tough choices and most politicians don’t want to touch them.   Voters are not noted for their prudence and are unlikely to pressure pressure policy makers for more taxes and less benefits. In order to sell these difficult proposals, I would add one more proposal.

4) Guarantee the payout of benefits for ten years, regardless of death.  Each retiree would name beneficiaries for their social security and payments would go to those beneficiaries until the 10 year anniversary that retirement benefits began.  This would incentivize retirees who could afford it to delay the start of their retirement benefits until 70, knowing that their heirs would get at least ten years of benefits. This delay would ease some of the fiscal shock as the boomer generation is now retiring.

Currently, the highest social security benefit is paid to a surviving spouse.  If a man dies with a higher monthly benefit than his wife, then the wife gets the husband’s higher benefit amount each month but loses her benefit.  Under this proposal, the wife would get her benefit and the husband’s benefit plus her benefit if her husband dies within ten years of retirement.  Often, a couple’s income is cut in half or by a third when a spouse dies.  Older women are particularly impacted, finding that they can no longer afford the mortgage or rent in their current housing situation. This feature would enhance the popular understanding that Social Security is like an insurance annuity.  It would help particularly vulnerable older surviving female spouses, an emotionally appealing feature that politicians could sell to voters, thus making it more likely that voters would accept the higher taxes and raised retirement age.  Whether the idea is fiscally sound is something that the Board of Trustees at the SSA could calculate.

Sales, Employment, Social Security

March 15th, 2014

Small business

The monthly survey of small businesses showed an abrupt decline in sentiment, below even the lowest of expectations,  and the sixth report since the beginning of the year to come in below the consensus range.  Two factors led the downward change: lowered sales expectations and hiring plans. The majority of business owners surveyed are reducing, not adding to inventory.  The steady but slowly improving sentiment during 2013 has now weakened.

This reading of optimism among small business owners is indexed to 100 in 1986.  The current survey reading of 91.5 is far above the pessimistic level of 80 that the index sank to in the early part of 2009.  In 2006, sentiment broke below the 95 level and has not risen above that since – eight years of below par sentiment among small business owners.

The lackluster small business report early in the week dampened market activity until the release of February’s retail sales report on Thursday.  The retail sales and employment reports that are released each month probably elicit the most response from the market.  A fall in February’s retail sales might have driven the market down at least 1%.  Instead, the report showed an annualized growth rate of 3.6%, offsetting the weakness in January and December.  Excluding auto sales, which accounts for about 20% of retail sales, total sales have formed a plateau.  Even auto sales were up this past month in spite of the extreme bad weather in parts of the country.  Some see this resilience in the face of the extraordinary weather this winter as an indication of an ever strengthening consumer base, a harbinger of solid economic growth.

The reason for the reduction in inventories indicated by the small business survey was revealed by Thursday’s report of the inventory-sales ratio for January.  Inventories rose at a 4.8% annualized rate versus a 7.2% annualized decline in sales.  January’s ratio of inventory to sales is at the same level as the beginning of the recovery in 2009.  Businesses will be cautious buyers this spring until excess inventories are reduced.


The number of unemployment claims declined again this week, bringing the four week average down to approximately 330,000, considered by many to be in the healthy range.  As a percent of the workforce, new unemployment claims are near all time lows.  Enacted in 1993, NAFTA had some small effect on employment but the more consequential impact was the admittance of China into the WTO.  As the relatively more volatile manufacturing employment decreased, so too did the surge in unemployment claims.  Note the reduced volatility of the work force today compared to the 1980s.

As a rule, employees quit jobs when they feel confident that another job is readily available.  The Quits rate has been rising since the official end of the recession in the summer of 2009 but is still relatively weak and declined in January.  The current level is at the lows of the recovery from the recession of the early 2000s.

As a percent of the workforce, however, the level of quits has not even reached the lows of that previous recession.


Now for a disturbing trend: the decline in disposable income below 1% has always marked the start of a recession.  This annual report from the Bureau of Economic Analysis (BEA) covers the period till the end of 2013 and was not affected by the recent cold weather.

Recent price increases in basic food commodities like milk and cereal nibble away at consumers’ pocketbooks.  An ETF that tracks agricultural commodities is up almost 20% in the last six weeks.

Whenever the growth in real, or inflation-adjusted, personal consumption has declined below 2.5%, the economy has always  gone into recession within the year.  In 2013, consumption growth fell to 2.0%.

Well, maybe this time is different.  Eternal hope, persistent denial. Those of us living in the present too often believe that we belong to an elite club with special rules that those in the past did not enjoy.


Social Security

Several years ago, the Social Security administration (SSA) estimated that 10,000 people would qualify for benefits each day.  Republican Congressman Eric Cantor and Democratic Senator Ron Wyden are two politicians on opposite sides of the political aisle who mention the 10,000 a day factoid.  The actual number of new retirees per day is actually higher.  Using recent data from the SSA, PolitiFact reported that 11,000 new retirees each day qualify for Social Security.  No one mentions the 4,300 who die and drop off the Social Security rolls (2008 data from the Census Bureau).  This number is likely to increase another 15% as the Boomer population swells into old age; the 1.6 million a year who die is likely to grow to 1.8 million who leave the Social Security system while 4 million become eligible for retirement benefits.  The result is an approximate net increase of 2.2 million beneficiaries each year of the next decade.

For now, let’s leave out the growth in the disability and Medicare programs and focus only on retirement and survivor’s benefits, or OASI.

At an average yearly benefit of $14K the benefits paid by the Social Security Administration rise by $31 billion this year, a 4.6% increase on the approximately $670 billion in Social Security and Survivor’s benefits paid out in 2013 (CBO report).  The relatively small deficit of $60 billion last year will grow into hundreds of billions within the decade.  Congress argues at length over $3 billion; efforts at tackling the really big deficits of Social Security are too often met with blowhard rhetoric, not serious negotiation.

The SSA estimates that “By 2033, the number of older Americans will increase from 45.1 million today to 77.4 million.” (SSA Basic Facts) At an inflation rate of 2.5%, less than the 3% average of the past 50 years, the average $14K annual benefit will grow to $23K by 2033.  Multiply that by 77 million people and the total of benefits that will be paid to seniors in 2033 is close to $1.8 trillion, almost triple the benefits paid in 2013.  

The current elderly count of 45 million people is 14% of today’s population of approximately 313 million.  In 2033, 77 million elderly will be 20% of an estimated population of 382 million.  More people getting paid while fewer people will be paying.  The SSA estimates that a little over 40% of the population who are working will be supporting the 20% of the population that is collecting SS benefits.
Independent Senator Bernie Sanders is fond of reassuring us that the Social Security Trust Funds have plenty of money to pay benefits over the next two decades.  What the trust funds have are I.O.U.s from the U.S. Government’s pool of tax revenues.  Where will the money come from?  Increased taxes. 
Politicians rarely lead.  The art of politics is to look like one is a leader, to position oneself at the front of the herd as it flees the pursuing lions.  In this case, the lions are demographics, and decades of promises, unrealistic assumptions and political cowardice.  The question is whether voters will force the leaders to lead before the lions attack.

Employment, New Orders, CWPI

CWPI (Formerly CWI)

The Constant Weighted Purchasing Index (CWPI) that I introduced last summer was designed to be an early or timely warning system of weakening elements of the economy.  It is based on a 2003 study by economist Rolando Pelaez on the monthly Manufacturing Purchasing Managers Index (PMI) published by the Institute for Supply Management (ISM).  ISM also produces a Non-Manufacturing index for service industries each month but this was not included in the 2003 study.

The CWPI focuses on five factors published by ISM:  employment, new orders, pricing, inventory levels and the timeliness of supplier deliveries.

The CWPI assigns constant weights to the components of both indexes, then combines both of these indexes into a composite, giving more weight to the services sector since it is a larger part of the economy.  Both the CWPI and PMI are indexed so that 50 is neutral; readings above 50 indicate growth; readings below 50 indicate contraction.  In previous months (here and here), I anticipated that the combined manufacturing and services sector index would move into a trough at this time before rising again in March and April of this year.

A longer term chart shows the wave like formation in this expansionary phase that began in the late summer of 2009.

February’s ISM manufacturing index climbed slightly but the non-manufacturing, or services, index slid precipitously, more than offsetting the rise in manufacturing.  Particularly notable was the huge 9% decline in services employment, from strong growth to contraction.  The service sector portion of the CWPI shows a contraction which some blame on the weather.  A slight contraction – a reading just below 50 – can be just noise in the survey data.  The past two times when the employment component of the services sector has dropped below 48, as it did in this latest report, the economy was already in recession; we just didn’t know it till months later.

A close comparison of the current data with the previous two episodes may sound a cautionary tone.   At this month’s reading of 48.6, the CWPI services portion is not showing as severe a contraction as in April 2001 (43.5) and January 2008 (33.1), when the employment component also dropped below 48.

New orders and employment in both portions of the CWPI are given extra weight. In January 2008, new orders and employment both fell dramatically.  The current decline is similar to the onset of the recession beginning in early 2001, when employment declined severely in April but new orders remained about the same.  Let’s isolate just these two factors and weight them proportionate to their respective weights in the services portion of the CWPI.

Notice that the decline below 50 signaled the beginning of the past two recessions.  Here’s the data in a different graph with a bit more detail.

Some cite the historically severe weather in the populous eastern half of the country as the primary cause for the decline in the services sector employment indicator and it well may be.  If so, we should expect to see a rebound in this component in March.  Basing a prediction on one month’s reading of one or two components of an indicator is a bit rash.  However, we often mistakenly attribute weakness in some parts of the economy to temporary factors and discount their importance because they are temporary – or so we think.

In the early part of 2008, many thought that a healthy correction in an overheated housing market was responsible for the slowdown in economic growth.  In the spring of that year, the bailout of bankrupt Bear Stearns, an undercapitalized investment firm which had made some bad bets in the housing market, confirmed the hypothesis that the corrective phase was nearing its end. As weakness continued into the late spring of that year, some blamed temporarily high gasoline and commodity prices for exacerbating the housing correction.  In the fall of 2008, the financial crisis exploded and only then did many realize that the problems with the economy were more than temporary.

In the early part of 2001, a healthy correction to the internet boom was responsible for the slowdown – a temporary state of affairs.  When the horrific events of 9-11 scarred the country’s psyche, the recession was almost over.  Many were not listening to the sucking sound of manufacturing jobs leaving for China or giving enough importance to the increasing competitiveness of the global market.  Employment would not reach the levels of early 2001 till the beginning of 2005.

This time the slowdown in employment and new orders in the services sector may be a temporary response to the severe winter weather.  Let’s hope so.


Private Sector employment and new unemployment claims

ADP released their February employment report this week and eyes rolled.  January’s benign reading of 175,000 private job gains was so at odds with the BLS’ reported gains of 113,000.  “Oh, wait,” ADP said this week, “we’ve revised  January’s gains down to 127,000.”  In a work force of some 150 million, 50,000 jobs is rather miniscule.  As the chief payroll processor in this country, ADP has touted its robust data collection from a large pool of employers.  A revision of this magnitude leads one to question the robustness and reliability of their methodology, and the timeliness of their data collection.  For its part, the BLS admits that its current data is based on surveys and that each month’s estimate of job gains is largely educated guesswork.  ADP is actually processing the payrolls, which should reduce the amount of guesswork.

Private job gains in February were 10,000 below the consensus 150,000 but this week’s report of new unemployment claims dropped 27,000, bringing the 4 week average down a few thousand.  As a percent of workers, the 4 week average of continuing claims is below the 33 year average and has been since March 2012.  In this case, below average is good.


Employment – Monthly Labor Report

This week’s labor report from the BLS carried a banner caveat that the cold weather in February may have affected employment data.  With that in mind, the headline job gains of 175K were above expectations for 150K job gains.  The unemployment rate ticked up a bit.  If we average the ADP job gains with the private sector job gains reported by the BLS, we get 150K plus 13K in government jobs added for a total of 163K total jobs.  The year over year growth in the number of workers is above 1%, indicating a labor market healthy enough to preclude recession.

A big plus this year is the growth in the core work force, those aged 25 – 54, which finally surpassed the level at the end of the recession in the summer of 2009. 

However, there are some persistent trends independent of the weather that underscore the challenges that the current labor market is struggling to overcome.

As I pointed out last week, there are several unemployment measures, from the narrowest measure – the headline unemployment rate – to wider measures which include people who are partially employed.  The U-6 rate includes discouraged workers and those who are working part time jobs because they can’t find full time jobs.  For a different perspective, let’s look at the ratio of the widest measure to the narrowest measure. The increase in this ratio reflects a growing disparity in the economic well being of the work force.

Contributing to the rise in this ratio is the persistently high percentage of workers who are involuntary part timers.  Looking back over several decades, we can see that the unwelcome spike in this component of the work force can take a number of years to decline to average levels.  Following the back to back recessions in the early 1980s, levels of involuntary part timers took 8 years to recover to average, then quickly climbed again as the economy sputtered into another recession.  We are almost five years in recovery from this recession and have still not approached average.

There are more discouraged workers today than there were at the end of the recession in the summer of 2009.  Discouraged workers are included in the wider measure of unemployment but not in the narrow headline unemployment figure.

The median duration of unemployment remains at levels not seen since the 1930s Depression.  Someone who becomes unemployed today has a 50-50 chance of still being unemployed four months from now.  That would make a good survey question:  “In your lifetime, have you ever been involuntarily unemployed for four months?”

Despite all the headlines that the housing market is rebounding, the percent of the work force working in construction is barely above historic lows.

A recent report by two economists at the New York branch of the Federal Reserve paints a disappointing job picture for recent college graduates.  On page 5 of their report is this telling graph of a higher percentage of recent college graduates accepting low wage jobs.

Low wage and part time jobs do not enable a graduate to pay back education loans.  Almost two years ago, the total of student loans surpassed the trillion dollar mark.  According to the Dept. of Education, the default rate in 2011 was 10%.  I’ll bet that the current default rate is higher.



As is often the case, data from one source partially contradicts data from a different source.  The employment decline reported by ISM bears close watching for further signs of weakness.  The yearly growth in jobs reported by the BLS indicates a relatively healthy job market.

The Market and Growth

March 2nd, 2014

Some pundits have made the case that the stock market is due to fall this year because of the almost 30% rise in prices in 2013.  On the face of it, it seems logical.  If the average rise in the SP500 over the past fifty years is about 8-1/2% and there is a 30% rise in one year, then the market has essentially “used up” more than three years of the average – all in one year.  But the stock market is the net result of billions of buy and sell decisions by human beings.  My experience has taught me that the connection between sense and the behavior of human beings is tenuous, at best.  The Red Carpet walk at the Oscars Award Ceremony is a demonstration of the nonsensical choices that human beings make.  I mean, can you believe the dress that actress is wearing?  And who told that actor he could grow a beard?  PUH-LEEZ!

So I looked at past history and wondered: what is the average yearly return of the SP500 index over the three years following a 20% rise in the market?  As an example, if the market rises 20% in Year #1, what is the 3 year average of yearly returns in Year #4?  The results surprised me – 9.5%.

But wait! you say.  The late nineties were an aberration of irrational exuberance that skews the average.  Removing those two outliers from the data set gives a yearly average of 6.2%.  Add in 2% dividends and the total comes to 8.2%, a respectable return.

But wait!, you say again.  What about the year after the 20% rise?  Surely, the index must compensate for the above average rise the previous year.  In the year after a 20% rise in the market, the average gain was 13.5%.  Again, there were those crazy years of the late nineties so I’ll take them out, leaving an average gain of 3.7%.  Add in the 2% dividend and it easily outpaces the current return on long term bonds.

This year the pundits could be right and the stock market falls.  However, a successful long term investor must learn to play the averages.


GDP and Savings

GDP is a measure of the economic output of a nation but what the heck is it?  A recent presentation by Gary Evans, an economics professor at Harvey Mudd College in California, has a number of wonderfully illustrated graphs that may help the casual reader understand the components of GDP and recent trends in the economy.

On January 30th, the Bureau of Economic Analysis (BEA) released their advance estimate of real GDP growth of 3.1% in the 4th quarter.  As more information of December’s slowdown became available in late January and early February, the market began anticipating that the BEA would revise their advance estimate down.  Slower growth might mean further declines in stock prices, right? Instead, the market anticipated that a slowing of growth in the fourth quarter would calm the hand of the Fed in tapering their bond purchases. As a result, the market  rebounded in February, more than making up for January’s decline.  On Friday, the BEA revised their second estimate of fourth quarter growth downward to 2.4%, almost exactly what the market consensus had anticipated and the market finished out a strong month with a small gain.  The BEA attributed the slower growth in the fourth quarter to reductions in federal, state and local government spending and a slowdown in residential housing.

As the BEA revises their methodology, they also revise previously published GDP data.  In the 2013 revision the BEA adjusted their data going back to 1929.  In the past few years, revisions have added about 1/2 trillion dollars to GDP.  Adjustments to the personal savings rate were substantially higher but savings in the past decade have been at historically low levels.  Personal savings are the amount of disposable income, or income after taxes, that families save.  The rate or PSR is the the percentage of their disposable income that they don’t spend.

When people charge purchases that decreases the savings rate.  Conversely, when families pay down their credit purchases that increases the savings rate.  Despite the explosive growth of household debt in the past thirty years,

the savings rate has remained positive, meaning that the people who do save are more than offsetting those who don’t or can’t save.

Let’s take an example of three families:  the Jones family makes $60K in disposable, or after tax income, saves nothing, but increases their debt $8,000 by buying a new car.  Their personal savings rate is $-8K/$60K, or -13.3%.  The Smith Family also has $60K in disposable income, but is frugal and pays down a few loans and saves some money for a total savings of $2K, or 3.3%.   The Williams family has a disposable income of $120K and has net savings of $20K, or 16.7%. Families with higher incomes tend to save proportionately more of that income.  Total disposable income for the three families is $240K.  Total savings is $14K, or 5.8% of disposable income, but that hides the fact that it is the Williams family that is making most of the contribution to that savings rate.

There is another subtle element contributing to this disparity in savings: inflation.  The Consumer Price Index charts the increasing prices of goods and services – spending.  A higher income family that spends less of its income is less affected by changes in the CPI than a lower income family and this helps a higher income family save proportionately more than the lower income family.  The difference is slight but the compounded effect over thirty years is significant.

During the past thirty years, the personal savings rate has steadily declined.

This doesn’t mean that families are saving less as a percentage of their income but that the number of families with net savings are becoming fewer while the number of families with little net savings or negative net savings are becoming more numerous.  The period from 1930 to 1980 was one of relatively more income equality than the period 1980 to the present.  Let’s look again at the chart above.  In the late 1970s, as income equality begins a decades long decline, so too does the personal savings rate.  The ratio of high income families with a relatively high savings rate to lower income families with a low savings rate also declines.

Savings drives investment in the future.  The low savings rate means that future U.S. economic growth must rely ever more on the savings from those in other countries.  Typically savings rates increase as a recession progresses and then the economy recovers.

Notice that the savings rate has stayed relatively steady in the past three years, indicating neither an increasing confidence or caution.  As shown in the table, only the three year period from 1988 – 1990 period showed the same lack of direction.  GDP growth in that period was stronger than it is today but the savings and loan crisis and the stock market crash of October 1987 had diluted the confidence of many.


New Home Sales
Here’s a head scratcher.  New home sales rebounded almost 10% in January, after falling 13% in December.  Even the figures for December were revised a bit higher.  As I noted last week, the rather flat growth in incomes has become an obstacle to the affordability of homes. December’s Case Shiller 20 city home price index reported a 13.4% annual increase in home prices. January’s rise in home sales was partially aided by sellers willing to make price concessions, resulting in a 2.2% decrease in the median sales price.


Durable Goods
Orders for durable goods, excluding transportation, were up about 1% this past month. A durable good is something which has a life of 3 years or more.  Cars and furniture are common examples. The year over year gain, a bit over 1% as well, indicates rather slow growth over the past year after adjusting for inflation.  However, several current regional reports of industrial activity indicate a quickening growth at the start of this year.  Reports from Chicago, Philadelphia and Kansas City hold promise that next week’s ISM assessment of manufacturing activity nationally will show a rebound.

As I have noted in blogs of the past few months, the pattern of the CWI index that I have been compiling since last summer indicated a rebound in overall activity in the early spring of this year.  This gauge of manufacturing and non-manufacturing activity is based on the Purchasing Managers Index released each month by ISM.  I suppose a better name for the CWI index would be “Composite PMI.”  Readers are welcome to make some suggestions.


New unemployment claims rose, approaching the 350K mark, but the 4 week average of new claims is holding steady at 338K.  In past winters the 4 week average has been around 360K.  If new claims remain relatively low during this particularly harsh winter in half of the country, it will indicate an underlying resiliency in the labor market.

Janet Yellen, the new chairwoman of the Federal Reserve, appeared before the Senate Finance Committee this week.  In her response to questions about the dual mandate of the Fed – inflation and employment – she noted that the Fed looks at much more than just the unemployment rate in gauging the health of the labor market.  One of the employment indicators they use is new unemployment claims.

When asked what unemployment rate the Fed considers “full employment,” Ms. Yellen stated that it was in the 5 – 6% range.  One of the Republican Senators asked about the “real” unemployment rate, without specifying what he meant by the word “real.”  Without hesitation and in a neutral tone, Ms. Yellen responded that if the Senator meant the “widest” measure of unemployment, the U-6 rate, that it was about 13%.  The U-6 rate includes discouraged workers and part time workers who want but can not find full time work.

When George Bush was President, “real” meant the narrowest measure of unemployment to a Republican because it was the smallest number.  With a Democrat in the White House, the word “real” now means the widest measure of unemployment to a Republican because it is the largest number.  Democrats employed the same strategy when George Bush was President, preferring the higher U-6 unemployment rate as the “real” rate because it was higher.  I thought that it would be a good response for anyone when confronted by a colleague at work about the “real unemployment rate” that we steer the conversation to more precise and politically neutral words like “widest” and “narrowest.”

A reader sent me a link to a Washington Post article on the pension and budget woes of San Jose, a large city in California.  I am afraid that we will see more of these in the coming decade.  Beginning in the 1990s politicians in state and local governments found an easy solution to wage demands from public workers: make promises.  Wages come out of this year’s budget; pension promises and retiree health care benefits come out of some budget in the distant future.  For an increasing number of governments, the distant future has arrived.

In Colorado, a reporter at the Denver Post noted that the Democratic Governor and the Republican Treasurer are hoping that the state’s Supreme Court will force the public employee’s pension fund, PERA, to open its books. It might surprise some that a public institution like PERA is less transparent than a publicly traded company.  Actuarial analysis estimates are that PERA’s asset base is underfunded by $23 billion, or about $46,000 for each retiree. It was only last year that the trustees of the fund reluctantly lowered its expected returns to 7.5% from 8%.  Assumptions on expected returns, what is called the discount rate, is a major component in analyzing the health of any retirement fund and the money that must be set aside today to pay for tomorrow’s promised benefits.  Many analysts contend that even 7.5% is a rather lofty assumption in this low interest rate environment.

Readers who Google their own state or city and the subject of pensions will likely find similar tales of past political promises and lofty assumptions running headlong against the realities of these past several years.