market commentary

     WEEKLY ECONOMIC COMMENTARY -- WEEK OF FEBRUARY 5, 2010

When Uncle Joe had news to tell the family, he always asked: do you want to hear the good part first, or the bad? Being family oriented citizens with a positive bent, we decided to parse the all important jobs report by offering the good part first. We also opted for this selection because the financial markets had been braced for a disappointment, reflecting some negative economic signals over the past week or so (including an unexpected rise in claims for unemployment benefits) and the bearish sentiment emanating from overseas developments, primarily the fiscal woes of Greece and other weaker members of the European Union. Stock prices staged a dispiriting plunge on Thursday, the day prior to the jobs report, as much in response to the "what's next" syndrome as to the possible contagion effects of the threatening foreign debt problem.

But the grim anticipation of "what's next" melted into a sigh of relief, as the jobs report had as many good as bad elements. Most promising and bound to receive the biggest media attention was that the unemployment rate fell in January, falling below the emotionally charged double digit threshold of 10% in December to 9.7%. As noted, economists were braced for worse news on this front, with the consensus looking for an increase to 10.1%. Even those analysts who “pooh pooh” the significance of this measure have to be pleasantly surprised, not only by the tick down last month but by the behavior of ancillary data tied to the jobless rate.

For example, a good deal of attention is paid to the so called "underemployment rate", which includes people who have stopped looking for work during the past four weeks but would like a job as well as those who are forced to work part time for economic reasons. This rate, designated U-6 by the Labor Department, fell from a horrendous 17.3% in December to a still dispiriting but more tolerable 16.5% in January. The peak for this metric was 17.4% last October, and many feared it would rise to depression like levels of above 20%, evoking memories of the 1930s. Nor was the improvement in the official jobless rate a function of people dropping out of the labor force, which often distorts the significance of that measure. In January, the labor force increased by 111,000, which was more than matched by the 541,000 increase in the number of households reporting they have jobs.

Still, the prevailing wisdom is that the drop in the unemployment rate last month was more of a quirk that the start of a declining trend. Keep in mind that a full one million workers have dropped out of the labor force over past year alone, reducing the civilian work force from 154.1 million to 153.1 million. As a result, the labor force participation rate, the fraction of the adult population in the labor force, has fallen to 64.7%; that's the lowest since the 1980s, before the influx of women bloated the labor force and sent the participation rate sharply higher over the next two decades. It stands to reason that as the economy improves and job prospects brighten, many of those dropouts will restart their job search, imparting a big boost to the labor force. And unless companies abruptly go on a hiring frenzy, these job applicants will overwhelm new job openings, driving the unemployment rate up as well.

Needless to say, the extent of the rise in the jobless rate will have political implications, as this measure is the most widely used weapon that politicians wield to drive home a point, either to show that labor market conditions are improving (by the incumbents) or that they are deteriorating (by the opposition seeking to replace the incumbents). But even with the January drop, hardly anyone in Washington is ready to break out the champagne. Aside from the potential rebound in the unemployment rate that is likely in coming months, there is little question that the job market is mired in a painful state. The number of people out of work for more than six months continues to climb, reaching 6.3 million in January compared to 2.7 million a year ago. With so much competition from the potential influx of job seekers, the plight of these long term unemployed workers will likely get worse before getting better. It’s a small wonder that president Obama is redoubling efforts to stimulate job growth through a variety of measures, including channeling funds as quickly as possible to credit starved small businesses that do the bulk of the hiring during a recovery.

To be sure, the fall in the unemployment rate is not the only "good news" contained in the January jobs report, although Uncle Joe would probably cite it up front. But before elaborating on the brighter aspects of the report, it is important to highlight its key message: companies are still not expanding payrolls. Keep in mind that the unemployment rate is derived from a survey of households whereas the figures on job creation that the financial markets focus on is derived from a survey of companies, which is much larger and generally considered to be a more accurate reading of labor market conditions. The headline message from the company, or establishment, survey is much less encouraging. In January, non-farm businesses shed another 20,000 workers from payrolls, disappointing the Wall Street consensus that had expected a modest increase.

Until the economy starts to generate positive job growth, it will be hard for Main Street to believe a recovery is underway, despite the assertions of statisticians in and outside of Washington. What's more, the job creating engine would have to run for some time before recovering the ground lost over the past two years. Indeed, the extent of the job destruction inflicted by the Great Recession was made even more apparent in the revisions to the numbers released as part of the January jobs report. As it turns out, there were almost 1 ½ million additional workers who lost their jobs since April 2008 than were originally counted, bringing the total job destruction since the recession started in December 2007 to an astonishing 8.4 million. Both in absolute numbers and as a percentage of the work force, the job market has not seen such deterioration since the end of the Second World War, when the nation was cranking down its wartime production.

That said, the discouraging revisions that made conditions look decidedly worse over the past two years have not altered the improving trend underway in recent months. If anything, it creates more of a contrast between the firing panic in place a year ago, when companies were purging an average of 753,000 workers a month from January through March, and the more hopeful trend over the past three months when payrolls held virtually unchanged. The January loss of 20,000 jobs comes on the heels of an upwardly revised 64,000 gain in November and a downwardly revised 150,000 decline in December. Hence, the average for the past three months comes to a statistically insignificant monthly loss of 35,000, which can easily be swallowed up in future revisions.

Still, the financial markets did not take kindly to the small loss reported for January; investors were hopeful that the job market had finally turned the corner and would show an increase for the month. After all, many leading indicators pointed to a rise, most notably six consecutive monthly increases in temporary worker hiring, a time honored precursor to job growth, and the very encouraging ISM manufacturing index, which shot up to the highest level in more than five years in January. If patience is a virtue, it can also be a frustrating experience when expectations are running high. Perhaps, as some economists are warning, some of these so called leading indicators are providing a misleading reading of underlying developments. For example, the surge in temporary hiring may not portend an imminent pickup of permanent hiring after all, but rather a fundamental change in the way companies are managing their workforce.

According to this argument, a sea change in the use of temporary workers has taken place, making them a permanent fixture in what is shaping up to more a more flexible work force. Not only does this give companies more latitude to expand or contract payrolls in response to rapid shifts in demand, it also contains costs because these workers are usually hired without all of the benefits associated with permanent positions. While this motive may be underpinning the extensive use of temporary workers, we still believe it will not be a persistent one. A more likely explanation is that the uncertainty regarding health care reform has caused many companies, especially smaller firms, from making staffing decisions, as the ultimate costs of hiring new workers was, and still is, unpredictable. We will see how this plays out as the recovery progresses and the health care debate is resolved.

What is undeniably encouraging in the January jobs report is that workers are putting in longer hours and getting pay raises. The average workweek increased by six minutes during the month and average hourly earnings gained 0.3%. Those are hardly barn burning gains, but they do fatten weekly paychecks by 0.6 for households, which is vitally needed to support consumption. If our calculations are correct, we should see an increase of 0.5% in wages and salaries in the next personal income report for January. That would be among the strongest monthly increases since late 2007, before the record post war pace of job destruction began. The impact on worker earnings from the firing frenzy is palpable. As the chart shows, wages and salaries have fallen on a year over year basis for a record 13 consecutive months through December, when it still stood 2% below its year earlier level.

All in all, we are mildly encouraged by the January jobs report. A positive number would have been better than another loss, for sure, but the trend is clearly moving in the right direction. It may well be that the unexpected 75,000 drop in construction payrolls, one of the major negative surprises in the report, was an aberration related to unfavorable weather last month, it actually snowed in Florida. As it is, the payroll figures are behaving very much as they usually do just before turning positive on a sustainable basis, flip flopping between plusses and minuses for a while. We suspect it will only be a matter of months before the economy starts generating positive job growth on a steady basis. We are also not convinced that the pace of job creation, when it does arrive, will be as sluggish as most economists seem to think. With the latest revisions to last year's figures, it becomes even more evident that there were a lot of "panic" firings in the heat of the credit crisis that was probably unnecessary. Quite possibly, many companies may feel understaffed when the economy starts showing renewed vigor, spurring more robust catch up hiring than is generally expected.