February 2014 A. Gary Shilling's
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INSIGHT
(ISSN 0899-6393) goes to press by the third business day of the month.
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The Fed Capitulates
And For Good Reason
In This Issue
April 2014
The Federal Reserve finally threw in the towel on its unfortunate target
the6.5% unemployment rate (
Chart 1
) at which it would likely raise the federalfunds rate in controls from essentially zero at present.
Unfortunate
We say
unfortunate
for two reasons. First, setting quantitative targets isridiculous in an era when monetary policy is subject to fiscal drag due to higherincome tax rates and the expiration of 2009's massive stimuli, uncertainconsumer spending, a skittish housing sector, Congressional gridlock and theunknown effects of foreign developments such as slowing growth and
Volume XXX, Number 4 April 2014
The Fed CapitulatesAndFor Good ReasonThe Fed junked its 6.5% unemploymentrate target for raising interest rateslargely because the declining labor participation rate has artificiallydepressed joblessness. About 60% of the participation rate drop from its 2000peak is due to demographics, principallythe retiring postwar babies. Fortypercent of the decline is due to youthswho stayed in school due to poor jobprospects. Middle-aged discouragedworkers also dropped out but wereoffset by the rising number of 65+people who work due to inadequateretirement funds as well as better health.The overall participation rate droppedfrom 67.4% of those age 16+ in 2000 to63% this year, and current trends willpush it to 60.1% in 2020. Even at thelow level, population growth will provideenough people to accommodate thereturn to rapid economic growth,assuring the proper skill matches andproductivity growth at the 2000s rate.How China's WoesCould Shock InvestorsThe ongoing "risk on" investment climatewould shift to "risk off" with asubstantial shock. Difficulties in Chinamay result in such a jolt, and 8 problemsthere point in that direction:1.Slowing Economic Growth2.Transition from Export-Led to Domestic-Driven Economy3.Rising Militarism4.Anti-Corruption Campaign5.Manipulation of the Yuan6.Shadow Banking Risks7.Interest Rate Deregulation8.Botched Bailouts
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1Alternative Measures of Unemployment
Source: Bureau of Labor Statistics
Last Points 2/14: unempl. 6.7%; alt. measure 12.6%
Jan-00Jan-02Jan-04Jan-06Jan-08Jan-10Jan-12Jan-142%4%6%8%10%12%14%16%18%2%4%6%8%10%12%14%16%18%Total unemployed (U-3)Total unemployed + marginally attached workers + employed part time for economic reasons (U-6)
Economic Research and Investment Strategy
A. Gary Shilling
s
INSIGHT
2
A. Gary Shilling's
INSIGHT
April 2014
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financial problems in China and other developing economies. After the meltdown of the subprime mortgage marketrevealed its opaqueness, transparency became the goal in Washington and in financial markets. Federal Reserveofficials, as mere mortals, caught the bug and have triedto apply transparency to their policy targets even thoughmonetary goals are driven by uncertain data and thereforeimpossible to quantify with any degree of precision.Even if monetary goals could be precisely and predictably delineated, doing so would remove the uncertainty andmystery from policy. And that unpredictability is whatkeeps markets honest and speculation in check. Considerthe Chinese yuan, which was raised vs. the dollar sosteadily in recent years that speculators jumped in to takeadvantage of a one-way bet, often moving money intoChina illegally to do so. That induced the government todepreciate the yuan, starting in mid-February, to createuncertainty and punish speculators but with as yet unknownunintended and possibly destabilizing consequences.
A Poor Indicator
The second reason the Fed's unemployment rate goal was unfortunate is because even though this is the headlinenumber, it is a notoriously poor indicator of labor marketconditions. It
s the ratio of the jobless, those who say they
ve actively looked for work in the last four weeks, tothe sum of that group and the employed. So it doesn
taccount for the quality of jobs. As we
ve noted in past
Insight
s, leisureand hospitality jobs have risen by 1.53million since the trough in January 2010 while manufacturing jobs have climbed622,000 since their February 2010bottom. But since leisure and hospitality workers are paid less and work fewerhours than in manufacturing, their weekly pay is only 35% as large.Furthermore, the headlineunemployment rate
U-3 in Bureauof Labor Statistics parlance (Chart 1)
doesn
t say anything about the leap inthe Great Recession in the long-termunemployed (
Chart 2
) or the widenedunemployment rate gaps based on raceand education levels. Ditto for the leap in part-timeemployees who would like to work full-time (part-timefor economic reasons). And, of course, the standardunemployment rate does not measure the ongoing incomepolarization in America, which we discussed in detail lastmonth, and the drop in median real income, even in theongoing economic recovery.
Labor Participation Rate
Most importantly, the headline unemployment rate doesn
taccount for the hordes who have dropped out of thelabor force and therefore aren
t counted as unemployed. As discussed in detail in
How Tight Are Labor Markets?
(June 2013
Insight
), if the labor participation rate now were the same as the 67.3% in February 2000, the laborforce would be 10.6 million bigger than it is.Since the unemployment rate back then was 4.1%, thisimplies 14.3 million more job holders. Without thatdecline and with today
s employment, the U-3unemployment rate would be 12.7%. Furthermore, 88%of the decline in the jobless rate since its peak at 10% inOctober 2009 was linked to the drop in the participationrate from 65.0% back then to 63.0% in February 2014.......
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2Duration of Unemployment
Source: Bureau of Labor Statistics
Last Points 2/14: 27+ weeks 37.0%; avg. weeks 37.1
Jan-48Jan-58Jan-68Jan-78Jan-88Jan-98Jan-080%5%10%15%20%25%30%35%40%45%50%51015202530354045% Unemployed for 27+ Weeks as a % of Total - left axisAvg. Weeks Unemployed - right axis
April 2014 A. Gary Shilling's
INSIGHT 3
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How China's Woes Could Shock Investors
In last month
s
Insight
, we noted that the
risk on
investment climate persists with robust U.S. equities even though
Consumer spending is subdued, even after accounting for inclement weather early this year
The housing recovery is slipping and has been driven by rentals, not the solid foundation of new homeowners
The Administration
s fixation on income redistribution reinforces gridlock in Washington as the 2014 elections loom
Tepid labor markets have weakened further and the weather isn
t to blame
Obama
s minimum wage proposal will cut employment by 500,000 while adding a trivial net $2 billion to incomes,according to the CBO
While Obamacare confuses individuals and employers alike, the CBO forecasts a 2.5 million job loss as people arepaid to not work
The Fed is determined to taper despite deflation risks, falling commodity prices and emerging market crises
Reduced Fed largess is separating the well-managed developing country Sheep from the poorly-run Goats whileglobal contagion remains a possibility
The crisis in Ukraine threatens a slowdown in East-West trade and a revival of the Cold War
Shocks
This month, we
ll begin to examine themany shocks that would force investorsinto an agonizing reappraisal and aswitch to a
risk off
strategy. Mostinvestors with long-only equity portfolios don
t want to walk away from a winning game. Like mosthumans, they play until they lose, as wastrue of the dot com stocks in the late1990s (
Chart 1
) and the housing bubble-driven market in the mid-2000s (
Chart 2
). They prefer to ignore the removalof fuel under the boiling equity potprovided by the Fed since August 2008. They also turn a blind eye to the basis of corporate earnings: the unsustainableleap in profit margins driven by cost-cutting (
Chart 3
) and the lack of solidsales volume gains in a slow growtheconomy and the absence of pricing power in an inflation-less businessclimate.It
s possible, of course, that equity investors
enthusiasm will be vindicated. All the problems we just listed may besolved without significant stock marketimplications. Economic growth may spurt this year and fulfill expectationseven though similar hopes in each of thelast five years have been dashed. But
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1Nasdaq Index
Source: Yahoo Finance
Last Point 4/1/14: 4,268
Jan-80Dec-83Nov-87Nov-91Oct-95Oct-99Oct-03Sep-07Sep-110500100015002000250030003500400045005000550005001000150020002500300035004000450050005500
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2S&P 500 Index
Source: Yahoo Finance
Last Point 4/1/14: 1,886
Jan-80 Dec-83 Nov-87 Nov-91 Oct-95 Oct-99 Oct-03 Sep-07 Sep-1102004006008001000120014001600180020000200400600800100012001400160018002000
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