While the government's reporting of February employment was improved, which is definitely beneficial to stocks today, the true state of affairs in the labor force is much worse than reported. If unemployment and underemployment are understated, then economic expectations and investor passion are likely overstated. Therefore, this economic analysis is critical, and we should be looking at 18.0%, not 7.7%, and acting accordingly.
The government's data excludes many Americans who have fallen out of the labor force, and not by choice. Not including these people assumes many have chosen early retirement, but the number of lottery winners has not changed, so I think it's more likely that these people have simply fallen off the government's radar screen. When Americans stop receiving unemployment benefits, a key incentive to report unemployment to the government is lost. But even as they don't report their unemployment, they live like they are jobless, and so spending and economic growth are impacted. In our calculations here, we've determined that true unemployment is likely 11.8%, not the 7.7% rate just reported by the government for February. Underemployment is likely closer to 18.0% than the government's reported U-6 figure of 14.3%.
Starting with the Reported Data
Nonfarm Payrolls increased by 236,000 on net in February, far better than the consensus projection of economists for 171K, according to Bloomberg's survey. Private nonfarm payrolls (excluding public sector job creation) grew by 246K, again much better than the 195K economists' consensus. The Unemployment Rate was likewise better than expected, with the rate improving to 7.7% from 7.9%, and against the economists' consensus forecast for a lesser improvement to 7.8%. So the employment situation clearly improved in February according to the government, and was better before our adjustments here. What's doubly distressing is that the improvement trend does not play through after our adjustments, so that the celebration of the positive change is uncalled for today. Furthermore, the absolute level of employment is not anywhere near as celebratory as the government data seems to say.
Cleaning the Data
There are several ways to measure underemployment, but the most common method is covered here because I believe it to be most important. I then apply the same math used to measure the real unemployment rate in order to find the real underemployment rate.
The underemployment equation incorporates people who are not satisfied with their less than full employment and also includes those desperate Americans who are detached from the labor force. However, even the traditional underemployment rate misses what may be a significant number of Americans who are not working and would like to be. To uncover those forgotten Americans, we replace the current labor participation rate with the one that existed when unemployment was under 5.0% instead. Whether it can ever be under 5.0% again is debatable and will be the topic of another article of mine for certain. For now, we assume it is possible to get there again.
It makes sense to use such a legacy participation rate if you believe population growth and the maturing of Americans at least matches the number of seniors retiring by choice and Americans passing away prematurely. Obviously there are demographic trends at play here that are skewing the participation rate, including the aging of the baby boomers, which is costing participation. That is what you will hear from economists who overlook the fact that the economy is burdened by something, and very likely an understated level of unemployment. Because of the relevant issue of long-term unemployment in America today and workers falling off the labor force radar screen while still interested in working, I believe these adjusted figures provide an important perspective of the true state of American labor.
The calculation of the under-employment rate, or the U-6 by government notation, takes into account the number of Americans working part-time for economic reasons and the detached workforce. Working part-time for economic reasons is equivalent to folks who would prefer full-time employment but have had their hours cut or have had to otherwise settle for part-time work. Detached workers are those Americans who have not recently looked for work, sometimes because they do not believe work exists for them today. In getting to the U-6 underemployment figure, we'll need to include these groups of workers with unemployed Americans. If we add back the excluded 2.588 million displaced workers to the labor market, and include the 7.988 million underemployed part-timers in the unemployed count, February underemployment is found to be ((12.032M + 2.588M + 7.988M) / (155.524M + 2.588M)) * 100 = 14.3%. In January, the rate was ((12.332M + 2.443M + 7.973M) / (155.654M + 2.443M)) * 100 = 14.4%.
This data can be skewed by any of its components. Starting with the denominator, the reported labor force count decreased in February by 130K, which would enhance the unemployment rate if all else were unchanged. Note also that in February the number of detached workers increased by 145K, which would also lift the rate. The number of forced part-timers increased only marginally by 15K, which would lift the rate ever so slightly. Most importantly, though, the number of people reporting unemployed status was down by 300,000, driving the critical change in the rate.
Historically speaking, U-6 underemployment is improved, as you can see by the table here. However, this improvement may be for another reason (a bad one) which is unaccounted for by this data, and which we discuss in the paragraphs below.
U-6 Unemployment Rate (Seasonally Adjusted)
What About the Forgotten?
I often talk about the great degree of long-term unemployment plaguing our nation today and how this has uniquely impacted reported employment data. The number of Americans unemployed for 27 weeks or longer increased by 89K in February, rising to 4.797 million. This represented 40.2% (38% last month) of the total unemployed count. The proportion had actually been improving up to now, though it continues to reflect poorly on the state of labor. That's because the longer people remain unemployed, the harder it gets for them to find jobs in their specialty fields due to eroding and outdated skill sets. My greatest concern is that the trending improvement in the proportion of long-term unemployment has been partly due to Americans simply falling out of the labor force count rather than finding new work.
For this reason, it's worth considering what the unemployment rate might be at labor force participation rates seen in the recent past. The labor force participation rate was 63.5% in February 2013 (63.6% in January). That compares against 66.4% in November 2006 when unemployment was much lower. Now, maybe that past participation rate reflected the excesses of the mortgage, construction and finance industries that resulted from greed and the fault of the rating agencies and those industries. Those faults are still bearing out in layoffs, like the significant cuts announced relatively recently by JPMorgan Chase (JPM), Goldman Sachs (GS) and Citigroup (C), and a year ago by Bank of America (BAC). Still, let's calculate what the unemployment rate would be at a legacy participation rate, because if the economy had not been so disrupted by the financial crisis, perhaps those employed in the synthetically fattened fields might have found other work.
Applying the 66.4% rate to the noninstitutional population count in February 2013, we get a civilian labor force count of 162,565,792, versus the 155,524,000 reported (Note calculation error exists when applying the reported participation rate to the current population count because of the seasonal adjustment to the labor force count). I've attempted to back into that adjustment and apply it to the theorized labor force count achieved above, resulting in this figure for the adjusted labor force: 162,626,671). After that adjustment, the difference from this February's workforce count is 7,102,671 million Americans who would be added to the unemployed count as well. So if those 7.1 million Americans have simply fallen off the radar, the true unemployment rate could be as high as 11.8% (not 7.7%), which is unchanged from January 2013. Likewise, the real underemployment rate could be as high as 18.0% today, which is actually up from 17.9% January 2013.
Those are significant differences reflecting a poorer state of health for American labor and the economy than the government has indicated. What's worse is that the real underemployment rate actually deteriorated, while an improvement is being reported by the government in unemployment. Today's celebrated report is misleading, and given the message conveyed by the fourth quarter GDP report, perhaps investors need to heed this reality check.
The SPDR S&P 500 (SPY), SPDR Dow Jones Industrial Average (DIA) and the PowerShares QQQ (QQQ) have gained approximately 8.7%, 10.0%, and 5.5% respectively, year-to-date through March 7, 2013. Fueled by massive capital flows out of money market funds, gold, gold ETFs like the SPDR Gold Trust (GLD) and other safe havens post the passing over of the fiscal cliff and debt ceiling issues, gains could continue. However, given the two important economic data points noted here, perhaps it is time to reconsider.
Employment services stocks were sharply improved Friday on the news. The shares of several of the nation's largest employers were also decidedly higher, likely on those same capital flow drivers discussed previously.
Friday's Change Thru Midday
Robert Half Int'l (RHI)
Korn Ferry Int'l (KFY)
Monster Worldwide (MWW)
Stocks will tend to lead the economy by approximately 6 to 9 months, and so the investment direction implies a market expectation more than a current situation. However, the economic takeaway here should be that America's unemployment situation could be significantly understated. Such a burden combined with increased payroll taxes should weigh on consumer spending growth and act as a drag on economic expansion. Therefore, fiscal and monetary policies, which have been backing away from once purely expansionary intent, should thus remain supportive of economic growth, and job creation.