The February unemployment number gave a modest upside boost to stocks on Friday. Those looking for evidence that the economy is finally gaining momentum - and I include myself in that category - can point to the .2% drop in the official unemployment number as just one more metric that shows that economic growth is finally beginning to accelerate.
However, to the chagrin of those who want the party to continue and don't care too much for those who insist on taking a look under the hood, I can't resist the need to look a little deeper. I intend to do just that but first, my initial thoughts as the numbers were being reported:
- Wow! That is a really great number.
- Could the economy really be gaining momentum?
- Is this due to improving sentiment from businesses, banks and consumers?
- I wonder what happens to the number when "sequestration cuts" are factored in.
- What did the labor participation rate do?
- What was the U6 number?
Then I had a few more thoughts. Here's what really matters - GDP. If GDP is growing then top line sales are growing and therefore higher corporate profits are certain to come, meaning stocks should move higher.
Keep in mind I don't think we are significantly overpriced on stocks based on trailing PEs. However, I do know that top line sales growth is flattening and profits peaked in early 2012 and have been trending slightly lower since - hence the virtual flat GDP print in the 4th quarter of 2012.
So, does the downtick in unemployment provide a compelling argument in support of the idea that we are finally beginning to see some real growth in the economy coming from the private sector or are we still dependent on fiscal and monetary stimulus? One thought came to mind regarding this question - will those newly employed people add to GDP as they begin to receive paychecks and spend them?
Perhaps not so much and here is why. It is entirely reasonable to assume these newly employed workers are moving off the unemployment rolls and into the pool that receives a paycheck but the likelihood that these new paychecks will add to GDP is substantially diminished. Consider that these newly employed workers were probably spending and contributing to GDP through unemployment benefits in the months prior to finding work. Consequently, it is not likely that they will add much to the total GDP as their spending will not increase appreciably now that they have jobs.
So those were some of my thoughts regarding the latest unemployment figure but they were just that - thoughts - and based on a lot of supposition. It occurred to me that I wasn't an expert on the method the BLS uses to calculate the unemployment numbers and that left me at a bit of a disadvantage. I have spent the better part of the weekend attempting to become an expert in this area.
What I found was that one of the best tools the government has for disseminating propaganda is the "Labor Force Participation Rate." The rest of this article is my attempt to shed some light on the methodology the government uses to convince us that things are really improving.
Explaining the methodology for calculating unemployment
At first glance the process seems a little confusing but it really isn't that confusing. Here are the four components that are used to determine the headline unemployment rate:
- Work age population.
- Labor force participation rate.
- Employment level.
- Labor force.
The tables below were extracted from the BLS website. I used the data to set-up an excel spreadsheet so that I could modify specific variables - primarily the "Labor force participation rate" - to see the significance of this somewhat arbitrary adjustment factor. The tables are presented only to confirm that the data source used was from the BLS website:
The missing component in the above tables is the total "work age population." The BLS website didn't provide that table so I had to back into it by dividing "total labor force" by the "labor force participation rate." The following table represents a portion of the spreadsheet I created with this data. The table below omits the last three zeros (000):
The propaganda machine is firing on all cylinders
The 7.7% unemployment rate is calculated by taking the difference between the "total labor force" (155,524) and the "employed workers" (143,492) which equals 12,032 and then dividing that number by the "total labor force."
155,524 - 143,492 = 12,032
12,032 / 155,524 = .07736 or 7.7%
The key to getting a .2% drop in the unemployment rate is the "labor participation rate" - a rate that I should refer to going forward as the "propaganda variable". By dropping the "labor participation rate" by just .1% we managed a headline unemployment rate decline of .2%. Here's the math:
Total population (244,920) * (labor participation rate) 63.6% = (revised "total labor force") 155,769
155,769 (labor force assuming 63.6% participation) - 143,492 (total employed) = 12,277 (revised unemployed)
12,277 (revised unemployed) / 155,769 (revised labor force) = .0788 or 7.9%
In other words by leaving the participation rate at the same level as January we end up with the same level of unemployment as January.
In the process of investigating how all this fits together I ran across an excellent article -- Making 9 Million Jobless "Vanish": How The Government Manipulates Unemployment Statistics -- that is worth reading for a much more in depth discussion on this matter. I strongly urge all to click on the link and read this piece if they want to know what is really going on.
The gist of the article is that we have literally lost 9,000,000 from the labor force by virtue of the government's shenanigans that attempt to convince us we are doing much better than we really are. Here's the math on the disappearing work force:
244,920,000 (current work age population) -235,088,000 (work age population as of 12/31/2008) = 9,882,000
155,524,000 (current labor force) - 154,655,000 (labor force as of 12/31/2008) = 869,000
9,882,000 (work age population increase) - 869,000 (labor force increase) = 9,013,000
The facts are we have effectively kicked approximately 9,000,000 workers clear off the bus. Daniel R. Amerman makes the following comment on this phenomenon in the article referenced above:
In an extraordinarily cynical act, the government is effectively saying that because the job situation has been so bad for many millions of unemployed people in their 40s, 30s, 20s and teens, they can no longer be considered to be potential participants in the work force at all. Because there is no hope for them - they no longer need to be counted. And it is this steady statistical cleansing from the workforce of the worst of the economic casualties - of these very real millions of individual tragedies - that is being presented as a rapidly improving jobs picture.
Amerman does point out that the argument for why the "labor participation rate" is falling is due to the rapidly aging "baby boomers" that are leaving the work force through retirement. According to Amerman that is a little deceptive as well:
Based on in-depth analysis of the government's own numbers, we will present herein the true picture: 74% of the jobless who have been removed from unemployment calculations are in the 16-54 age bracket, with only 26% in the 55 and above bracket. Yes, the population is aging - but the heart of the workforce participation deception isn't about the old.
Interpreting the data
As I pointed out at the start the only thing that matters for investors is whether or not the jobs increase will really drive GDP. What really matters is the total number of workers that have been added to the payrolls since moving out of recession in the 3rd quarter of 2009.
According to the BLS we have added 5,287,000 jobs since the depth of the recession as measured by GDP.
However, when the Bush administration ended and the Obama administration began the total number of employed was 143,369,000. Today the number is 143,492,000. It is fair for Obama to claim he has added 5,287,000 jobs from the December 2009 low but it is not fair and a major distortion of the truth to claim that 5,287,000 jobs have been added under his watch unless he first informs us that we also lost about the same number in the first year of his first term. The facts are that we are back to where we started. The following chart compares two scenarios. The first is the actual data as calculated by the BLS and the second is the rate assuming the "labor participation rate" had remained constant at the level it was at when Obama took office.
Forecasting stock prices is the end goal here. The unemployment rate is just one metric we use to assess the health of the economy. The chart below showing corporate earnings on the S&P 500 is another metric. The fact that corporate earnings peaked in early 2012 and have since rolled over and moved down a little is a troubling sign. The GDP coming in well below the most pessimistic estimates in the fourth quarter of 2012 is another troubling sign.
As far as the unemployment number is concerned the only thing that really matters as a driver of GDP is the total number of workers earning and spending a paycheck and the size of that paycheck. The CBO's estimate is that we will lose a total of 750,000 jobs in 2013 resulting form the "sequester cuts" suggesting that we are going to have a move to higher unemployment in coming months.
Assuming all other components of the unemployment calculation remain the same, a loss of 750,000 jobs will push unemployment back to 8.2%. GDP tracking lower, earnings flat lining and rolling over and real unemployment based on the actual job count are all suggesting a market that is simply running out of fuel.