Consider These Conditions When Using the Unemployment Rate as 'Any Kind' of Indicator

Investors and the media (CNBC) are too quick to affirmatively state that “unemployment is a lagging indicator.” The unemployment rate is not so much a “lagging indicator” as it is a reflection of investors’ past behavior to use it to predict the beginning of a large stock market recovery.

However, there is no rocket science in investors’ ability to forecast peak unemployment. A close look at historical stock market movements vs. unemployment rates reveals that “reference” behavior is prominent. Investors simply use prior peaks as their prediction for future peaks. In the recession of the mid ‘70s and early ‘80s, unemployment rate’s failure to peak at prior peaks (6 to 7%, 9%, respectively) caused investors angst through fake rallies. Now that 9 percent has been passed it’s no coincidence that in our current recession consensus forecasts for peak unemployment are in the range of the early ‘80s peak, sure to be a bogey for many investors.

Instead, investors should focus on the conditions of the time to understand how unemployment data can be used to make significant investment decisions, rather than look at unemployment in isolation. Wouldn’t this be more effective than using a reference point that was reached just once in the last 60 years.

The emergence of the technology age. Information travels faster today than 25, 50 or 100 years ago. Information is instantaneous. As a result unemployment data is dispersed to investors in a more equitable fashion. The competitive advantage of gaining access to this data before others has been mitigated, and therefore the opportunity to act on the information should be limited. In its present form, CNBC is only 20 years old and the Wall Street Journal (with the “Asia” and “Europe” edition, and “Money and Investing” section) is only 21 years old. What was a “lagging indicator” may be more of an “at the moment” or “leading" indicator as news flow has quickened over time.

The speed of layoffs was arguably the fastest in history. Though hard to quantify, this factor impacts the ability of the average family/person/consumer to manage their daily life. The farther we look back on history, it is clear that the employee/employer relationships were much stronger, and that working for the same company for an extended period or your whole life was very common. Corporations were slow to layoff because of these strong bonds and a higher sensitivity level, and hence employees had more preparation time to handle a “negative” event. Today the time involved for a firm thinking about reducing staff to the actual action has been greatly condensed. Thus, in contrast to the past, current laid off employees are less equipped (less savings) to handle this type of traumatic event. Hence, more loan delinquencies and defaults, and not a gradual decrease in consumption, but a sudden drop to a new base level.

Corporations also are usually not quick to hire after just conducting staff reductions, and unknowingly have lengthened the time for an individual worker from unemployment to finding a new job. Not the historical gradual layoff process, instead creating an environment where 1 job posting receives 100 to 200 resumes, and potentially a weak job recovery. The negative effect is less savings and an increased debt burden for our society as people are tapping into government support and savings earlier, and giving up their houses. The consumer multiplier effect on our economy should fall to a new lower level as capital is used less efficiently (out of necessity to survive, resulting in much less growth).

Wal-Mart (WMT) will also continue to garner a larger portion of the consumer’s wallet. For all those who say that the consumer will stop shopping at Wal-Mart when the economy gets better, the onus is on them to prove. Wal-Mart has shown time and time again that it does not easily lose customers. Consumers love this “deflationary giant”, in sharp contrast to what a recovery in the economy and markets need.

The reliability of unemployment data? Over time, the method of calculating unemployment statistics has varied, as pointed out by many economists, much more of an expert than I. But as an outsider, the first question that pops into my head is, “If the data is not apples to apples, how much faith can I put in the conclusions drawn from this data?” Despite this, my biggest concern is that the data is underestimating the severity of the situation. Do we count 2009 graduates that cannot find employment? They are not eligible to file an unemployment claim, and therefore are not included in the weekly claims data, nor the jobs lost data. Living off one’s parents surely cannot be good for the economy.

How do we count the employment statistics of companies “quasi-owned” by the government? Is it accurate that each AIG, Fannie Mae, GM (GMGMQ.PK), etc. employee equal 1.0 person employed or should it be 0.5 employed. How are these employees any different than those receiving unemployment benefits, except that they receive more? Given the deterioration in their businesses one could argue that these organizations could be over-employed by private market standards. I understand that Obama is trying to save jobs, but cosmetically helping these companies has been put in the “bailout” category in the U.S. budget, whereas one could easily argue that the money belongs in the “unemployment benefits” category. Given the lack of robustness in the unemployment data, the reliability of using unemployment as “any kind” of indicator should be reexamined. Does the data really tell us when the “true peak” has occurred?

The use of historical unemployment rate peaks to predict future peaks. Only twice in the last 100 years has unemployment significantly surpassed 9 percent. In those instances anticipating the recovery of the stock market and economy were more difficult. What this data showed was that when unemployment surpasses certain thresholds, predicting the unemployment peak is a guessing game. Again if you guess enough times, and can afford to, you will eventually be right. This philosophy does not help those that cannot afford to suffer the losses before the recovery. What will investors do if the unemployment rate surpasses the early ‘80s peak (close to 11 percent)? The answer: "Guess", as the reference points after this are thin.

Comments

[David Braun...:]

Very nice article. Good insights. I agree, too many people beleive that unemployment is a lagging indicator and dismiss it.

Jul 10 10:17 AM

[Partly Sunny:]

Well said:
'Given the deterioration in their businesses one could argue that these organizations could be over-employed by private market standards. I understand that Obama is trying to save jobs, but cosmetically helping these companies has been put in the “bailout” category in the U.S. budget, whereas one could easily argue that the money belongs in the “unemployment benefits” category.'

Jul 11 10:54 AM