Excluding dividends, the S&P 500 Index finished the first half of 2014 up 6.1%. That's a decent return for any year, let alone one during which the economy has been struggling. Indeed, during the first quarter of the year GDP contracted at an annualized rate of 2.9%. That's a frightening figure even if bad weather was largely to blame as many economists claim.
As they have for several years, investors have been overlooking bad news, preferring instead to focus on what they hope will be a brighter future. Right now, they are betting that the economy had a strong rebound during the just completed second quarter. We will find out about that when the first estimate for second quarter GDP is released by the Commerce Department on July 30. I have been hearing forecasts of well above 3.0%. Still, that would hardly make up for the contraction during the first quarter. In fact, the economy is so weak that even the Federal Reserve turned less bullish about growth. It recently reduced the central tendency of its forecast for full year economic growth to just 2.1-2.3%. That's a large revision from its previous estimate of 2.8-3.0%.
Furthermore, despite the seemingly glowing headline numbers coming from the Department of Labor, the employment market continues to struggle. Most economists touted the robust 288,000 increase in nonfarm payrolls in June and the corresponding decline in the unemployment rate to 6.1%. That so-called U-3 unemployment rate is now at its lowest level since the end of the December 2007 to June 2009 Great Recession. That's the good news. You don't really uncover the bad news, however, until you dig deeper into the data. Here are some facts that concern me:
First, with some exceptions, most of the job growth is coming from lower-wage categories. For example, employment in food services and drinking places rose by 32,800 in June. Furthermore, government employment rose by 26,000 in June. While government work is better than no work, sustained economic growth depends on the improving health of the private sector.
Second, the civilian non-institutional labor force participation rate remains stuck at 62.8%-its lowest level since 1978. Of course, back then there were large numbers of women who did not participate in the workforce. Instead, they worked at home. These days it is uncommon for women not to be in the workforce. Yet the participation rate is stuck at the same level it was back when Kate Jackson, Farrah Fawcett, and Jaclyn Smith were chasing criminals on Charlie's Angels.
Third, there were 7.54 million people in June working part-time out of economic necessity. That's up from 7.27 million in May. These are people who worked part-time only because they could not find full-time work or because their full-time hours were reduced to 34 per week or less. Even though this category shows improvement from a year ago, the shorter-term trend is worrisome. In addition, there were 19.88 million people who were working part time in June by choice-perhaps due to family or childcare issues. This figure is up by more than a million from a year ago. Like government work, part-time jobs are better than no jobs, yet they are less likely than full-time jobs to get our economic engine roaring.
Fourth, related to the increase in part-time jobs, average weekly hours remain stuck at 34.5, exactly the same as a year ago. One bit of good news for workers is the increase in average hourly pay, which is up 2.0% from a year ago to $24.45. That should make the Fed happy. If pay rates continue to rise, the Fed will finally get the wage inflation it is hoping for. Maybe then the Fed will talk seriously about returning short-term interest rates to more normal levels before inflation gets out of hand. That's a prospect that could cause investors to hit the "sell" button.
Fifth, the most recent job openings report showed 4.64 million openings in May, up substantially from a year ago, but up only slightly from the April figure of 4.46 million openings. One of the more interesting pieces of data in the JOLTs (Job Openings and Labor Turnover) report is the so-called Quits rate. These are voluntary separations. Economists believe that an increase in Quits is a good sign because people do not normally quit their job unless they have a better job already lined up. The Quits rate in May was 1.8 (i.e., 1.8% of people employed quit their job). That figure has remained steady over the past four months and it is only slightly higher than it was a year ago.
All in all, I don't see much to get excited about. The employment situation looks good according to the headline figures, yet the underlying data is still weak. There aren't many well-paying jobs being created. As for the economy, it appears that growth will remain anemic at best for the foreseeable future. This is precisely why the Fed has been promising to keep short-term interest rates at extraordinarily low levels. The rise in stock prices is largely (if not almost entirely) due to the Fed and its loose monetary policies. Ironically, the selling in stocks will probably begin just when the economy shows real signs of improvement and the Fed decides that its unprecedented help is no longer required.