It was an interesting week. Chairman Bernanke said that there could be no strong recovery without "a sustained period of stronger job creation." Thomas Hoenig (of all people) said that, after QE2 is completed, QE3 will probably be discussed. And, to top it off, on Friday it was announced that 39,000 new jobs were created in January - not nearly enough to keep up with the growth of the work force. Does anybody think that short term interest rates will be going up anytime soon?
Monetary policy is a crude tool to use to create job growth. I did a little math and the results were surprising. The work force is 154 million of whom 15 million are unemployed. Average wages are $780 per week or $39,000 a year. To get the unemployment rate down to about 6 percent, you need 5 million jobs. Assuming (generously) that these would be at the at the average wage, the wage expense would be $200 billion. Throw in payroll taxes and benefits and you get to $250 billion. Now, $250 billion used to be considered a lot of money but in the context of a $600 billion QE2, a $750 billion stimulus package, a $700 billion bank bailout, and a $1.5 trillion dollar deficit, $250 billion is - as put so well in the movie "Social Network" - a "speeding ticket."
Of course, putting 5 million people to work would cost much less because a lot of the money would come back to the Treasury in the form of tax receipts and reduced unemployment compensation. In a modern, international economy expansionist monetary policy and deficit spending are very blunt instruments if the objective is reducing unemployment. The increased consumption created by the wealth effect and lower taxes can create jobs but many of those jobs are likely to be overseas. A lower dollar can increase exports but we are not the only country that has figured this out and other countries are taking steps to reduce the exchange value of their currencies as well.
It would be wonderful if our politicians were engaged in an effort to come up with a more cost effective policy instrument to increase employment. The Germans have a program called Kurzarbeit which encourages employers to shorten the work week rather than laying off workers; Congress should be analyzing this kind of program and determining whether it could work here. I am sure there are other constructive ideas that could be developed.
But that is not what is going on in Washington. We are instead engaged in finger pointing about the deficit, theoretical discussions about Austrian economics (which do not seem to be actually used in Austria), and a "serious" discussion about how we may start to reduce the deficit 4 or 5 years from now. So, the only tool left is monetary policy. And monetary policy will ultimately increase employment. But it will take a whole lot of monetary easing to produce a little bit of employment growth and, before we see a "sustained period of stronger job creation", we are going to see a lot of other things happen.
One of those things - already under way - will be a sustained period of strong corporate earnings. Another of those things will be a lot of consumer spending on the part of those people benefiting from the "wealth effect" - essentially, people getting rich in the stock market and buying second homes, sports cars, etc. A third will be a reviving commercial property market. A fourth will be much stronger bank balance sheets and earnings. And - only after all of that happens - will we see a "sustained period of stronger job creation" and, only after several months of that, will we finally see higher short term interest rates. Hey, I'm 66; it may not happen in my lifetime.
So, what does this mean for investors. I have written about the implications of ultra low interest rates for equities. To sum up, it should be a good time for:
- High dividend paying stocks (electric utilities, VZ, T, PM) as well as other high yield vehicles - MLPs, Canadian royalty trusts, etc.
- Dividend growers with strong international exposure so that they can benefit from a declining dollar (MCD, IBM, PG, KO, PEP, XOM);
- Companies whose balance sheet strength puts them in a position to engage in financial engineering (share repurchases, etc.) (MSFT, AAPL, INTC, WMT);
- Companies that can save money be refinancing debt at lower borrowing costs (F);
- Companies that can profit by borrowing cheap and lending at higher rates (NLY, HTS, the BDCS - ARCC, GLAD, GAIN, KCAP, SAR, TICC, etc.);
- On a riskier note, companies that can use an easier credit market to restructure their way to profitability (ACAS); and
- On a more speculative note, takeover targets as cash for stock takeovers become more and more attractive.
I think that part of the reason the market was up rather than down on Friday is the bad news/good news nature of the jobs report; the bad news is that not many jobs are being created, the good news is that this means that interest rates will be held at a low level for a very, very long time.
As I have said before, I am generally an optimist but I have some misgivings about our long term trajectory. It is very possible that the next decade will not be great for the stock market and that, over the next ten years, the market may produce mediocre returns. The problem with sitting on the fence is that it is entirely likely that most of those returns may be realized in the next 24 months.