Is Unemployment Really 19%? Your Tactical Asset Allocation Should Reflect Economic Reality

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Includes: EWG, EWJ, FXI, HYG, SPY
by: Gary Gordon

Summary

The economic reality on employment is sobering.

The notion that the middle class feels no different today than it did during the previous two recessions has support in household income data.

There will likely be another opportunity for a moderate growth and income investor to benefit from downshifting, though it will likely require a "bear market bounce."

Several weeks ago, a comment provider ripped into me for being a left-wing nut job. What did I do to draw his ire? I explained that the tapering of QE3 and the 0.25% rate hike bump - modest stimulus removal efforts on the surface - adversely impacted everything from currencies to commodities, sovereign credit to corporate credit, equity prices to equity valuation.

Today, I am taking aim at the 4.9% - an endeavor that may spark angry comments about my right-wing wacko credentials. Who are "the 4.9%?" They do not represent an income bracket. Rather, 4.9% is the headline data point on unemployed Americans.

At the risk of ruffling political feathers, shouldn't we have a more honest discussion about the well-being of the labor force? The number of civilians who are employed or who are actively looking for work is 62.7%, down from 66% in December of 2007 before the Great Recession. This means that millions and millions of working-aged people who wish to work have stopped doing so. What's more, it would be disingenuous to dismiss everyone who cannot find desirable work as "retirees" or "students."

The economic reality on employment is sobering. We can remove all of the 16-24 year old individuals from the picture, pretending that each and every person in this age group is a "student." In a similar vein, we can pull out each civilian in the 55-plus category and assign each with the tag of "retiree." Yet you would still come up with 19% of 25-54 year-olds who are actively looking for work and who are not employed. That's 19%.

There's more. The 81% participation rate in this demographic is far worse than the 84.5% participation rate in 2000 or the 83.5% in 2008. In essence, fewer 25-54 year old workers are working today in 2016 than during the Great Recession.

25-54 Demographic

Now, before left-of-center voters become incensed, let's identify a very positive trend in employment: the U-6 unemployment rate. The Bureau of Labor Statistics (BLS) offers a broader snapshot of unemployment with its U-6 measure which incorporates discouraged workers and marginally attached workers. In addition to those who recently lost their job and/or who filed for unemployment benefits, there are people who want to work, but who have given up on the job hunt, searched in the past 12 months or settled on a part-time gig where a full-time job could not be found.

Whereas the labor force participation statistics represent deterioration since the Great Recession, the U-6 unemployment trend represents unmistakable improvement since the Great Recession's end in June of 2009. The U-6 unemployment rate hit 17% at its peak. It is down to 9.9% in 2016. Conspicuous job progress is something worthy of celebration. (And now, many will cast me as a left-wing radical once again.)

U-6

It should be noted, however, that U-6 unemployment shows why many Americans regard the six-and-a-half year economic recovery as hollow. For one thing, U-6 unemployment hovered near 10% after the 2001-2002 downturn in the economy. For another, U-6 unemployment prior to the Great Recession's inception in November of 2007 was 8.5%. In other words, Americans may feel as though the country has yet to recover from the Great Recession and that the country is no better off than it was after the 2001-2002 recession.

The notion that the middle class feels no different today than it did during the previous two recessions has support in household income data. On an inflation-adjusted basis, households today are taking home somewhere in the neighborhood of $56,746 per year. Prior to the 2008 financial crisis, the typical American family brought home $57,798; after the earlier recession in 2001-2002, the dollar amount was slightly higher at $57,905.

Household Income

It follows that John Q. Public wonders why established politicians on the Democratic side of the aisle trumpet economic well-being. Left-leaning voters who do not feel better off are, instead, "feeling the Bern" of Mr. Sanders. On the Republican side? Similar dissatisfaction with the establishment. Many right-of-center citizens have grown weary of the same-old solutions to the same-old economic sluggishness; they're gravitating to outside-the-Beltway voices like Ted Cruz and Donald Trump.

Indeed, some financial pundits hypothesize that political uncertainty is a significant contributor to the selling pressure on Wall Street. In truth, though, the popularity of outsiders is merely a symptom of persistent labor market concerns, ongoing household income struggles and seven years of sub-par 2% annualized economic growth. Worse yet, the economy has been slowing across different sectors and sub-sectors, from manufacturing to industrial production, from retail to services.

ISM

These structural troubles were less worrisome when the Federal Reserve was deliberately depressing borrowing costs. Since the central bank officially completed its final asset purchase on December 18, 2014, though, the removal of stimulus began weighing on investor willingness to pay extraordinary premiums for stocks. And since the Fed upped its stimulus removal again in mid-December of 2015 with its 0.25% rate hike, many have questioned the impact of stimulus removal on corporate earnings, future sales as well as fair value price-to-earnings (P/E) and price-to-sales (P/S) ratios.

Not surprisingly, then, the lack of confidence in central bank stimulus removal is widespread. The percentage price swings intra-day have widened for riskier assets like stocks as well as higher-yielding corporate credit proxies like the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA:HYG). Even the implied volatility of S&P 500 index options ($VIX) has been steady in its advance, with its 50-day moving average rising above and staying above its 200-day moving average for five-and-a-half months.

VIX Volatility

The average S&P 500 stock is down approximately 26% form an all-time high set in May of 2015, even as the the S&P 500 SPDR Trust (NYSEARCA:SPY) clings to a far milder 13% depreciation. Still, selling directly into this type of weakness is rarely advisable. Right now, the S&P 500, Russell 2000, NASDAQ and Wilshire 5000 currently trade at 52-week lows.

In contrast, last summer provided ample opportunity for a tactical shift in one's asset allocation - a shift that included a reduction in the percentage of stock and bond holdings as well as an increase in the quality of equity and debt holdings. There will likely be another opportunity for a moderate growth and income investor to benefit from downshifting, though it will likely require a "bear market bounce." Note: Our tactical shift last summer from 65%-70% stock/30%-35% down to 45%-50% quality stock/20%-25% investment grade income/25%-30% cash equivalents is the allocation we have for moderates today.

For those with foreign assets, it may be equally challenging to sell into a storm that has devastated corporations in the second, third, fourth and fifth largest economies around the world. The iShares MSCI Japan ETF (NYSEARCA:EWJ) and the iShares MSCI Germany ETF (NYSEARCA:EWG) have entered full-fledged 20%-plus bear markets. Meanwhile, the FTSE 100 in England sits at a 3-year low. And you may not even want to think about losses in the iShares China Large-Cap ETF (NYSEARCA:FXI), where exposure to the world's second largest economy has been even more devastating for buyers in the first half of 2015.

FXI ETF

Assuming that you prefer to wait for a bounce prior to selling an asset or three, you might also consider the possibility of adding non-correlated assets to your portfolio mix. The types of unleveraged assets that have gained ground during the recent selling stampede include inflation-protected securities, intermediate- and longer-term Treasury bonds, municipal bonds, gold and the Japanese yen. (Keep in mind, all of these assets are "overbought" on a short-term basis. One might benefit from a bit of a pullback before picking up one or more stock hedges.)

Not sure whether to buy gold? Treasuries? The Japanese yen? You could buy ETFs for a wide variety of non-stock, non-correlated assets for multi-asset stock hedging purposes. Diversification across prospective hedges reduces risk and increases the likelihood of outperforming T-Bills. For instance, since the Fed hiked overnight lending rates 0.25% in mid-December, the FTSE Custom Multi-Asset Stock Hedge Index (MASH) has provided shelter from the S&P 500 storm.

MASH

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Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.