The Bureau of Labor Statistics released the latest employment figures for the U.S. economy on Friday. Included in the report was the announcement that the unemployment rate had fallen to 8.1%, which marked the lowest level since February 2009 in the early days of the financial crisis. While this is certainly a move in the right direction, focusing on such a reading neglects the far larger problem - there remains a disturbance in the labor force.
While the unemployment rate is a useful gauge, it is just a starting point and not an ending point in drawing any conclusions about the current state of employment in the U.S. economy. I've heard a variety of commentary since Friday focusing on the fact that the unemployment rate has dropped to 8.1%. This is good news, right? After all, the unemployment rate was as high as 9.1% in August 2011 and 10.0% in September 2009, so the fact that this number keeps moving lower suggests the economy is on the mend, right? Not so fast.
Dissecting exactly what the unemployment rate measures is important in understanding both whether and by how much the jobs situation is actually improving. The unemployment rate is measured using the following basic formula:
Unemployment Rate = Unemployed Workers / Total Labor Force
The numerator in this equation makes sense. If you don't have job, you're unemployed. But what many people overlook is the fact that the denominator in this equation is not fixed. Instead, it also changes, and can change quite dramatically. Other times, it can remain worryingly stagnant. And this can lead to results that may overstate or understate how much better or worse the economy is actually performing at any given point in time.
The Total Labor Force consists of two parts. It is the sum of Employed Workers and Unemployed Workers. But this number does not necessarily include all people who are eligible to work. After all, what qualifies someone as part of the Total Labor Force is that they are of working age AND either employed (an Employed Worker) or actively seeking employment (an Unemployed Worker). But a variety of people in this country are eligible to work but are NOT either employed or actively seeking employment. These people are characterized as Not In The Labor Force. And this is where any enthusiasm associated with the improving unemployment readings completely breaks down.
The problem is not that jobs are not being created. To the contrary, monthly employment numbers since the beginning of 2010 show steady gains in most months. But it should be noted that these employment gains still pale in comparison to the jobs that were created emerging from the last three recessions since the early 1980s.
But the larger issue is not job creation. Instead, it is that the size of the Total Labor Force is still stagnating while the number of people Not In The Labor Force is soaring. This is where the real disturbance for the economy lies.
Until recently, the Total Civilian Labor Force in the United States has steadily risen. Since World War II through the beginning of the financial crisis in late 2008, the Labor Force had risen by a +1.6% average annualized rate. But since the beginning of the financial crisis in late 2008, growth in the Labor Force has completely ground to a halt. In September 2008, the U.S. economy had a Total Labor Force of 154.6 million workers. In April 2012, it has a Total Labor Force of 154.4 million. Thus, over the last 43 months since the beginning of the crisis, the U.S. economy has experienced a net decline in the Total Labor Force.
Making this Total Labor Force trend particularly problematic is what is occurring among those individuals Not In The Labor Force. Historically, the Not In The Labor Force total grew at an annualized rate of +0.9%. But since the beginning of the financial crisis, this growth rate has ballooned to an annualized rate of +2.9%. In other words, millions of people in this country that might otherwise be either working or out looking for a job in a normal economy have either given up looking or never bothered to start looking for a job. And this presents a problem in trying to generate sustained economic growth.
Highlighting further the importance of these recent labor force trends, suppose the Total Labor Force continued growing at its normal historical rates in the last few years since the beginning of the financial crisis. Under such a scenario, the Total Labor Force would be larger by 9.1 million workers at 163.5 million. And given that we already have 12.5 million unemployed workers already looking for employment, presumably this additional 9.1 million would also be out of work. Thus, if normal historical conditions had been in place since the beginning of the financial crisis, the unemployment rate today would have steadily risen to 13.4%, not declined to 8.1%.
A renewed expansion in the Total Labor Force is critical in supporting sustainable economic growth going forward. In order for domestic businesses to produce more output, they need rising overall demand for these products and services. And since the consumer makes up nearly 70% of overall U.S. GDP, more people need to be working to drive this increase in demand. Of course, these are the forces necessary to drive a sustained increase the stock market (NYSEARCA:SPY) over time. So not only do we need to see more unemployed put back to work, but we also need to see more potential workers that have either dropped out of the labor force or never entered the labor force decide to first begin looking for work and then actually land a job.
Thus, the problem on the employment front is multilayered. And focusing on a number like the unemployment rate simply does not capture the extent of the current problem. And the last thing we need with millions of people out of work and millions more waiting to try to look for a job is any suggestion of complacency by policy makers on both sides of the aisle that things are getting meaningfully better when they actually are not.
Given these persistent imbalances, it remains prudent to remain hedged in investment portfolios. This includes stock allocations that can perform well if the employment situation finally picks up. In the current uncertain environment, defensive names such as McDonald's (NYSE:MCD), HJ Heinz (HNZ), Tootsie Roll (NYSE:TR) and WGL Holdings (NYSE:WGL) are attractive. And even better opportunities reside beyond the stock market. This includes Gold (NYSEARCA:GLD) and Silver (NYSEARCA:SLV) for hard asset protection against price instability and further stimulative monetary policy response to the employment situation. It also includes allocations to U.S. TIPS (NYSEARCA:TIP), Agency MBS (NYSEARCA:MBB) and Long-Term U.S. Treasuries (NYSEARCA:TLT) that can perform well in the event of an economic slowdown.
Continuing to monitor the monthly employment numbers will remain important in the months ahead. But be sure to look past the headline unemployment rate number and into the details of the data to determine whether the disturbance in the Labor Force and the overall economy is finally being resolved.
Disclaimer: This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.