The Incredible Lightness of Being (Employed)

The economic outlook for this year changed dramatically with the release of the December unemployment numbers on January 3. The expectation of a moderate recession or slowdown for the year was based on the assumption that unemployment would stay low. But, the December rate jumped from 4.7% to a full 5%. Historically, this is huge. Since 1949 any jump of this magnitude was followed by a recession, so it doesn't look good for the economy and it doesn't look good for investors for 2008. It also looks dismal for those who are employed for wages. Jobs will be scarcer, wages will tend to be stagnant, overtime trimmed, and benefits reduced.

How bad will it be for the economy and the stock market? I can’t say, but there is mounting evidence that it can get out of control easily if there is not some quick action from the Federal Reserve and Congress.

Looking at some of the specifics in the job market: Retailing lost 24,000 jobs in December. Financial services lost 7,000 (with more probably to come). Construction was down 49,000—with more probably to come. And last, and more unsettling, manufacturing lost 31,000 jobs in December. (New York Times of 1/4/08)

These are serious shrinkages, and it bodes badly for the economy, because jobs of this type, shrinking as they are, will put a serious strain on consumer spending. If it does, and there is no off-setting growth in other employment sectors, then a spiral could begin. With reduced employment you get reduced consumer spending. With reduced consumer spending you get higher business inventories which prompt reduced production and more layoffs. With more layoffs you get more contraction in consumer spending. . . down and down you go!

On the plus side, this is an election year, so pressure on both political parties to do something will be great. So, given the Fed’s likelihood of reducing interest rates and given the Congress’ ability to reduce taxes and pump up spending on things that employ people, the worst of a spiral could well be contained. I hope this is how it works out, but even if it does, there will still be plenty of pain to go around.

For investors, it will be a year of challenge. I don’t envy anyone hoping to make money in a declining market, though some will be able to. For me, whenever there is a chance of a significant decline in interest rates, then fixed income instruments come in to play. If there is a serious recession in 2008, interest rates (at least short term rates) will be pushed down in an attempt to stimulate business spending. This possibility will probably give fixed income one of its rare opportunities to outperform equities for the year. Holders of fixed income ETFs of short to medium duration could see some nice price appreciation as interest rates fall. A fixed income allocation of 33% short-duration ETFs, 33% intermediates and 33% TIPS would spread your risks for this opportunity without making too large a bet on one particular spot on the yield curve. iShares Lehman 1-3 Year Treasury Bond (SHY), iShares Lehman Short Treasury Bond (SHV), SPDR SERIES TRUST (BIL) or VANGUARD BD INDEX FD INC (BSV) would be good choices for short term ETFs. iShares Lehman Aggregate Bond (AGG), SPDR SERIES TRUST (LAG) and VANGUARD BD INDEX FD INC (BND) would work for intermediate, and SPDR SERIES TRUST (IPE) or iShares Lehman TIPS Bond (TIP) would work for inflation protection.

Another good point for fixed income instruments, it won’t hurt you too badly if you guess wrong. As long as you stay away from the longer maturities, the price fluctuations will not be too bad, and you will have the monthly dividends paid as compensation for holding them. There are no guarantees, and things may not work out as expected, so don’t spend the profits just yet. Remember, these are just guesses. But, if you are willing to take a fairly moderate risk with part of your portfolio, look toward fixed income for 2008.

President Bush makes his State of the Union speech on January 28, so look at this event to hear his announcement of a stimulus package. At about the same time, the Federal Reserve Open Market Committee will be meeting, and my bet would be for a sharp reduction in short term rates. If you can see this scenario playing out, then now is the time to place your bets: the wheel is in spin.

Comments

[Scott Weitz:]

Agreed...nice article....the fed can help with the markets through rates cuts which seem imminent given the recent numbers. The broader eceonomy, however, almost certainly will suffer.

2008 Jan 06 11:05 AM

[JohnB:]

Great advice, thanks.

2008 Jan 06 12:00 PM

[Kunst:]

I watched the two New Hampshire debates the other night. It amazes me how the candidates are NOT talking about some of the most serious issues. Virtually no discussion of the health or future of the economy. No mention (except Ron Paul) of the decline of the dollar, or the federal deficit/debt, or the current account deficit. I don't even recall anyone talking about the mortgage/credit squeeze. Limited discussion of Social Security, none of Medicare.

This country is way beyond denial. Just sit on the beach and wait for the tsunami.

2008 Jan 06 11:36 PM

[SimonS:]

Here's a thought: buy commodities. Something that hasn't been said here is run away inflation. We're in for a ride.

2008 Jan 07 12:54 AM

[lefty:]

The afore mentioned SPIRAL started several years ago. Now approching critical mass. There is one, and only one answer. To find out, research how we came out of the 1929 recession.

2008 Jan 07 06:49 AM

[Kunst:]

Lefty-

I think we're already at war and up to our eyeballs in debt. This time, that may be part of the problem rather than the solution. And I sure don't see any FDR around. (Although he ran on a very different -- conservative -- platform in 1932 than what he actually wound up doing.)

RonPaulFan-

I'm betting against commodities (SMN) for now, as a worldwide recession will do nothing good for demand. After the downturn, commodities (especially oil) will be the big winner for a long time.

At least your guy has some connection to reality. That does make him unique among the candidates, just not electable.

2008 Jan 07 03:45 PM