It's the economy, stupid.
- Bill Clinton's successful 1992 presidential campaign
Twenty years after President Clinton won his presidential bid, today's stock market is still about the economy. One of the nagging issues that wouldn't seem to go away during this election year is the stubbornly high unemployment rate. It has been above 8% over the past year. Friday's weak job data caused major pain in the stock market.
While some signs clearly indicate that a recovery is on the way, unemployment kept saying "no" to a conventional recovery. What is going on?
In this article, I'm going to argue that unemployment is no longer the problem. It is not diagnostic of the current economic condition.
1. Who are unemployed?
According to the Bureau of Labor Statistics, the following table shows the rate of unemployment by education in 2010 and 2011.
| Year | Less than high school | High school graduates | Some college or associate degree | Bachelor's degree and higher |
| 2010 unemployed (1,000) | 1,765 | 3,943 | 3,093 | 2,167 |
| 2010 unemployment rate | 14.9% | 10.3% | 8.4% | 4.7% |
| 2011 unemployed (1,000) | 1,632 | 3,521 | 2,937 | 2,024 |
| 2011 unemployment rate | 14.1% | 9.4% | 8.0% | 4.3% |
Obviously, the unemployment rate among those with bachelor's degree or higher was fairly low at 4.3% by 2011. Not only that, the unemployment rate among them never went up very high during the crisis (4.7% in 2010).
2. Why is it different this time?
During the past two years, corporate profits have improved, largely driven by cost cutting and productivity improvement. The jobs lost in this recession however are not coming back quickly, especially among the less educated population.
Why?
Because this crisis is different -- it is the first time that globalization is in full force. During the recovery stage, large businesses have been doing well. However, when expanding, they chose the cheaper option by outsourcing millions of jobs to overseas labor market, particularly to countries such as India and Philippines where labor is cheap and English is the official language.
In other words, jobs are created, just not in the United States. And these jobs are not coming back anytime soon.
What's particularly relevant is most outsourced jobs require less educated labor force, which explains the relationship between education and unemployment rate.
3. The unemployment is structural.
Considering globalization, it is safe to say that the current unemployment rate is structural, meaning it is here to stay, perhaps for a long time.
Even if the economy recovers, the unemployment rate across board may stay high for quite a while. Since the stock market is generally forward looking, by the time unemployment goes down decisively, the stock market will perhaps have been already at a much higher level.
In this recovery, unemployment rate has become a lagging indicator. Therefore, it is dangerous to wait for unemployment rate to drop before getting into the securities market. One might miss the whole bull market waiting for unemployment rate to go down.
Given that situation, how should investors play this market?
1. Stay away from major consumer businesses
Big non-discretionary consumer driven businesses, including retailers such as Wal-Mart (WMT) and consumer products such as P&G (PG) have fully come back to pre-crisis levels. Not that these companies' stocks will drop, but looking into the future, one shall not expect these companies to create above market average returns.
Among business serving the mass population, McDonald's (MCD), Nike (NKE), and smaller dogs such as Under Armour (UA) have been amazing resilient in this recession. These companies are already overvalued by their PEG ratio and price/cash flow ratio. We shall not expect them to create above market average returns either.
2. Pay close attention to the business to business market
On the consumer side, the unemployment rate may linger. But expanding businesses will have to start spending. They will purchase hardware, which helps companies such as Dell (DELL), HP (HPQ), and IBM (IBM). In turn, companies like Intel (INTC), Cisco (CSCO), and Oracle (ORCL) will also profit from this trend. With Microsoft's (MSFT) Windows 8 on the way, the PC market should be fairly active this year.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
