Last week’s release of non-farm payrolls data was a reality check for the bulls. Expectations of a V-shaped recovery following the severe collapse of the past year were sullied by the larger than anticipated job losses, and the release of the relatively more positive ISM data did not do much to cheer up the markets either.
At this stage, it is important to keep these developments in context. This recession has been ongoing for more than a year and a half by now, and we must expect some rebound to occur sooner or later, as inventory liquidations, capacity reductions and labor discharges create a bearish extreme in the economy. It is only natural that such a severe contraction will be followed by a period of readjustment, during which positive growth should not be surprising. The question that must be asked is, will this period of shallow growth, or contraction translate to new job openings, greater capital spending, business investment, and confidence for the private sector? We can be reasonably confident that it will not. And there are many interesting details in the recent release that reinforce this conviction.
Payrolls have been falling for months by now, and an interesting aspect of the private sector’s behavior in this crisis is the tendency to cut hours worked while reducing wages, and discharging workers at the same time. Thus, the actual fall in the number of employees does not reflect the earthquake in the labor market with sufficient clarity. We all know that many urban areas in this country can, and will do equally well with a smaller number of retail outlets, restaurants, and entertainment venues. As these, and other businesses shut down, the resultant rise in unemployment is neither surprising nor even unhealthy, and indeed, there is little that can be done to reverse this trend either. The real worry, as evinced in the data of the past week, is that the perception that jobs are precious and few will lead employees to be content with whatever sum they are offered by employers, regardless of the quality of their work, or their productivity. In such an environment, consumption will fail to grow, asset prices will continue to fall, and investments will continue to be postponed indefinitely, which will lead employers to cut wages further, as a vicious spiral is created.
Falling hourly wages and contracting work hours all create a poverty effect for the working population at large. The perception of falling wages, and poorer living standards cannot be countered by government checks, first because the sums involved are too small in comparison to the size of the problem, and also because they are temporary. Consumers are not stupid, and are well aware that the recent changes in labor trends are not temporary disruptions which will disappear soon. As correctly identified by the Federal Reserve, and the government, in such an environment deflation, and not inflation is the obvious and imminent problem. Ultimately, the fate of everything else in the U.S. economy including the labor market is dependent on whether long-term deflation can be avoided or not.
The question of where the markets will go from here is in everyone’s mind, but we believe that it is fairly safe to expect the path of least resistance to be to the downside in the absence of any fundamental changes that will cause sustained depreciation in the value of the dollar. This is unlikely for reasons that we discussed previously, and another foray towards the 500 level for the S&P 500 in autumn or winter cannot be disregarded.