Tuesday, January 25, 2011

The Unemployment Picture

"Moving on is a simple thing; what it leaves behind is hard. "
Dave Mustaine

Paper thin, tepid, anemic; these are the words being used to describe the American economic recovery. Why are so many experts so cautious when the recession is officially over? Because this is unlike most post World War II recessions.

Most recessions are caused by tight monetary policy. The economy tends to turn around as soon as interest rates fall and more money is available to banks and borrowers. This recession was caused by loose monetary policy and bad lending practices. So just lowering interest rates (which are already historically low) will not help. The Federal Reserve has resorted to purchasing bonds (QE2 or “Quantitative Easing Round 2”) to try and pump more money into the system but, this will have only a limited effect.

A quick fix is not possible this time. The unemployment rate is emblematic of the problems facing the U.S. economy. The unemployment rate in December did drop to 9.4%. However, only 103,000 jobs were created. The U.S. economy needs to create 125,000 a month just to keep pace with population growth. A strong economic recovery really requires job growth of over 200,000 a month. So currently we are only creating jobs at half this rate.

Another reason that the unemployment rate dropped from 9.8% to 9.4% in December is many people just stopped looking for work. The real unemployment rate is estimated to be over 16%. To put this into perspective that would be as if the whole state of California were unemployed.
This is a new problem in the U.S. Unlike Europe, we are not used to dealing with long term chronic unemployment. The average unemployed worker in December had been out of work for 34 weeks, an increase of 19% from a year ago. The percentage of unemployed that have been out of work for over 28 weeks increased to almost 45%.

The government hopes that its stimulus programs will encourage companies and corporations to start hiring again. However, this may not fix the unemployment problem because many businesses are already looking for new employees and are having a difficult time finding qualified applicants. The Department of Labor reported in the fourth quarter that there are more than 3 million new job openings. If all those positions were filled the official unemployment rate would fall below 7%. So why aren’t these positions being filled?

Many economists believe that there is a mismatch between the job candidates’ skills and the qualifications employers require. This type of unemployment is notoriously difficult to fix. It is a shift in an economy from one set of jobs to another which require different skills.
A new report by Godofsky, Van Horn and Zukin from the Rutgers University’s John J. Heldrich Center for Workplace Development follows workers who have been displaced. It tries to capture the state of those unemployed during the Great Recession by interviewing workers unemployed in August 2009 and then re-interviewing them in March 2010 and November 2010. The results were startling. By November 2010, 54% of the participants were still unemployed. In addition, 13% had given up looking. In other words, 67% of those unemployed in August 2009 had not found a full time job.

For the one-third that had successfully found employment, it was not a bed of roses. Only 43% of the employed found jobs in a few months and over a third had been out of work for over a year. In addition, more than half the re-employed say that their new jobs will not allow them to get by financially and most were still looking for a better job. A third said that they took a reduction in fringe benefits. Over 40% had to accept work in a different field and almost 70% of these workers took a pay cut.

Only one-third of those unemployed in August 2009 believe that they will recover financially and return to where they were before the Great Recession. Over 80% say their finances are in fair to poor shape. It is not a pretty picture. Those displaced by the Great Recession are falling out of the middle class, and it is unlikely that they will ever regain their footing.

I would submit however, that the Great Recession only accelerated these dislocations in the labor market. It is ultimately the pace of innovation and technological change that is causing dislocations in the U.S. labor market. Jobs for unskilled labor are fast disappearing but so are many middle management jobs. Technology allows companies to do more with fewer workers and as a result flatten their organizations by eliminating the middle.

In addition, jobs can travel anywhere due to technology. So now many skilled workers are competing with workers located all around the world. New technologies create new jobs as they destroy others. It is this pace and these dislocations resulting from creative destruction-ism that is so unsettling. We see the results of this accelerating upheaval in our own lives and those around us. New statistics show that the chance that someone in your family will suffer a cut in pay or lose their job in any given year has increased to 26%.

The lesson from all this is to invest in human capital. Workers need to keep investing in their own training and update their skill set. Since it is now commonplace for workers to be constantly changing employers, it will become less common for companies to pay for or provide anything but direct skill training. So each person will need to actively manage their education and retraining through their entire career. Retraining and re-inventing ourselves will become imperative in order to stay employed and have a forward moving career.
The good news is that America continues to be the global leader in innovation and new ideas. The robustness of U.S. ingenuity and creativeness is the envied around the world. The way out of our current economic malaise is to innovate our way out of it. This will only further accelerate the pace of change, but hopefully more jobs will be created than destroyed.

But how will the least skilled be re-employed? Since the least skilled vie for jobs with unskilled labor around the world, their plight will not be easily resolved. To attract unskilled jobs to this country the cost of labor must drop to be competitive with the rest of the world. So in the long term unskilled labor will continue to experience a declining wages. Only when the cost of labor is competitive will manufacturing jobs return to this country. The good news is that manufacturing jobs have begun to return but the bad news is that the jobs are at reduced wages and benefits.

The global economy will continue to repair itself and the unemployment rate will fall modestly in 2011. There will still be bumps along the way. Rising interest rates may cause the bond market to perform badly. Rising food and energy markets will hit the pocket-books of the poor and middle classes hard while their salaries stagnate. However, falling wages will keep inflation moderate. The economy will continue to grow, just slowly. Don’t expect a miracle cure. The economy will keep progressing through rehab but it will take years not months.

Friday, January 21, 2011

Year End 2010 In Review

When money is once parted with, it can never return.
Jane Austen

The results have been tabulated and the winner is: The U.S. Stock Market. Yes, the U.S. stocks outperformed its international counterparts in 2010. While international stocks came in a distant second, bond funds began to languish. The U.S. S&P 500 Large Cap Index actually generated double digit gains of 15.1% return for the year.

These results seem implausible given the haphazard manner in which the returns were generated. In fact, more than half the gains for the year were generated in December. The S&P 500 rose 17 out of 22 trading days for the month. It was the best December in almost 20 years. If this were a ride at Disney most entrants would have thrown up by now, and the ride doesn’t seem to be getting any smoother or predictable.

In addition, the riskier the asset in 2010 the better it performed. U.S. Small (S&P 600) and MidCap (S&P 400) stocks each rose 27% while U.S. Large Caps (S&P 500) rose 15%. In all U.S. equity arenas (Large, Mid and Small Cap), the riskier Growth strategy outperformed Value. The Mid Cap (S&P 400) Growth ishares were up 30% while the Value strategy rose 22%. The same was true in the Small Caps (S&P 600) where Growth strategy delivered 28% compared the Value strategies 23%.

International stocks lagged the U.S. but still delivered solid performance. The Developed Countries’ index (MSCI EAFE Intl) grew 8% while the Emerging Markets fared better producing a 16.5% return. Similar to the U.S., the riskier international stocks performed the best with International Small/Mid Cap Growth funds, growing 22.3%.

As the year ended it became clear that there was a divergence in performance for bonds and stocks. Bonds became a trouble spot in December as interest rates began to rise. Much of this decline was in response to the positive economic news and despite the Federal Reserve announcing that it would be purchasing bonds. This market intervention (quantitative easing round 2) is referred to QE2 by the press. The Fed is buying bonds in order to pump more money into the financial system and drive long term interest rates down. Despite the Fed’s efforts long term interest rates have been creeping up. Remember, as interest rates rise the value of bonds fall. This trend will most probably continue next year making it even more difficult to generate consistent income in most retirement portfolios.

Commodities had a fabulous fourth quarter rising 16% after being essentially flat for the year. This surge was caused by strong demand for raw materials from emerging markets especially China. Investors continued to be drawn to physical assets (e.g. gold, silver) due to concerns about the continued instability of the international markets. This pushed prices in many commodities to multi-year highs that are probably not sustainable in the short term. Some of these gains have been erased in the first weeks of 2011 but the long term outlook for commodities remains strong.

Tuesday, January 4, 2011

Libby Interviewed

I was interviewed by George Avalos of the San Jose Mercury and the Contra Costa Times. Here is the article that was published today.

http://www.contracostatimes.com/real-estate-news/ci_17001081?nclick_check=1