A market crash by jobless recovery?

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This post is a guest contribution by Dian Chu*, market analyst, trader and author of the Economic Forecasts and Opinions blog.

While certain signs have pointed to the end of the recession, unemployment remains rampant. With a double-digit unemployment rate, President Obama has been traveling throughout the nation, pushing his job-creation agenda.

Meanwhile, the House overwhelmingly approved extending the filing deadline for unemployment benefits and the COBRA health coverage subsidy through the end of February, and also narrowly passed the $154 billion jobs bill.

Billions would probably go toward highway construction and mass transit. However, the total is considerably less than the $780 billion stimulus bill passed earlier this year, and is not expected to hit the Senate until early next year. But if the legislation is ultimately passed into law, the total spending could amount to almost 1% of U.S. gross domestic product (GDP).

Worse Than You Know
The nation’s employment picture is certainly grim. The unemployment rate jumped to 10.2% in October, the highest in 26 years, albeit the number went down to 10% in November (most likely a sampling error). Nearly 16 million Americans are out of work, and there are now six workers competing for every job vacancy.

The headline unemployment rate; however, does not take into consideration discouraged workers, part-time workers who want full-time work and underemployed workers. Include these people, and the rate increases to 17.2% in November vs. 12.2% from a year ago.

Additionally, the U.S. Labor Department survey of companies doesn’t count the self-employed and undercounts employees of small businesses. So the economic picture could be even more dire, as small businesses account for about 60% of the nation’s jobs.  Adding to the demand decrease associated with the recession, small businesses have been crimped further by banks tightening credit not willing to lend.

Stimulating the Wrong Way
In a recent Forbes article, Mr. Joel Kotkin points out that the latest job growth trend reflects the critical weakness in the stimulus package.  The stimulus focused on government bailouts and transfers of research funds to universities while with less than 5% going to basic infrastructure.

“The strongest growth in high-end services is usually propelled by growth in tangible industries, such as energy, agriculture or manufacturing. When those industries tank….high-end services decline with them.”

A Different Joblessness This Time Around
The number of people unemployed for longer than 27 weeks is almost 6 million. Generally, the number of these workers is about half those unemployed for less than five weeks. This relationship switched midway in 2008.

Now, the mean length of unemployment is about 27 weeks, up from 15 weeks in December 2007. While the number of unemployed and the duration of unemployment is running deeper, those who are employed are working less hours resulting in smaller paychecks.

Recovery Paradox
Job losses have been unusually steep in this latest recession with some 7.3 million jobs have been lost since December 2007, according to NABE. And little evidence suggests that employees will start hiring on a mass scale anytime soon.

The severity and the speed of the downturn has made businesses exceedingly cautious about the recovery and is contributing to a substantial disconnect between their more cautious forecasts, and more confident recovery talk from government officials as well as many in the investment community.

Businesses remain skeptical about the economy and just how much Washington can do as the White House and Congress are tied up with health care reform and foreign policy issues. In addition, their ability to institute new programs will be hampered by the nation’s record budget deficit.

GDP vs. Unemployment
One economic theory – Okun’s Law, suggests an empirically observed relationship relating unemployment to losses in a country’s production.

The theory posits that for every point above normal that unemployment moves, GDP growth falls by 2%, and vice versa. While not an exact science with plenty of critics, the equation does provide a good quantifiable estimate of the effects of unemployment upon GDP output.


Indeed, unemployed workers represent wasted production capability, and it also means less money being spent by consumers. With consumer spending accounting for about 70% of the U.S. GDP, prolonged high unemployment leading to chronic lower spending has the potential to lead to lower growth, more unemployment, beginning a vicious cycle. (Fig. 1)

A Lagging Indicator No More
The unemployment rate is traditionally characterized as a lagging indicator, and Raymond James just reminded investors that on average, unemployment starts to go down seven months after the trough in the S&P 500 is reached.

Nevertheless, due to the sheer speed and volume of job losses across a wide range of sectors, I have to agree with PIMCO‘s Mr. Mohamed El-Erian that the unemployment rate should no longer be regarded as a lagging indicator as it does have the potential to influence future market behaviors and outlooks.

Unemployment Could Go Even Higher
Just last month, the OECD noted that growth in the world’s industrialized economies has resumed, but warns that unemployment is set to continue to rise well into 2010.

This is echoed by the testimony before the Senate Democratic Policy Committee this week from Brookings Institution, who warned that even if the economy adds 200,000 jobs a month (a tall order, by the way), it will take seven years to lower the unemployment rate to 5%.

Moreover, even if companies do start re-staffing next spring, the unemployment rate could easily hit 11% from a growing labor force, the return of discouraged workers, the hiring of part-timers instead of the unemployed.

Bull to Bear from Tightening Liquidity
Now, the Federal Reserve has just upgraded its assessment of the US economy and highlighted its intention to shut down most of its crisis-fighting liquidity facilities in early 2010.

This tightening could potentially boost interest rate along with the dollar.  This, coupled with lower consumer spending/growth in the US could mean the current liquidity-driven lofty commodity and equities price level could no longer be supported however bullish the market sentiment is.

Market Crash by Jobless Recovery?
Investors are moving in unprecedented lockstep driving up almost all asset classes (stocks, commodities, bonds and emerging markets) mostly on a weak dollar and easy money.

The simultaneous rally also suggests the market is betting on a V-shaped recovery, particularly in the second half of next year, with companies getting their earnings growth mainly from outside the U.S. However, America is still the largest consuming country in the world. A majority of the emerging economies, even China, remains largely dependent upon exports to the U.S. for their livelihood.

As discussed here, with the high unemployment plaguing the U.S. economy, the rest of world is unlikely to enjoy a robust growth as some tend to believe. In that sense, if the unemployment rate does not go down below 9% by the end of 2010, it is conceivable, for example, that crude oil price could fall to the $40 to $45 per barrel range, the generally considered fair-market-fundamental price by oil industry leaders.

Meanwhile, the market herd mentality could leave investors with no refuge amid more signs that the worst U.S. recession since 1958 isn’t abating as perceived.

*Dian Chu, Market analyst, trader and financial writer for Seeking Alpha, Zero Hedge, Daily Marksts, iStockAnalyst & StraightStocks. My articles also appear in Reuters, USA Today and BusinessWeek, etc. Professional credentials include M.B.A., C.P.M. and Chartered Economist with extensive professional experience in market segment forecasting and strategies. Previous employers include Enron, Time Warner & Clear Channel. I’m currently working in the U.S. for the energy sector.

Click here to view her full profile

Source: Dian Chu, Economic Forecasts & Opinions, December 17, 2009.

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