Hockey Stick or a Plank?
"Only" U.S. 36,000 jobs lost in February (we get our numbers in Canada next week). That is relatively good news. The storyline was the following. Given all the snow, the U.S. should have lost more jobs. 36,000 was a relatively good number because if there was no snow the U.S. would have seen growth. But there was no growth. In addition, there is a lot riding on the March numbers which will be released April 2. Assuming no more snow, this argument predicts a big positive gain.
The real issue here is what the recovery will look like. Are we stuck in a quagmire of persistently high U.S. unemployment (the plank) or are we going to see a sharp rebound (the hockey stick).
I vote for the plank.
The Jobs Numbers
Despite the snow, the unemployment rate held steady. Only 36,000 jobs were lost from non-farm payrolls. Temporary jobs increased again and temporary jobs are a good leading indicator of full time jobs. All of this is good news.
On the bad news side let me list some issues:
- The unemployment rate did not drop. Are we stuck in the high 9% range?
- The all-in rate which counts people that are marginally attached and working in part-time jobs (not by choice) increased to 16.8%.
- Temporary jobs have been increasing for quite a while. Usually, they are a leading indicator - but they haven't been (so far) in this cycle. Things might be different this time.
- Duke-CFO Survey was released Wednesday. CFOs forecasted a lethargic 0.2% employment growth over the next 12 months. That will do nothing to the unemployment rate.
The Case for the Hockey StickLet me consider eight factors that have been mentioned by a leading economic consulting house.
1. Corporate profits will robustly grow, perhaps, 30% in 2010
This is definitely good news and credible. Remember that non-financial corporations (and excluding the autos) were in generally good shape before the melt down. Corporations have been reducing their leverage since 2002. There is plenty of cash on balance sheets. The recession has led to unprecedented productivity gains. CFO's expect a further 3.2% productivity gain in 2010. They will spend. Capex will jump by 8.9%. R&D by 3.7%. Advertising by 3.4%. But, as I mentioned, not on employment. I can't see how you can have a hockey stick recovery with 9-10% unemployment. By the way, the Duke-CFO survey puts earnings growth at 14.3% in 2010.
There is another important point but related point here. Where has the profit growth come from? Mainly cost cutting. The layoffs and restructuring costs that were taken in 2009 are now paying off in 2010. The key is sustainability. You cannot indefinitely cut costs. Growth depends not just on productivity but demand for the product. The profit numbers we are seeing are largely driven by the big bath in 2009 and the realization of cost savings in 2010.
2. Credit markets have greatly improvedDepends on who you are. Yes, credit spreads have dramatically decreased. It is a lot cheaper for large firms to go to the bond market because the spread they must pay over government bonds is a lot less. However, the problem is that corporate bond market is not accessible to small and medium sized businesses. SMB usually rely on bank lines of credit not the capital markets. The Duke-CFO survey showed that 70% of small and medium sized businesses said that credit conditions were worse than 2007. In other words, they face a continued credit crunch. Small and medium sized firms are the drivers of employment growth. It is hard to see a robust recovery if these firms are still being frozen out of the bank lending market.
3. Global short rates are low and low rates lead a recovery by one to two yearsIt is true rates are low. But why are they low? They are low because the economy is in recession. They are only a leading indictor of recovery in the sense that a recession is a leading indicator of a recovery. A recession is always followed by a recovery. Yes, there will be a recovery. The question is what it will look like. Low short rates are not particularly informative.
4. The yield curve is steep and has been for quite a whileI'll write a whole blog on this one of these days. The predictive power of the yield curve was first documented in my dissertation at the University of Chicago in 1986 - so I have a bit of knowledge about this. The yield curve has accurately forecasted every recession since 1969 - without a false signal. Inverted yield curve means a recession will follow (at least so far). However, there is only so much you can ask from the yield curve. It provides very little information about the shape of a recovery. I would interpret the current reading as telling us that a double dip is unlikely (over the next year).
5. The Fed and the Administration are fully aware of the downsideUhh, I guess so. This refers mainly to the Rogoff-Reinhart idea that once the size of government debt to GDP gets sufficiently large, it stunts future GDP growth. This is based on their careful study of 200 years of financial crises. However, I see no indication that the Administration or Congress wants to take steps to reduce this drag. The Fed has no power over fiscal policy. Indeed, most of the talk in DC is about additional spending which would make the debt to GDP situation even worse.
6. Sub-optimal growth is politically and socially unacceptable and if it occurs there will be more policy responsesBut that is exactly the problem. More bailouts and more spending on short-term employment does not lay the foundations for future growth opportunities. Indeed, you can argue the reverse. When the government deploys capital, it is effectively taking it away from consumers and corporations. It is taken away via means of taxes or by their borrowing (future taxes). It comes down to who you believe has the best shot of creating growth opportunities.
7. The global economy is surging and will drag the U.S. alongLet's be clear here. Emerging markets are surging. The bulk of the global economy is not surging. Europe is in a very low growth mode. Japan will unlikely see any meaningful growth over the next five years. Canada is in relatively good shape mainly because of their sensible financial regulation and their refusal to subsidize housing through mortgage interest deductibility. Even though the Canadian fundamentals are strong, they are strongly linked to the U.S. which will diminish their growth opportunities. The reference to global is really just emerging markets. The demand for U.S. exports from these markets has moderated an already very serious recession. However, the global economy is not surging. There is a big divergence between the prospects of developed and developing countries. It is a tough case to make that the global economy will make the difference for the hockey stick.
8. Emerging markets will potentially grow at 7% in 2010.This is really the same point as #7. Yes, the U.S. has benefited from emerging markets growth. This is a plus for the recovery but it is not enough to meaningfully reduce the unemployment rate.