SERIOUS MONEY:THE CONVICTION of investors that the "old" normal has returned is rapidly gaining momentum as the bull continues to roar.
The US economy moved from the recovery phase to expansion during the fourth quarter as economic activity exceeded its pre-recession peak, corporate profits have more than doubled from their cycle nadir and record earnings are expected for the 2011 calendar year, while the labour market continues to improve with the unemployment rate registering its largest two-monthly drop in more than half a century in January.
The improving fundamentals combined with massive monetary stimulus has seen the major stock market averages jump more than 90 per cent from their bear market lows and the ultra-bullish believe that all-time highs are not far away, but is really safe to conclude that happy days are here again?
The bulls appear to have little appreciation for the damage the Great Recession inflicted upon the average American household and the recovery to date has done little to engender confidence in the optimists’ so-called self-sustaining economic upturn.
Indeed, the unemployment rate has been above 9 per cent in each of the past 21 months, the longest stretch in the post-second World War era, and civilian employment is no higher today than the summer of 2004.
Furthermore, and perhaps more importantly, the recent drop in the unemployment rate has nothing to do with job creation and everything to with the exodus of disillusioned workers from the labour force, who have either returned to full-time education, retired, simply given up looking for work or who have become part of the institutionalised working-age population that includes mental hospitals and prison – both of the latter happen to be positively correlated with long-term unemployment.
The fact is that civilian employment has dropped by more than 650,000 since the economic recovery began six quarters ago. Had the labour participation rate held at the level that was registered at the recession’s end – a reasonable expectation given both the duration of the upturn in economic fortunes and the recent passage from recovery to expansion – then the rate of unemployment would be close to 11½ per cent – more than double the rate that reasonable commentators believe to approximate full employment.
The odds that America’s labour market returns to equilibrium before the next recession strikes are less than good. Full employment is believed by most expert commentators to be circa 5¼ per cent, but reasonable projections that account for growth in the working-age population alongside a modest uptick in the participation rate, suggest that countless American workers can expect to remain underemployed for a decade or more.
Lower the bar to a 6 per cent unemployment rate and the picture painted is hardly a cause for celebration. America needs to increase civilian employment by roughly 130,000 each and every month in the years ahead simply to stabilise the rate of joblessness and absorb the natural expansion arising from the upward trend in the working-age non-institutionalised population.
Should the expansion ultimately match and sustain the highest five-year trailing monthly average rate of increases in civilian employment registered during the Bush years, then a further 40,000 positions would be created each month to bring the monthly total to 170,000. Incorporating working-age population projections and assuming the participation rate increases gradually to the level registered at the recession trough, this implies that civilian employment exceeds its pre-recession peak in the autumn of 2014, though the rate of joblessness does not drop below 6 per cent before the winter of 2020.
Even assuming a constant participation rate – a relatively negative assumption given that is already at the lowest level since 1984 – the labour market would still not reach full employment until the summer of 2017.
The future unemployment rate can also be projected using an empirical tool known as Okun’s Law, which describes a stable relationship between changes in economic output and changes in the unemployment rate.
The relationship implies that the unemployment rate should fall by roughly four-tenths of one percentage point for every one percentage point increase in real output above the economy’s long-term sustainable growth rate of circa 2½ per cent. Assuming the economy grows at an above-trend 3½ per cent for the next several years, it would still take until the summer of 2017 for the unemployment rate to fall below 6 per cent.
The labour market remains fragile despite six quarters of economic recovery and, although the rate of entry to unemployment has dropped significantly, exit rates remain painfully low. Unemployed workers’ skill sets are being gradually eroded, which will make it increasingly difficult for them to find gainful employment, while those workers who have found new jobs have done so only at a sizable pay reduction versus their previous work.
Developments in the labour market deserve close attention as the economic expansion unfolds.
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