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Jubak's Journal
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A jobless recovery can't go on for long
For now, Wall Street buys the idea that the economy will improve before employment numbers do. But watch out if hiring doesn't pick up soon.
By Jim Jubak
When it comes to job losses, Main Street sees a glass half empty, Wall Street a glass half full.
Initial claims for unemployment, one indicator of how many people are working and how many are looking for work, rose to 413,000 for the week that ended Aug. 30, the U.S. Department of Labor said last week. That was 15,000 higher than the week before and a solid 20,000 above Wall Street expectations. And, thanks to the increase, the less volatile four-week moving average climbed back above 400,000 for the first time in five weeks. Many economists believe that initial claims must drop below 400,000 for the economy to be adding jobs.
How did the markets react to these dismal numbers? With a shrug. For now, anyway.
The Dow Jones Industrial Average ($INDU) and the Nasdaq Composite ($COMPX) were both solidly in the black from the previous days close 75 minutes after the Labor Department released its report. The Standard and Poors 500 ($INX) joined them on the plus side 20 minutes later.
The initial claims report was followed Friday by the Labor Departments widely watched report showing nonfarm payrolls in August shrunk by 93,000 jobs. Analysts were expecting an increase of 18,000 new jobs. August marks the seventh consecutive month of job losses, adding up to a total of 595,000 jobs lost since January.
The picture in the manufacturing sector is even grimmer: August was the 38th consecutive monthly decline. The total number of manufacturing jobs lost in the last three-plus years reached 2.73 million.
Buying into the conventional wisdom
Even though real people are losing real jobs that likely wont be replaced anytime soon, the stock market seems to have bought into the conventional wisdom that unemployment is a lagging indicator of economic growth. Companies lag in rehiring laid-off workers or in hiring new workers until they see concrete, undeniable evidence that their own businesses are growing. Any recovery will be months, perhaps quarters old, before it results in a sizable wave of hiring.
You can see the lag in the most recent data from the Institute of Supply Managements August survey of purchasing managers. The index of manufacturing activity climbed to 54.7% in August, the non-manufacturing index to 65.1%. Both numbers are solidly on the plus side because any reading above 50% indicates expansion. But the index of manufacturing employment still contracted, from 46.1% in July to 45.9 in August. The nonmanufacturing employment index expanded only slightly to 51% from 50.7 in July. Hardly a ringing endorsement of a recovery.
But this lag has a silver lining, again in the short term, for investors. The stock market knows this hesitancy to hire provides an extra boost to corporate profits in the early days of any rebound. Companies ask the workers that they still have to do more even as sales pick up. The result: Productivity increased 6.8% in the period. Thats good news for company profits. Unit labor costs for the second quarter fell at an annual rate of 2.8%.
From this point of view, the disappointing numbers on initial claims for unemployment and on jobs loss/creation are just what youd expect at this point in the economic cycle. And as the economic recovery continues, companies will hire when they are confident the recovery is for real and sustainable. Its all just business (cycle) as usual.
The stark reality
But there are trends working their way through the economy that arent cyclical. Some -- and no one knows exactly how many -- of the jobs lost in the recent economic downturn wont be coming back. Theyre gone for good, exported to low-wage countries such as China. Thats especially the case in the manufacturing sector.
Since February 2001, the United States has lost about 15% of all jobs in the manufacturing sector. Those job losses havent been limited to old-economy, metal-bending industries. About 25% of jobs in the computer and electronics manufacturing sector are gone, too.
Some of those will return along with demand for networking equipment, machine tools and PCs. But the vast majority of the 2.7 million jobs lost since the 2001 recession began are the result of permanent changes in the U.S. economy, a recent report by the Federal Reserve Bank of New York concludes. Job creation of the magnitude needed to significantly reduce unemployment will require the creation of new jobs in emerging economic sectors, the Feds report continues.
Thats no mean task, given that it takes the creation of about 100,000 new jobs a month just to keep up with population expansion, and growth of about 200,000 jobs a month to reduce unemployment significantly.
The New York Feds report goes out of its way to differentiate this downturn from past recessions. Three factors are at work now:
The importance of cyclical companies in the economy has declined. Large industrial companies with cyclical employment practices -- that is they regularly lay off workers when the economy goes sour and regularly rehire when times improve -- account for just 21% of the work force now. Thats down from nearly 50% in the early 1980s, the Fed reports.
And many of the new industries that now dominate the economy have used this recession not just to lay off workers but to permanently change they way they do business to cut costs for the long term. Theyve done this by increasing automation, improving production processes and shipping work overseas.
The period of jobless growth has been extraordinarily long. In the 1991-1992 recovery, job growth remained flat more than a year after the recovery started.
In 2002 and 2003, the Fed study notes, the economy grew while the job market shrunk 0.4% each quarter. In some industries, the magnitude of jobs lost during the recovery comes close to the number lost in the actual recession. The brokerage industry cut 44,000 jobs during the recession, for example, and 25,000 during the recovery so far.
The trend of sending work overseas isnt about to slow down. Forrester Research has predicted that 3.3 million U.S. jobs will be shipped overseas by 2015. Thats not limited to manufacturing, either. About 200,000 of those jobs will come from the service sector, Forrester predicts. Consulting company A.T. Kearney estimates that financial services companies will send more than 500,000 jobs overseas in the next five years. Consultants at the Gartner Group estimate that one in 10 tech jobs could move overseas by the end of 2004.
Why is the possibility of a recovery with substantially below-normal job growth (by historical standards) important to investors?
The major problem in this recession (which officially began in March 2001 and officially ended eight months later) and recovery has been an excess of capacity and a lack of demand growth. Weak job growth wont do anything to create extra demand: People without jobs dont buy stuff. And to the degree that consumers with jobs start to worry about the security of their jobs, weak job growth can undermine even existing demand as consumers tighten their belts in anticipation of tougher times. Thats exactly the kind of mind set that produces recessions.
With companies managing to meet modest demand growth from increases in productivity, the current slump in capital spending that has turned the corporate sector of the economy into such a drag on economic growth is likely to continue.
Stocks in 2004 could be at risk
And a recovery with weak job growth could lead to serious problems for U.S. companies and their investors in 2004. Take a look at the expectations built into the price of shares of Cisco Systems (CSCO, news, msgs), for example. Recent Wall Street increases in earnings estimates for Cisco imply revenue growth of 15% for the fiscal year that ends in July 2004 and of almost 20% for the year that ends in July 2005.
Not bad for a company that reported flat revenue for fiscal 2003. And a very tough target to hit if demand for the companys products remains sluggish.
The possibility of a jobless recovery and its effects on the demand side of the economy fits into what Id call the secular bear market theory held by prominent market strategists such as Ned Davis of Ned Davis Research and Richard Bernstein of Merrill Lynch. According to this scenario, the recent stock market rally is merely a temporary bull market inside a secular bear market for stocks -- and the economy -- that could last for a decade. The bear could return as early as the first half of 2004, the most pessimistic say, with the optimists seeing a peak for the market in mid-2004.
The Fed is worried
The Fed is clearly worried about the possibility of a jobless recovery. Fed Gov. Ben Bernanke said on Sept. 4 that the continued lack of job growth could lead the bank to lower short-term interest rates, now at 1%. Growth that is generated solely by increased productivity and that is unaccompanied by substantial employment growth, may possibly require monetary ease, rather than monetary tightening, in the short run, Bernanke said in New York.
Will weak job growth derail this recovery by mid-2004? Its a possibility, but still less than a 50/50 chance. I think the economy has until the end of the year to put some positive job numbers on the board before the inability of this recovery to reduce unemployment starts to eat away at consumer and investor confidence.
But along with persistently high energy prices and the possibility of higher long-term interest rates, the possibility of jobless growth gets my attention as one of the top three problems facing the stock market and the economy in the next six to 18 months.
New developments on past columns
Lost in the market fog? Follow the dividends
The investor relations folks at Exxon Mobil (XOM, news, msgs) and General Dynamics (GD, news, msgs) sure are careful readers: Both companies sent me tweaks on my Sept. 2 column that listed their stocks as among those sending out the strongest buy signals in recent dividend hikes. First, Exxon Mobil took issue with my description of declining refining margins: Note that refining margins did improve earnings by $420 million in the second quarter 2003 vs. the second quarter of 2002, although you are correct that refining margins were $70 million lower sequentially. And, second, General Dynamics noted that Id either missed a dividend hike or miscalculated the 12-month total: You might have had some out-of-date info. Our board increased our quarterly dividends to $0.32 a share in March, payable to shareholders of record as of April 11. That would put total dividends over the past 12 months at $1.28 per share. I had listed General Dynamics' trailing 12-month dividend as $1.18.
Editor's Note: A new Jubaks Journal is posted every Tuesday, Wednesday and Friday. The Wednesday edition stems from Jim's appearance on CNBCs Business Center most Wednesday nights at approximately 5:45 p.m. ET.
At the time of publication, Jim Jubak did not own or control shares in any of the equities mentioned in this column. He does not own short positions in any stock mentioned in this column.
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