Economic Slowdown: Employment Holding Up Well

by: Vikram Saxena posted on: May 05, 2008 | about stocks: DBA / DIA / ITB / IVV / QQQQ / ROM / RTH / SMH / SPY / TLT / UYG / XLB / XLE / XLF / XLK    

The current economic slowdown owed its genesis to the housing bubble and the subsequent meltdown in the credit markets. It is primarily a consumer driven recession; US corporations are doing fine. As a result the employment situation is not as bad as many observers had feared.

During the past decade American corporations have enjoyed the fruits of the massive investment in Information Technology in the late 90s. The overhaul of IT systems ushered US corporations into a new era of efficiency. The availability of high speed communication and data networks significantly increased the ability of companies to focus on their core competencies. As a result American companies are much leaner in their structure than they have ever have been.

Case Study: Post Bubble Silicon Valley

After the technology bubble burst in 2000, Silicon Valley was in a slump. There were massive amount of layoffs and Santa Clara County lost more than 200,000 jobs from the peak of the bubble. As the local economy emerged from the carnage, valley companies, big and small, had a distinctly different feel. A lot of non-core tasks, especially administrative and non-hiring related HR tasks like Benefits had been outsourced (not to be confused with off-shoring) to third party providers. The third party vendors benefited from economies of scale and could provide services at significantly lower costs than permanent in-house employees.

As communication moved to the electronic domain, the number of administrative support staff needed went down significantly. Often the ranks of administrative assistants were cut down in more than half. It was not uncommon to have start-up companies with up to 50 employees operating with just a single, often part-time, administrator.

Modern US corporations are very lean in their structure which gives them the ability to weather economic slowdowns better than before. The hiring-firing cycle has become much less pronounced than before. Companies have to think twice before they lay-off employees since a vast majority of workers fill roles essential to the core competency of the organization.

Just in Time Manufacturing

Similarly Just in Time manufacturing and demand prediction systems have enabled firms to get excellent visibility into demand pipeline. This has significantly reduced the need to maintain extensive inventory. Lean inventories also mean that manufacturing companies go through less severe swings between economic cycles. Companies today have the ability to fine-tune their operations based on real-time information which enables them to be very nimble.

The change is being felt in the current economic slowdown where inventory build-ups are significantly less than comparable points in the past. The ability to fine tune production based on the pipeline demand allows manufacturing industries to be less prone to the boom/bust cycles.

Economic Slowdown and Corporate Financial Performance

The current earning season is shaping out to be much better than what many pundits were predicting. GE (GE), the company that never misses, missed big and set a negative tone for the market. However, over the past week have established that GE's miss was primarily due to the problem in the financial markets (a bulk of the shortfall was in from the financial services division).

As I had written in an earlier post, this is a niche phenomenon. Since the worst of the credit crunch was in the last two weeks of the quarter companies strongly dependent on the credit markets did not have enough time to recover. Growth in exports and the weak dollar has helped the large US multinationals, especially those focused on the technology and materials.

US companies have excellent balance sheets, have lean operations and are in no rush to shed employees. The job situation in this down-cycle has so far been much better than previous recessions. The unemployment rate is hovering around 5%.

April Non-Farm Payroll Report: Financial Sector Employment in Focus

Non-Farm payrolls are improving with the report on Friday showing a fall of 20K, a much lower fall than what many economists have feared. Some Wall Street observers cast some doubts on the report since it showed an increase in financial services employment. Data from BLS (page 21) shows a year to year decrease of 90K jobs in this sector (without seasonal adjustments) which is consistent with the overall slowdown. Wall Street has seen a lot of job losses but the financial industry does not end in New York.

CNBC has a piece about PIMCO, based in California, looking to hire employees laid off by other firms. At the consumer level the mortgage industry is now recovering after shedding tens of thousands of jobs over the past two years. This increase is coming on two fronts:

a. Foreclosure Handling and Loss Mitigation departments

b. Plain vanilla refinancing as low interest rates and increase in confirming loan limits trigger a massive wave of mortgage refinancing, especially for home-owners who took hybrid ARMs (e.g. 3 year/5 year/7 year fixed) between 2002 and 2006 and are now looking to roll over their low rates into new mortgages.

With the worst of the credit crunch behind us, the financial industry is bound to recover further.

Decline of Home Equity Loans: Effect on Spending

Many observers that are bearish on the US economy feel that decline in availability of home equity credit will have a significant impact on consumer spending. A research paper published by the Federal Reserve in 2007 estimated the sources and distribution of money extracted from home equity over the past two decades. A key observation was that a bulk of the money extracted went either to repay old loans or towards home improvements. Contrary to popular wisdom, the home equity spending as a percentage of the personal consumption expenditure (PCE) rarely crossed 3% even at the peak of the housing boom. Typical numbers are in the 1-2% of PCE.

Consumer Spending: Jobs, Jobs & Jobs

Though the housing slowdown will have a definite impact on consumer behavior, the magnitude of the impact is overblown by the media. At the end of day, consumers spend if they have money and most of the money comes from jobs. As long as the job situation remains in control, consumer spending is unlikely to collapse.

Another aspect to note is that a large portion of jobs lost over the past two years have been in the construction sector. This sector has a large concentration of undocumented workers who do not qualify for unemployment benefits but are counted in the non-farm payrolls. The WSJ reported that workers from Latin America have cut down on the remittance out of the USA. The number of undocumented aliens, intercepted by border enforcement agencies in the South has gone down, indicating a slowdown in the number of workers entering the United States.

The economic stimulus checks will be hitting the banks soon and consumer spending is likely to receive a shot in the arm this quarter.

The Markets: New Leaders Emerge in Equity Markets

Major equity indices broke through key resistance levels representing the downward trend lines. The Dow Jones Industrial Average closed above 13,000, the S&P 500 closed above 1400 and the NASDAQ closed above 1425; all above the highs reached in February.

The Fed has signaled an end to the current loosening cycle and the dollar has rallied strongly against the Euro. Commodities, especially oil, which were seen as a contra-dollar plays have started to lose their momentum. Bond markets yields have started rising indicating that the markets are no longer fixated on the credit crunch. Unlike other Fridays this year, long term bond yields (short TLT) ended at their highest level of the day, showing the end of the weekend safety trade. The VIX volatility index is under 20 and close to the lowest levels seen this year.

Since equity markets typically look ahead six months, it is likely that we have seen the lows of this bear market. The averages now face a lot of small resistance lines and are likely to zigzag over the next few weeks. However, they are well above their mid-March lows and it is highly unlikely that we will see those levels again.

I believe it is time now to buy whenever there is a pullback to major support lines. Financials (XLF) (UYG), Technology (XLK) (ROM) especially semiconductors (SMH), Home Builders (ITB), and Retailers (RTH) are sectors which are likely to benefit the most in this rally. The energy (XLE), agriculture (DBA), and materials (XLB) sectors are in the middle of a well deserved pull-back in a secular bull market; they will provide secondary medium-term leadership.

Disclosure: Vikram holds long/short equity, equity options and index futures positions in many of the securities and indices mentioned.

This article has 7 comments! Add yours below...

Vikram Saxena

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This article has 7 comments:

  •  
    fxtrader07
    May 05 08:33 AM
    OH NO! The superficial, useless and absolutely dumb articles continue to grow at an alarming rate at SA.
    first, it#s obviously just another author who is believing the Bullsh!t's department's (BLS) "statistics and doesn't bother to even look into them beyond the surface.
    so, even when we accept these strange numbers for a moment: each and every item that is important for signalling the state of the domestic economy, i.e. recession or boom was down - considerably: manufacturing, construction, retail. all in all, another 110.000 stuff-producing-jobs were lost. on the other hand, 90.000 non-producing "service" jobs (whatever these services are) were added. services jobs, btw, are usually much lower paid and add much less value than the "producing" jobs. which makes a huge difference over the longer run. worse, they provide the basis for the services in most cases. with (imagined) zero production jobs there is finally nothing left to support the services pyramid atop of it.
    a positive exception was, lo and behold, financial services. of course finance does not end at wallstreet - but a lot of financial services deliver to wallstreet nonetheless. and mortgage and finance companies trying desperately to survive certainly do not add jobs either. so who are we made to believe is hiring the supposedly large amounts of "financial services" people?
    the bulk though, came from the absolutely nonsensical birth-death-model that is used by the bls basically to make up the num,bers to whatever level they wish. so 72.000 business services jobs were added by way of new firms. helloo?? didn#t the author dare to ask himself what strange businesses these might be and whether they will add anything to the economy - or rather be a burden?
    no he didn't because he didn't care.
    what a crap.
    but alas, there is no recession, no weak dollar, no deteriorating economy until the govt. confirms it, right?
    unbelievable.
  •  
    fxtrader07
    May 05 08:43 AM
    oh, and btw: the BLS just ASSUMED that a net total of 45.000 NEW jobs were created in CONSTRUCTION in April!
    I really do not know how anyone can even for a second believe this bullsh!t published by the govt!
    even a very brief look at the housing market and the businesses involved in housing and related activities tells exactly the opposite.
    no wonder the futures market where the dumb money bets on the odds of a u.s. recession for 2008 have fallen to a 28% probability of a recession in 2008 - down from 70% just 2 months ago!
    but then again, the govt surely will succeed to massage the numbers in such a way that no recession shows up in the statistics until november at least.
    yeah, right. believe it at your own peril
  •  
    Vikram
    May 05 09:45 AM
    My Website
    fxtrader07:

    The anger in post seems to suggest that you are short the dollar and are a bit unhappy about the last week. If you had read through my post, you would have noticed the link to the BLS report which has all the details. My article is not based on a cheat sheet someone sent to your trade desk.

    -As I have noted, the report still indicates a 90K drop in financial services on an year to year basis, but a recent uptick. I strongly believe that the uptick is coming from the retail mortgage industry which has been decimated and is ready for a big refinance wave.

    - Similarly page 20 of the report says that the construction industry lost 61K jobs between March and April on a seasonally adjusted basis. It did gain jobs on a non-seasonally adjusted basis which is due to the end of winter when construction activity resumes in the snow-bound areas of the US. There are about 200K more unemployed workers in the construction industry right now compared to an year ago. There is nothing which suggests manipulation; all data points to a industry in deep recession.

    -The birth-death model takes into account new business formation and the death of old businesses and the time-lag between their formation/death and collection between the employment generated ( www.bls.gov/web/cesbd.... ). The same model contributed to a loss of 378,000 jobs in January 2008 which contributed to the bear-case. You want the cake and eat it too?

  •  
    gaucho
    May 05 10:10 AM
    My Website
    FXTADER is right. The government is lying. The Inflation rate is 5% and above while the government keeps saying it is 2.6%!!! I am not blind and do not believe that crap for one moment. We have had two back to back quarters of negative growth if the real numbers are plugged in.

    The housing market continues to plunge at an accelerating rate. This will continue through at least 09. Keep believing that crap and buy financials and you will be bankrupt soon. Did anyone notice that credit card debt went up an astounding 5% in March alone! That is due to the resets on the ARMS and people using credit cards to prop up their finances. This cannot continue for more than 3-4 months before their finances hit the wall along with the economy. It is going to get much much worse. The FED cannot keep this up all year even if an election is on the way. They are blowing more money into the I BANKS than the Iraq war and they still will not lend to each other.
  •  
    fxtrader07
    May 05 12:18 PM
    Hi Vikram: I am quite net long equities - though only certain stocks, not the broad market and I am not really short dollar. rather, i have hedged and these hedges are doing pretty well, thank you very much. btw, a week's performance isn't something that i care for anyway.
    My anger may be a bit overblown but the cause for it is something else than you suspect: If one wants to write a piece on the employment report, fine, but then one should dig really into the facts and look beneath the surface - or else you could leave that exercise to those willing to do it. But then, what's the sense and the need of writing a piece on the matter in the first place? there is simply no analysis - you basically took the numbers at face value and based on that non-analysis you arrived at some conclusion about the economy and the markets.
    regarding the cake: this mubo-jumbo with the net birth-net death model has been going on for quite some time, yes. and there were a lot of months when the numbers were absolutely nonsensical. the question one might ask: being (still) the world's economic superpower why is the USA not capable of producing RELIABLE labour statistics?? (I mean, a LOT of important economic indicators also for international comparisons are based on that: wages, incomes, productivity, labour costs etc). other countries, for instance in Europe have very detailed statistics that are based on facts, on very thorough data collection from companies and the governmental unemployment agencies. Whereas in the USA, the numbers are created by interviews, polls and mark-to-wishes-models (e.g. the infamous net birth-net death humbug).
    Does really anybody want to tell me that the economic superpower of the world has no means to get precise figuresc - which are after all quite important for policy makers at the fed and the govt.? or is there something else to it? (hint: the decision to discontinue the publication of the highly important monetary aggregate M1 for the USA - in Europe M1 is THE premier aggregate for the European central Bank - certainly has a reason, too. and it might be quite a similar one)
  •  
    Vikram
    May 05 01:04 PM
    My Website
    fxtrader:

    Your posts focus on my interpretation of the job numbers and completely ignore the thesis behind the arguments.

    Having worked in 'real' companies before coming to Wall Street, I saw with my own eyes how companies became leaner and more effecient. I also noticed that unlike the past where it was easy to shed excess, there is not much excess left. The unemployment rates for college grads is close to an all time low. That is why I am not at all surprised that job losses in this cycle are not as severe as before.

    I also gave specific arguments about why the financial services number is better than what many expected (repo/refi in the mortgage market).

    I had gone through the BLS report specifically focussing on the construction and financial sector. Both of them show big year to year losses; construction even shows a month-to-month loss on a seasonally adjusted basis.

    All the doom/gloom headlines condemn the birth-death (of companies) model; however they too are shallow in their interpretation. The same bearish pundits did not mind when the same model contributed to a big loss in January.

    If you take a dispassionate look at the birth-death model, you will see some correlation with reality.

    -The fourth quarter of last year was the time when the economy really hit the brakes and consumer spending plumetted. So it is not surprising that a lot of businesses did not survive the weak Christmas season and shut down (death of businesses).

    -Right now, the economic trends (ISM indices) are reversing their downward trend and after accounting for seasonal factors, it is likely that the new business formation is increasing. This is being reflected in the birth aspect of the birth-death model.

  •  
    iThinkBig
    May 05 01:37 PM
    My Website
    I own a business. The business is in consumer healthcare marketing. In June of 2007, I spent a week compiling all the current numbers and pulling in some VC buddies feedback/projections on the U.S. economic outlook for Q4 and the first half of this year. Let's put it this way, by the time I was done I told all friends and family to expect deep recession, pay off debt and take no more on. Then, I sent an email to my board (I am the CEO) and stated we should change our M/A strategy to sell by the end of this year. Lastly, I cancelled the family vacations and spent 14 hours a day at work, 8 hours directly going on larger deal opportunities and the other 6 managing the business. Q4 2007 was soft, but Q1 of this year was the WORST year I have ever seen in the twenty years I have been in business, much worse then 1991. The company survived and we are now reaping the benefits of the responsible and realistic based on fundamentals.

    Let me say this, the consumer is tapped out. Main St. will drag down Wall St. Offshoring by the multinationals is guaranteed. That's great if you work for one as mid-level or above executive or if your are a peasant in India, China, Phillipines or Costa Rica. Short-term commodities will cool off as the dollar gains a smidgeon of strength and stimulus has a temporary positive effect on the market. If Washington does not realize the world is flat and creates policy that creates jobs (I am especially talking about energy in this regard) then in late 2009 I am investing in a vacation cabin, ammunition, medicine and foodstuffs that will be 50 miles from the nearest major metro. Right now, it appears the U.S. will attempt to Socialize it's way out of the Great Depression part 2 but I guess time will tell.

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