Grow Job

Yesterday’s employment data was reasonably strong with the economy adding 244,000 jobs. Although this is only 44,000 more jobs necessary to keep pace with population growth, it far exceeded the street consensus estimate of 185,000. Does this mean that job growth is set rocket higher? Probably not, as there are too many headwinds facing the U.S. / global economy.

Hiring at this pace will barely make a dent in the bloated number of people on the unemployment roles. Budgets cuts necessary to pass an agreement on raising the debt ceiling (or to keep the U.S. solvent without raising the debt ceiling), a persistently weak housing market and signs of slowing in emerging market economies promise to keep job growth, and the U.S. economic growth, modest. The fact that there are over 7 million people receiving unemployment benefits means that at anything close to the current pace, it could be several years or more to bring the unemployment rate down below 7.00%. If course by then the economic cycle could start a normal downward trend and nip the job recovery in the bud.

Speaking of the unemployment rate, many investors were confused about how the unemployment rated could tick higher from 8.8% to 9.0% in the face of better-than-expected job growth. This was due to how the so-called household survey is conducted. If a respondent answers that they are not working, but not actively seeking employment they are not considered to be unemployed. However, if a non-working respondent answers that they are seeking employment they are considered to be unemployed. Typically, as job prospects improve, non-working respondents become more confident and answer that they are seeking employment. Because of this, a rising unemployment rate in conjunction with a stronger Nonfarm Payrolls report is considered a positive phenomenon.

All signs continue to point toward a sustainable, but modest recovery. However, the fun may be over for commodities and the equity markets. Make no mistake, the spike in commodities prices during the past year was due in large part to Fed policy which weakened the dollar and had the potential (at least in theory) to cause a robust “v-shaped” recovery. Now we are seeing speculators take their profits and are going home. With their support out of the commodities prices have plummeted.

The equity markets have also benefited from Fed policy as low corporate financing rates and a weaker dollar making U.S.-made goods price-competitive in overseas markets. The result has been a sharp and stout balance sheet recovery. As the Fed removes stimulus, the equity markets could experience a correction. Sell in May and go away could be a good strategy this year. Autumn could be a better time to re-enter the equity markets.

I would wager many investors have interpreted the drop in commodities prices, especially oil prices, as being anti-inflationary. Au contraire, a drop in oil prices should make more consumer cash available to be spent in other, more productive, areas of the economy. Lower oil prices could in fact cause the Fed to act somewhat more aggressively to tighten monetary policy. To those who believed the Fed should have raised rates to combat higher oil prices my thinking may be confusing, but this speaks to the lack of knowledge of what inflation is measured and occurs within the investor community,

If the trend of weakening commodities continues the Fed may be better able to remove stimulus. The first action y the Fed will be to end QE2 purchases. Next, the Fed could cease re-investing maturing QE2 assets and increase the interest rate paid in reserved kept at the Fed. . Then the Fed is likely to engage in a combination of Fed Funds rate hikes and the selling of QE (1 and 2) assets,

Fed Funds rate hikes will likely be modest, few and, possibly, far between. Remember quantitative easing? Well the ending and removal of quantitative easing is quantitative tightening, Investors waiting for high Fed Funds rates are likely to be disappointed during the forthcoming economic cycle. Since U.S. dollar LIBOR is very much linked to the Fed Funds rate, Libor-based floating rates and preferreds are likely to disappoint investors.

Does this mean we will be faced with a stagnant economy in the near future? Probably not, but we could experience trend growth of approximately 3.00% during the next three to five years. What about unemployment? Without a bubble such as what we experience in tech during the 90s and housing during the first decade of the 2000s, the unemployment rate could remain above 7.00%.

Investors must understand that the growth experiences from the mid 80s to 2006 was not fundamentally sustainable, but was rather a Fed-induced and supported recovery from the poor policies of the mid-60s to the late 70s. As with every policy, the Fed’s overshot its mark with two bubbles (tech and housing) near the end of its run.

The low rate, high growth of the middle first decade of the 2000s was called the “Great Moderation.” I think “the “Great Moderation” will occur over the next five years or so. Growth, inflation and employment will all me moderate. After that, your guess is as good as mine.