Yesterday stocks closed mixed after a strong opening. 10-year Treasury yields moved higher on good economic data. Oil prices spiked on improved demand forecasts and a sign that OPEC production increases would be measured, designed to meet increased demand at best.
In March our economy created 916,000 new jobs. In April it created just 226,000 new jobs. I am no economic whiz, but if I were, I couldn’t possibly offer a coherent reason to explain the one-month difference. Despite the lack of a coherent cause for the difference, for the past month pundits, economists and analysts have offered a parade of reasons why the April report was so far below expectations. They told us unemployment supplemental payments kept people on their surfboards rather than visiting their employment board. They talked of a skills mismatch. They blamed Covid-19. I could add a dozen other reasons. However, if I add in February and take a 3-month rolling average, I come up with a number well above 500,000. That makes more sense to me and it is a perfectly fine pace. Yet all the explanations given after April’s disappointing number are true in part.
What are key, as we look to May’s numbers due Friday morning, are the following factors:
1. The number of employed Americans at the end of April was about 7 million below the pre-pandemic peak. That sounds like a lot of slack remains in the work force. However, the size of the work force was 5 million people less at the end of April than it was pre-pandemic. If our economy was close to full employment before Covid-19, when the unemployment rate was only slightly over 3%, one could argue that if just 2-3 million more workers find jobs over the next few months we will be back close to full employment unless the size of the work force recovers to pre-pandemic levels.
2. It is obvious that businesses are struggling, near term at least, to keep up with surging demand. That is forcing them to raise starting wages, and offer sign-up bonuses and retention payments. How long will this continue?
3. Some of the surge in demand is a pent-up release resulting from the end of cabin fever. Part relates to the enormous amount of money pumped into our economy from both Congress and the Federal Reserve. When will those surges wind down?
The Federal Reserve says all these influences are transient. Supply will catch up with demand over most swaths of the economy over the next several months. High prices will crimp demand, increase supply, and restore balance. At least that’s the theory.
But if the economy gets too hot too fast, or the stimulus just keeps coming (there are almost $4 trillion in administration proposals just now winding their way through Congress), there is an obvious and real threat that transient doesn’t mean months, it means years. That will seemingly require the Fed to act quicker than it might want. This conundrum is what makes Friday’s employment report so important.
I have always said that a strong jobs report is good news. Certainly, thinking in terms of overall economic growth, you want to see as many Americans employed as possible. But too much growth in too short a period of time will ignite inflation. The Fed welcomes inflation, but only within reasonable bounds. Right now, we are experiencing a spike in productivity. Any economy rebounding from a recession always experiences a spike in productivity. Productivity is a measure of output per manhour. When sales suddenly rise, everyone employed has to work harder to meet demand. For a short period, that’s OK. But before long employees become frazzled, they make mistakes, shortages crop up, and everyone has to scramble to catch up. The way to do that is to hire more people to keep up. Once that happens, productivity normalizes.
A rise in systemic productivity, built on a base of technology (e.g. robots or kiosks replacing humans), helps to keep costs contained. But while technology keeps advancing, there are few signs of any sudden upward shift in the pace of technological improvements. What would really move the needle, for example, would be autonomous vehicles, trucks, taxis, and delivery vans that don’t require humans. Indeed, some pandemic “advances”, such as more restaurant food delivery to the home, are counterproductive. They may meet the desires of those not wanting to venture out, but the cost for a restaurant to deliver a meal is much less to patrons sitting at a table versus the video gamer sitting in a dark room whose sole source of light is their computer screen.
Thus, the key question, along with the pace of job creation post-pandemic, is will the labor force quickly return to its former size once expanded unemployment benefits expire, and the threat of catching Covid-19 at the workplace fades? To answer that we have to look at why the workforce declined. Some reasons are obvious. The ongoing risks of catching Covid-19 are clearly a contributing factor, but it is fading. Some jobs have been displaced during the pandemic and associated workers are waiting for restrictions to end. Airline and cruise ship personnel are obvious examples. The extra unemployment benefits are already winding down. Most will end by Labor Day. Laziness is a convenient explanation but it hardly explains a drop in the workforce of 5 million people.
The pandemic caused many small businesses to close. Some will never reopen. If owners were anywhere near retirement age, starting all over may simply be too overwhelming. Walk down Main Street in your community and see all the empty store windows. They will fill eventually, but it will take time.
Demographics play a key role. The peak birth year for baby boomers was 1953, 68 years ago. Boomers have been working longer, partly due to good health and part due to the impact of zero interest rates on their retirement nest egg. Some felt the need to work longer in order to insure they had enough money to live the life they wanted during retirement. But Covid-19 has changed the picture. I just mentioned the downside. Losing a business or losing a job at any age close to retirement may be the straw that broke the camel’s back. But equally as important are the rise in stock prices and home values. The stock market influence is obvious. 401k plans are now worth significantly more today than they were 12 months ago. Leading averages have almost doubled their March 2000 lows. In many cases, their nest eggs are now sufficient.
We all see the lines at open houses every weekend. As noted earlier in this letter and many times before, high prices are the cure for shortages. There haven’t been enough homes for sale, but for those willing to trade down, or rent for the rest of their lives, the current spike in prices will allow empty nesters and others a serious opportunity to capture a spike in value. Suddenly, selling your suburban home and moving to a comfortable place in Florida is achievable. Communities built 15-30 years ago around young families are now turning over at an accelerated pace. When your friends start to move, you move as well.
Between rising home prices and rising stock market values, the pace of retirement is increasing. Some of the 5 million who disappeared from the work force will return as Covid-19 fades, extra unemployment benefits expire, and businesses reopen. But some are gone forever. I can’t calculate with a sharp pencil how much of the 5 million drop in the size of the workforce is permanent, but I suspect it is a significant amount. Some displaced by the pandemic may return part time. But the real conclusion is that getting back to full employment may happen a lot sooner than some expect.
Other factors are in play. Generally, those still unemployed are lower skilled workers. High skilled workers eager to work have already found new jobs. Said a bit differently, there is a skills mismatch between the 8 million job openings, and whatever part of the 7 million displaced by Covid-19 are still ready to work. You hear these stories regularly. As the mismatches get more difficult, the key incentive will be higher wages. You see the headlines about McDonald’s or Amazon paying more for workers. But it is happening at all job levels. Higher wages will clearly coax some off the couch and back into the workforce, but they are not likely to coax the newly retired boomers back to work. To compound the problem, the number of 16-18 year old Americans now joining the work force is no match for the number of boomers entering retirement. The power of demographics is much stronger than most think.
A company can build a new plant to meet sustained demand, but no one can create more people overnight. Stimulating more immigration might help, but with all Congress is already dealing with, immigration reform, although badly needed, is not a subject Washington is about to undertake.
Here’s the conclusion and why any trendline defined by Friday’s employment report matters. If job creation rises too quickly, wages will rise faster than expected. If productivity reverts to normal rates, as it does a year or two after every recession, productivity gains will no longer be able to offset wage increases, causing a systemic rise in the rate of inflation.
The Fed is in a bind already. With budget deficits expanding and likely to stay near record levels through the decade, the Fed is going to have to monetize much of our newly created debt. It may back off its pace of bond buying for a while, but if it pulls away entirely, who will replace it as a buyer of all the newly created debt? Fewer buyers mean lower prices and higher interest rates. Higher rates, which would be in synch with higher inflation, could quickly make debt service more costly to the government than Social Security.
Which brings us back to Friday’s report. Too hot a number (anything close to the March figures over 900,000) will spark fears of earlier-than-expected Fed intervention to limit the rise in in inflationary pressures. Bear markets and recessions are caused by economic imbalances. Too much of a good thing can’t last. A return to full employment is an admirable goal, but too much demand always ends up with adverse consequences. 400,000-500,000 new jobs would be a pace that might allow for a strong but orderly recovery. 900,000 will send signals to the Fed that it is at least time to begin removing stimulus. That means higher rates, and a big headwind for stock prices.
Today, Wayne Brady is 49. Andy Cohen turns 53.
James M. Meyer, CFA 610-260-2220