Can the US Economy Grow Without Employment Gains?

February 5, 2010 Edition, Volume IV

Inside Signature Update

- The Market – Better Dollar, Labor & Earnings: why are stocks lower?
- The Economy – Can the US Economy Grow without Employment Gains?
- The Takeaway – Relax and Enjoy the Super Bowl


THE MARKET – Better Dollar, Labor & Earnings: why are stocks lower?


With the strengthening US dollar, improving unemployment and stronger corporate earnings, why has the US stock market had such a difficult time in recent weeks? The answer is more complex than most care to consider, but can be boiled down to a few basic parts: a possibly overdue market correction, the strengthening of the US dollar against foreign currencies, anti-business rhetoric, recovery fears, and basic uncertainty.

To begin with, the market has enjoyed an impressive rally from its early 2009 low of 6,500 on the DOW. Even compared with today’s close of just over 10,000 that’s a 54% rise in just over 10 months. Most market analysts would expect a market correction of up to 10% to follow this sort of increase before the market would be poised to rise to yet higher levels. For traders (short-term) this represents an opportunity to sell profitable positions and buy back into the market at lower levels; the problem is knowing when and at what levels. For investors (longer-term) there’s less cause for concern. At worst it should be an opportunity to adjust allocation parameters; again the question is when and at what levels. Most investors wisely choose to ride through this type of correction; most traders increase their intake of antacids or alcohol.

The real strengthening of the US dollar has been the byproduct of improved GDP reports (5.7% for 4th Quarter 2009), increased productivity and earnings for many US corporations; as well as stabilizing, if not outright improvement, in the US labor market. At the same time that the dollar has enjoyed “real” improvement, it has also experienced “relative” improvement against foreign currencies. For example: the Euro is having a difficult time in the wake of concerns over default of Greece’s and Spain’s sovereign debt obligations. Right now it looks as though these countries will either default on their debt or be bailed out by the EU, either way the Euro will suffer and the concern has resulted in a flight to safety into the US dollar. So much for sensationalized reports of the dollar’s demise as an international currency.

Historically, when the dollar has strengthened the US equities market has enjoyed extended gains. But in more recent years the two have been counter-correlated; that is, they’ve tended to move in opposite directions. It’s difficult to tell how long this phenomenon will last and even more so to explain why it is present at all, but for right now, a stronger dollar results in lower US stock prices. It also yields lower commodities (oil, gold, etc) values.

The anti-business rhetoric coming out of Washington has many investors and decision makers concerned. It’s not just that the President and his advisors seem determined to stall economic gains by putting pressure on profitable employers (see Not a Good Time for Anti-Business Rhetoric), but the tone breeds uncertainty; the markets disdain uncertainty. If you’re on Wall Street, you’re likely to prefer bad news over uncertainty and confusion; at least then you know what you’re dealing with.

In addition to Obama administration proposals to limit banks’ ability to create profits, which also limits their ability to lend, we’re now hearing about plans to tax the foreign earnings of US corporations as those earnings are realized in the US. While the prospects of new tax revenues may be appealing to legislators, we have to realize that the more likely result will be those profitable corporations keeping foreign earnings in their countries of origin; i.e. outside of the US. The result: new jobs created outside of the US, R&D spending outside of the US and corporate innovation outside of the US. This isn’t exactly what the US labor market needs right now.

All of this has brought renewed concerns over the strength and sustainability of the ongoing economic recovery. No longer do we hear questions about whether the recovery is real, rather, we now hear comments regarding how sustainable it might be. And it’s a good question. (For a more complete discussion take a look at the following THE ECONOMY section of this article)

On the positive side; GDP is rising, unemployment is moderating and may even be in the early stage of a reversal, and corporate profits are returning. Corporate revenues and profits are well ahead of 2009 levels and as of this morning, there were 39 major US corporations that had either reinstated or increased dividends to shareholders. Retail sales have been slowly improving and the US consumer has decreased short-term debt at the highest rate in decades. The Treasury yield curve (a relatively consistent indicator of a rising stock market) has extended its positively sloping trend and the US markets are up dramatically.

On the negative side; US auto sales are still lower than optimal, real estate values continue to be depressed in most markets, prolonged unemployment is ravaging otherwise fiscally healthy households, capital markets (lending) have yet to return to healthy levels, and deflation is still a real possibility at the same time that inflation concerns continue to capture media attention. Added to all of this to the fact that Washington insiders can’t seem to coalesce around a clear plan for growth and prosperity, and there’s little doubt as to why the markets are still more than a little jittery.

So why are the markets experiencing the sort of volatility reflected in today’s positive opening, sharp declines through the middle of the afternoon, and then surprising rebound for a profitable close? Maybe it’s just because it’s Friday and a major storm is bearing down on the east coast and maybe there’s a lot more to it than you’re likely to hear on the nightly news.


THE ECONOMY - Can the US Economy Grow without Employment Gains?

This morning’s release of the latest employment figures showed a surprising, though small improvement: unemployment is down to 9.7% from 10% and manufacturing jobs increased by more than 11,000. That may not sound like much, but this has all taken place without the expected build up in US inventories. When manufacturers are finally able to obtain the capital needed to build inventories back to reasonable levels, manufacturing employment at home and abroad will reflect robust improvement. But what if the confidence needed to rebuild inventories doesn’t materialize? What if the concerns arising from the current administration’s tone and legislative landscape continue to stifle potential employment gains? Then today’s sorry employment levels may become the new norm, even if only temporarily.

The real question becomes, can the US economy experience sustained growth without employment gains? The unfortunate answer is yes, but. Gains occur when revenues rise and/or productivity increases. Historically, productivity gains have directly and proportionately benefited workers, but that was when the productivity gains were more a product of improving labor efficiency. The productivity gains we’ve seen in recent years have been more a byproduct of technology improvement rather than through labor. When improving profits come about due to investment in technology rather than increased labor productivity, then little of the benefit is passed to the worker. The major part, if not all of it, is passed to investors (shareholders and/or capital market makers) who made available the capital needed to invest in the technology.

If shareholders and investors were evenly distributed across the spectrum of US households, then the benefit would likewise extend through all income classes, but that’s not our reality. Even though more households own stocks through 401(k)’s, IRA’s ESOP’s, and trading accounts than at any time in history, the bulk of equity ownership is still held by the highest income earners and the wealthiest of Americans. Additionally, the substantial capital investment needed to support corporate growth is largely made available through hedge funds, institutional investors, and venture capital firms – not exactly those living on Main Street, USA.

What this amounts to is that while economic growth can extend through periods of higher unemployment, it may serve to exacerbate the already widening income gap and yield far more benefit to wealthier households than to those in more critical need of additional resources. Many nations across the globe have lived this way for extended periods of time, but in the end, there’s been a heavy price to pay.


THE TAKEAWAY – Relax and Enjoy the Super Bowl

- The recent volatility in the US stock markets, though arising from a complex set of variables, is more of healthy correction that at is a long-term concern. Investors may do well to relax and enjoy this weekend’s Super Bowl; traders may watch it as well, but are less likely to be able to remember the outcome on Monday morning.

- It’s time for Washington to wake up to what really makes an economy prosper: innovation, jobs and investment and step aside from growth inhibiting proposals, regardless of how well they may be received by the mass electorate.

- Interest rates aren’t likely to rise until unemployment shows meaningful improvement, and that’s not likely to be observable until well into 2010, perhaps as late as the 4th quarter.




Signature Update is offered by Richard Haskell, Managing Director of Signature Wealth Management and CEO of Signature Management, LLC