The Labor Market: The End Of The Innocence?

One of the first of life’s lessons we all learned is that we need not rush life; it will do that for us and in the end against our will.

The inspiration for this wisdom could well have sprung from Ecclesiastes wherein we read these peaceful words: To every thing there is a season, and a time to every purpose under the heaven. Co-writers Don Henley and Bruce Hornsby embraced the spirit of this message as the 1980's were coming to a close. You must agree 1989’s The End of the Innocence, that haunting and mournful ballad, was just the coda needed to move on to the last decade of the last century.

“Let me take a long last look, before we say goodbye,” the song asks of the listener who can’t help themselves but to listen.

Many veteran investors, those who don’t need to be reminded about the Reagan era because they were there, may be feeling a bit more wistful as they peer over the horizon. They have lived through extraordinary economic times and maybe even recall the early 1970's, the last time initial jobless claims were at their current historically low levels. They know, in other words, this can’t go on forever, that we are nearing the end of our own innocence.

Federal Reserve Chair Janet Yellen has been adamant that economic cycles can’t die of old age. At the end of this month, we can proclaim to be living through the third longest expansion in postwar times. The parlor game occupying those on the Street these days entails devising scenarios that can push us into the second, or dare we dream, longest expansion of all.

The Wall Street Journal perfectly captures the infectious optimism, the yearning to keep that dream alive, by asking this in a headline: How Low Can the Unemployment Rate Go? Rather than keep you in suspense, the article’s answer is as follows:

“Assuming the economy adds around 200,000 jobs a month in 2017 and the labor-force participation rate stays relatively constant, the unemployment rate would fall to 3.9 percent by the end of the year, according to a model maintained by the Federal Reserve Bank of Atlanta.”

If we do get there, a big if, we are sure to be staring down the barrel of appreciably higher interest rates and a flat, if not by then, inverted yield curve. The only precedent is, you guessed it, that which occurred in 2000, when the unemployment rate hit 3.6 percent as the longest cycle of all time was finally flaming out. Economics 101 teaches one tenet above all – that the unemployment rate is the most lagging within the data universe.

A recent visit with Dr. Gates, that steel-eyed sleuth, corroborated this maxim. “The unemployment rate is the single, most visible economic indicator for households. It’s easy to understand, black and white. Up is bad, down is good,” Gates observed. “If we keep getting downside surprises, it will feed even more consumer optimism. That happens late in the cycle.”

What goes hand in hand with these late cycles guideposts? Since you asked, that optimism Gates cites tends to correlate with households overreaching their paychecks, which is exactly what we’re seeing.

When adjusted for inflation, credit card borrowing is up 4.5 percent over last year, a full two percentage points above wage income, which is up 2.5 percent over the same period. That’s a new high for the current cycle. At 2.9 percent, inflation-adjusted spending is also running ahead of wage income. These data are validated by separate data that shows state withholding tax collections are way off last year’s figures.

“Vulnerabilities in household demand don’t happen overnight; they take time to rise to the surface,” Gates cautioned. “Households aren’t overstretched yet, but they’re getting there. Just like corporations substitute debt for profits late in the cycle, households also are starting to do just as they ride the wave of Trump optimism. Eventually this will run its course.”

The bottom line is households are really happy about the Trump win and they’re showing it by spending beyond their means. If we haven’t yet seen the low in the unemployment rate – a big if – expect many among the reluctant to be emboldened to jump ship at the prospects of a higher paying gig.

Before rushing out to buy that new SUV, as we know countless millions of Americans have, it might be wise to make note of the recent run in the length of the average workweek. As The Liscio Report notes, at 34.3 hours, the workweek has drifted down from 34.4 hours the first half of 2016 and an average of 34.5 hours from 2014-2015. Their conclusion: “This suggests there’s not a lot of pent-up hiring demand.”

The marked slowdown in temporary hires in December would agree with their assessment as would the trend that’s emerged among retailers. Hiring announcements in the critical September to December period fell to the lowest level in seven years, coming in just a hair above 2009 levels when the economy was on its knees. The paltry 6,000 announced retail hires in December’s nonfarm payrolls report, a third of its long-term average, could be but a precursor to what’s to come in the wake of Macy’s and Sears store closure announcements.

The mirror image is transportation and warehousing, where 15,000 workers were added to payrolls last month, three times the norm. Call that the Amazon effect whose sales figures were in a word, ‘astonishing'.  Bezos & Co. dominated e-commerce holiday sales to such an extent that at nearly 40 percent, Amazon’s share of the pie was ten times that of the next closest e-tailer’s numbers.

The odds are it will come down to a race to the Hill to determine if it’s possible to breathe new life into the last gasp of the current cycle. Will the stronger dollar and tighter financial conditions overwhelm profit margins before tax reform legislation is passed and validates all of that cocky confidence? Good question. If Trump expends all of his political capital on repealing Obamacare and confirming his nominees, the economy could be in for a reality check.

And then there are the conspiracy theorists out there who have begun to spread rumors that Yellen could have a Trump card of her own up her sleeve. The market continues to tell itself we’ll be on the beach by the time the Fed first hikes rates come June. A surprise hike at the March meeting would thus send a loud and clear message that there is more 2017 tightening to come, more than any investor expects and spending bill could withstand if a yield curve inversion is in the making. But wait! Politically motivated maneuvers amount to less than ladylike behavior from the Fair Chair. Surely not.

Dr. Gates for his part expects 2017 to be the year of Red Swans. Come again? “Black Swans don’t happen first. Red Swans precede them,” he explained. “First comes the heat and then they burn out. What we’re left with is Black Swans.” Hey, don’t shoot the messenger on that one. He said it. Plus, the heat, fueled by more credit card spending, subprime car sales and higher wages for coveted skilled workers, feels good when the economy is threatened with catching a chill.

Look. No one wants to see the end of any prosperous era, even one that’s left so many behind. But die off every era eventually does, some quicker than others. To the bulls who refuse to acknowledge that even the best intentions cannot stave off inevitabilities, Henley invites you, one and all, to, “Offer up your best defense.” But we all know how the song ends right after that – “But this is the end. This is the end of the innocence.”

Disclosure: None.

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Moon Kil Woong 7 years ago Contributor's comment

I don't believe Trump is actually a big factor in the recent run up and certainly not a factor for Christmas and NY spending. The constant promises about the end of a slow recovery and the ushering in of a new growth period are less innocence and more blatant lies. The only real way to get rapid growth back is to readjust our economy which would hurt painfully first as the economy goes back to small medium sized growth and gets off of the punch being offered by the Federal Reserve which has only led to massive hoarding and artificial wealth creation for the few which would be correctly named as corruption in other more innocent eras.