In spite of how great the employment numbers are, there’s always room for complaints. It’s important to realize that we don’t want certain numbers to be too good though.
Investors tend to look at the jobs report from the perspective of wanting to see evidence of more economic expansion. Investors love more expansion, and will bid up the price of stocks based upon seeing more rather than less, and bid them down when they perceive things may not be growing as much as they hoped.
This is a given, and we see these things happen right before our eyes every time this report comes in over or under expectations. The main focus here is on the overall number of jobs added during a month, with more simply being seen as better and less seen as a step backward.
We also keep an eye on unemployment numbers, but this number tends to sit well in the background, even though this number is actually a more important one than the new jobs number, even though the two are closely related. When we add more jobs, this keeps unemployment down, but we need to know how this is keeping up with growth in the labor market, where we look at both supply and demand and both are represented in the unemployment rate.
When the number of new jobs goes up, and the unemployment remains stable, like we just saw with Friday’s numbers, this means that both supply and demand are increasing, and at the same rate. When you are already at full employment, this is exactly what we want to see, whether or not the jobs number comes in a little lower than predicted.
We need to realize that with full employment, expanding the number of jobs will be more difficult, because we do need people to fill them, where our capacity to do this is already full. There may be job postings out there which could add to the numbers but employers aren’t filling them fast enough, and doing so by getting people to switch jobs to a better one doesn’t add anything to the number of new jobs nor the percentage of people employed.
We need the supply of workers to grow to see this happen, and while this does exist as a constraint on the overall jobs market, it is not one on the supply side, and it’s the supply side that we’re out to measure with these numbers. Seeing the jobs numbers grow is healthy, but when they don’t grow at as fast of a rate as we would like or have predicted, this does not necessarily mean that things are slowing down as far as potential employment goes, as we could import workers for instance and drive the numbers up that way.
When unemployment is so low, the number of jobs available therefore can be understated given that it’s simply harder to fill net new positions. As long as the unemployment rate remains stable, and the number of new jobs is still moving forward, this means that new entrants to the labor market are finding positions and this demand is being met by the supply in the market.
This doesn’t mean that the stock market won’t see these predictions being a little off like they just were as a negative, in the very short run at least, and we can blame all the program trading out there for this, programs that buy when news looks favorable on its face and sell when it doesn’t.
Some people don’t like program trading, although if you are an investor, you have no business caring about the market giving back a little one day and then correcting for it later. We see this with all sorts of events, and really saw this in full force when the Iraqi missiles started flying, even though this happened during off-market hours where you had to be watching the futures market to see this play out.
Stock indexes are traded virtually around the clock during the work week though, although they are closed during the weekend, and this trading really does go on in the real market, where the regular stock market just picks up the action when it opens in the morning. This is thanks to the element of arbitrage, as if the cash and futures market are out of alignment, people can buy one or the other at a discount and sell it on the other market and make a profit.
What happened here is that things got beat down way too much from this program trading, and when it was finished, we just drove things right back up. We see this sort of thing quite often in the face of breaking news, especially when the futures market has driven things down too low and the regular market returns the serve and reclaims some of the ground lost. We usually don’t reclaim it all, but in this case, we did and then some, but this was an event where the bark was much bigger than the bite and that ended up making a complete reversal possible.
This happens during the trading day as well, and as long as the event in question that spurred the selloff is not seriously bad, we do often see a reversal, but these things are only of practical value to traders who look to capitalize on this effect. Investors can benefit from understanding these things though as they will be less prone to get worried, and as foolish as it may be for them to do so from events like this, it still happens and if we can understand these things a little better, that can’t hurt.
We reached another all-time high in the early hours of Friday morning, and ended up giving back a couple of hundred points with the Dow by the time the market closed that day, due mostly to the bit of disappointment the market felt with the jobs report, but this is far from a reason to be concerned, as this is a natural part of how the market moves.
There are Real Limits of Further Growth at Full Capacity
The argument that people make here is that previous moves forward have priced in a certain jobs number, the prediction, and if we miss that, they will claw back additional amounts that have been handed out with the previous expectation that has been somewhat negated.
That’s not how it works in practice though, as no one is doing this sort of calculation, not that it would be possible anyway. Investor sentiment, or rather, trader sentiment has been affected, as it’s traders not investors that make this all happen. Investors don’t really care about month-to- month little blips like this, as they are instead rightly concerned with bigger picture events, and this was not one of those.
As a trader, we would be on the lookout for a reversal from this at some point early next week, which may or may not come depending on whatever other influencers that bear on the situation. When fairly insignificant news ends up bucking overall trends, which right now is upward, this tends to present even better opportunities. Playing reversals is the stock in trade of traders, and this in itself defines what they do. Investors will ride long-term waves, and traders will ride ones of a much shorter duration and will reverse directions very often, as the trading shifts course.
The bottom line for investors is that none of this speaks ill of the simply fabulous labor market that we are currently in, and if people have over-predicted them this time or any time, and things still look very healthy, we’ll let them live with their mistakes and keep our eye on things that actually should matter.
Getting back to the unemployment number, the reason why economists will claim that we have full employment with a 3.5% unemployment rate is that there needs to be a certain level of unemployment to account for job transition, and 3.5% is actually beneath historical transitory unemployment.
We need to understand that the job market is more efficient than it was in the old days, where people were limited to personal contacts, the newspaper and other job listings in print, and prospecting to find a new job. The internet has greatly increased the speed of this, reducing the time required for both job hunting and job placement by employers, and this has allowed for higher employment overall and the effect of this transition on unemployment numbers to be lessened.
The fact that we have just kept adding new jobs and have not seen this go below 3.5% is testimony to the fact that we are at full employment, with this number representing the time it takes from when you first enter the workforce or leave your job and the time it takes to find a new job.
This situation will also affect net new jobs created, as you need people out of work to add them, and the less people there are out of work, in our case having this being close to zero actually, the harder it is to fill these jobs. We’re actually at a point where we would want to describe as a bit of a labor shortfall right now, so we should not be alarmed when net new jobs does not respond quite like we might have thought if our assumptions did not include the effects of this shortage.
While the unemployment number does speak pretty loudly to the health of the economy, we can go deeper here and look at the duration of unemployment to get a better sense of how well we are doing on this front. We’ve seen this steadily decline from 40.7 weeks in July 2011 to 20.8 weeks in December 2019, which both indicates strength and also demonstrates a higher percentage of transitory unemployment and a lower percentage of persistent unemployment.
Within this statistic, we also know that a lot of people hold out for certain types of jobs within their sector and field of expertise, and some of this therefore may come from weaker sectors where the economy as a whole may still be very healthy. These things transition as well, and if we are transitioning from more of a manufacturing-based economy to a more service one, as is actually happening, this will cause hold-outs, especially when we need to transition to a job that pays less.
This can’t go down to zero either, for the same reasons that unemployment can’t, as it simply takes time to find a new job, especially if you are laid off. There will always be layoffs as business evolves, but seeing this get wait time get halved over the last 8 ½ years is a real positive that doesn’t really get discussed much in the media.
We Need to Be Careful with Wage Growth
A third statistic that we look at is wage growth, and there are economists out there who see this as having a lack of positivity right now. This is the one that we want to be careful with, and even economists can forget themselves here even though they should know better. We can’t just look at this number from an expansionary point of view and not account for how it fits into the bigger picture, how it may overfeed the beast we call inflation.
Just like economic growth overall, wage growth has been tamed these days as well, currently sitting at an annualized percentage of 2.9%, in contrast to the 4% that we normally see in an expansionary cycle. While we may wish to bemoan this, like our current level of GDP growth, less is more, because if wage increases actually did grow the way some economists would like, that would take us into the danger zone, a place we have visited many times.
This is most definitely not something we want right now, and while we don’t want this number too low, we do not want it too much higher either. This is a number that the Fed looks at very closely as it is the front door to higher inflation, as when people make more, this puts prices up and we call that inflation.
It is wages that constrain inflation, because if you don’t have more to spend, you won’t be prone to doing it. When you do, you are prone, especially in our economy with people so eager to spend if they have it, and even if they are not, but wage growth even constrains consumer credit because it affects our capacity to borrow.
If wages grew at a higher rate, this just isn’t going to fit the expansionist monetary policy that we have now and investors have come to love so much. We could easily see ourselves back to where we were two years ago, where the Fed had to step in to cool things off, and what they would be seeking to cool off in particular is this wage growth.
The reason why we’re in such good shape economically is that we are growing at a sustainable rate, avoiding overextending ourselves and requiring things to be damped down. These moves aren’t always very accurate, so if you can avoid the risk of needing to adjust our adjustments, and stay in the zone, that’s ideal.
While these efforts at contracting the economy would be designed to achieve equilibrium, we already know from 2018 that this is not so easy to do and the tendency is to overreact, but this happens because fighting inflation is that important. As we also saw in 2018, this upsets the stock market a great deal, and this is not something we should ever be wishing for regardless, especially if we enjoy seeing our stock values go up rather than down.
The modest rise in wages that we are seeing right now is actually another feather in our cap, where the goal is not too much or too little but just right, and this along with the other numbers are sitting at just right, where we might put them if we had the power to create them ourselves and knew what we were doing.
The only real lack with the labor market is a supply problem, but that’s really not a bad thing either, as if we had more supply, we’d have to worry about this adding to inflationary pressures, and it wouldn’t take that much to get us moving in the wrong direction here.
What we do have is very well balanced though, and balance is a lot more important objective than we tend to think it is. Not expanding too quickly is very important actually, and we have finally figured out a way to keep the engine warm enough but not have it overheat. Recent jobs reports, including this last one, have things humming along very nicely, which we need to be grateful for and resist the temptation to be overly picky with.
This is all about keeping our eyes on the overall picture, which is a fine looking one indeed right now, in spite of the little selloff that this last report inspired. This is not to say that there isn’t risk out there, but as long as our canary in the coal mine, the unemployment rate, remains so healthy, it’s clear sailing ahead.