The Holbert Wealth Management Group
of Raymond James & Associates, Inc.
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Weekly Commentary by Dr. Scott Brown
Looking Further Into The Job Market
August 30 – September 3, 2010
The job market has been a critical focus in the economic recovery. We tend to concentrate on net employment figures (overall payroll gains or losses). However, there’s a lot going on under the surface. The underlying details hold the key to why the economic recovery is going to be gradual.
In normal (that is, good) economic times, initial claims for unemployment insurance benefits might run about 320,000 per week or 1.3 million per month. That sounds like a lot, and it is. Moreover, not everyone who loses a job files a claim for unemployment insurance benefits. The high level of claims reflects seasonal variation in employment (the school year, the holiday shopping season), but also a fair amount of flux.
The Bureau of Labor Statistics compiles gross job figures in its report on Business Employment Dynamics (BED). These figures are released with a lag (the BLS recently released data on 4Q09). The unadjusted numbers reflect the seasonal pattern in job creation and destruction. The adjusted figures point out some interesting and unexpected items. In the 2008-09 recession, job destruction appears to have been no worse than in the 2001 recession. The difference is that job creation was a lot lower in the recent recession. Moreover, job destruction was higher during the booming labor market of the 1990s. The difference was a much greater pace of job creation. In the 1990s, we lost a lot of low-end jobs and added more high-end jobs (technology, particularly cell phones and the Internet, played a big part).
Recently, weekly claims for unemployment insurance benefits have moved somewhat higher. Most likely, this increase reflects either the layoffs of census workers or classification errors related to the extension of unemployment insurance benefits. However, the claims data may be influenced by shifts in job creation. If job creation is high, as it is during a strong economy, laid off workers are more likely to find new work and are less likely to file a claim for unemployment insurance benefits. The opposite happens when job creation is low.
The BLS’s BED data also include breakdowns by size of firm. Small firms, those with fewer than 50 workers, typically account for more than half of gross job gains (they also account for more than half of gross job losses). Small firms accounted for about a third of net job gains during the two previous economic expansions, a relatively small share of the net job losses in the 2001 recession, and a larger share of net job losses during the more recent economic downturn.
There’s a long-standing debate regarding the relationship between firm size and growth of the firm. A recent research report by John Haltiwanger, Ron Jarmin, and Javier Mirada indicates that once you adjust for the age of a firm, small firms are likely to grow no faster than large firms. It’s the age of the firm that matters. Newer firms tend to growth more rapidly than older firms. This research has important consequences for the current environment. Someone starting a business is likely to pledge a home as collateral. With home equity down, you should see fewer business start-ups. In turn, the job creation machine isn’t going to be revving up anytime soon.
The Budget Outlook
August 23 – August 27, 2010
The 2010 fiscal year ends in September. The nonpartisan Congressional Budget Office lowered its forecast of the FY10 federal budget deficit slightly (to $1.342 trillion, vs. the March forecast of $1.368 trillion), but raised its projection of the FY11 deficit (to $1.066 trillion from $996 billion). That’s still a lot of money and investors are naturally worried about the implications of large government borrowing. Yet, the near-term deficit should not be a major worry. The bigger problems, which we knew about 20 or 30 years ago, lie further out in the future.
The budget deficit is the difference between the government’s outlays and its revenues. The national debt is the total of the deficits since the beginning of the country, now at around $13.4 trillion, up sharply in the last few years. The acceleration in the debt has been due to the financial crisis and the efforts to fight it. Tax revenues have fallen sharply and there have been two major spending programs, the bank rescue and the fiscal stimulus. Much of the increase in debt over the last decade has been in debt that the government owes itself, mostly the trust funds in Social Security and Medicare.
Many have worried that the debt-to-GDP ratio is on an unsustainable track. Kenneth Rogoff and Carmen Reinhardt have written about periods of high debt and its consequences. Their research is widely respected. However, their conclusion that a debt-to-GDP ratio of 90% is a trigger for financing problems seemed a leap and has been widely criticized (note: both Rogoff and Reinhardt have come out in favor of another round of fiscal stimulus). What matters is the debt service burden, which should remain manageable for the foreseeable future. However, the debt-to-GDP ratio cannot rise indefinitely. The government shouldn’t act to reduce the ratio right away, but will eventually need to halt its rise and begin to lower it.
The CBO bases its budget forecasts on current law, including this year’s health care and financial sector reforms and the upcoming expiration of the Bush tax cuts (which were legislated to sunset at the end of the year). Growth is likely to be relatively subpar in the near term, according to the CBO (2.1% GDP in 2011, restrained partly by the ramping down of the fiscal stimulus), but the recovery should pick up steam later on (4.1% annual GDP growth for 2012 to 2014, not a stretch if the economy were to move towards its potential), before settling back to a 2.4% annual pace for the remainder of the decade.
The CBO expects the federal budget deficit to be 2.5% of GDP in FY14 and remain below 3.0% of GDP through FY20. That’s not bad, by historical standards, but rising costs in entitlements will lead to a surge in spending beyond that. One could make a case for moving to reduce the deficit further over the next several years in order to prepare for the added burden.
Politically, the budget deficit remains a point of confusion and mixed messages. Polls show that most Americans want deficit reduction, but how they want to get there is unclear. Excluding defense and entitlements (Social Security and Medicare), there’s not a lot of spending to cut relative to the size of the deficit. Tax increases seem all but certain, but hopefully not in the near term.
How Much Of A Threat Is Deflation?
August 16 – August 20, 2010
The Federal Open Market Committee voted to maintain the level of credit easing last week, which was an increase relative to the status quo. Specifically, the FOMC decided to reinvest principal payments from its holdings of agency debt and agency mortgage-backed securities in long-term Treasury securities – which will keep the level of its security holdings steady over time. By itself, the Fed’s decision is not a major move. Long-term interest rates were already very low. More importantly, the move signals that the Fed could do more if needed. The Fed’s action was almost certainly made to fend off the risk of a deflationary spiral, but how much of a risk is deflation?
Core inflation has trended lower over the last several months. This is disinflation (a declining inflation rate). If it continues, disinflation will eventually lead to deflation (a negative inflation rate or, equivalently, a decline in the general price level). Note that over any particular time interval, some prices will be rising faster than others. As the overall inflation rates gets closer to zero, more prices are likely to be falling. More than a third of the CPI was down over the 12 months ending in July.
Not all deflations are bad. Increased efficiencies and strong productivity growth could push prices lower. What we worry about is deflation caused by insufficient demand. Deflations tend to paralyze economic activity. Consumers don’t want to buy, since things will be cheaper next month. Businesses have less incentive to make capital expenditures, since they’re less likely to get a return on their investment. Weaker growth then leads to even lower prices – you’re in a deflationary spiral.
How does the inflation process work? There is no long-term trade off between unemployment (or the output gap, the difference between actual and potential GDP) and inflation, but excess capacity should put downward pressure on inflation over time (conversely, pushing the growth rate beyond its potential should lift inflation over time). As long as the output gap persists, inflation should be trending lower.
However, inflation expectations also play an important role. In the Great Inflation of the 1970s and early 1980s, inflation expectations were rising. The Volcker Fed engineered a recession to bring inflation expectations down. Inflation expectations act as a base for the inflation rate. The inflation rate could be higher or lower, but won’t deviate too much from expectations if those expectations are sufficiently well anchored. Yet, over time, if actual inflation continues to deviate from expectations, those expectations are likely to change.
Most gauges of inflation expectations, whether through surveys or through market-based measures, have remained relatively steady. The Philadelphia Fed’s quarterly Survey of Professional Forecasters includes a 10-year CPI forecast. This long-term inflation estimate has bunched closely to 2.5% since 1998, but dipped to 2.4% in the first and second quarter of this year and hit 2.3% in the latest survey (for 3Q10).
Outright deflation is not likely, but it could result from a more substantial downturn in the overall economy. The Fed’s latest move should prevent the economy from weakening a lot more.
The opinions offered by Dr. Brown should be considered a part of your overall decision-making process. For more information about this report – to discuss how this outlook may affect your personal situation and/or to learn how this insight may be incorporated into your investment strategy – please contact our office today.
All expressions of opinion reflect the judgment of the Research Department of Raymond James & Associates (RJA) at this date and are subject to change. Information has been obtained from sources considered reliable, but we do not guarantee that the foregoing report is accurate or complete. Other departments of RJA may have information which is not available to the Research Department about companies mentioned in this report. RJA or its affiliates may execute transactions in the securities mentioned in this report which may not be consistent with the report's conclusions. RJA may perform investment banking or other services for, or solicit investment banking business from, any company mentioned in this report. For institutional clients of the European Economic Area (EEA): This document (and any attachments or exhibits hereto) is intended only for EEA Institutional Clients or others to whom it may lawfully be submitted. There is no assurance that any of the trends mentioned will continue in the future. Past performance is not indicative of future results.
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