The Federal Reserve’s decision to delay tapering was heavily influenced by the still tepid nature of the labor market. At first glance, this statement seems at odds with the recent improvement in a number of employment statistics, particularly the unemployment rate. However, look under the surface and three factors still suggest a labor market that is far from healthy and that is likely to continue to frustrate the Fed:
1. Fewer people are working. The US participation rate is at a 35-year low. In other words, an ever smaller percentage of Americans are participating in the labor force. While this trend clearly has a cyclical component–jobs are harder to find–there is also a longer-term, demographic component. The truth is labor force participation has been declining for well over a decade, and may continue to decline as the population ages.
2. Unemployment is lasting longer. Perhaps the most frightening statistic is the length of unemployment today. In the recessions of the early 1980s, the early 1990s and 2000s, the average duration of unemployment peaked at around 20 weeks. Today, four years after the end of the recession, it’s still at more than 35 weeks, as the chart below shows.
Economists on the right would decry the use of extended unemployment benefits, which some believe discourage work, as the reason for unemployment’s long average duration. Others talk about a skills gap–in other words, the unemployed mortgage broker cannot easily be reinvented as an ultrasound technician. But the hard truth is that regardless of the reason, if you lose your job today, you are likely to be unemployed for a far longer period than you would have been in an earlier recession.
3. Income growth hasn’t recovered. Given the still sizable pool of available workers, employees have little bargaining power, meaning it’s no surprise that income growth is weak. That said it’s worth highlighting just how bad the situation is. Today, real disposable income is growing at a less than 1% year-over-year, below the already unimpressive post-recession average rate of 1.4%. By contrast, in the four years following the early 1990s and 2000s recessions, real income growth averaged around 3%. Following the recession of the early 1980s, it was close to 4%.
The bottom line: Despite some real improvements in the labor market, fewer people are working, jobs take longer to find and even when you have a job, raises are few and far between. The persistent weakness in the labor market has at least two investing implications.
1. The Fed knows all of this and, given its dual mandate, is likely to continue to err on the side of more rather than less stimulus. Last week may not be the last time the Fed surprises with a dovish decision.
2. I’m staying cautious on consumer stocks, particularly those that depend on a still struggling middle-class. This is partly because despite the Fed’s best efforts, some of these labor market problems do not lend themselves to monetary solutions. At best, the Fed can mitigate the impact, although at the cost of an ever expanding balance sheet. This means that US income growth is likely to remain muted, and US consumption along with it.