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Economic Recovery vs. Rising Unemployment

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
October 27, 2009

IN THIS ISSUE:

1.  Overview of Recent US Economic Trends

2.  Snapshot of the Latest Economic Data

3.  Fed’s “Beige Book” Sees Modest Improvement

4.  Unemployment: The 800-Pound Gorilla in the Room

5.  Conclusions – Storm Clouds on the Horizon

Introduction

Eyes around the world are intently focused on this Thursday’s advance estimate of 3Q GDP in the US.  Everyone is anxiously awaiting the report which will signal whether or not the US economy moved into positive territory in the July-September quarter.  Pre-report GDP estimates are all over the board, ranging from -1% to +3% or more.  I can’t recall another quarterly GDP report that was this uncertain in terms of pre-report estimates than this one.

As I have reported over the last couple of months, most economic reports of late have suggested that the US economy is coming out of the recession a little sooner than many of us expected earlier this year.  In the pages that follow, we will review the latest economic reports in the hopes of giving us a little more insight as to what we may learn on Thursday with the release of the 3Q “advance” GDP estimate.

While the GDP report on Thursday is generally expected to be positive, we all know that the unemployment rate continues to rise, now at 9.8%, and likely headed even higher just ahead.

While most economists concur that the jobless rate will move even higher for at least several more months, recent data paint a grim picture for the likelihood of the unemployment rate falling significantly anytime soon.

And the truth is, the real unemployment rate in the US is now at 17%, if the government reported all of the people who are out of work and those who are having to work part-time because they can’t find a full-time job.  This week, I will give you all of the unemployment numbers, not just the official unemployment rate which now stands at 9.8% and rising.

Finally, most forecasters believe the economy will rebound, at least modestly in 2010, and I don’t disagree.  Yet few are offering forecasts beyond 2010 because no one knows what will happen if President Obama doubles the national debt in the next 5+ years.  All I can say is that I don’t believe this liberal experiment will end pretty, and I will have more to say about it in the weeks and months ahead.

Overview of US Economic Trends

Global attention will be intently focused on Thursday’s 3Q GDP report as it is widely expected to show that the US economy emerged from the worst recession since the Great Depression.  As noted above, not all pre-report GDP estimates are positive, but most are as I will discuss below.

But before we get to the latest estimates for Thursday’s GDP report, let’s quickly review the quarterly GDP data for 2008 and the first half of 2009.  Here are the official annualized numbers:

1Q 08 2Q 08 3Q 08 4Q 08 1Q 09 2Q 09
-0.7% +1.5% -2.7% -5.4% -6.4% -0.7%

On September 30, the Commerce Department released its third and final GDP report for the 2Q, showing the economy contracted at an annual rate of -0.7%, as compared to its prior estimate of -1.0%

As you can see, the worst of the recent economic slump occurred in the last half of 2008 and the first quarter of this year as the housing/credit crisis played out.  But it should also be pointed out that the US economy was already slowing down its growth rate even before the latest recession.  GDP growth was only 2.7% in 2006 and 2.1% in 2007 (annual rates).

Most economists agree that apprx. 3% annualized growth in GDP represents the average rate of growth in the US economy in the post-WWII era.  Periods of growth below 3% represent “below-trend” time windows, while periods above 3% indicate “above-trend” examples. Clearly, the US economy has been growing at below-trend rates for the last several years.

With that perspective, let’s look at the latest economic reports.

Snapshot of the Latest Economic Data

The consensus view based on recent economic and financial data is that the US economy is coming out of the credit crisis and recession.  The National Association for Business Economics (NABE) recently surveyed leading economists, and over 80% believe the recession is over and an expansion has begun, but they expect the economic recovery will be slow as worries over unemployment and high federal debt persist.

“The survey found that the vast majority of business economists believe that the recession has ended but that the economic recovery is likely to be more moderate than those typically experienced following steep declines,” said NABE President-elect Lynn Reaser, chief economist at Point Loma Nazarene University.

Most of the forecasters surveyed had upgraded their economic outlook for the next several quarters, but cautioned that unemployment rates and the federal deficit are expected to remain high through the next year.  On balance, the economists now expect the economy, as measured by GDP, to advance at a 2.9% pace in the second half of 2009, after falling for four straight quarters for the first time in more than 50 years. On average, they expect GDP to gain 3% in 2010.  I wish I were so optimistic.

The best news in recent months has been in the Index of Leading Economic Indicators (LEI), which has long been one of my favorite economic benchmarks.  The LEI has risen for six consecutive months, with a strong increase of 1.0% in September, following +0.6% in August. 

The LEI rise over the last six consecutive months, alone, would suggest – with the benefit of hindsight – that the recession was coming to an end.  The six-month rise in the LEI gives credence to positive forecasts for the 3Q GDP number and perhaps the 4Q as well.  Beyond that, it is anyone’s guess.

For the benefit of our many newer readers, the Index of Leading Economic Indicators is, for the most part, a compendium of economic indicators: new orders, jobless claims, money supply, average workweek, building permits, and stock prices.  The LEI is maintained and reported by the Conference Board (www.conference-board.org).

Consumer confidence is arguably the next major indicator of the direction of the economy, since consumer spending accounts for roughly 70% of GDP.  Since rising sharply in April-May-June, the Consumer Confidence Index has gone basically sideways since then.

Consumer Confidence IndexThe other widely followed measure of consumer confidence is the University of Michigan Consumer Sentiment Index.  After reaching a new recent high of 73.5 in September, the UM Consumer Sentiment Index fell to 69.4 earlier this month as announced on October 16.

Consumer spending is generally gauged by two economic reports, both of which are generated by the Commerce Department.  One is the monthly retail sales report which dipped slightly in September.  However, if we revise this retail sales report to exclude auto sales (which plunged last month due to the end of the “cash-for-clunkers” rebate program in August), retail sales actually increased marginally (+0.5%) in September, following a 2.2% gain in August.

The other widely followed indicator of consumer spending is the Commerce Department’s “personal consumption expenditures” (PCE) measure, which is a part of the quarterly GDP reports.  Americans increased PCE by 0.6% in the 1Q, only to see it decline by 0.9% in the 2Q.  We will get our first look at 3Q PCE on Thursday with the latest GDP report.

Regardless of which report we use to gauge retail sales, the results are not eye-popping.  Yes, consumer spending is finally on the rise in the wake of the recession, but we are far from out of the woods.  

On the manufacturing front, things continue to improve at least modestly.  The ISM Index basically was flat in September at 52.6.  Industrial production rose 0.7% in September.  The factory operating rate rose to 70.5% in September from 69.9% in August.  Construction spending rose 0.8% in August (latest data available).  The ISM Services Index rose to 50.9 in September, another indication that the recession may be ending.

And finally, on the housing front, there was more encouraging news last Friday.  The National Association of Realtors reported that sales of existing homes rose 9.4% in September.  The inventory of existing homes on the market declined slightly last month, and the decrease in home sale prices was somewhat less than was expected.

Fed’s “Beige Book” Sees Modest Improvement

The Federal Reserve publishes an economic report eight times per year (roughly every six weeks) that is based on surveys conducted by the Fed’s 12 regional banks that continually collect economic data within their respective regions.  This periodic economic report is called the Fed’s “Beige Book,” and the latest report was released last Wednesday.

Basically, the latest Beige Book indicated that the US economy is continuing to improve, albeit very modestly, in most (but not all) regions of the country.  The survey indicates that the economy, while gaining momentum, has yet to overcome weaknesses in bank lending and employment.  According to the report, unemployment continued to rise last month in 23 US states, giving the Fed additional reasons to hold the main interest rate at a record low to stoke a recovery.

In particular, Federal Reserve district banks identified commercial real estate as the weakest part of the economy, while most saw “stabilization or modest improvements” in areas including housing and manufacturing.  All 12 district banks reported a weak or declining commercial real estate market.  You may recall that I wrote about the problems in commercial real estate in great detail in my September 29 E-Letter, so my readers should not be surprised.

While the latest Beige Book tried to present a guardedly optimistic outlook for continued economic recovery, it included several prominent caveats, such as: “Reports of gains in economic activity generally outnumber declines, but virtually every reference to improvement was qualified as either small or scattered.”  The report also demonstrated how heavily many businesses are relying on government spending in the face of huge contractions in the private sector.

Unemployment: The 800-Pound Gorilla in the Room

It is widely estimated that over 7 million jobs have been lost since the recession began in late 2007.  The unemployment rate rose to 9.8% in September, with the “official” number of job losses at 263,000 last month.  That is the highest unemployment rate since June 1983.

Most forecasters expect the US unemployment rate to continue to climb until sometime in mid-2010 when the rate is expected to peak somewhere north of 10%.

As many of you know, the official Labor Department unemployment rate is quite misleading in several ways.  While it is useful as an indication of the trend in the unemployment rate, it actually understates the real percentage of Americans who are out of work.

The official unemployment rate that is announced every month does not include: 1) workers who have had to settle for part-time jobs because they can’t find full-time jobs; and 2) Americans who have given up looking for a job. 

If laid-off workers who have settled for part-time work or have given up looking for new jobs are included, the true unemployment rate rose to 17% in September.  Here is the actual data from the Labor Department: 

Table A-12.

Alternative measures of labor underutilization
Seasonally adjusted rates as of September 2009:

U-1 Persons unemployed 15 weeks or longer, as a percent
of the civilian labor force

5.4%

U-2 Job losers and persons who completed temporary
jobs, as a percent of the civilian labor force

6.8%

U-3 Total unemployed, as a percent of the civilian
labor force (official unemployment rate)

9.8%

U-4 Total unemployed plus discouraged workers, as a
percent of the civilian labor force plus discouraged workers

10.2%

U-5 Total unemployed, plus discouraged workers, plus
all other marginally attached workers, as a
percent of the civilian labor force plus all
marginally attached workers

11.1%

U-6 Total unemployed, plus all marginally attached
workers, plus total employed part time for
economic reasons, as a percent of the civilian
labor force plus all marginally attached workers

17.0%

NOTE:  Marginally attached workers are persons who currently are neither working nor looking for work but indicate that they want and are available for a job and have looked for work sometime in the recent past.  Discouraged workers, a subset of the marginally attached, have given a job-market related reason for not looking currently for a job.  Persons employed part time for economic reasons are those who want and are available for full-time work but have had to settle for a part-time schedule.  For more information, see "BLS introduces new range of alternative unemployment measures," in the October 1995 issue of the Monthly Labor Review.  Updated population controls are introduced annually with the release of January data.

(Source:  Bureau of Labor Statistics Economic News Release – October 2, 2009)

All told, 15.1 million Americans (17%) are now out of work, the Department said.  And an estimated 7.2 million jobs have been eliminated since the recession began in December 2007.

The Labor Department said 571,000 of the unemployed dropped out of the work force last month, presumably out of frustration over the lack of jobs.  That sent the so-called “participation rate,” or the percentage of the population either not working or looking for work, to a 23-year low.  The unemployment rate would have topped 10% if the labor force hadn’t shrunk again in September.

Older, laid-off workers are dropping out and requesting Social Security at a faster-than-expected pace, according to government officials. The Social Security Administration reported earlier this month that applications for retirement benefits are 23% higher than last year, while disability claims have risen by about 20%.

Meanwhile, the number of people out of work for six months or longer jumped to a record 5.4 million in September, and they now make up almost 36% of the unemployed, also a record.  Making matters worse, weekly wages fell $1.54 to $616.11 in September, according to the Labor Department.  Also, the average hourly work week fell back to a record low of 33 hours in September.

Unemployment to Remain High for Years to Come,
Even if the Economic Recovery Gets Stronger

With the unemployment rate so much higher than most expected, and headed higher still, more and more analysts are trying to determine how much job creation will be required to bring us down to 5% unemployment.  Many economists and analysts consider that 5% unemployment is the equivalent of “full employment,” since there will always be some percentage of the working population that is unemployed at any given time. 

The job creation numbers required to get us from the current 9.8% unemployment to 5% unemployment, at this point, are simply staggering.  And they are likely to get even worse,  since we are likely headed for at least 10% unemployment in the months ahead. 

As noted above, well over seven million jobs have been eliminated since late 2007.  Most economists agree that most of these jobs have been eliminated permanently.  Also as noted above, there are now 15.1 million Americans (17%) who were out of work, or forced to work part-time, as of the end of September.

In addition to the 15.1 million Americans who are out of work, most economists agree that apprx. 1 million new people enter the US job market every year (high school and college grads, legal immigrants, etc.).  So not only does the economy need to grow by enough to re-employ 15 million unemployed, it also must create another 1 million jobs each year to provide for new entrants to the labor force.

With 15 million out of work already, and with the labor force expanding by more than 1 million new workers annually, economists Joseph Seneca and James Hughes of Rutgers estimate that even the robust job growth of the 1990s (2.4 million new jobs a year) wouldn’t reduce today’s 9.8% unemployment to 5% until 2017.

We increasingly hear about the so-called “jobless recovery” that we are likely facing.  With the economy still losing over 250,000 jobs per month, it is a real stretch to assume that we will get anywhere near the 1990s pace of adding an average of 200,000 jobs per month (2.4 million annually).  For example, the Business Roundtable, a group of CEOs from large corporations, said earlier this month that only 13% of its members expect to increase hiring over the next six months.

As these numbers continue to sink in, we are hearing new calls for more federal aid to state governments, a further extension of unemployment insurance (now up to 79 weeks) and a tax credit for companies that create new jobs.  One such proposal would give employers a $7,000 tax credit for each additional worker hired (over some base period).  

The W.E. Upjohn Institute for Employment Research thinks such a credit might create two million jobs.  Sounds good on paper, perhaps, but the budgetary cost to the government would likely be $40 billion annually or higher.

As you will likely recall, President Obama rammed through his massive $787 billion “stimulus package” back in February, largely on the promise that it would create jobs.  What he didn’t tell us was that most of the money would not be spent this year, and that much of the money would go for pork-barrel spending programs over the next few years that won’t create large numbers of jobs in the first place.

Supporters of the stimulus argue that without it, unemployment would be even worse than it is now and suggest that the stimulus spending in 2010 and 2011 will boost the economic recovery significantly.  That remains to be seen, of course.  I tend to doubt it.

Conclusions – Storm Clouds on the Horizon

Economic and financial reports continue to support the idea that we have seen the worst of the economic recession and the credit crisis, as I have suggested in recent weeks.  Most estimates suggest that the economy, as measured by GDP, will show a positive number for the first time in over a year with this Thursday’s advance 3Q GDP report.

Pre-report estimates are all over the board, and some analysts believe the report could show 3Q growth of 3% or more.  Of course, we must all keep in mind that year-over-year comparisons of 3Q 2009 to last year’s 3Q should make this year look pretty darned good in any event.

But the bigger problem is that unemployment continues to rise and is likely to do so until at least sometime in the first half of 2010, reaching well over 10% in the official number.  As I have explained in detail above, the official unemployment rate significantly understates the real unemployment rate, which is now at 17%, as admitted by the Labor Department.

Despite the continuing unemployment trend, most forecasters believe that the US economy came out of the recession in the 3Q.  Likewise, most mainstream forecasters believe that 2010 will be a year with at least modestly higher growth rates.  Most estimates I read suggest the US economy will grow by 1.5%-3% in GDP next year.  That remains to be seen, however.

Yet the most interesting thing for me is that we are seeing very few forecasts for 2011 and beyond.  Usually, forecasters are more than happy to provide multi-year economic projections, so why not now?  The reason is, in my opinion, that no one has a clue what the long-term effects will be as a result of President Obama’s plans to run trillion-dollar deficits for the next several years at least and double the national debt in possibly the next five years.

The US dollar continues to fall as I discussed in detail last week.  While I don’t believe the dollar will be replaced as the world’s “reserve currency” in the near-term, the long-term prospects for the dollar are questionable at best, especially if Obama doubles the national debt over the next 5-plus years.  At some point, foreigners who buy our massive debt may decide to stop buying dollars, or worst case, begin to unload dollars.

If that were to happen, the implications for the US financial markets would be enormous.  That could cause a financial crisis that dwarfs the one we’ve just been through.  Maybe we do see an economic recovery in 2010 as most economists predict.  But I want to go on record in predicting a “double-dip recession” in 2011 and perhaps beyond, especially if the dollar accelerates its decline.  Space does not allow me to go into my reasons for this prediction this week, but I will be writing more about it in the weeks and months ahead.

Stocks Up 60% - Now What?

If the current troubling economic forecast doesn’t call for a defensive investment approach, I don’t know what does.  Stocks have exploded since the March lows, with the S&P 500 Index up almost 60%.  Now, more than ever, you may want to consider active management strategies that can move to cash or hedge long positions should stocks switch direction just ahead.

We recently sponsored live webinars featuring two of our recommended Investment Advisors.  The overwhelming response we received shows us that investors are beginning to realize that the market can’t continue to go up forever, and that market euphoria will run into economic reality at some point. 

Increasingly, sophisticated investors are increasingly turning to professional money managers that can take advantage of whatever remains of the stock market upside, but that also have the ability to move to cash, or hedge long positions, when the current bull market rally plays out.

Fortunately, we recorded both of these webinars and have placed them on our website.  I urge you to check out both the Potomac Fund Management and Niemann Capital Management webinars.  Both of these Advisors have actual track records going back well over a decade, so they are not recent entrants in the field of active money management.  Click on the following links to learn more about how these professional money managers add value to their clients’ investments.

Potomac Fund Management Webinar

Niemann Capital Management Webinar

If you would like to discuss either of these managers, or learn more about our other actively managed investment programs, feel free to call one of our Investment Consultants at 800-348-3601 or send an e-mail to info@halbertwealth.com.  We look forward to hearing from you!

Very best regards,

Gary D. Halbert

SPECIAL ARTICLES

Why Government Health Care Keeps Falling in the Polls
http://online.wsj.com/article/SB10001424052748704335904574495131591949574.html

Is the healthcare “public option” really back?
http://www.realclearpolitics.com/articles/2009/10/27/if_public_option_is_really_back_why_such_a_heavy_lift_98890.html

The Dethroning of King Dollar (an interesting read)
http://www.weeklystandard.com/Content/Public/Articles/000/000/017/124jwyuq.asp?pg=1


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Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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