IN THIS ISSUE:
1.November Unemployment Rate Plunges to 7.0%
2.3Q GDP Report Surprises Big on the Upside
3. Fed: No More Excuses Not To Taper – Just Do It!
4. How to Invest During the Fed’s Taper Tantrum
We had some terrific economic news late last week. The 3Q GDP report and the November unemployment report were so strong that some are wondering if the data are credible, and are likely to be revised lower next month. The government reported that 3Q Gross Domestic Product jumped from 2.8% as reported last month to a whopping 3.6% in its second estimate last Thursday, well above the consensus estimate of 3.1%.
Then on Friday, we got another stunner. The US unemployment rate plunged from 7.3% in October to 7.0% last month. In addition, the report cited 203,000 net new jobs created in November. Both jobs numbers were significantly better than the pre-report consensus.
What you probably didn’t hear was the fact that several hundred thousand government workers who were furloughed in October came back to work last month, thus contributing to the big drop in the headline unemployment rate.
Given that these two key economic reports wereso much better than expected, it’s only natural to expect that the discussion would turn to the Fed and the possible implications for “tapering” its monthly QE bond and mortgage purchases. At its October policy meeting, the Fed said it was awaiting better economic news. Well now they’ve got it!
So, the question now is, will the Fed move to taper at its next policy meeting on December 17-18? I was never a fan of QE in the first place, so in my view there is no question that the Fed should start to taper as soon as possible. That will be the thrust of our discussion today. But let’s start with some details on the latest surprising (but questionable) economic reports.
November Unemployment Rate Plunges To 7%
The pre-report consensus was that October’s 7.3% unemployment rate would fall to 7.2% for November, with 180,000 new jobs created. Thus, it was a big surprise last Friday when the headline number fell all the way to 7.0%, the lowest in five years, and the number of net new jobs jumped by 203,000.
One reason why the headline number fell so sharply is that the number of persons reported to be on “temporary leave” fell by 377,000 in November. Almost all of that decrease was due to federal workers who had been furloughed due to the government shut-down in October but were back at work in November.
Contributing to its firm tone, the jobs report showed that the length of the average workweek reached a three-month high and that 8,000 more workers were hired in September and October than previously reported.
Before we get too excited about an unemployment rate as low as 7% for the first time in five years, though, let’s take a look at this chart of the labor force participation rate. It tracks the percentage of Americans actively involved in the labor force. Back in 2000, it hit a post-World War II high, but today it’s near its lowest level since 1978.
Yes, the seasonally adjusted labor force participation rate ticked up from 62.8% in October to 63% in November, suggesting that the unemployment rate fell because more people found jobs and not because they got discouraged and stopped looking for work. Yet the country is still 1.3 million jobs shy of its previous peak, set in January 2008. And that’s to say nothing of the fact that the country has added 14 million people to its working-age population since then.
Labor force participation remains at decades-long lows and the ranks of the long-term unemployed at historic highs. And yes, the so-called under-employment rate, which includes those discouraged job seekers and part-time workers who would prefer full-time jobs, fell to 13.2% from 13.8% in October. Still, there are 10.9 million Americans who are out of work.
While Friday’s report generated a lot of optimism, it remains to be seen whether the economy can continue to produce more than 200,000 net new jobs each month going forward. In the 53 months since the recovery started, there have been only 16 months where job growth exceeded 200,000. The average monthly job growth over the past four years is just 158,000.
By comparison, during the Reagan recovery, monthly job growth averaged 244,000 (at a time when the US had a much smaller population). Indeed, had Obama's recovery been merely as good as the average recovery since World War II, there would be 7.3 million more people employed today.
The good news is that over the last 12 months, the monthly jobs number has averaged 195,000. At least we’re headed in the right direction.
3Q GDP Report Surprises on the Upside
The government reported last Thursday that 3Q GDP surged to 3.6% (annual rate), up sharply from its initial estimate in November. The latest number is significantly above both the pre-report consensus of 3.1%, the advance estimate of 2.8% last month and the 2.5% recorded in the 2Q of this year. It is rare to see the official GDP estimate change this much in one month.
The government reported that the significant increase in 3Q GDP was mainly due to private inventory growth. The report also noted that the increase in real private inventories alone added 1.68% to the 3Q increase in GDP, after adding only 0.41% in the 2Q. According to the report, private businesses increased inventories by a whopping $116.5 billion in the 3Q, following increases of only $56.6 billion in the 2Q and $42.2 billion in the 1Q.
The report did acknowledge that 3Q GDP – without the big increase in inventories – rose only 1.9% in the 3Q, compared to an increase of 2.1% (without inventory growth) in the 2Q.
So the question is: Why are businesses adding so dramatically to their inventories, if in fact they really are? It could be that companies expect demand will pick up in the near future, so they are stocking their shelves in advance. But that seems odd what with consumer confidence plunging in recent months.
Or, it could be an indication that demand is weaker than expected, and goods are lingering on the shelves longer than planned as a result. Already this year, we’ve seen that back-to-school sales, Halloween sales and Thanksgiving sales were disappointing, which suggests that the unexpected accumulation in inventories isnot good news.
Fed: No More Excuses Not To Taper – Just Do It!
With the release of two key economic reports that were significantly better than expected late last week, there was widespread speculation about when the Fed might decide to taper its gigantic QE purchases of Treasury bonds and mortgage-backed securities. The Fed has made it clear that it is waiting for stronger economic news before starting to dial back its monthly purchases of $85 billion.
Stocks reacted sharply higher following Friday’s unemployment report, which was a bit unusual. Since Bernanke first hinted that the Fed was considering tapering back in May, stocks and bonds have generally reacted negatively to good news on the economy. So, why did last week’s unexpected very good news not affect the markets negatively?
The answer is that a broad consensus developed very quickly that the Fed wouldnot vote to taper at its December 17-18 Fed Open Market Committee (FOMC) meeting, and would not make such a decision until its late January or March policy meetings early next year. I don’t know why the media and most forecasters made this assumption, and I’m not sure I agree. Here’s why.
At the last FOMC meeting on October 29-30, there was considerable discussion of starting to taper QE purchases in coming months. Here are a couple of excerpts from the minutes of that meeting:
“…all members but one again judged that it would be appropriate for the Committee to await more evidence that progress toward its economic objectives would be sustained before adjusting the pace of asset purchases.
… some pointed out that, if economic conditions warranted, the Committee could decide to slow the pace of purchases at one of its next few meetings.”
It was this language, apparently, that convinced most Fed watchers to decide that “one of its next few meetings” didnot include the December 17-18 FOMC meeting. I’m not so sure. But here are some excerpts from the New York Times that are representative of this belief that the Fed won’t taper until late January or even March:
“Federal Reserveofficials are in no hurry to retreat from their bond-buying campaign to stimulate the economy and are likely to postpone any cuts to the program until next year, according to public statements by Fed officials and interviews with some of them.
Job growth has strengthened in recent months, and Fed officials expect continued improvement in the coming year. The Fed’s chairman, Ben S. Bernanke, predicted in June that the Fed would taper its purchases by the end of this year, and officials say they still could announce such a cut next week, when the Fed’s policy-making committee is scheduled to hold its final meeting of the year.
But influential Fed officials see little harm in postponing the decision, particularly compared with the risks of pulling back too soon. Significant details of the eventual retreat also remain the subjects of unresolved debates, according to the public statements and interviews. And some officials argue that the slow pace of inflation is itself a reason for the Fed to maintain its stimulus campaign.
‘Everything else equal, I would like to see a couple of months of good numbers,’ Charles L. Evans, president of the Federal Reserve Bank of Chicago,told Reuterson Friday, referring to the relatively strong jobs numbers in November.”
First off, I don’t agree with the Times that the Fed is “in no hurry” to start tapering its QE purchases. I think the Fed would like to taper just as soon as it can – without spooking the stock and bond markets, of course. Whether that’s at the December 17-18 meeting or not remains to be seen.
Second, it is still uncertain whether Bernanke wants to start the taper as his last action while in office and save Janet Yellen (presumably) from having to take that action early-on in her new role as Fed chief.
On the other hand, it could be that the FOMC wants to wait and see the December unemployment report, which should be released in early January. If the unemployment report for December remains strong, that could open the door for the Fed to taper in late January.
The January FOMC meeting will be held on the 24thand 25thand this will presumably be the first policy meeting with Janet Yellen as Chairwoman. The next two FOMC meetings are on March 13 and April 24-25.
How to Invest During the Fed’s Taper Tantrum
So does the market’s recent positive reaction to good economic news mean that we’re back to “normal” (whatever that is)? Or is the market just guessing that actual tapering won’t happen until Yellen takes over next year? The health of your investment portfolio might just depend upon the answers to those questions.
Just as in the late 1990s tech bubble, “experts” are opining about whether the stock market’s upward momentum can continue. The bullish analysts say that there’s plenty of upside left no matter what the Fed does, while the bearish side expects stock prices to lose steam if the Fed turns off its printing press. Which side is right?
A lot depends, of course, on how the Fed enacts the taper, whether slowly or aggressively. The Fed’s comments in recent policy meetings suggest it will not taper aggressively. Even so, the stock markets are addicted to the stimulus, and I will not be surprised if the markets have a serious negative reaction.
In any event, most investors are not speculators, so guesses (even educated ones) are not what they seek. Instead, investors want to grow their wealth to achieve their financial goals while also managing risk. As the hype about tapering or not tapering continues, these investors are concerned about two major issues:
- They need growth so they don’t want to miss out on any upside that may be left in the stock market; and
- If they do get back into the market (or are already there), they don’t want to get hammered by another bear market that could erase half of their nest egg, or more.
Putting this into perspective, if the Fed tapers and stocks get hit or go sideways, the bond features can provide a floor value, even if interest rates start to rise. If, however, stocks ignore the Fed’s tapering and continue on the upside, convertible bonds have the potential to participate in that gain. In short, convertible bonds offer the potential to profit in almost any market environment – up, down or sideways.
Gary D. Halbert
© Halbert Wealth Management