I typed out Dr. David Kelly’s, Chief Strategist at J.P. Morgan Funds, weekly market insights podcast because I love, just like my writing idol, Dr. Hunter S. Thompson, to hear the music of someone’s thought process that is relayed through their writings.
It also helps a young money manager to grasps the “Economic Machines’ -Ray Dalio” workings through one scenario to completion and then through another. Therefore, without delay here Dr. Kelly.
Increasingly over the next two years, the U.S. economy will test the limits of low unemployment. How low the rate could possibly fall is in itself an important issue for investors. As it will likely determine how long we can sustain above-trend economic growth and profit growth.
However, an even more interesting question is what happens if the limit proves firm and the unemployment rate simply stops falling. Will finally employers BID up wages, aggressively, to keep their companies well-staffed? Will they back off on the U.S. hiring plans because they would rather hold costs down?
Or will the current fiscal and monetary stimulus currently being employed and testing these limits cause an asset bubble and bust? Resulting in a pullback from full-employment long before wage growth ever materializes in a big way?
On the first issue, there are some signs that the U.S. is now getting close to an absolute trough in unemployment. Last Friday’s Job report showed an unchanged rate of 4.1%. This ties the lowest unemployment rate since December of 2000.
Moreover, it is worth noting that if it fell just another 0.03% it would have been the lowest unemployment rate is forty-one years. In modern history, there are simply no examples of the unemployment rate falling below 3.8%.
Why is this? Well, part of the reason may simply be the time it takes for qualified new entrants, re-entrants, and those unexpectedly laid off to find a new job. In November, over a third of the 6.6million unemployed Americans had been searching for a job less than five weeks. In the real world, the search interview, and hiring process can easily take this long. Suggesting that there is very little scope to reduce this number further.
Second, there is a skills mismatch. Today, while 40% of those employed have an undergraduate degree or better. Just 25% of the unemployed do. In September, there were 1.2 million unfilled jobs in professional and business services and 1.1 million unfilled openings in HealthCare and Social assistance. Many of these jobs simply require a higher level of education than is available in the pool of unemployed. This week’s GILLS report for October could show that this problem is getting worse.
In addition, the advanced Labor Market survey from the National Federation of Independent Businesses November report showed that 85% of firms hiring reported finding few or no qualified applicants.
Third, there is something of a location mismatch. The National Unemployment Rate for October was 4.1%. However, it was 5.1% in Iowa and West Virginia below 3% in Colorado and New Hampshire. The problem is many workers can’t easily move halfway across the country in search of a job.
Finally, there are sadly many in the American Labor force today who have problems with functional literacy, drug addiction, or criminal records. These people are more likely overrepresented among those unemployed. Making it difficult no matter how hard they search. All of this means we will never see close to zero percent unemployment and indeed we may now close to the limit this statistic can fall. And if, for example, the unemployment rate can fall no lower than 3.5% than a major source in this expansion may be gone by the end of 2018.
For while the 2.2% growth that we’ve seen since the fourth quarter of 2009 is miserably slow, it would have been just 1.4% if reemploying the unemployed had not acted as a powerful supplement to anemic labor force growth.
For those dreaming of 3.0% sustained economic growth, a firm lower limit of 3.5% on the unemployment rate will make sustaining 2% percent economic growth challenging. An even more interesting issue is how the economy will behave as we approach a firm lower bound of 3.5% unemployment? The most obvious scenario is that the economy would overheat. Under this traditional path, wages accelerate, along with inflation. Causing the Fed to tighten into higher interest rates that would eventually crush both consumption and investment sending the economy into recession. This risk would seem to be increased due to the “sugar rush” likely to be injected into the economy by tax cuts.
Corporate tax cuts and capital expensing should boost investment and in turn, could boost productivity somewhat to mitigate this affect. However, it is generally unlikely that a mixed consumption and investment boom would boost the capital stock fast enough to prevent overheating.
A second possibility is that businesses could simply hold the line in wages. Refusing to increase them faster, regardless of their need for skilled labor. Without higher rising wages, it proves impossible to entice people to increase job searches or come into the labor market from the sidelines. Tax cuts boost consumer spending initially but this impetuous fade without jobs and wage follow through.
Meanwhile, stock buybacks and corporate tax cuts repeal equity prices higher, amid a general surge in asset prices. The Fed still tightens and higher interest rate brings the party to an end. Aided by the dampening effect of the pace economic growth.
The best scenario for the economy could be somewhere in the middle. It is possible that employment growth could stay stronger for longer. If reforms to immigration health insurance and social security have the impact of increasing the supply of workers and lowering the unemployment limit to a level last seen in the 1950s. It could be that asset prices take an important rest. Allowing the Fed to boost real interest rates to more normal levels before more serious bubbles emerge. And it may be that companies take a more pragmatic approach towards wages and profits. Allowing the former to rise just fast enough to keep the expansion rolling forward without threatening general inflation.
However, for investors, it is as well to consider the implications of excess demand and needing a hard limit to how low unemployment can fall. Because as investors have a serious stake in the long-brewing standoff between what the U.S. economy will demand and what it is capable to supply.
-Dr. David Kelly
- R.W.N II