Jobs? Glass Half Full? Half Empty? Or Broken?

David R. Kotok co-founded Cumberland Advisors in 1973 and has been its Chief Investment Officer since inception. He holds a B.S. in Economics from The Wharton School of the University of Pennsylvania, an M.S. in Organizational Dynamics from The School of Arts and Sciences at the University of Pennsylvania, and a Masters in Philosophy from the University of Pennsylvania. Mr. Kotok is also a member of the National Business Economics Issues Council (NBEIC), the National Association for Business Economics (NABE), the Philadelphia Council for Business Economics (PCBE), and the Philadelphia Financial Economists Group (PFEG).


January 11, 2010

To be blunt: in our view the jobs data were plainly miserable and disappointing. Like many of our readers, I listened to the debate on CNBC and read numerous analyses. We will set aside the perennial optimists who find positive outcomes in any data set. Simply put: a 10% unemployment rate and a 17.3% underemployment rate are two extremely serious numbers.
They help explain the market’s immediate reaction, which was a Treasury bond price rally and a drop in the 2-year note yield to an intraday low of 0.936%. The 2-year note yield under 1% is a very important figure for market watchers. It is a key market-based pricing of expectations for the Federal Reserve’s interest-rate policy. This reaction essentially suggests that the Fed will maintain the policy-setting Federal Funds interest rate range of 0.0% to 0.25% for at least the first half of 2010.

That has been Cumberland’s expectation for some time. The assumption of a very low US interest-rate policy continues to drive our investment decisions as we conduct stewardship over portfolios through these extraordinary times. Talk about an imminent exit strategy by the Fed is just talk. It is quite possible that the Fed will maintain the zero-bound rate for the entire year. Maybe, they will firm the rate to 0.25% instead of a range this summer. Our longer-term estimate is that we will not see the Fed Funds Rate above 1% until 2011 at the earliest.

Let’s dig a little deeper into the jobs situation. We expect the January report is going to be a startling one when it is released in early February. It will be the first time we will see the full results of the annual revisions of the benchmarks used by the Bureau of Labor Statistics. The revisions will show that there was a net job loss in the United States for the entire decade. We guess the net loss will be about 1 million.

Furthermore, the number of discouraged workers who have left the labor force and the true size of the labor force will be better estimated once the revisions are public. Also, the differences between the two survey methods used to determine these statistics may become clear. They will show that if the labor force figure included those who would be genuinely seeking jobs were they not discouraged. We believe the revised figures will indicate the true unemployment rate might be closer to 11% than 10%.

Some of the details in the report show how severe things are. The unemployment rate for college graduates hit a new all-time high of 5%. The fact that 1 in 20 graduates cannot find a job means that the cost pressure from the higher-paid and better-educated element in the labor force has disappeared. Labor cost is about two-thirds of the impetus that triggers inflation. This is another reason why the Fed has plenty of time before it has to raise rates. Inflation is not a threat.

The components within the labor force are important because they reveal the human-suffering side of joblessness. The unemployment rate among 1.25 million women who maintain families rose to a record high of 13%. These are the single moms who head households. Married women with spouses present number about 2.2 million. Married men with spouses present number about 3.4 million. Their respective unemployment rates are 5.8% and 7.3%. Those are about double the historical averages and double where they were before the recession started.

Some pundits point to the hiring of census workers as a way to kick-start the job recovery. We are not sanguine about that. Sure there will be a temporary blip up in workers. Most census takers are hired for between 2 and 3 months and get paid between $10 and $20 an hour, depending on the geography. This temporary government job creation will peak in May or June. Serious ramping up will start in March. Ramping down will be completed by Labor Day of 2010. Census taking is not a way to solve the jobs problem.

So far the economic recovery has been reflecting a rebuilding of inventories from a very low level. That process will run into the second quarter of 2010. After that it will take a sustained rise in labor income to confirm the notion that the crisis time is behind us. We are not there yet. Also, we need to note that it takes about 120,000 to 130,000 new jobs each and every month to keep pace with the expansion of the size of the labor force. That means the demographics require that permanent job creation in the US must be above that level on a continuing basis before the country can begin to restore the nearly 8 million jobs that have been cumulatively lost.

Bottom line: this unemployment issue is here for a long time and will heal slowly. The Fed is not about to do anything to choke off a nascent and fragile start to the healing process. Inflation is not a threat and is not likely to be one for a number of years. We stand by our forecast that very low interest rates will be with us all year long.

Our US tax-free and taxable bond portfolios continue to be positioned with long duration for these reasons. Our US stock market accounts are fully invested, using only ETFs. We see very wide profit margins in American companies, because the labor force cost pressure is low. Hence productivity is quite high and will continue to be that way for a while. Our target for the S&P 500 index remains 1250 to 1300 and we expect the market to fully close the “Lehman Gap.”

In our view, the looming threat to US monetary policy arises in the Congress and not in the labor statistics. There each and every proposal in the House or the Senate removes elements of our central bank’s independence. This is the same Congress that will not admit error in the construction of Fannie or Freddie. This is the same Congress that has a time horizon of two years or less until the next election. And this is the same Congress that is incapable of managing the federal budget. Markets know that once this Congress seizes control of monetary policy, a political bias will act against the value of the dollar and against inflation restraint. Markets can perform well when there is a loose fiscal policy (deficits) as long as monetary policy is balanced. Markets also know that politically driven monetary policy is inflationary. This is the fight ahead after the healthcare debate is over. For now, we hold to our portfolio views articulated above. We will paraphrase what Lord Keynes said: if the facts change we will change our minds.

David R. Kotok, Chairman and Chief Investment Officer, email:

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