Stocks have been rallying with little pause since March 9. Last Friday, the Dow Jones Industrial Average closed above 9500 for the first time since November of last year. After falling 58% from the October 2007 high, the S&P 500 has rallied 54% from the bottom. Still, the market remains 35% below peak levels.
The rally has been fueled by expectations of an economic recovery. Those expectations have been largely driven by increases in a series of economic statistics that are reputed to have strong predictive value about the direction of the economy. These “Leading Economic Indicators” have risen for the last 3 months possibly signaling that economic conditions may improve in the near future. On the other hand, certain “coincident economic indicators,” in free fall until July, have yet to confirm that the economy is on the mend.
On the surface, the rebound in certain economic data, including a revival of the stock indices, appear encouraging. What lies below the surface should still give pause for concern. The decline in economic activity has leveled off, but at extremely low levels. As most of you know, consumer spending drives nearly 70% of the economy and the consumer remains notably absent from this so called “recovery.” In my view, consumer spending has been and will remain anemic for some time. I cite soaring unemployment rates as the primary reason among a host of others.
Involuntary unemployment rates are at the highest levels since the Great Depression. While the unemployment rate reported by the mainstream financial media stands just below 10%, a more accurate measure released by the Bureau of Labor Statistics (aka: U6) but not widely disseminated, calculates unemployment closer to 18%. The U6 definition includes those who have given up the search for work, those who have exhausted their unemployment benefits and subsequently fallen off the unemployment rolls, and those who want full-time work but have involuntarily settled for part-time work due to economic circumstances.
According to sources, the U6 definition of unemployment more closely reflects the method that was used in the 1930s. If this is truly an “apples to apples” comparison, today’s unemployment numbers are not that far below the 28% unemployment experienced during the Depression. Oh brother! Or should I say, “Oh brother can you spare me a dime.” This is obviously not a laughing matter since the typical American family has a minuscule pile of savings and maxed-out credit to fall back on. They absolutely need their jobs to put food on the table and shelter over their heads.
Most economists would argue that employment is a “lagging indicator,” meaning that the job market is the last thing to improve coming out of a recession. Then again, unless these economists are pushing 80+, most have never seen unemployment this high and I think all will agree that this has not been a run of the mill recession. It never is when a massive debt bubble collapses. During the Great Depression, extremely elevated unemployment rates became more the cause than the consequence of low economic activity. I would hate to see high unemployment cause a self-reinforcing negative feedback loop leading to further economic deterioration.
Let me be clear, I’m not forecasting the greater depression. Hopefully, the vast money printing initiative that our leaders have embarked upon will lead us to lasting expansionary cycle chock full of new high paying jobs. Of course, when the government spends a dollar, it must come from the private sector’s pocket through higher taxes or loss of purchasing power. That’s one less dollar that can be used toward creating private sector jobs. I have serious doubts about whether robbing Peter to pay Paul will create a high quality job market, but I suppose anything is possible.
On the other hand, the stock market seems to be pricing in a much more robust consumer spending cycle than the unemployment picture can support. The equity markets are overextended by almost every measure going into September which is historically the worst month for stocks followed by October which is only a scant better. Any hint that the recovery is illusory could lead to much lower stock prices. Of course markets can remain irrational longer than anyone might anticipate. We should be prepared for anything.
We have plugged our noses and waded into stocks because nobody wants to be on the beach when everyone else is having fun in the water. All the other kids are probably laughing because we are wearing our life preservers, carrying spear guns to ward off sharks, and holding onto lifelines to prevent being swept away by deadly riptides.
In other words, we’re partially invested in the markets with tight downside risk controls. I will be watching for signals to add or reduce exposure. I look forward to the day when it’s advisable to throw caution to the wind…. For now let’s proceed with care.