Tuesday, February 04, 2014 - Adjust Accordingly

Adjust Accordingly

by Sinclair Noe

DOW + 72 = 15,445
SPX + 13 = 1755
NAS + 34 = 4031
10 YR YLD + .04 = 2.62%
OIL + 1.16 = 97.59
GOLD – 2.70 = 1255.40
SILV + .17 = 19.61

Here come the bears; they tend to come out of the woods when the Dow has a day like yesterday, and they tend to growl. The latest noise is in the form of a couple of projections and predictions that the market will drop 40%. Perhaps we’re just going through a period of pricing discovery as the markets digest information. Maybe this will pass or maybe not. The typical bear market lasts 2 to 4 years and the average drop is about 40%, so it isn’t unreasonable to guess. And bear markets come around with regularity. The median duration for a bull market is 50 months and the average duration for a bull market is 67 months. The current bull market dates back to March 2009, which is right at 58 months. The idea of a bear coming along right about now should not shock anybody. We’re not there yet; a bear market would be a 20% correction; so we’re not there yet. Of course you might not want to just sit around and wait to get mauled by a bear.

So, let’s consider where we are right now. Here’s the rundown:

China’s GDP is slowing and their manufacturing sector is contracting and their shadow banking system may be harboring a few entities on the verge of default;

emerging markets are hemorrhaging and that includes Argentina with runaway inflation, Brazil with export problems, Turkey which just raised short term rates to 12%, Ukraine with street protests, and Russia hosting the Olympics;

the Eurozone still hasn’t recovered and the PIGS – Portugal, Italy, Greece, and Spain – are essentially experiencing depression and the northern countries are experiencing double dip recession, and ECB Pres Mario Draghi  has said he’ll do whatever it takes but he hasn’t done it;

US economic data has been a string of disappointments including durable goods, auto sales, the ISM manufacturing report which included a nasty new orders index, the December jobs report, and a polar vortex, and a drought;

and Congress still hasn’t figured out the debt ceiling hike, and the Federal Reserve still seems bent on tapering, and NYSE margin debt is at high levels reminiscent of 2000 and 2007 which foreshadowed downturns, and PE ratios are a bit lofty;

and for all my technically oriented friends, the Dow Industrial Average has dipped  below its 200 day moving average and the S&P 500 has dropped below the 50 day MA.

Now, does this mean we’re in a bear market? No. Does this mean you should be complacent? No.

Maybe things are better than we think. It’s important to remember that good things happen all the time, every day. Go out for dinner tonight, if you want to. When things get tough, don’t get in a tither, and remember to look on the bright side of life. That is the new motto of the Federal Reserve Bank of New York: look on the bright side and adjust your data accordingly.

You will recall that last month, when the December jobs report was released, we learned that the economy had only added 74,000 net new jobs and at the same time the unemployment rate dropped from 7% to 6.7% because people were leaving the labor pool, dropping out of the labor force. The thinking was that many of the dropouts were discouraged workers who had given up on job prospects, or had simply been meeting with disappointment for so long that the government stopped counting them.

But the New York Fed says it’s just a bunch of Baby Boomers retiring. If these economists are right, then that means the recent swift drop in the official unemployment rate is a real sign of job-market health and not a function of people giving up on finding work. It also means that "slack" in the labor market could disappear more quickly than anybody expects. That could cause inflation pressures to rise suddenly, forcing Fed policy makers to raise interest rates to cool down the economy much sooner than they expected.

Certainly part of the reason is because Baby Boomers are retiring. Boomers have always had an outsized impact on the economy and as they slip into retirement that will be felt economically, but it seems optimistic to imagine that the jobs situation is really great. So let’s dig into some numbers, specifically the labor force participation rate and the employment population ratio.

The participation rate refers to the percentage of working-age Americans either working or looking for work. Participation peaked out in 1999 and then fell off sharply in the 2001 downturn and the 2008 downturn, and is now at the lowest level since 1978. So, it seems pretty clear that a big reason for the big drop in the labor force was a weak recovery and a lack of good job opportunities. Labor-force participation is trending down anyway because of Baby Boomer retirements, sure, but clearly something else happened after the recession.

So let’s look at the Civilian Employment Population Ratio, which is exactly what it sounds like: the ratio of employed civilians to the total population. It stands right around 58%, which is the lowest it’s been since the early 80s. Again, this ratio peaked in the late 90s and took a sharp dive in 2001 and a really big dive in 2008.  The employment population ratio tends to fall during a recession and then climb back during a recovery, but following 2008, the ratio did not recover, it just went sideways.

The New York Fed economists think the ratio has gone sideways because it doesn’t account for the mass retirements of the Baby Boomers, and so they made some adjustments. There is a little problem with the adjustment. More young people lost jobs in the downturn and over the past few years than older workers. Americans 55 and older didn’t lose their jobs during the recession to the extent that younger ones did. In fact, the proportion of older Americans with a job is higher now than in 2006, partly because it is harder to retire than in the past when asset prices were high and rising. The Boomers can’t retire and the younger workers can’t get a job.

And then today the Congressional Budget Office, the CBO, the nonpartisan numbers crunchers for Congress issued a report saying the labor force could shrink by the equivalent of 2.5 million full time workers due to the Affordable Care Act, or ObamaCare. They give two big reasons for this shrinkage.

First, the health reform law offers subsidies to low-income Americans that decline as their income goes up. It also offers expanded access to Medicaid benefits for the poorest workers, which is similarly tied to income. That means that for some people, it may make sense to earn less money through work so they can get a bigger break when buying health insurance. In other words, some workers will decide that having subsidized health coverage is more valuable to them than having more money to spend on goods and services.

Second, for some Americans the subsidies will essentially function as an increase in income because they won't be paying as much for their health care, allowing them to work less and still maintain the same standard of living.

The report states: "The estimated reduction stems almost entirely from a net decline in the amount of labor that workers choose to supply, rather than from a net drop in businesses' demand for labor.”

According to the CBO most full-time workers will probably decide that it doesn't make sense to reduce their own hours or leave their jobs to qualify for coverage. The people most likely to make that choice are low-wage workers, who either don't get company health benefits or are making so little that they would be close to qualifying for Medicaid or the subsidies.

In a somewhat unusual disclaimer, the CBO report says their “estimate of the ACA's impact on labor markets is subject to substantial uncertainty." One reason for the uncertainty is simply that the changes that will result from the health care law are going to take place on an unprecedented scale. Another reason is that there are a variety of ways Obamacare could affect workers: Some provisions may incentivize Americans to work more and some could push them to work less, resulting in the net loss of labor supply over a decade.

The White House issued a statement today in response to the CBO report, and they think the people most likely to reduce their hours or stop working are those who have a job mainly to get affordable health coverage -- people like second wage earners in a household, potential entrepreneurs or workers close to retirement. This is a phenomenon known as “job lock” where a worker stays on a job just for the insurance and it is generally considered a labor market inefficiency.

The White House statement reads: "Individuals will be empowered to make choices about their own lives and livelihoods, like retiring on time rather than working into their elderly years or choosing to spend more time with their families."

The CBO report says ObamaCare could incentivize hiring or decentivize employers to hire.  The law will require companies with at least 50 full-time workers to offer health benefits to anyone who works more than 30 hours per week starting next year. That may in turn give employers a reason to hire fewer people or more part-time workers to keep their labor costs down.  At the same time, the health care law could indirectly spur companies to hire. With lower-income families spending less for their health care, they would have more money to spend on goods and services, and companies would have to hire to meet the increased demand.

Always look on the bright side and adjust based on whatever reality you choose.