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Straight Talk on Employment Data

By Roger Conrad on October 6, 2012

I’m the new chief investment strategist for Personal Finance and this ancillary newsletter. I’m probably no stranger to most of you; I’ve been writing for Personal Finance since 1986.

I’d like to begin my tenure by thanking my predecessor and good friend Elliott Gue, for his skillful stewardship of PF and this companion weekly the past four years. Elliott has departed to pursue his own venture and we wish him all the best.

I’m proud to be the latest in a long line of PF editors that dates back to the inaugural issue in 1974, a troubled year for investors. For nearly four decades, PF has served as a voice of reason and successfully guided investors through bull and bear markets. With the assistance of our talented team of analysts, I will uphold this legacy.

Now, let’s roll up our sleeves and get to work.

The biggest economic news:
the Friday release of September data on employment. By almost any measure, it was a welcome surprise.

The headline number was a drop in the official US unemployment rate to 7.8 percent, the lowest rate since January 2009 and a contrast with a consensus forecast prior to the report for a rise to 8.3 percent.

Job growth was also much better than expected, with the economy adding an estimated 114,000 jobs, despite an estimated 16,000 drop in manufacturing positions. Tallies for July and August were also revised upward, reflecting an average of 141,000 jobs created in each of the past three months.

The news comes on the heels of Thursday’s relatively subdued level of unemployment insurance claims, which is a rarely revised figure measuring the number of individuals filing for unemployment insurance. That number has been below 400,000 for some time, which generally augurs well for future employment news.

Significantly and for the first time in many months, the drop in the unemployment rate occurred while more people were entering the ranks of those looking for work. That’s a contrast from past months, when a lower unemployment rate was credited in large part to Americans throwing in the towel in their search for work.

Just the Facts, Ma’am

We’re in the midst of a fiercely contested presidential race, so it’s no surprise that political wags are weighing in with great alacrity about what the employment data portends. Some Republicans are even suggesting that the numbers have been “cooked” in President Obama’s favor.

This publication’s job is to provide investment guidance, not political commentary. We always avoid the temptation to jump into the partisan fray. Mixing political bias with investing is an inherently emotional response, and rarely if ever leads to intelligent investment decisions. Instead, let’s dispassionately examine the following critical facts.

One, this data is entirely consistent with the economy we’ve had since credit markets stabilized in mid-2009. This period has been marked by a slow and often jagged economic recovery hit by occasional setbacks, such as the infamous “Black Swan” events of 2010.

The drop in unemployment is the latest evidence that this recovery continues. And it’s underscored by the increase in consumer confidence from 61.3 percent in August to 70.3 percent in September.

But there’s still a great deal of slack in this economy, starting with an unemployment rate that remains above historical norms. That’s demonstrated by still subdued wage growth.

In short, this is good news for the economy and it’s all the more positive because it was largely unexpected. But it’s really just affirmation that the economy is still recovering from the historic deflationary hit it took from 2007-09. And there’s still a way to go before unemployment drops to 1990s lows.

Two, this employment data is based on surveys. And as we saw with Friday’s numbers, these are often revised. This number is consistent with the under control unemployment insurance claims (UIC) numbers we have been seeing. UIC is rarely if ever revised significantly, because it’s a hard number rather than the result of surveys.

But again, it’s possible employment numbers released in November for October will be less favorable. That’s why it’s important not to get too excited by a single month’s set of numbers 

Finally, unemployment is pretty much a lagging rather than leading indicator. Several major factors could have a big impact on future growth and therefore unemployment rates, including China’s greater-than-expected slowdown and the possibility of the economy plunging off the “fiscal cliff” if Washington is unable to work out a deal on taxes and the federal budget after the election.

The upshot for investors? We can expect a continuation of the same market trends that we’ve witnessed during the past few years. Healthy and well-run companies will continue to grow earnings and dividends. Those that aren’t overvalued already are likely to score solid capital gains.

However, odds of a rising tide floating boats of weaker companies are still low. That makes wise stock selection as critical as ever.

Slow-growth economies are vulnerable to external shocks. But that’s tempered in this case by the historic de-leveraging of corporate America, whereby corporations have used the lowest borrowing rates in decades to essentially eliminate near-term debt maturities and risk to a near-term tightening of credit markets. Those recapitalized balance sheets represent the single most bullish indicator of the economy’s future health.

Today’s environment is reminiscent of the early 1990s, when the economy seemed impervious to rock bottom interest rates. Back then, loose money did eventually ignite an era of prosperity in the US. This time around, many fear it could also ignite inflation, meaning it’s critical for investors to own the kinds of investments that hold value in such times, notably gold and stocks that pay dividends in commodity-linked currencies such as Australian and Canadian dollars.

That said, companies are flush with cash and they’ll eventually start investing in growth. The drop in last month’s unemployment rate may or may not signal the beginning of this pivot, but it’s another good reason to stick to the stocks of healthy and growing companies. That’s the real meaning for investors of the latest drop in the unemployment rate; the rest that you’re hearing is mostly white noise.

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