A specific problem: Employment
There are several problems in the economy keeping economists fretting and policymakers anxious about re-election. Price inflation, double-dip recession, fiscal overspending, housing woes, consumer & business confidence all weigh heavily, but - more than anything - employment is the factor policymakers would like to change because – in theory – it is the most easily fixed and it can have a direct, positive impact on the other issues. Employment measures continue to hover between distressing and miserable. The August jobs report was flat – with 17,000 new jobs created in the private sector and an equal number lost in the public sector. By comparison, 154,000 new private sector jobs were created in July, although the government shed about 37,000 positions. Unsurprisingly, the unemployment rate is stuck at a painful 9.1%.
The Obama administration (and several of his Republican counterparts looking for his job at the 2012 election cycle) has made job growth the new imperative. Direct public sector employment (i.e. – borrowing money to simply hire government workers) is not possible, so the President and the presidential candidates have been weighing tax-reform, hiring incentives, reduced regulation (e.g: E.P.A. and “Obamacare”), free-trade agreements, and streamlining patents to boost employment. Again, some of these measures may increase the gap between government revenue and spending, and so they may be politically challenging to enact.
The broader view from the Top
The employment debate is just one aspect of a larger dispute. The new effort from developed economies, particularly in the United States and the Eurozone, to implement long term fiscal spending plans that are not financed with debt has required painful austerity measures. Paradoxically, the effort to abruptly slash government spending is having a chilling effect on the growth in the private sector, already weakened from the effects of the 2008 Great Recession. International Monetary Fund (“I.M.F.”) head Christine Lagarde describes the phenomenon:
“Put simply, while fiscal consolidation remains an imperative, macroeconomic policies must support growth. Fiscal policy must navigate between the twin perils of losing credibility and undercutting recovery. The precise path is different for each country. But to meet the credibility test, each country needs a dual focus: a primary emphasis on durable measures that will deliver savings tomorrow which, in turn, will help to create as much space as possible for supporting growth today—at least by permitting a slower pace of consolidation where possible. For instance—measures that change the rate of growth of entitlements, health or retirement.”
Federal Reserve Chairman Ben Bernanke August 26th 2011:
“I am fully aware of the challenges we face in restoring economic and financial conditions conducive to healthy growth, some of which I will comment on. With respect to longer-run prospects, my own view is optimistic.
Although important problems certainly exist, the growth fundamentals of the US do not appear to have been permanently altered by the shocks of the past four years. It may take time, but we can reasonably expect to see a return to growth rates and employment levels consistent with those underlying fundamentals.
In the interim, however, the challenges for US economic policymakers are twofold: first, to help our economy further recover from the crisis and the ensuing recession, and second, to do so in a way that will allow the economy to realize its longer-term growth potential.”
What is the likely outcome?
Sadly, several notable economists (e.g. – Nouriel Roubini, Paul Krugman) have suggested that our policymakers are, instead, going to pull back on fiscal spending too quickly and generate another recession. Roubini, advocating for additional stimulus plans to spur employment, suggests that the economy has hit a “stall-speed” and places the odds of recession at 60%. On the surface, other experts are more sanguine; for example, World Bank President Robert Zoellick expects the US economy to “limp along with slow growth and high unemployment, but avoid a recession” but he also acknowledges the dangerous situation. Although the odds of a recession have clearly risen, the base case scenario from most large investment banks echoes that sentiment: the economy may sputter along, but a stall and nosedive into recession is not the most likely outcome.
In the real world, the differences between a weak growth environment and a moderate recession may matter to the National Bureau of Economic Research, but it may not feel very different for the average investor. The market is faced with ongoing short term shocks to the system and has only imperfect information upon which to base projections. Thus, the market has “priced-in” much of the bad news, but with a lot of explosive, directionless trading along the way.
Volatility is back with a vengeance. For instance, there were 23 market trading days of August. The Dow Jones Industrial Average moved more than 100 points (from intraday highs to intraday lows – including the opening and closing values) on 21 of those 23 days. In some instances, the market moved more than 100 points positive and negative within the same trading day. Technical analysts (those that study historical stock prices and volume to try and forecast future stock prices) are running headlong into the “random-walk hypothesis” which argues that stock market prices are essentially unpredictable.
The average investor may expect ongoing turbulence, but institutional investors will face unique challenges during this adverse environment. For instance, Defined Benefit plans may be under the most pressure given an environment where equity prices have dropped precipitously, and liabilities have increased from falling interest rates.
Base Line Scenario
Sadly, we see very little in the way of immediate relief. We expect weak employment numbers. We expect the heightened volatility to persist as markets oscillate between hope and despair. We expect growth to be sluggish at best. The recovery was anticipated to be sub-par and bumpy, but we see the possibility of a smaller recession increasing. By design, the US political system requires a certain level of consensus between the executive and legislative branches to make changes, so the ongoing disagreements between key policy makers will prevent meaningful change for the foreseeable future.
The headlines are grim, and we don’t expect that to change quickly. However, we encourage our clients to follow their own unique long term strategic plan. We continue to focus our attention on value generation through diversification, reduction of expenses, and modeling portfolios with sensible levels of risk and return, rather than the short-term pursuits like trying to guess the next asset class to outperform in this fickle environment.