Unemployment Blues

John Mauldin | Thoughts from the Frontline
August 3, 2001

Today we learned that unemployment has held steady at 4.5% for the month of June. I happened to be watching TV as the announcement was made, and immediately I learned from the resident cheerleader that this was good news as it signals that we are poised for a turn-around in the economy.

A look at past unemployment patterns doesn't make me as confident.

In addition to all the reading I do, every now and then one of my readers sends me some of their analysis. I am often amazed at the quality and amount of time spent on the studies. Of course, I shouldn't be, as anyone astute enough to read my tomes is both brilliant and clearly has some extra time on his/her hands.

I was sent a lengthy study this week by Tony Glennon, an investment analyst formerly with Merrill Lynch. He sent it to me to show how unemployment correlates with the stock market. In it he looks at monthly unemployment figures for the past 53 years, notes when there has been a recession and when the peaks and troughs of the stock market have occurred.

He made the following point: "Typically a good time to start looking for the bottom (of the stock market) is right around the time that the unemployment rate moves up 1% from its cyclical low point. The attached worksheet shows this information. Over the past 50+ years, there have been a few times when unemployment has risen by 0.5% or so only to see it start to head lower for a while. I've only found one instance where unemployment has risen more than the 0.6% increase (from 3.9% last Oct. to 4.5% in the most recent data) we've seen thus far without a recession taking place. That was in June of 1959, it rose 0.8% before falling for a few months only to rise again with a recession in 1960 (one of those infrequent double dippers). Never has the US economy in the past 50 years experienced a full 1% increase in unemployment without a full scale recession being declared shortly thereafter."

In light of the positive spin I heard on today's numbers, I went back to the chart to see if there really is a connection between two back to back months of steady unemployment numbers and a turn-around in the economy.

And the simple answer is: no, there is no historical connection. In some recessions the unemployment numbers simply kept on going down. In other recessions, unemployment could actually improve for a month or two before continuing to get worse. The only pattern I can see is that there is no pattern other than a general downward trend going into a recession. Each period was dependent upon the then current circumstances for producing the unemployment trend.

Tony also notes that with a few exceptions The Bottom usually happens around the time the unemployment number rises about 1%.

Just this last May unemployment improved by 1/10 of 1%, before dropping again in June. I wrote then that unemployment would get worse as announced lay-offs take months to actually happen. Let me now write that again. The unemployment numbers will get worse.

Not exactly a brave prediction, but I fear it will be an accurate one.

Interestingly, looking at Tony's chart and making some extrapolations, we once again are led to the potential for the Bottom late this fall, as unemployment rates, on their present trend, are due to be about 1% higher then (than the recent 3.9% bottom last fall).

Unemployment is The Final Answer connection to consumer spending. Consumer spending is what is holding up the economy. As high consumer debt and unemployment problems wreak havoc on consumer spending, we will see the economy continue to weaken. This in turn is going to produce another round of negative earnings warnings and more heartburn for investors.

Third quarter problems may indeed produce another market sell-off. If we see some signs of life about that time from our Three Amigos (capacity utilization, NAPM Index and junk bonds), it could be a very good buying opportunity.

A Wrench in the Production Machine

But not yet. Greg Weldon's latest missive chronicles more trouble for US manufacturers. Let me sum it up for you.

Factory orders have plunged a negative 14.8% since June of last year. This is far lower than we saw at any time during the last recession of 1990-91 and down HUGE from the record 18%+ growth in that index we saw as recently as last year.

Think about that. Early last year, managers were planning for an 18% growth in orders. That meant they had to increase manufacturing capacity to meet demand. Now, orders are 14% less. That is one reason we are seeing such a serious drop in capacity utilization.

"Further, orders for Non-defense Capital Goods ex-aircraft, often utilized as a proxy for forward trends in capital spending, spiraled to a monstrous 20.1% yr-yr drop as well." This was from well north of a positive 20% last year!

We keep hearing about how companies are supposedly reducing inventories. Maybe, maybe not. Shipments declined, but not as much as new sales. Weldon notes the recent NAPM numbers also suggest that despite efforts, inventories are not declining because sales are dropping even faster.

Conclusion? Even though companies are slowing down production lines, they are going to have to slow them down even more. I believe many companies have been reluctant to let skilled workers go in the hopes that things will turn around quickly. They have kept production lines going in an effort to maintain the ability to ramp back up quickly if things go back up as fast as they have come down.

Soon that hope is going to fade. You cannot continue to produce widgets if you can't sell them. There will be further cuts in production, further drops in capacity utilization and therefore even more lay-offs.

Higher unemployment means a drop in consumer confidence and therefore consumer spending. It's a vicious cycle. But as always, the cycle will end and the economy will start growing again.

But for now, our Three Amigos don't look all that friendly.

Waiting for the Crash

I don't make the news. I just comment on it. Del Ball sent me a link to a Reuters article. Seems another firm is predicting a crash. Not worthy of much note, perhaps, except that it is Dresdner Kleinwort Wasserstein, a major investment banking firm not noted for ranting and raving. Quote:

"U.S. productivity data due out on Tuesday could shatter the belief in a "new paradigm" economy of high growth and low inflation, triggering a stock market crash, a leading investment bank has predicted.

"Dresdner Kleinwort Wasserstein said in a note to clients that revisions included with second quarter productivity numbers will revise away the "productivity miracle" of recent years, cited has a major factor in the bull market of the 1990's.

"Investing in the U.S. miracle will in retrospect be seen as a sick joke. The markets will be forced to confront this harsh reality on August 7," DrKW Global Equity Strategist Albert Edwards wrote. "Make a date in your diary! The U.S. 'new paradigm' will then be officially revised away! The risks of an equity crash are high."

Edwards could not be reached to comment on how quickly this crash might happen."

The thrust of his argument is that productivity will be lowered to about 1.5% a year from the current 2.5% that is assumed. Because earnings estimates are based on a 2.5 percent rate, Edwards said the equity market is vulnerable.

Honestly, if it wasn't DrKW, I would completely ignore this. I am amazed a major firm would put this into a note to clients. I am even more amazed at how he can get this information in England and there is NO hint of it over here in the sources I read.

Talk is cheap, I heard today. And Wall Street gets it wholesale. I print this story to illustrate one of my chief problems in writing this e-letter. What information to take credibly and what to ignore? And maybe Edwards didn't actually predict the end of the world, but the Reuters reporter simply wanted a hot story. I sympathize with investors who get analysts reports, assume because they work for a major firm that they must know something an act on the information and get burned. It really illustrates how important it is to know who is giving you information you actually invest on.

As you know, I will make a prediction or two. But naming the date of the next crash is aggressive. The good news is that we won't have to wait long to see if he is right. I predict the market does not crash next week.

By the way, John Templeton (one of the more famous and rich investment managers in the world) is predicting a nine year bear market. Seems I am an optimist after-all.

Social Security Theft

A lot of Democrats have been screaming of late about the recent bi-partisan presidential commission on Social Security.

"Theft!", they scream. "The President wants to take your money and put it at risk." That is, of course, long before any recommendations have been made. But they know what a mean-hearted man Bush is, so they just go ahead and assume he plans to run away with the cash.

Coincidentally, I arrived home yesterday to find a very interesting letter from the Social Security Administration. This letter details my contributions to Social Security and Medicare since I first began reporting wages in 1966.

Interestingly, at the bottom of the report was the total of my contributions, plus those of my employers, which has generally been me for the last 25 years. It seems there has been a total of approximately $266,000 paid into these fine trust funds on my behalf. Over $110,000 has gone into the Social Security Trust Fund, waiting there for me until I retire

I was delighted to find out that if I retire in 11 years at the ripe old age of 62 I could get $1,267 a month for the rest of my life. If I waited until 70 I could get a whopping $2,391 per month or almost $29,000 per year. I did not let my wife see this form, as if I die she would get $1,247 a month for life starting now. I did not want to let her know what riches await should something happen to me. No use tempting fate.

On second thought, I wonder what would happen if they just gave me the $110,000 back and we could skip the future payments. They can keep any interest on the amount they have earned. I would settle to just get my money back into an IRA I control.

If I put that amount into an IRA for 20 years at 15% I would have more or less $1,700,000. If I took out 10% annually at that point, I could have $170,000 per year and when I am 100 I would still be able to leave my kids and charity something like $3,400,000, give or take a dollar.

Worried about the principle? Put it into 20 year Ginnie Mae bonds and go to sleep. I would still make more in 20 years than you would get from Social Security. And my kids would have a nice sum later. (Much later.)

And that doesn't count the $10,000+ a year I am currently throwing into Social Security.

Senator Daschle, you want to talk about theft? What Daschle and his friends are really worried about is the report says by the time I might want to retire we will have to either reduce benefits, means test benefits or double the taxes on my kids, or all three. They worry that too many Americans might make the same calculations I just did and come to the conclusion that they would like to control their own future, thank you.

Prediction: I will not get one red cent of Social Security. By the time I retire, there will be means testing and through the Grace of God I will not qualify, as they will deem me to have too much independent means. I think it will surprise people, though, just what "too much" will be to the government in 2020 unless they dramatically change Social Security now. Playing politics with this money is criminal.

I think every congressman and senator should have their unbelievably lucrative pensions rescinded and they should be made to live on Social Security or whatever retirement funds they can save on their own. That would bring some quick and needed reforms.

Nothing like a touch of reality to clarify one's thought process.

And before my more conspiracy minded friends write: yes, it is scary that somewhere in a government computer they can access my economic life history at the touch of a button.

Jail Time

The analysts we read about who were shorting stocks they had buy recommendations on should be in serious trouble. Ditto the ones who received pre-IPO stock and then offered glowing recommendations.

If I were to recommend you buy a stock and then sold into that buying or shorted the stock afterwards the SEC would justifiably fine me, put me out of the business and maybe even offer me free housing courtesy of the federal penitentiary system.

It will be interesting to see what happens to these analysts.

It has been a long week with some very long days and nights. Time for a night out with my bride. A nice dinner and some blues sounds relaxing. Enjoy the weekend.

Your not planning to retire until he is 100 analyst,

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