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Friday, November 05, 2010


EMRATIO issuing a warning

i've already gone through a bear case for leading indicators, and that remains unchanged. now i want to examine another indication of economic weakness that played a major role in forecasting a recession in september 2007 -- EMRATIO.

the bureau of labor statistics publishes the ratio of its estimate of the employed population against the total population of the country on a monthly basis in the non-farm payrolls report that was released this morning. while the headline figure of payrolls was a positive surprise, the EMRATIO, as it's known, headed lower alongside labor force participation, retreating to 58.3%.

this is, incidentally, down from a highwatermark of 64.7% in 1999 and 63.5% in 2007 -- the implication being, in a country of nearly 300mm souls, over 15mm people have lost their jobs (voluntarily or no) since the start of the depression.

anyway, it is the change in EMRATIO that can act as a convincing indication of the onset of recession. EMRATIO has now fallen about nine-tenths of the percent from its april peak reading. this graph illustrates all comparable declines in EMRATIO from a local peak back to 1966.

as you can see, EMRATIO hasn't backed off its local peak to this degree without entering a recession since the mid-1960s. and it is worth noting that the united states was a very different kind of employer fifty years ago than it is today -- while manufacturing output has remained around 15% of total output over the years, the fraction of the workforce employed in the highly-cyclical and therefore more-volatile manufacturing sector has been radically reduced by mechanization. in other words, in a service economy the level of employment tends to be somewhat stickier -- it was easier to generate a drop in EMRATIO in the 1960s than today, and the volatility of the series back then reflects that.

so what are the possible positive spins of this development? the onset of the retirement of the baby boomers -- a person born in 1945 turned 65 this year -- is likely to tip the trend down in EMRATIO as a product of natural demographics. so it is likely that dips in the ratio will be steeper than was normal for the period from 1970 until recently. there's also been reports of significant migration out of the united states of foreign workers from latin america as jobs have become very difficult to find, changing the cost-benefit of leaving one's family. to the extent that such people are captured by the report, that exodus might have an effect on EMRATIO, though it would be difficult to quantify.

but it's also worth noting that these effects, regardless of their source, still represent a relative decline in the number of workers in the united states. many have cited the ageing demographics of japan as a contributing source of their twenty-year economic malaise and the repeated and persistent disappointments that have characterized it, helping to drive the deleveraging of the yen economy. just because declines in EMRATIO may not be entirely a result of net corporate firings does not make them economically positive.

moreover, consider that if a lack of available labor was really the driving force behind the drop, one would expect to see accelerating costs of employment as well as jobs-hard-to-get measures being relatively low. clearly that isn't the case now. to the contrary, the pace of increase of average hourly earnings YoY is near a local low (EDIT: krugman makes this point today as well) while the conference board survey of consumer confidence indicates "jobs hard to get" rose in the most recent report to 46.1% of respondents, stubbornly high and near its cyclical peak.

all things considered -- particularly in the context of very slow and fading real final sales, the consumer metrics institute leading data and the leading economic indicators excluding the yield curve -- this contraction in EMRATIO is guilty until proven innocent. we can all certainly hope for a benign outcome, but my expectation continues to be for a return to recession (and possibly a surprisingly deep one) in coming quarters.

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Given your outlook, where are you invested (or where would you be, if you were?) I'm not looking for any secrets, but it seems to me that cash is not where you'd be, unless I'm reading you wrong?

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i'm not a great trader, john -- you'll probably get better advice elsewhere. i'd expect treasuries and cash to do best in any economic downturn as core deflation would have to come to the fore.

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