Employment: steady gains continue

If there's anything remarkable about the private sector jobs market (the only one that really counts, since the public sector is far less efficient), it is the under-appreciated fact that it has been growing at a relatively steady pace of just over 2% per year for the past four years. That's as fast as it grew in the prior business expansion (2002-2007), but that pace of growth lasted only three years. So in at least one important aspect, this recovery has actually been better than the last. The big difference between the two, of course, is the labor force participation rate: there are upwards of 10 million people who have dropped out of the workforce. The economy has been adding jobs at a decent rate, but from a lower base.

The current recovery boasts four years of jobs growth exceeding 2%. In the prior one, there were only three years.

The labor force grew at just over 1% for many decades until growth virtually ceased starting in 2009. There's been only a very slight uptick in growth in recent years. 

Despite four years of over 2% growth in private sector jobs, total employment today is only marginally higher today than it was at the peak of the last expansion. If this had been a normal recovery there would be at least 10 million more people working. That adds up to an annual income shortfall of about $2 trillion.

The big question is whether this picture will change if the Fed continues to keep short-term interest rates extremely low. I for one fail to see how low interest rates will cause the economy to add jobs at a faster rate than it has managed for the past decade, or how low interest rates will encourage 10 million people to start looking for jobs again.

I think the underlying problem is not interest rates or monetary policy. We've created numerous barriers to re-entry to the labor force: transfer payments are at all-time highs relative to disposable income; and marginal tax rates for those receiving government assistance are extremely high (for many, the decision to work would mean the loss of benefits and less disposable income). And there are barriers to jobs creation as well: marginal tax rates on capital are higher than they have been for decades; and regulatory burdens have never been so heavy. In short, the economy still faces a nmber of significant headwinds which will not diminish just because interest rates are low.

So the fix needs to come from Congress, not from the Federal Reserve. I'm optimistic that Congress will manage to convince Obama to accept at least a few pro-growth changes in coming years.

Election results hold out hope for change

Today's October ADP private sector payroll report didn't change the economic outlook, but I still think the economic fundamentals are gradually improving. Job growth, as estimated by ADP, was marginally higher than expected (+230K vs. +220K), but as the chart above shows, that's within the range of what we have seen for the past several years. We would need to see numbers of +250-300K or more before getting really excited about a stronger economy.

The October ISM service sector report (first chart above) was OK, but the employment subindex (second above) was the highlight: a significant gain, of the sort we rarely see. This speaks to an improving level of confidence in the future, and that is one ingredient that has been sorely lacking in this recovery. As the third chart shows, the U.S. service sector continues to outpace that of the Eurozone, but neither one shows any meaningful deterioration.

Nevertheless, even relatively lackluster numbers like these carry an important measure for investors who are uneasy about holding cash: as long as the economy avoids recession and continues to grow, risk assets are likely to outperform cash since they carry yields which are significantly better than the zero yield on cash.

Meanwhile, yesterday's election results offer real hope for the future. The so-called Republican "wave" was not only a repudiation of Obama's liberal agenda and his anti-growth policies (e.g., Dodd-Frank, Obamacare, anti-carbon agenda), but also of his failed leadership and his aversion to bipartisan reform. If anything is to get done in the next two years, it will need to have bipartisan support. I'm pretty sure the Republicans understand that, and Obama will find it hard to veto bills which represent the newly expressed will of the country.

At the very least, a Congress at odds with the President means that federal spending is likely to remain subdued; taxes are highly unlikely to rise (the current burden of taxation is intolerable, but it surely is not going to get worse); there is a decent chance of some reductions in tax rates (especially for businesses) accompanied by some simplification of the tax code; and some growth-oriented measures (e.g., Keystone pipeline approval, market-based reforms of healthcare, reductions in employer mandates) have a good chance of passing. Any or all of these would act to convert headwinds into tailwinds, restore confidence, and boost optimism. A Republican Congress could be the best thing to happen to Obama's otherwise failed presidency.

Speaking of confidence, the ongoing decline in the price of gold confirms that the world is becoming less risk averse and gradually more confident. The declining price of 5-yr TIPS (using the inverse of their real yield as a proxy for their price) also reflects less risk aversion. These are very important indicators to watch. Further declines in gold and TIPS prices would bolster the bull case for markets and the economy.

No wonder the dollar is up

One way to think about the value of the dollar is that it's like the price of admission to the U.S. economy. The more attractive the economy looks, the more a ticket ought to cost. That's what is happening to the dollar today, because on at least a few fronts, the outlook for the U.S. economy is improving.

According to the Institute for Supply Management's October manufacturing survey, the economy's growth rate may finally be ramping up a bit from the sluggish 2.3% which has prevailed for most of the past five years. The October ISM manufacturing survey was stronger than expected (59 vs. 56.1), and as the chart above suggests, that is fully consistent with overall GDP growth of at least 3-4% in the current quarter. 4% is probably too much to hope for, but 3-3.5% would be a good deal better than what we've seen so far in this business cycle expansion.

The New Orders subindex of the ISM survey was especially strong. As the chart above shows, it has only been stronger about a half dozen times in the past 15 years.

Manufacturing conditions are clearly much better in the U.S. than in the Eurozone, as the chart above shows.

As the chart above shows, the 52-week moving average of container shipments via railroad is up a strong 6% in the past year, and has clearly surpassed the pre-recession high. This is physical and very real sign of increased economic activity.

In a similar vein, the physical amount of goods hauled around the country by trucks (truck tonnage) hit an all-time high in September, up 3.75% in the past year. As the chart above shows, this is fully consistent with the improvement we have seen in equity prices. A growing economy naturally leads to rising equity valuations over time.

In inflation-adjusted terms, in the past three years the dollar has gained almost 20% against other major currencies. But as the chart above shows, that still leaves the dollar below its long-term average value. The dollar is still somewhat weak, from a long-term perspective, but it has regained a considerable amount of its former value in. This confirms the good news that we are seeing in the manufacturing, rail, and trucking sectors. A stronger dollar will help keep inflation low, and at the same time it tells us that the world is now more disposed to invest here. Stronger investment flows will help strengthen the U.S. economy in the years to come—it's a welcome and virtuous cycle.