Kamis, 14 Februari 2013

Continued improvement in the labor market

Initial jobless claims last week were less than expected, but the 4-week moving average (chart above) was roughly unchanged. Compared to this time last year, claims are down a little over 5%. What we have here is a picture of a jobs market that has been slowly but steadily improving for the past four years. There is as yet no sign at all in this very timely indicator of any deterioration in the economy.

Meanwhile, the number of people receiving unemployment insurance continues to decline significantly on a seasonally adjusted basis. As of two weeks ago (this data comes out with an extra week's delay) there were 18% fewer people collecting unemployment checks than there were a year earlier, almost 1.3 million fewer. This continues to be one of the most significant changes on the margin in today's economy. More and more people have an increased incentive to find and accept jobs, and that brightens the economic outlook.

The economy may not be generating a lot of new jobs, but it is most certainly improving and not deteriorating, and that is a powerful message for investors. Why? Because the market in aggregate is still braced for a recession.

With guidance and encouragement from the Fed, the market is priced to the assumption that the U.S. economy will be very weak for the foreseeable future, and remains at risk of a relapse. That is the only possible interpretation of 0.27% 2-year Treasury yields, 2.03% 10-yr Treasury yields and -1.63% real yields on 5-yr TIPS. Investors are willing to accept nominal yields that are close to zero and negative real yields on TIPS (which effectively guarantee a loss of purchasing power) because they fear that nominal and real returns on alternative asset classes could be much worse.

The Eurozone economy is one source of recession risk, since it has shrunk for the past 5 quarters, and has not experienced any net growth for the past six years. So far, though, weakness in the Eurozone has been more in the nature of a headwind for the U.S. economy than an obstacle to growth.

Another potential source of weakness and concern is the looming spending sequester. The actual "cuts" to spending will be almost trivially small, however, and only strike fear into the hearts of committed Keynesians. Supply-siders like me see any shrinkage in the size of government as a reason to cheer, given that spending is still substantially above its long-term average relative to the economy. A smaller government means less "crowding out" of the private sector. It means the private sector will be able to keep more of the money it generates, and that in turn means a more efficient and healthier economy on the margin.

As I mentioned last month, avoiding a recession is all that matters. As long as the economy continues to expand, even if only by a little, the returns to owning risk assets will tower over the returns to safe assets like cash, TIPS, and Treasuries.

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