The present American economic recovery is driven to a large extent by the surge in equities since November. There are no caves for any bears to take cover, and the bulls are having a field day. I am sceptical of how far the availability of cheap credit can go in sustaining this jobless recovery, and even more sceptical of the complete disregard for bad data. The American economy seems to have gone into complete denial mode, and that is by no means indicative of a healthy recovery. American unemployment has traditionally been high for a developed country, at an average of around 5.7% from 1948 to 2010, but the slow pace of job creation is surely going to pinch.
In December, about 103,000 jobs were created in the American economy (later revised to 1,21,000), which was a very disappointing number after the optimism that had already been priced into the S&P 500 by the time the Non-Farms data was released. The equity markets took the headline number in their stride and shifted focus to the drop in the unemployment rate from 9.8% to 9.4%. It was assumed that the headline numbers were heavily influenced by the holiday season in December.
On 4th February, the first reading for Non Farm Payroll again had disappointing headline numbers. January saw the creation of a mere 36,000 jobs, while the unemployment rate again fell from 9.4% to 9%. The markets once again chose to focus on the unemployment rate falling rather than the lacklustre job creation in the private sector. The S&P 500 and Dow Jones Industrial Average finished the week at new multi year highs. Last week’s rally showed that fear of a contagion in the Middle East, and rising commodity prices have been priced in, and equities are not concerned about the ballooning deficit (even as 10 year treasury yield has climbed over 30 basis points last week to reach its highest levels since May 2010).
It is estimated that around 2,60,000 people have dropped out of the work force in America, and this has been a strong contributing factor to the fall in the unemployment rate. People are giving up looking for jobs, and people are running out of benefits to claim (unemployment benefits without extensions typically last for about 26 weeks). How can a shrinking labour force and disenchanted job seekers indicate a healthy recovery to the markets? This rally in stocks seems to be based on self fulfilling optimism, and a myopic view towards debt sustainability. In the words of the famous economist Joan Robinson “modern capitalism has no purpose except to keep the show going”.
In his recent State of the Union address, Barack Obama said a lot of things that were expected from him. He stressed on the need for America to innovate itself out of the crisis, and emphasised that America’s education system needs overhauling to become more competitive. This would have made Schumpeter happy but he forgot to mention that there are thousands of recent college graduates, who are either looking or have given up looking for jobs. He also spent a large proportion of his talk on new spending measures while conveniently forgetting about the $1.5 trillion deficit that needs to be addressed soon.
The Federal Reserve has stated that unless the unemployment rate falls to 7%, the second stimulus programme will be pursued till June at the very least. Even at the current rate at which unemployment is dropping due to people leaving the workforce waiting for hiring conditions to improve, this number will not be reached. So the equity markets are secure in the knowledge that bond yields will not be allowed to go up significantly, and investors will keep pouring in their money into equities for lack of an alternative for investing their savings. The real test for the American economy and the so called recovery is going to be in June, when the stimulus runs out. For now markets are happy in the knowledge that the Fed is looking after its equity investors.
When the stimulus runs out, and America’s unemployment and debt problems rise to the surface of the average investor’s consciousness once again, it will be the real acid test for the Ben Bernanke and his colleagues. There is no doubt in my mind that there will be little hesitation on their part to announce another asset purchase programme if markets tumble significantly after the exhaustion of the current round of asset purchases. For now they must be hoping that the current aggressive policy will guide equities to a point from where even a significant fall would seem like a much needed correction to the markets. Keeping in mind that we are at almost double the levels in the S&P 500 from early 2009 to now, even a 200 point fall would seem like a minor correction in the longer term scheme of things.
Whether or not one believes in the invincibility of the Federal Reserve and the Greenback; it is certainly clear that the current situation is reminiscent of a ponzi scheme. The current economic climate is catering to a select few individuals in the economy. Consumer spending is up, but only for the top 30% of the population. Employment is not picking up, and the construction sector has seen a net decline in hiring over the last month. Debt is reaching 100% of GDP, currently standing at well over $13 trillion. Equities are soaring at elevated price to earnings ratios, and are affordable only to the well off. Tax cuts have been extended for the rich, and there is no talk of addressing deficit cutting through curbing entitlements. All this seems a bit too messy to justify an unabated rally, and neither Obama’s administration nor the Fed, seem in any mood to curb the enthusiasm amongst the well off. Delay is indeed the deadliest form of denial.
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