Unemployment as a lagging indicator: Is this time different?
Wall Street opens this week less confident that a turning point for the economy is on the near horizon, after last Thursday's report that the U.S. lost a net 467,000 jobs in June.
But as I noted in my weekend column in The Times, many stock market bulls are sticking with the view that the employment situation isn't a good indicator of where stocks are headed. Investors, the bulls point out, know that the job market always is the last thing to recover, and so are more likely to take their cues from other economic signposts in deciding whether stocks deserve higher prices.
Pimco CEO Mohamed El-Erian, however, takes issue with the idea that unemployment is a lagging indicator in the current recession.
He writes on Pimco's website:
"The unemployment rate is traditionally characterized as a lagging indicator and, as such, is viewed as having limited forward-looking information. After all, unemployment is a reflection of decisions taken earlier in the cycle so the rate always lags behind the realities on the ground – or so says conventional wisdom.
"This conventional wisdom is valid most, but not all of the time. There are rare occasions, such as today, when we should think of the unemployment rate as much more than a lagging indicator; it has the potential to influence future economic behaviors and outlooks.
"Today’s broader interpretation is warranted by two factors: the speed and extent of the recent rise in the unemployment rate; and, the likelihood that it will persist at high levels for a prolonged period of time. As a result, the unemployment rate will increasingly disrupt an economy that, hitherto, has been influenced mainly by large-scale dislocations in the financial system."
Pimco, of course, is mainly a bond investor, so stock bulls will accuse El-Erian of talking his book. Bill Gross, El-Erian's co-chief investment officer at Pimco, also has been arguing for some time that the economy's structural challenges (too much debt, too little savings, etc.) will mean very slow growth, at best, in any recovery -- an environment that could favor many fixed-income investments over stocks.
But then, almost nobody expects a strong rebound for the U.S. economy this time around. The question is whether, despite high unemployment, many companies will be able to get their earnings back on a growth track with even a very modest increase in demand (which might well come from places outside the U.S.). Reviving earnings, after all, is what all the corporate cost-cutting of the last nine months has been about. And it's the expectation of rising earnings that draws investors back to stocks.
The market's spring rally was built on the assumption that the economy was no longer in a free fall, and that some kind of recovery was on the way -- a reason to hope.
After the dismal June employment report, two big tests now loom for Wall Street: Will other data this month support the optimists' view that the worst has passed for the economy overall, if not for jobs? And will companies in their second-quarter earnings reports provide guidance for the rest of the year that offers enough incentive to investors to stick around for better times?
-- Tom Petruno