Forget Jobs Number. It's Not a Predictor
June 8, 2012
On the first day of June, the Dow Jones Industrial Average dropped 1.95%, the Standard & Poor's Index 2.18% and the and Nasdaq Composite Index 2.5%. In effect, stock market gains for the year were wiped out. The reason: Jobs.
That was the day the Labor Department said the U.S. economy created only 69,000 jobs in May, not the 150,000 it had predicted. "The vast majority of investors are choosing to panic," said Brian Jacobsen, chief portfolio strategist at Wells Fargo Funds Management, in a Reuters analysis. Evidence: Lower yields on government bonds and a spike in futures traded on the Chicago Board Options Exchange's Volatility Index, the so-called Fear Index.
But, says Craig Callahan, president of Icon Advisers, a Greenwood Village, Colo., developer of value funds, says there is no reason to panic.
That's because, he says, there is no statistical link between unemployment and spending by Americans. Which means investors or funds basing their financial instrument choices on an expectation that higher employment, now edging back up to 8.2%, will lead to economic contraction are mistaken.
To check this out, Callahan went back to 1960 and worked forward, comparing employment to spending on nondurable goods. He used that measure as a proxy for spending by individuals for personal consumption. Nondurable goods are about 30% of personal consumption expenditures and 20% of gross domestic product. They have useful lives of three years or fewer, he notes.
In the 1960s, an almost-idyllic co-existence persisted. Unemployment steadily grew. As did spending on nondurable goods. But even then, when employment fell, such as in 1961 and 1969, spending on nondurable goods kept picking up.
In the 1970s, employment fell dramatically in 1975, in the wake of a quadrupling of oil prices, the U.S. departure from the gold standard and wage controls. Layoffs ensued, but spending on nondurable goods started falling in 1973, before employment did.
In the 1980s, spending on nondurable goods ignored the 4 million jobs lost to the recession of 1981 and 1982. Spending dropped in 1980, picked back up in 1981 and then rose steadily through the rest of the decade.
In the 1990s, there was no correlation between spending and unemployment in the first half. Only in the second half did they both move upward, at same time.
And in the first decade of this century, spending kept growing in the aftermath of the dotcom bust of 2001 and 2002 and faltered like employment in the wake of the credit crisis of 2008. But, in that financial fiasco, employment fell faster at first. Then spending came back, first and more steadily.
What happens, perhaps naturally, is that "spending leads employment, not the other way around," he said. Employers won't hire unless they are confident that spending will keep going up. "The common belief is that jobs cause spending. But I haven't been able to find proof of that,'' he said. "If anything, spending causes jobs. People spend more, jobs increase. People spend less, jobs go away. ''
The correlation - spending precedes hiring - can be seen in the components of indices that show factors that "lead" an economic recovery and "lag" it, notes Tom Howard, co-founder of AthenaInvest, a Greenwood Village-based registered investment advisor.
One of the 10 components of the Conference Board's Leading Economic Index, for instance, is manufacturers' new orders for consumer goods and materials. Employment gains or losses is not.
A top component of its Lagging Economic Index? Average duration of unemployment. The disconnect has import for mutual funds that make investment selections based on economic conditions.
There are 78 such funds that AthenaInvest classifies as based on "top-down economic conditions." The biggest is Neuberger Berman Genesis (NBGNX), with $12 billion assets. Next is the T. Rowe Price New Era (PRNEX) fund, at $4.7 billion, then the Van Eck Global Hard Assets (GHAAX) fund, at $4.3 billion.
Such funds only amount to about 3% of assets held in stock funds, Howard said. And mutual funds, in the main, should not fixate on jobs numbers - or perhaps economic numbers at all. "If we surveyed investors, and said, what do you think a good manager should do?'' Callahan asks.
"They'd say, well, you should forecast the economy, and then find bargains, and then you should find the ones growing the fastest, and you want the ones that are very profitable and on and on."
It turns out the more factors a manager looks at, the worse the results that ensue, he said. The good managers look at about "three or four elements, make their decision and go,'' he said.
The fewer elements a manager looks at, the better their performance. Focus pays.
At Icon, that means sticking to value stocks, by its own approach to valuation. Icon operates nine sector funds, three international funds and four diversified funds.
For Icon, here are the three factors that count: Known earnings, a future growth rate and a discount back to present value, based on a rate that bakes in interest rates and risk. Not job gains or losses.