Saira Malik, Managing Director and Head of Active Equity Research
For a six-month period starting in the fall of 2011, unemployment in the U.S. fell rapidly, from 9% to 8.3% this past February. But the improvement hasn't been sustained; the unemployment level has basically stalled since then. In June, the Federal Reserve acknowledged that its previous forecast had been too optimistic, and issued a new, gloomier forecast for U.S. unemployment in 2013. The Fed now says it expects unemployment still to be 7.5% to 8% at the end of 2013, a dismal prospect for the 20 million Americans who have been looking for work lately. High unemployment is also likely to slow the rate of growth in the U.S., an economy heavily dependent on consumer spending.
In this article, Saira Malik, Managing Director and Head of Active Equity Research for TIAA-CREF, talks about the challenges of job creation in the U.S. and the impact on equity markets.
How much of a disappointment have the unemployment numbers been this spring and summer, especially after improving so much between last August and February?
They’ve been particularly disappointing because, earlier in the year, the steady drop in weekly first-time unemployment claims was a primary factor in leading the markets to conclude that the U.S. recovery had become self-sustaining. However, even as claims were falling and more jobs were being created, we remained cautious about the possibility that these favorable trends were happening, in part because of unusual seasonal factors, such as extremely mild winter weather. Our concern was that employers who typically would have waited until spring to hire did so earlier in the year. This skewed U.S. job growth higher earlier in the year and set up an inevitable drop in activity in the second quarter. As a result, financial markets have been uncertain as to whether further deceleration is likely, or whether more benign scenarios will unfold as volatile jobs data begin to normalize—if they begin to normalize, that is.
From your perspective, why haven't the numbers continued to come down? Why has job creation been so problematic?
Well, a lot of it has to do with uncertainty. Economic data overall have been sending mixed signals, and this has not inspired the kind of confidence that would lead to increased levels of hiring. Employers have been reluctant to hire given the lack of clarity about the strength and trajectory of the U.S. economy. Although some surveys indicate a need for more hiring, U.S. employers seem to be taking a wait-and-see attitude before committing to more jobs and capital expenditures. This reluctance can have a self-fulfilling negative impact on overall activity.
How many jobs must be created on a monthly basis in order to get meaningful declines in the U.S. unemployment rate? What specific developments—economic or political—would enable that to happen?
Estimates vary, but many economists believe that 200,000 to 250,000 jobs per month would need to be created on a sustained basis in order to drive significant improvement in the unemployment rate. In 2012, we saw jobs grow by 275,000 in January and 259,000 in February, before payroll figures started falling in the next few months. In April, May and June combined, a total of 219,000 jobs were created—an average of only 73,000 per month. The numbers picked up again in July, to 163,000, which cheered the markets, but that level of job growth is still not adequate to put a meaningful dent in the unemployment rate. In fact, the rate actually ticked up by one tenth of a percentage point in July, to 8.3%.
In terms of specific developments that would help, there are a number of factors to consider. One is Europe, where the economy continues to fall deeper into recession. Depressed demand from Europe hurts revenues of U.S. companies that derive a portion of their profits from European sales. If companies are selling less, chances are they’ll be hiring less too. Until we see some significant, lasting progress in addressing the eurozone’s economic and fiscal problems, we can expect Europe’s economic weakness to act as a drag on U.S. job creation.
Another factor is demand here in the U.S. As we recently saw, even with personal incomes growing a bit in July, consumers remained wary and chose to bolster their savings rather than spend on goods and services. If consumer spending is not playing its necessary role in fueling economic growth, fewer jobs are likely to be created.
How might the U.S. presidential race play into the unemployment equation for later this year and 2013?
It’s not just the presidential race that has implications for unemployment and the economy, but the broader political environment and the gridlock that continues to prevent meaningful policies from being enacted. Our chief concern for the U.S. is the looming “fiscal cliff” the economy and financial markets face if this gridlock continues into November and after the elections. There would be a significant negative impact on GDP in 2013 if the debt ceiling is not lifted in November, as this would trigger automatic budget cuts, tax increases and other problems. Earlier in the year, equity markets were really focused on this possibility. In recent months, however, investors have become more attuned to the potential toll these fiscal hits could take on economic growth, corporate profits and stock prices.
How big an impact will continued relatively high unemployment have on the equity markets? Or is it basically priced in?
Higher unemployment depresses consumer incomes and reduces the rate of household formation. Those two variables are currently reflected in the low level of expected growth for the U.S. economy. This diminished growth outlook, in turn, is being discounted by the market.
How does your outlook for unemployment affect your view of the stock market? Where are we seeing opportunities to invest as a result?
The key for stock-picking is the direction of unemployment relative to expectations. Among market sectors, consumer discretionary is generally the most sensitive to those changes in expectations. This sector includes companies in the retail, automobile, media, consumer durables, apparel, and hotel and leisure industries. These areas are more likely to outperform when economic conditions are improving (and personal income and consumer spending are rising), and more likely to lag when conditions are deteriorating. We saw this play out in the first quarter of 2012, when employment indicators were strengthening, and the consumer discretionary sector of the S&P 500 Index gained nearly 16%. In the second quarter, weakening employment indicators took the wind out of the sails of the sector, and it declined 2.6%.
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Past performance is no guarantee of future results.
TIAA-CREF Asset Management provides investment advice and portfolio management services to the TIAA-CREF group of companies through the following entities: Teachers Advisors, Inc., TIAA-CREF Investment Management, LLC, and Teachers Insurance and Annuity Association® (TIAA®). Teachers Advisors, Inc., is a registered investment advisor and wholly owned subsidiary of Teachers Insurance and Annuity Association (TIAA).