YCG Investments
“If you buy above average businesses at below average prices, on average, we believe you should come out ahead.” — Brian Yacktman

Unemployment – the LEADING indicator

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Do you recall the Fed forecasting positive growth for 2008? When it comes to inaccurate forecasts, it looks like the Fed has some company. Earlier this year, the Obama administration had predicted the unemployment rate would peak at 8 percent before beginning to fall toward the end of 2009. The numbers are in. Drum roll please…the nation’s unemployment rate hit 10.2% for the first time since 1983, and only the second time since official recordkeeping began in 1948. Well, when it comes to forecasting, we’d suggest the Fed and Obama administration “don’t quit their day job.”

We’re not saying forecasting is an easy job, but when it comes to unemployment, the writing has been on the wall. In our December 5th, 2008 blog, we wrote: “The jobs report is in, and unemployment doesn’t look so good coming in at 6.7%. But we need to realize that this is actually about in line with historic norms of an unemployment rate around 7%. The current unemployment rate would need to double to reach the 81-82 recession levels, and is still nothing compared to the 25% levels seen during the Great Depression. We wouldn’t be surprised to see this number continue to hike up. “Experts” see this number reaching 9% by the end of 2009, we wouldn’t be surprised to see this number enter double digit territory by then. Yet another reason to continue to invest in businesses that make products people will continue to consume…even without a job.”

Well, here we are. This brings the official count of job losses since the recession began in December 2007 to about 8 million. Unfortunately, the tally of 15.7 million unemployed out of a job pool of 154 million workers (that 10.2% number) doesn’t even accurately reflect what’s really going on underneath.

First, the jobless rate can be misleading because there is downward pressure on this statistic from discouraged workers dropping out of the labor force altogether. Furthermore, when you include those who are called “marginally attached workers,” meaning those who “would like” and are able to work, but have not looked for work recently (2.2 million), and those involuntary part-timers who wish they had a full time position with benefits (9.2 million), this number bloats from 10.2% to over 17.5% (a.k.a. the U-6). We find it ironic that headlines highlight that claims are now rising less than expected, while overlooking the fact that we are at historically high levels.

History suggests employment levels are traditionally a lagging indicator. This is because employers tend to avoid shedding workers until after they’ve been hit by a downturn, and they are unwilling to hire until they are overwhelmingly convinced the recession is over. Frequently, unemployment will actually worsen even while the economy is on the upswing. Even when companies are confident economic conditions are improving, they are reluctant to hire and instead focus first on tapping their current, under-utilized employees who are working part time against their will.

However, this time things are very different and we strongly believe unemployment will act as a leading indicator. In the past, when the consumer was in limbo searching for a new job, they could either use their saved up rainy day funds or borrow against their home or on a credit card to maintain their spending. But this time a good portion of homes have negative equity, and in general, consumers are laden in more debt than we have ever seen – thus little credit available. Second, for many of those who have saved, uncertainty has led to fear about the security of their future employment and consequently more frugality. With this combination of either the inability to borrow and/or the cautious, more frugal consumer, it seems to make sense that the revenue lines of businesses will not be able to increase until employment picks up again.

No government magic job wand is going to fix this workforce problem anytime soon. Bear in mind, when this historic borrowing binge ended, millions of jobs were lost in the financial and construction industries – jobs which likely won’t return for years to come. We imagine cautious consumers won’t be doing a lot of discretionary spending on Christmas presents this year. As for next year, with these swelling unemployment numbers, we can’t help but think analysts have overly rosy earnings expectations. We believe the media, and analysts, need to stop dismissing unemployment as a “lagging” indicator and give respect to this vicious consumer deleveraging process.

Disclaimer: The specific securities identified and discussed should not be considered a recommendation to purchase or sell any particular security. Rather, this commentary is presented solely for the purpose of illustrating YCG’s investment approach. These commentaries contain our views and opinions at the time such commentaries were written and are subject to change thereafter. The securities discussed do not represent an account’s entire portfolio and in the aggregate may represent only a small percentage of an account’s portfolio holdings. These commentaries may include “forward looking statements” which may or may not be accurate in the long-term. It should not be assumed that any of the securities transactions or holdings discussed were or will prove to be profitable. Past performance is no guarantee of future results.

Posted by: Brian Yacktman | November 09, 2009 | Permalink

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