by Asset Allocation Committee | PDF

A poor jobs report for January cast doubt about the strength of the recovery. There was only a 49K rise in non-farm payrolls, well below expectations of 105K. Making matters worse, the previous month’s jobs report was revised downward from a loss of 140K to a loss of 225K. The report has not gone unnoticed by the public as policymakers and citizens alike have urged Congress to do more to stimulate the economy. Although the report was generally underwhelming, there were some bright spots. In this report, we will focus on the strength of the labor market recovery and what it could mean for the economy going forward.

On its face, the employment report may be a bit misleading, especially if it is being compared to previous recessions. Due to the pandemic lockdowns, overall employment fell by more than 16% last year, by far the most in history. For comparison purposes, the second largest drop in payrolls was less than half as severe.  On top of that, when lockdown restrictions were lifted, employers were forced to adapt to additional restrictions and regulations designed to protect their consumers and workers. Thus, a return to normalcy was never going to be an easy task. That being said, the gains that we have seen so far are astounding, especially given the circumstances.

In less than a year since the recession started, the labor market has recovered over half of the jobs lost during the pandemic. This is much better than most economists had anticipated. In his remarks to the CFA Society of St. Louis this month, St. Louis Fed President James Bullard claimed that the U.S. labor market recovery is about four years ahead of schedule. Even industries that struggled prior to the pandemic have seen a vast improvement. Retail Trade, which was one of the hardest hit sectors, has recovered 84% of the jobs lost during the pandemic. On a state basis, the recovery is even more impressive as 28 states have outpaced the national recovery in payrolls. In fact, only five of the remaining 23 states (which includes Washington, D.C.) are below one standard deviation of the national average, and four of those states still have restrictions in place that limit business activities. Hence, this recovery has not only been strong but has also been well dispersed throughout the country and will likely improve.

A disproportionate share of the pandemic job losses came in the Leisure & Hospitality sector. By itself, this sector accounted for nearly 40% of the job losses in 2020. However, a deep dive into this data shows hidden surprises. For example, despite reports that restaurants and bars have struggled during the pandemic, dining places have fared far better than other industries within the sector. Since the start of the pandemic, Food & Drink Places have recovered 60% of their job losses, while Arts, Entertainment & Recreation and Accommodation have recovered 39% and 34%, respectively. As the weather improves and restrictions are lifted, we expect payrolls to expand within the Leisure & Hospitality sector as many people (including ourselves) are eager to attend sporting events, musical shows, and concerts again.

A few industries have been able to exceed their pre-pandemic employment levels. For example, the surge in home improvement sales coincided with an all-time high in the number of employees working in Building Material & Garden Supply Stores. Another example can be seen in industries related to housing, where record-low mortgage rates have boosted home buying and residential construction. These outlier industries probably benefited from the fact that many consumers were able to keep their jobs during the pandemic and were willing to use their stimulus checks to purchase goods, homes, and home improvement projects. The additional spending from stimulus not only helped boost sales, but also supported employment.

Although we acknowledge that more needs to be done to aid the recovery, we do believe the labor market is much stronger than most people realize. In our view, the recent stall in payrolls was possibly a blip caused by an unforeseen rise in COVID-19 cases. Therefore, we are optimistic that payrolls will begin to strengthen throughout the year, especially as temperatures begin to rise and vaccines become more readily available. As a result, we anticipate the labor market will still provide a tailwind for equities in the coming months.

View PDF

by Asset Allocation Committee | PDF

Jan Tinbergen was a Dutch economist, the first to win the Nobel Prize for economics[1] for his work on applied dynamic models of economic processes.  Perhaps his most important contribution to economic policy is the penning of the Tinbergen Rule, which states that policymakers need an equal number of policy tools for each policy goal.  If policymakers violate the Tinbergen Rule, they can leave a policy goal unaddressed.  Of course, there are circumstances where two goals are solved with one policy tool, but that does require some degree of good fortune.  Relying on luck is usually not a solid plan.

The classic case of the Tinbergen problem is the use of monetary policy to meet both inflation and full employment targets.

This chart shows the unemployment rate and CPI on the upper part of the graph and fed funds on the lower part.  History shows that the FOMC mostly pays attention to inflation when setting policy and only reacts to rising unemployment when recessions occur.  To some extent, the unemployment rate only rises when a recession is imminent, which is the idea behind the Sahm Rule.  From 1965 into the early 1980s, there was a clear “whipsaw” in policy.  Rapidly rising inflation tended to lift the fed funds rate.  As unemployment began to rise, policymakers faced a dilemma—do they cut rates to help the economy but risk higher inflation, or do they focus on inflation and risk rising unemployment?

Since the early 1980s, this dilemma has mostly been resolved.  Inflation has been low and mostly steady, which allows for the FOMC to focus on unemployment.  And, the inflation problem was mostly fixed by regulatory policy; globalization and deregulation reduced price pressures, meaning that policymakers had two tools—interest rates combined with globalization and deregulation—to deal with two policy goals, low inflation and full employment.  Thus, the Tinbergen Rule was satisfied.

However, these two goals are not the only ones that the FOMC and other policymakers are concerned about.  Financial market stability is another one.  Clearly, we have seen the impact of regulatory policy changes on monetary policy.

This chart shows the National Financial Conditions Index, created by the Chicago FRB, and fed funds.  From the early 1970s into mid-1998, the correlation was very close.  In fact, one could argue that the FOMC either adjusted policy to financial stress levels, conducted policy with little regard to stress, or actually targeted stress as a policy tool.  Because the financial system was generally more regulated until the late 1990s, Fed policymakers worried less about financial conditions.  But, since Gramm-Leach, which essentially created conditions where commercial banks could freely operate in the non-bank financial system, the FOMC has clearly shifted the relationship on monetary policy and financial conditions.  Now, the Fed finds itself in a situation where financial conditions are mostly immune to the policy rate.  When a financial crisis emerges, it seems to require aggressive easing and accommodative policy for extended periods to bring calm back to the markets.

Lately, the Fed has faced criticism from commentators arguing that persistently low rates and balance sheet expansion have contributed to financial excesses.  Although we would agree with these comments, it should be noted that the Fed is facing a Tinbergen problem.  It has only one policy tool, interest rates, to reduce unemployment and maintain financial stability.  Raising rates would likely contract the P/E but there is little reason to expect that increased rates would reduce unemployment.  What the Fed needs is an additional policy tool, something akin to Glass-Steagall, to reduce the liquidity available for the purchase of financial assets.  Since that outcome isn’t likely, we expect financial assets to remain supported.

View PDF

---

[1] Strictly speaking, there is no Nobel Prize for economics.  Its official title is the “Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel.”  He shared the prize with Ragnar Frisch.

by Asset Allocation Committee | PDF

The residential real estate market has made a strong recovery over the past year.  Virtually all areas of housing, including home prices, starts, and ownership are showing signs of strength.  Let’s start with prices.

Home prices have been very strong recently.  This chart shows single-family existing home sales.  Over the past year, existing home prices are up 13.4%.  Increases of this magnitude or higher only occur 4.8% of the time.   New home prices are up as well, but not to the same degree; the median new home price is up 8.0%.  Price increases of that level or higher occur abut 35% of the time.

Despite this rise in prices, housing affordability remains high.  A rising NAR affordability index suggests easy buying conditions.  The current reading is off its recent highs but well above the levels seen in 2005.

The index combines home prices, average wages, and mortgage rates.  The latter two have improved the index recently,[1] offsetting the impact of higher home prices.

The rapid rise in household formation should provide a catalyst for continued home sales and construction.

This chart shows the level of household formation on a log basis.  Household formation has been declining since 1990 but has started to stabilize recently.  In addition, recently the data was recovering quickly but did pull back due to the pandemic.  We expect the recent bounce is a signal of faster formation as the large millennial generation begins to form households.  If so, a rise similar to what was seen from 1960 to 1980 may be in store.

Finally, one of the factors that had hampered this sector was suburban sprawl.  In some areas, the commutes to work had become so lengthy that workers could no longer move further away from urban centers to find affordable housing.  However, the pandemic has proven, for many workers, that working from home is a possibility.  As a result, workers are looking again at buying more space further “out” with the idea that instead of commuting five days a week, it may be three or less, which is more manageable.

For these reasons, the Asset Allocation Committee remains favorable toward the homebuilding and related industries, expecting them to perform well in the coming years.  And, as we noted in our 2021 Outlook, if the Federal Reserve is serious about improving the lot of the bottom 90% of households, then it should keep interest rates low because this group’s largest asset is its home, and low interest rates support the price of that asset.

View PDF

---

[1] The pandemic has pushed average wages higher because lower paid service workers have suffered larger job losses.