The LFPR Recession
Thursday, 8/24/2023 09:01
Numbers hiding in plain sight...
WHY does the US economy look so strong in comparison with the rest of the world?
asks Jim Rickards in The Daily Reckoning.
The answer is timing.
The economy does not go from growth to recession like throwing a switch. It takes time. The positive signs are real but they're fading. The negative signs are real and they're growing.
Some data lead the economy; other data follow with a lag. It's the analyst's job to know which is which, and to focus on trends, not snapshots.
First off, low unemployment may not be a source of comfort because employment trends tend to lag the economy. The latest unemployment report (July's) showed an unemployment rate of 3.5%, among the lowest since the 1960s.
That's a healthy report on its face but there are two serious characteristics that need to be taken into account. The first involves what's known as the labor force participation rate (LFPR).
This counts all of the working-age population of the US who do not have jobs as a percentage of the total working-age population. That's different from the unemployment rate because to be counted as "unemployed" you must be looking for a job.
There are tens of millions of working-age Americans who do not have jobs but are not looking for one. They are not counted as unemployed, but they do show up in the LFPR calculations.
Right now, the LFPR is 62.6%. That's the same level the US first reached in November 1977 when women were entering the workforce in large numbers. It's significantly below the 67.2% level reached in January 2001, when baby boomers were in the prime of their careers. Essentially, 6.7 million workers have simply dropped out of seeking work relative to 2001.
If those 6.7 million workers were added to the number of unemployed today, the national unemployment rate would be 7.6%, a rate more closely associated with a recession. In effect, the low participation rate is hiding a large unemployed cohort not being counted by the government in the official employment report.
The second and even more critical defect in using employment statistics in economic forecasting is that employment reports are lagging indicators, not leading indicators. When the economy begins to slow down, businesses will do everything except lay off workers to keep the doors open.
They'll cut inventories, lower prices, seek rent reductions, cut administrative costs and a lot else before they fire valuable workers. All of those strategies are clear signs of a failing economy, but they don't show up in the employment reports.
By the time employers get around to firing workers, it's too late for the economy. So you can't rely on low unemployment rates to conclude all is well. The opposite could easily be true.
Still, there are powerful indicators suggesting the US economy is in or near a severe recession in addition to better-known measures such as the unemployment rate. The first of these is an inverted yield curve.
I'm not going to get too technical here, but it's important to understand the basics and their implications. A yield curve shows interest rates on securities of different maturities from one issuer or it can show interest rates on a single instrument at different points in the future.
In either case, the curve is normally upward sloping (longer maturities or later settlement dates have higher interest rates). That makes sense. If you're lending money for longer or betting on rates further into the future, you want a higher interest rate to compensate you for the added risk from such events as inflation, credit downgrades, bankruptcy and more.
Yield curves in US Treasury securities are steeply inverted today. So are yield curves in SOFR (formerly EuroDollar) futures contracts. Again, don't worry about the technical details. Just understand that these are important warning signals. The last time both yield curves were this steeply inverted was prior to the global financial crisis of 2008.
If you're not factoring this signal into your forecast, you're missing a five-alarm fire. The system is flashing red.
There are many other such warning signs such as negative swap spreads. Without getting into the technical details, it's enough to understand that negative swap spreads mean that bank balance sheets are contracting. Balance sheet capacity is strained. That's another early warning of a credit crunch that presages a recession.
There are other warning signs and, again, I'm not going to get into the technical details here. It's enough to say that all of the technical signs are unusual and all point in the direction of a recession. They all have good track records of predicting recessions going back to the 1970s and earlier depending on the time series.
So in the US, the fundamentals (industrial output, global trade, inventory accumulation, credit, commercial real estate) are negative. The technicals (yield curves, swap spreads, bank equity) are negative. The only positives are unemployment (a lagging indicator) and the stock market (a cap-weighted bubble). Unfortunately for investors, stocks and jobs are the only things the financial TV talking heads talk about. Don't fall for it.
Investors who look abroad for rescue by former highfliers such as China, Japan and Germany will also be disappointed. China is slowing dramatically; the reopening narrative was always a myth.
Meanwhile, Japan is hanging by a thread partly because of its close economic alignment with China. Germany is already in recession and that will get worse as the Ukraine war drags on and one whom the Russians call General Winter appears by November.
It's becoming increasingly apparent that we're looking at a global recession, if not a global financial crisis. These are highly unusual. It's often the case that one or more major economies are in recession while others display growth and help pull the weak performers out of the ditch.
But today, we're facing a case where, one after the other, all of the major economies are falling into the ditch. Now, that doesn't mean investors should just throw their hands up in the air and run for the hills.
But they should lighten up on equities, increase allocations to cash (paying good 5% yields these days), allocate about 10% of investable assets to gold and silver and take a close look at sectors such as energy, agriculture, mining and natural resources that will stand the test of time.
You don't have to follow everyone else off a cliff.
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