Why post-2008 labor market dynamics support equities and credit
Backdrop: Productivity and population continue to decline
The below graph reflects a potentially serious challenge for U.S. economic growth as well as investors. The below graph reflects the ongoing decline in both population growth and productivity growth in the USA. Essentially, this is a graph of economic decline—much like the trend lines of both real GDP growth and fixed investments in the USA. While this data isn’t new news, the ongoing bull market in equities and bonds tends to distract investors from fundamental factors, which can eventually, and sometimes suddenly, lead to market reversals. This series provides an overview of the unemployment rates of the Bureau of Labor Statistics—“U-1 through U-6” unemployment data—within the context of the current U.S. economy, which suffers from an ongoing decline in fixed investment, productivity, and overall economic growth. This series considers the implications for both equity and fixed income investors and compares the benefits of value versus growth strategies in equity ETFs, as well as credit quality and portfolio duration considerations in fixed income ETFs.
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For a detailed analysis of the U.S. macroeconomic environment supporting this series, please see Must-know 2014 US macro outlook: The crack in the debt ceiling.
U-1 through U-6: Baby Boomers and discouraged workers
As we described in the Market Realist series Is Baby Boomer retirement more good news for stocks and labor markets, the U.S. labor market has begun to go through a very significant transformation since the 2008 crisis, as the number of discouraged workers had grown from a mere 200,000 before the crisis to as high as 700,000 right after the crisis to as low as 450,000 today. That isn’t a large number of workers in relation to the nearly 98,000,000-strong workforce in the U.S. However, the loss of 4,000,000 workers—most of whom were likely Baby Boomers—since 2008 is quite significant. It isn’t known with certainty how many of these 4,000,000 newly “unavailable workers” retired out of choice or out of discouragement. While the economists noted in the prior series point to the inability of “structural unemployment” to explain the currently weak labor market conditions, for those over the age of 55, employment prospects certainly seem to be rooted in structural unemployment or other incurable economic illnesses.
A mixed picture for investors
The following labor data series paints a mixed picture for investors. On one hand, it may be a positive for the dynamics of labor supply versus demand as the Baby Boomer “lump of labor” begins to exit the market. On the other hand, analysts have shown that, on net, the older Baby Boomer generation has played a significant role in stimulating new jobs and wage growth—much more so among male workers than female. This shift in the labor market might mean more jobs for the unemployed and lead to a more fully functioning labor market—thereby shrinking the economic output gap of the country and restoring economic activity to its full potential.
A demand-side solution is required
On the other hand, with many elderly people out of the labor market, consumption could soften, domestic demand could weaken, and the newly re-employed might not be so happy with the purchasing power their new found jobs provide them. We can only hope that economist Paul Krugman can come up with some great demand side ideas that can be successfully implemented in order to avoid the weak domestic demand scenario. For investors, it will be important to pay attention to the broad data noted in the above graph. If the labor pool shrinks and stays flat, and productivity growth stays below 1%, get ready for more weak economic data, and think twice about buying stocks. On the other hand, if this data can continue to improve—and the initial success of the Affordable Health Care Act (Obamacare) continues, it’s possible that the U.S. economy will continue to grow in a fairly strong and sustainable fashion—with solid consumption data, and without the need for additional government deficit spending to compensate for the current weak level of domestic demand.
Credit comment: T-Mobile USA—Solid BB credit
T-Mobile USA (TMUS) has a market capitalization of $25.44 billion and is also a BB credit. T-Mobile USA holds $22.68 billion in debt and $7.34 billion in cash, leaving about $18 billion in debt. In contrast to Verizon’s (VZ) 9.54% profit margin and Sprint’s (S) -8.5% profit margin, TMUS has a profit margin of 0.14%. TMUS has an earnings before interest and taxes (EBITDA) of $4.78 billion to service its $18 billion of net debt, while Sprint has $5.47 billion of EBITDA to service net debt of $25.5 billion, and Verizon has $48.57 of EBITDA to service its net debt of $42 billion. T-Mobile currently has a September 1, 2018, company-guaranteed bond yielding 3.00% versus CIT Group’s February 19, 2019, senior unsecured bond yielding 3.46%, Sprint’s August 15, 2007, senior unsecured bond yielding 2.95%, Verizon’s February 15, 2008, senior unsecured bond yielding 2.00%, and Caesar’s Entertainment’s June 1, 2017, senior secured bond yielding around 11.00% (Bloomberg & Capital IQ, December 31, 2013 Quarter).
To see an overview of U-1 through U-6 Data, please see the next article in this series.
For more detailed analysis of the U.S. labor market, please see Is Baby Boomer retirement more good news for stocks and labor markets? and US labor: Is the discouraged worker bad for stocks and bonds?
Equity outlook: Cautious
Should the debt ceiling debate re-emerge after the mid-term elections in November, and macroeconomic data fail to rebound in sync with record corporate profits, investors may wish to consider limiting excessive exposure to the U.S. domestic economy, as reflected more completely in the iShares Russell 2000 Index (IWM). Alternatively, investors may wish to consider shifting equity exposure to more defensive consumer staples-related shares, as reflected in the iShares Russell 1000 Value Index (IWD).
Plus, even the global blue chip shares in the S&P 500 (SPY) or Dow Jones (DIA) could come under pressure in a rising interest rate environment accompanied by slowing consumption, investment, and economic growth. So investors may exercise greater caution when investing in the State Street Global Advisors S&P 500 SPDR (SPY) or the State Street Global Advisors Dow Jones SPDR (DIA) ETFs. Until there’s greater progress on the budget and federal debt issue, and consumption, investment, and GDP start to show greater signs of self-sustained growth, investors may wish to exercise caution and consider value and defensive sectors for investment, or individual companies such as Wal-Mart Stores (WMT).
Without sustained improvement in economic growth data, there’s little doubt that the debt level issue and tax reform will be a big issue later in the year. Current economic data noted in this series suggests that the probability of the 2013 sequester issue returning—in one form or another—could be higher than many think. The data is simply not that robust—yet.
Equity outlook: Constructive
However, if investors are confident in the ability of the USA to sustain the current economic recovery as a result of the improving macroeconomic data noted in this series, they may be willing to take a longer-term view and invest in U.S. equities at their current prices. With the S&P 500 (SPY) price-to-earnings ratio standing at 19.65 versus the historical average of around 15.50, the S&P is slightly rich in price—though earnings have been solid. However, with so much wealth sitting in risk-free and short-term financial assets, it’s possible to imagine that a large reallocation of capital that is “on strike,” including corporate profits, into long-term fixed investments. This could lead to greater economic growth rates and support both higher equity and housing prices as well. In the case of a constructive outlook, investors should consider investing in growth through the iShares Russell 1000 Growth Index (IWF) or through individual growth-oriented companies such as Google (GOOG).