Labor Market Recovery: The Missing Ingredient

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Part 5
Labor Market Recovery: The Missing Ingredient PART 5 OF 5

Declining Labor Force Participation: Implications for Investors

Other factors may be contributing to the decline as well, including a larger percentage of younger Americans in college and a sharp spike in Americans on Social Security disability. Looking forward, while a stronger labor market should slow, or at least temporarily reverse, some of the decline, demographic trends and structural changes in the labor market suggest that participation rates will remain under pressure.

For investors, this has two critical implications: slower real U.S. economic growth and low rates. If aggregate hours worked grow more slowly because fewer Americans are working, absent a spike in productivity, real growth will be slower. And to the extent real growth slows, nominal growth is also likely to be slower, a trend normally associated with lower interest rates.

Declining Labor Force Participation: Implications for Investors

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The above graph shows how entitlement spending by the federal government has shot up from 1990 to 2013. More people are opting to apply for Medicaid, disability benefits, and food stamps instead of joining the workforce. This has contributed to the declining labor force participation.

According to Will Deener of Dallas News, 3 million availed disability benefits in the 1990s. This figure has shot up to 9 million today. According to a recent report from the U.S. Census Bureau, more than 100 million Americans are availing monthly government benefits.

Declining Labor Force Participation: Implications for Investors

The above graph shows the increase in enrollments for disability, Medicaid, and food stamps from 2008 to 2012. The increase in welfare benefits is contributing to the declining labor force participation rate as more and more workers decide to subsist on benefits and drop out of the workforce.

A declining labor force participation rate is likely to put downward pressure on economic growth since it leads to lower productivity. This phenomenon may force the Federal Reserve to keep rates low for long.

Moreover, as the population ages, the demand for safe haven assets like gold (IAU) (GLD), silver (SLV), Treasuries (TLT) (IEF), and bonds (BND) (AGG) tends to go up as investors become risk-averse and avoid equity markets (SPY) (IVV). This will cause rates to stay low as demand for Treasuries and bonds rises.

If the labor force participation rate continues to decline, it’s likely to exert negative pressure on consumer spending. Consumer discretionary (XLY) and consumer staples (XLP) sectors are likely to take a hit in such a scenario. Since low rates typically induce M&A (mergers and acquisitions) activity, global financial firms (XLF) involved in large capital market operations are likely to benefit. Financials look to be relatively attractive in today’s context as well and thus could prove to be a value investment going ahead.

Read our series 4 Factors Weighing On Labor Markets—And Implications On Fed Policy to understand other factors affecting the labor market recovery.


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