Marginally attached, less marginalized
The below graph reflects the same pattern in improvement in the U-2 through U-6 data. The Bureau of Labor Statistics defines U-5 unemployment data as “total unemployed, plus discouraged workers, plus all other persons marginally attached to the labor force, as a percent of the civilian labor force.” This means that U-5 data is essentially the same as the U-4 data, plus those marginally attached to the workforce. All U-2 through U-6 data exhibits the same basic level of improvement. All U-2 through U-5 data reflect lower levels of unemployment today versus when President Obama took office. This is a very positive development for the labor markets overall, and we can view it as a fair achievement for the Obama Administration—if not the Federal Reserve Bank for its ultra-aggressive monetary policy measures. Regardless, the U-1 data—the long-term unemployed—are still higher in number than when Obama took office, and the discouraged workers (the difference between U-3 and U-4 data) remain at elevated levels. This article considers the overall improvement in the U.S. labor market and the implications for both equity and fixed income investors.
As the above graph suggests, U-5 unemployment rates are returning to normal levels. Should the current trend remain intact, U-5 unemployment levels in general would likely approximate more normal levels of unemployment consistent with historical averages within two years—just in time for the next presidential election.
Implication for labor market normalcy
As we pointed out in Part 3 of this series, a return of the employment rate to the NAIRU rate of 5.6% (non-accelerating inflation rate of unemployment) might provide the USA the opportunity to focus on basic policy issues once again—including the demand-side issues raised by economist Paul Krugman and others. While current policies seem to be entrenched as a result of the post-2008 crisis, it’s possible that the entire supply-side doctrine noted in Part 3 of this series could become social policy fair game. The dramatic increases of the lower quartile income earners relative to the higher quartiles, noted as the Nixon and Clinton anomalies, could be revisited in the future, as trickle-up economics (via new demand-side policies) are reconsidered by Washington.
To see how the U-5 unemployment compares to the unemployment rate that also includes “those employed part time for economic reasons” or “U-6 employment,” 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?
Credit comment: T-Mobile US versus Verizon
T-Mobile USA 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 9.54% profit margin and Sprint’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 $48.57of 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%. Overall, given TMUS fairly solid liquidity position and EBITDA relative to debt, it would appear to be a fairly solid credit, and may be worth the the extra 1.0% yield over the high-quality Verizon, should investors be interested in incremental yield. (Bloomberg & Capital IQ, December 31, 2013 Quarter.)
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).