Unemployment is falling
Right now, the unemployment rate is the most important data point out there. The rate has been falling. So, why doesn’t the average citizen feel better about the economy? Let’s look at the labor force participation rate to answer this question.
To be considered unemployed, you have to make an effort to get a job. If you haven’t done anything in the prior month, you aren’t considered unemployed. As far as the government is concerned, you’ve dropped out of the labor force. Of course, you’re still unemployed, but for the purpose of the official unemployment rate, you’re not.
Labor force participation rate
The labor force participation rate is the ratio of the labor force against its demographic cohort. In other words, it’s similar to the employment-to-population ratio that the Fed uses, but it takes demographics into account.
As you can see in the above graph, the labor force participation rate rose steadily from the early 1960s through the early 2000s as more women entered the labor force. Since the Great Recession, the labor force participation rate has fallen. Now, it’s back to levels we haven’t seen since the late 1970s.
In May 2016, the labor force participation rate fell to 62.6%, down 20 basis points from April. The labor force fell from 158.9 million to 158.5 million. The population rose from 252.8 million to 253 million during the month. The employment-to-population ratio was steady at 59.7%.
To put the change in the labor force participation rate into perspective, consider that roughly half of the gains attributed to women entering the labor force, starting in the 1960s, have been lost. This is one of the biggest reasons the economy remains below par. Yes, Baby Boomers are retiring, but the Millennial generation is larger.
Implications for mortgage REITs
As more people get back to work, the economy improves. However, the effect on inflation is hard to forecast. If the labor force participation rate remains low, that would mean an earlier return of inflation. This would be detrimental for mortgage REITs with large levered portfolios of agency mortgage-backed securities, especially Annaly Capital Management (NLY) and American Capital Agency (AGNC). These two REITs are the most vulnerable to rising inflation. Inflation will drive long-term rates higher, which investors can trade through the iShares Barclays 20+ Year Treasury Bond ETF (TLT).
Non-agency REITs such as Two Harbors Investment (TWO) should benefit somewhat from moderate inflation since it boosts real estate prices and helps debtors. Increasing real estate prices are good news for origination-focused REITs such as Nationstar Mortgage Holdings (NSM).
Meanwhile, investors interested in gaining exposure to the mortgage REIT sector might consider the iShares Mortgage Real Estate ETF (REM).
In the next part of our series, we’ll look at wages. They’re increasing 2.5% per year.