Unemployment is falling
Right now, the unemployment rate is the most important data point out there. The rate has been falling, but the average citizen doesn’t feel better about the economy. Why? 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 have dropped out of the labor force. Of course, you’re still unemployed, but for the purpose of the official unemployment rate, you aren’t.
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 Federal Reserve 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 July 2016, the labor force participation rate rose to 62.8%—up 10 basis points from June. The labor force rose from 158.9 million to 159.3 million. The population rose from 253.4 million to 253.6 million during the month. The employment-to-population ratio ticked up 10 basis points to 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 that inflation would return earlier. This would be detrimental for mortgage REITs with large leveraged 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 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 Capped ETF (REM).
In the next part of our series, we’ll look at wages. They’re increasing 2.6% per year.