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Thursday, March 26, 2015

Investing Based On Unemployment Data Is Like Driving With The Rear View Mirror

Following the Fed's announcement last week I discussed how the U.S. employment data is showing strength while most of the other economic data is showing weakness. Why is this important? Employment data is a lagging indicator. During most recessions employment peaks after a recession has already begun. 

MISH put together some excellent information this morning on this topic in Jobs and Employment: How Much Recession Warning Can One Expect?:

In the previous five recessions, jobs peaked two months after the start of the recession once, one month later once, one month prior twice, and once during the recession month.

In the previous five recessions, employment peaked one month after the start of the recession twice, one month prior twice, and once during the recession month.

The NBER says the last US recession started in December of 2007 and lasted until  June of 2009. Let's take a closer look at stats from that recession.

2007-2009 Recession Stats

  • Jobs were higher three months after the recession started than two months before the recession started.
  • Jobs were higher two months after the recession started than one month before.
  • Employment was higher three months after the recession started than two months before.
  • Employment was higher two months after the recession started than one month before.
This is the bind the Fed faces today. The economy is weakening rapidly but the broader public has not noticed due to the jubilation around the jobs number (which I have shown numerous times is actually weaker than the data suggests due to how they calculate unemployment).

Meanwhile U.S. stock market investors believe any weakness in economic data or weakness in stock market prices will mean the Fed announces a delay in raising interest rates or additional easing (QE4).

The belief in the Fed "put" underneath the market has never been stronger. Market participants (behind the strength of the media) believed the Fed would stop any decline in the market in 2000 and 2008 with rate cuts and additional easing. The Fed began cutting interest rates in the fall of 2007 and continued cutting through March of 2009. Stocks fell close to 60% during that easing period.  

The belief in a Fed put only pushes stocks artificially higher in the short term which creates more damage when reality ultimately returns to the markets. Or maybe this time around the laws of gravity no longer apply and QE can keep stocks elevated forever. My personal investment bet is the Fed will not be able to stop the next decline and when it's over there will be an entirely new paradigm shift toward how the world views the Fed and other major central banks.