U3 & Participation Rate Updates

In a post from last December titled "Fighting the Last War," I looked at the vast differences between the initial conditions of the tech bubble recession and the one that the US entered in December of 2007. At this point, if there was any lingering doubt residing in the populace, it should be shaken.

This post then, is not to re-iterate that point but rather just to provide an update of those charts to see just how much worse things have become. First, there was the rather cluttered chart with SPX, U3, and the Fed target rate. U3 has shot up on both the SA and NSA measures to 7.6/8.5%, respectively. Keep in mind my projection of a 7.9-8.1% U3 (SA) rate from early February, so obviously I think this has room to get worse. What is ominous about this number is that JPM had a loss projections for the WM takeover that used 8.0% in its "severe recession" scenario. Obviously, that is going to be overtaken if not this month than the next. Not coincidentally, the banks have not reported their loss sensitivities based on U3 as of late.

The next chart was the U3 values with the participation rate. This make the picture even more bleak when it is noted that the participation rate is about 1% lower than during the bubble recession, even while U3 is itself 1.5 points higher. This does not bode well for consumer spending since now even more households have a single income.

Finally, but on a similar point, the home ATM is now functionally empty. I'm not putting that chart up but the net equity extraction from homes went to a -$64B for Q3/08. (The last data point available.) Suffice to say, this is very bad for anyone that had relied on consumers tapping their houses for big ticket items. I'm looking at you, HOG!

Bottom line: the picture is growing darker.

Update (3/6/09): U3 (SA) was 8.1% today and the NSA value hit 8.9%.

U-3: NSA vs. SA

The unemployment report from BLS came out today and it was ugly, even with the headline reporting of the seasonally adjusted numbers. What stuck out at me when I looked into the A-12 table was the difference between the non-seasonally adjusted (NSA) and seasonally adjusted (SA) values. They were respectively 8.5% and 7.6%. Consider the following stories from the last part of 2008:

- "November retail hiring was 53 percent lower than a year ago, when retailers added nearly 458,000 holiday workers, compared with 217,200 hires last month, according to an analysis by Challenger, Gray & Christmas Inc. (Source: Boston Globe - Dec. 5, 2008)

- "Department stores hired 88,000 fewer people this November compared with 2007, and clothing and accessories stores cut 65,000 jobs, according to the Labor Department. (Source: Forbes - Dec. 11, 2008)

There are tons more of these stories if you're inclined to look. If you read a local Picayune, Gazette, or News you'll likely recall similar headlines. So with that backdrop, how valid is the U-3 SA number? As ever on this blog, to the charts!

The first chart looks at the monthly trend in the difference between the NSA and SA numbers. You would expect there to be a pattern because of the whole idea behind the NSA value. However, there is some variation inside in the monthly differences which would be expected. The question is whether or not this is a systematic pattern or just noise. The next chart can shed some light on that question.

This chart requires a little bit of explanation. It uses the difference values for all the January numbers from 1989-2009 and plots them against the U-3 NSA value. The line fits reasonably well with an R2 = 0.805. This certainly seems to imply some correlation with the background unemployment level - a higher U-3 number tends to have a higher difference between the NSA and SA values. I think the stories noted above explain the reason behind this phenomenon.

The SA model would assume that post-holiday season there would be more seasonal workers in the job market just as there should have been more seasonal workers employed in Q4. However, this year that doesn't seem to have been the case. This year, holiday hiring was muted at best and thus the substantial differences between the two measurements. Bottom line: the most recent period does not fit the pattern that the SA modeling assumes.

What to look for in February? Predicting a bump in the U-3 SA number would seem like a no-brainer at this point. The question to me is how much of the difference between the SA and NSA values will be bridged. I would not be surprised to see the NSA number actually hold steady and the SA value to creep up one or two tenths to maybe 7.7 - 7.8%. (see update below)

One other note: the participation rate slid further to 65.4% (SA) and 65.5% (NSA). These are 20 year lows. I've omitted discussion of that for brevity's sake but these are also important to watch as signs of a very anemic labor market. I've touched on that before in my original post to this blog.

Update: I have been thinking more about this and want to revise my expectations of SA unemployment. Here's why: First, the normal SA model appears to expect a fall in February NSA employment figures and compensates upward a bit as a result. I don't believe that this year, there will be a fall in February NSA unemployement and the NSA number is already very elevated. Second, the ongoing mass-layoff stories would point to a higher value. So my revised estimate is 7.9-8.1% for SA unemployment in the next report.

Wy-Pfi

I've seen more than a few comments bemoaning the buyout of Wyeth by Pfizer as it will throw 8K people out of work and that these are just the sorts of jobs that the US needs to retain - i.e. "knowledge jobs" - and that this is the sort of merger that will further reduce the research and what-not done at these two companies. Although I certainly do not celebrate any job loss - particularly now - I don't believe this is the case that knowledge jobs are going to vanish. Here's why:

Despite Montel's travelling circus telling the nation about "America's Pharmaceutical Research Companies", a cursory examination of the annual reports for Pfizer and Wyeth reveal something peculiar...

To the left, is a page out of Pfizer's 2007 annual report with a little bit highlighted. Notice that R&D expenditures (the "knowledge jobs") are roughly 1/2 of the percentage of the SI&A (sales, informational & administrative) expenses. So Pfizer basically spends $2 on selling stuff to you through advertising, drug rep giveaways, etc. for every $1 they spend on research. Further in the text, this specific detail on radio & TV advertising is laid out: Advertising expenses totaled approximately $2.7 billion in 2007,$2.6 billion in 2006 and $2.7 billion in 2005.

So maybe Wyeth is better? Let's have a look at their 2007 annual report. Well, how about that? SI&A for Wyeth is a little over twice what is spent on R&D there too.

Now this isn't meant to trivialize what is a substantial amount spent on R&D by Pfizer and Wyeth. Combined, in 2007 they dropped about $11.1B in R&D expenses. But at the same time they spent over twice that on selling the public on these drugs - or selling us on the idea that they are heavy into R&D when they actually spend twice as much on things that have nothing to do with drug research.

The most oft-heard reason for Pfizer's purchase of Wyeth is that Pfizer is about to lose patent-protection on Lipitor, one of PFE's cash cows. This leads to a more interesting observation or at least personal speculation.

Anyone that really enjoys gambling on the stock market knows about how enticing the returns can be on a biotech company that gets FDA approval for one of the drugs in its pipeline. And anyone that has followed the sector knows that there is a veritable graveyard of zombies, corpses and tombstones for every one or two lucky souls that emerge. And what of these lucky one or two companies? Why, they're usually purchased by (or partnered with) the likes of PFE, MRK, BMS or one of the "Big Pharma" group. Case in point, I picked a page out of 2007 annual report of a company I used to follow - MEDX - to see how much they spent on R&D vs. SI&A.

Unsurprisingly, R&D dominates the expenses in this true biotech company. MEDX has some partnerships with BMS for some of their technology, though I haven't followed them for awhile.

The point of all this is my hunch that the merging of PFE and Wyeth into Wy-Pfi does not mean we should all expect a massive slashing of R&D budgets and thousands of scientists out of work. What I believe it forecasts is thousands of drug reps, HR and admininstrative staff out of work. (Perhaps unfortunate for the economy is that I suspect in many cases, the drug reps are better paid and disperse more dollars into the economy than the scientists.) New drugs are still the lifeblood of these companies. But PFE and their ilk have long been far larger marketing machines than R&D houses. The true drug innovation (and risk-taking) goes on at the smaller biotech firms and universities. Big Pharma is simply very innovative at finding new ways to extract dollars from our pockets through creative patenting, lobbying and marketing.

For more reading, I would definitely recommend the New Yorker's article "High Prices" by Malcom Gladwell for a glimpse at the marketing creativity of Big Pharma as well as "The Pipeline Problems" also in the New Yorker.

Sources:

Wyeth's 2007 Annual Report (Page 7)

Pfizer's 2007 Annual Report (Page 41)

Fighting the Last War (or: This Is Not a Replay of 2001)

Who doesn’t want to look at the current economic forecasts and want to do some prognosticating based on the last recession? After all, there's a lot of nostalgia for a recession that was practically over before it was even called out for being what it was. The NBER declared it started in March 2001 and over in November 2001. And lately, I’ve read a few market projection opinion pieces that sure sound like they are trying to run the playbook from the last recession, even if that premise is not explicitly stated. So what’s different?

As usual, I’ll start out with a chart:

This chart needs a little clarification:
- The days are done on market sessions for SPX rather than on calendar days. (True for subsequent charts as well.)
- Day 1 is one calendar year prior to the NBER declared start of the recession. March 2001 for the tech bubble and December 2007 for the current one.
- The data series noted with “TB” are the tech bubble runs.

All things considered, the charts are not that much different if you were just to take a quick glance at it – U3 moving up, Fed slashing rates, SPX plummeting – albeit at much faster rates on those last two items. But when more detail is added to the picture it gets far darker.

Here are some additional specifics on the unemployment rate then and now. (For more, revisit my inaugural blog post.)

At a similar point in the last recession, U3 (SA) was 5.7% vs. the 6.7% currently observed. But worse, the participation rate was 66.6% whereas now it is 65.8%, which likely adds to the general malaise in the employment area.

Unemployment is not the entirety of the picture here, however. There is also the consideration of the recovery from the recession in 2001, and this is where it starts to get uglier. Homeowner’s equity stood at 56.98% in Q4/2001 and consumer credit held by commercial banks was just about $235B. Flash forward to today and homeowner’s equity as of Q2/2008 rests at 44.66% and consumer credit has shot up to $363.1B. Additionally, net equity extraction has declined precipitously to $9.5B – probably reflecting the combined reality of less credit available via HELOCs and limted remaining equity in homes. Over the period from Q3/2001 until the Q2/2008, the total net equity extracted has been approximately $3.72T.

And all of this is happening on the backdrop of an economy for which consumer spending drives nearly 70% of GDP.

My 2 Cents worth of 2001 narrative: The broad economy stabilized but many households had one less income, reflected in the participation rate which never recovered. Once the employment situation allowed for enough comfort to do so, these households and others, decided to juice their lifestyles (despite new income levels) via equity withdrawal and spending on credit. (See chart at source 4 below)

Bottom line: be very wary of anyone who sounds like they are trying to replay the last recession. The conditions are vastly different and far more disturbing.

Sources:

1) Federal Reserve Data Series: FL155035015.Q, FL155035065.Q
2) http://www.bls.gov/cps/cpsatabs.htm
3) http://www.wealthscribe.com/wp-content/uploads/2008/11/equity-extraction-data-2008-q2.pdf

4) http://research.stlouisfed.org/fred2/series/REVOLNCB

U3, U6, & the Participation Rate

I've been having a running conversation with a friend of mine regarding how dire the employment situation really is. She believes that BOL statistics do not reflect the reality that so many people's unemployment benefits have expired or they have simply stopped looking for work.

Just so you don’t think I’m being a cheerleader or a naïf when it comes to government statistics or the broad economy, I decided to do a little hunting and digging. Several years ago, I used to post and debate things on Slate in the Moneybox forum and there were a few of the posters that were engaged in an ongoing and occasional effort to tease out what exactly the statistics meant. One of the things that was brought up several times was the “participation rate” which is exactly what it sounds like – what percentage of the available labor force is engaged in work.

Anyhow, I dug back into the BOL website and found the participation rate series and then compared it to both U-3 and U-6 measures. U-3 is the most reported measure of unemployment but, as you note, it doesn’t quite capture all unemployment. U-6 is a much broader measure and counts discouraged workers, marginal employment, etc.

So here’s a chart:
The participation rate and U-3 series go back all the way to 1950, whereas the U-6 line is a recent development - I believe when the BOL started changing the calculations a bit. The participation rate obviously reflects some basic shifts in work patterns such as more women entering the workforce. This rate peaked out in early 2000 at 67.3% and has since fallen back to around 66%.

I disagree with the statement that BOL statistics do not in any way capture people whose unemployment benefits have run out. I believe that the participation rate does capture this even if they are missed by the counts of initial and continuing claims or the U-3 measure.

The peak labor participation rate was 67.3% in April 2000 and the U-6 (not seasonally adjusted) measure was 6.6%. During the December 2006 trough in U-6 measure was 7.8% but the participation rate was 66.4%. This is a difference of -0.9% from the April 2000 peak and the U-6 measure difference is 1.2%. I don’t believe this is a coincidence, particularly considering the noise in the data.

Bottom line, I agree that U-3 most likely understates the true unemployment situation but I disagree that workers that are no longer collecting unemployment benefits are not counted. The numbers are simply not reported by a lazy and stupid press corps who are either not trained or constitutionally incapable of digging into statistics and attempting to draw a conclusion.

Tangents and Digressions:
I didn’t include it here but I’m very curious if that increase in participation rate in the late 80s and 90s overlaps with any real wage stagnation. An increase in the labor pool would logically depress or at least slow wage growth. Of course, that makes our current situation even more dreadful since the labor pool via participation rate has already shrunk and wages have, if anything, shrunk on a real dollar basis.

I don’t think it’s entirely coincidental that consumer revolving credit leaps during the lowest periods of participation rate: