James Paulsen: Investment Outlook (December 4, 2014)

Unemployment Rate Falling Much Faster Than Expected

by James Paulsen, Chief Investment Strategist, Wells Capital Management

December 4, 2014

The current recovery has been characterized by much slower growth compared to most post-war recoveries. Despite modest economic growth, however, the un- employment rate has declined steadily in recent years.

Indeed, in the last three years, the unemployment rate has fallen slightly more than 1% annually even though real GDP growth has averaged only 2.47% and annual average job growth has been even less at 1.78%. More- over, despite far more tepid economic growth in this recovery, the unemployment rate during its first five years has fallen nearly as fast and as much as it did in the early 1980s recovery (the only other post-war recovery which began from an unemployment rate above 10%).

How, when the pace of job creation has been widely perceived as insufficient to reduce unemployment, has the unemployment rate fallen so quickly? Many have postulated the improvement is probably temporary and due primarily to a large segment of discouraged work- ers remaining outside of the labor force since the last recession. However, this argument is becoming less con- vincing as the unemployment rate continues its decline back near full employment with little evidence of a rush of previously discouraged workers returning to the job market. Our own view is the rapidly declining unemploy- ment rate in the face of continued modest economic growth is mainly due to aging demographics and a very slow growing working age population (i.e., slow growing labor supply).

The most important question for investors, however, is whether the unemployment rate continues its rapid decline. With the unemployment rate now below 6%, further brisk declines (e.g., if it continues at its recent pace of falling at about 1% a year), with or without evidence of accelerating wage inflation, would likely be- come increasingly problematic for the Federal Reserve and on Wall Street.

How weak growth = Rapid declines in the unemployment rate?

Chart 1 shows how sluggish the pace of job creation has been in this recovery compared to post-war history. In the last few years, annual job growth has been between about 1.5% to 2%, slightly less than the weak employ- ment growth experienced in the last recovery and far weaker than the 2.5% to 4+% annual job gains experi- enced in many past recoveries.

Screen Shot 2014-12-04 at 7.52.00 PM

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Copyright Ā© Wells Capital Management

 

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