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Curb your enthusiasm

Contributed by Raymond James

By Scott J. Brown

Market participants got ahead of themselves last week. There were a number of calls for a positive gain in nonfarm payrolls, which failed to materialize. The economy is in recovery mode, to be sure. However, that doesn’t mean that we’re off to the races. The labor market was expected to lag in the recovery process. This is not going to be a V-shaped recovery, but growth should improve gradually over time. There are a number of headwinds and the list of second half worries is long.

The December Employment report was disappointing, but hardly a disaster. Nonfarm payrolls fell by 85,000 instead of rising as many anticipated. The broad range of evidence suggests that the pace of job losses slowed dramatically toward the end of last year. Initial claims for unemployment benefits have trended lower, nearing a level (about 400,000) that would be consistent with net job growth. Announced corporate layoff intentions for the last three months were the lowest fourth quarter total since 1999. However, new hiring has yet to pick up. That should happen soon. Hiring for the 2010 census should lead to gains in nonfarm payrolls in 1Q10 and 2Q10.

The unemployment rate held steady at 10.0% in December. However, it would have risen to 10.3% if not for a decrease in labor force participation (which fell from 64.9% to 64.6%). That could reflect people exhausting their unemployment insurance benefits. Annual benchmark revisions showed little change from previous estimates of the unemployment rate. The government’s broadest measure of unemployment, which includes discouraged workers (those that have given up looking for a job and are no longer officially counted as “unemployment”) and those working part time but preferring full-time employment, rose to 17.3%, vs. 17.2% in November and 13.7% a year ago. The unemployment rate for teenagers remained elevated (27.1%) and the rate for young adults (those aged 20-24) edged somewhat lower (15.6%).

In the recession, negative feedback loops took over. Fearful of recession, firms curtailed capital expenditures and trimmed payrolls – which was a self-fulfilling prophesy. Bad news fed on itself. These negative feedback loops appear to have been broken and we seem to be on the brink of some positive feedback loops. If consumers spend a little more, if business invest a little more, if banks lend a little more, that will create a snowball effect. That’s how recoveries progress. Yet, there are still serious headwinds. Problems in the residential and commercial real estate markets will continue for some time. We need to see job growth to ensure a recovery in the housing sector. That should come, but it will take some time.

There is still room for more policy efforts – this time more specifically directed at increasing the flow of credit to small businesses and to increasing new hiring.

Support for the housing market is less certain. The Fed is scheduled to end its purchases of mortgage-backed securities in March. While the Fed cannot support the mortgage market indefinitely, its efforts have reduced mortgage rates significantly. Mortgage rates are expected to pop higher as the Fed stops buying, and long-term interest rates could be higher in general, putting a damper on the traditional spring selling season. Additionally, homebuyer incentives will end in April (the initial transaction must occur by the end of April, closing by the end of June). Will this program be extended? Most likely.

Last week’s reports showed a further increase in inventories through November. These figures are not inflation adjusted and were boosted partly by higher oil prices. Remember, inventories don’t have to rise to add to GDP growth in the fourth quarter. They only have to fall at a slower rate. Depending on what the Bureau of Economic Analysis assumes for December, the estimate of real GDP growth for 4Q09 could be as high as a 5% or 6% annual rate. Don’t get excited. Ex-inventories, growth appears to have been relatively lackluster (1% to 2%) – positive, but aided by fiscal stimulus. Real GDP growth is likely to be in the 3.0% to 3.5% range in 2010 (4Q-over-4Q), but inventories are likely to be choppy, generating relatively large swings in GDP growth quarter-to-quarter.

The economic outlook is cautiously optimistic, not ecstatic. The bigger concerns arrive toward the end of the year. The fiscal stimulus begins to ramp down in the second half of the year and into 2011, effectively acting like a drag on GDP growth. More importantly, the Bush tax cuts are scheduled to sunset at the end of this year. Most likely, there will be some sort of compromise, either extending the tax cuts or phasing them out over time. However, there is a groundswell of public opinion wanting to reduce the budget deficit. The uncertainty may work against consumer and business sentiment later this year.