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Why Weekly Unemployment Numbers Matter
February 5, 2009
Earlier today, the Department of Labor released the nation’s weekly unemployment claims. The headline number showed that, on a seasonally adjusted basis, the number of people filing unemployment claims rose to 626,000 for the week ending January 31. The unadjusted number was 675,590, an increase of 56,578 from the previous week.
Continuing claims for the week ending January 24 rose to an adjusted 4.79 million people. The unadjusted number was 5,793,331, an increase of 62,724 from the prior week. Both sets of numbers are the highest reported so far for this recession. Given the accelerating deterioration in both numbers, one would expect the stock markets to react violently down. Yet, as of mid-day (New York time), the indices are all decidedly UP!
Why would the opposite happen? The word going around is that the markets are increasingly pinning their hopes on both the economy and the banking system to quickly recover as a result of both the second half of the TARP plan being implemented coupled with the passage of a $900+ billion economic stimulus package.
One detail of the bank rescue being circulated on CNBC is that the government is going to be circumventing or eliminating some rules relating to “Mark to Market” accounting rules. As a refresher, these rules essentially require banks to regularly mark their investments down (or up) to a price that would allow them to be readily sold into the marketplace. By doing so it would allow investors to get a less opaque view into the balance sheet of a company. One of the challenges to the banking system has been the quickly deteriorating assets on their books. The resulting declines have brought on wave after wave of hits to their equity and income statements. The reason why the talk of suspending the accounting rule is significant is because suspension would obviate the banks from taking additional write down hits as a result of deteriorating underlining assets. The victim of the rule suspension would ultimately be investors and shareholders, as more opaqueness would potentially depress multiples on valuations as more potential risk is priced in.
Getting back to the unemployment numbers, there is no doubt that they are ugly and deteriorating further. The risk to investors lies in too much discounting of economic numbers like this, while putting too much faith in the short-term simulative impact of the stimulus billing in the US Senate.
To illustrate this risk, let’s play out a potential scenario. Let’s assume that the current stimulus bill ending up passing and had a total size of $900 billion, of which $300 billion impacts this year, $300 billion in 2010, $150 billion in 2011 and $150 billion in 2012. To frame the size of the stimulus bill we see the US economy is about $14 trillion in size. So the stimulus bill, in its totality, represents about 6.5% of GDP. If $300 billion of it is to take effect this year, which is generous, given the 2009 amounts being actively debated in congress, it would equate to about 2.1% of GDP.
In the 4th Quarter of 2008, the U.S. GDP contracted at an annual rate of 3.8% as reported by US Commerce Department. This number was buoyed by an inventory build-up in the quarter. It is unlikely there will be such a benefit going forward in 2009.
Despite foreclosure rates rapidly increasing, unemployment deteriorating rapidly and consumer spend retrenching from the levels in Q4 2008, let’s assume that the economy stays flat at -3.8% for 2009. If we add in the 2009 portion of the stimulus bill of 2.1%, we still get an economy that contracts 1.7% in 2009. The majority of the proposed stimulus would take effect in the second half of 2009. The challenge for investors is in understanding what kind of shape the economy will be in once the second half arrives. If it continues to deteriorate as the data suggest, the GDP base going into Q3 could be 5% - 10% lower than the same time last year. This is why data like the weekly unemployment claims, retail sales and other economic markers are so important to watch. They are concurrent indicators of the health of the nation. They will provide a good view into “how bad is it really getting”.
That is why it is so surprising that the market would stage a rally in the face of such negative numbers. What investors may also be unaware of are countervailing factors. There are several of such factors which may blunt or outright negate the impact of the stimulus bill. These include rising commodity prices brought on by a depreciating dollar as well as rising bond rates (brought on by having to float massive deficit spending). A rise in oil prices of just $20 could lead to a significant jump in fuel prices at the pump. A depreciating dollar would translate into high product prices in the store. With CRB Index down 40% since February of 2008, the consumer has been buoyed by lower prices for necessities like gas. The simulative impact of such a decline measures in the billions of dollars. Imagine that punch bowl being taken away in 2009! It is a real possibility and one of many that the equity markets don’t seem to be seeing.
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