A quick look at a timely topic of interest - with a brief review of why it could matter to investors.

Chart of the Week

August 11, 2014

That's the slack, Jack! (Or is it?)
US unemployment rate and labor force participation rate

chart

Source: Bloomberg, as of 8/1/14. Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

The Bottom Line:

  • How much real slack is there in the US labor force?
  • Why it matters: employment is a prime concern of the Federal Reserve (Fed), which takes wages into account in making decisions about interest rates – since wage levels have a significant impact on inflation.
  • The Fed has signaled that it still sees signifcant slack in the labor market, and has explicitly stated it will be cautious about moving rates sharply—even if labor markets tighten more than forecast.
  • At first glance, the decline in the unemployment rate from 10% in October 2009 to 6.2% in July 2014 suggests that labor markets have already tightened significantly.
  • However, the decline in the unemployment rate since mid-July 2010 is more a statistical by-product of a simultaneous drop in the labor force participation rate rather than a boom in the number of jobs.  So the unemployment figure may not be capturing a true picture of the health of the labor market.
  • Meanwhile, the labor force participation rate, currently at 62.9%, suggests there's still considerable slack — a large pool of available labor.
  • In principle, the participation rate should rise in response to increased demand for workers, with potential workers re-entering the labor market as jobs become more plentiful. 
  • But that assumes a sizable "reserve" of employees who could return to the labor force. And there are several factors in place that could diminish that reserve relative to the past: the gathering wave of baby boomer retirements, a sharp increase in permanent disability recipients, and the continuation of a pre-recession trend of young people delaying entry into the labor force.  
  • If a decline in labor market slack were to drive up the cost of labor, one possible outcome could be nervous investors second-guessing the Fed, resulting in higher bond market volatility.  
  • That kind of environment can create opportunities for attentive fixed-income investors, including active managers that seek advantage through tactical shifts in duration, curve positioning and sector allocations.

The Chart:

  • The chart shows the labor force participation rate and the unemployment rate for the past ten years.
  • In July 2014, the labor force participation rate was 62.9%, down from 66% when the recession began in December 2007; and down from a peak of 67.3% in April 2000.
  • The unemployment rate was 6.2% in July 2014, down significantly from a peak of 10% in October 2009, but still above the most recent low of 4.4% in May 2007, a few months before the recession began.

Context & Perspective:

  • The relationship between the unemployment rate and the labor force participation rate during this cycle might provide important insight about overall economic growth and why the Fed does not appear too worried about inflation right now.
  • The decline in the unemployment rate from 10% in October 2009 to 6.2% in July 2014 coincided with a decline in the labor force participation rate from 65% to 62.9%.  
  • Comparatively, the last time unemployment fell from double-digit levels was during the early 1980s. From a peak of 10.8% in December 1982, the unemployment rate declined to 6% over the following five years, but it did so alongside a rising labor force participation rate (from roughly 64% to 65.7%).
  • The net difference in terms of jobs created: 15 million new jobs were created between December 1982 and December 1987 compared with just 9 million new jobs between October 2009 and July 2014.
  • The addition of six million working consumers in today’s economy would likely have a notable impact on the rate of growth.

Definitions:

The labor force participation rate is the labor force as a percent of the civilian noninstitutional population. The labor force includes all persons classified as employed or unemployed. The civilian noninstitutional population is all persons 16 years of age and older residing in the 50 States and the District of Columbia who are not inmates of institutions (for example, penal and mental facilities, homes for the aged), and who are not on active duty in the Armed Forces.

The Federal Reserve Board ("Fed") is responsible for the formulation of policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.


The opinions and views expressed herein, as well as references to individual companies or securities, are not intended to be relied upon as a prediction or forecast of actual future events or performance, or a guarantee of future results, or recommendations to buy, hold or sell, or investment advice.

Past performance is not a guarantee of future results.

All investments involve risk, including possible loss of principal.

Common stocks generally provide an opportunity for more capital appreciation than fixed-income investments but are subject to greater market fluctuations.

Fixed income securities involve interest rate, credit, inflation, and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.

Active Management does not ensure gains or protect against market declines.

Unless otherwise noted the "$" (dollar sign) represents U.S. dollars.

This material is for information only and does not constitute an invitation to the public to invest in any funds, securities, strategies or other products. You should be aware that the investment opportunities described should normally be regarded as longer term investments and they may not be suitable for everyone. The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Past performance is no guide to future returns and may not be repeated. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested.

Please note that an investor cannot invest directly in an index. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed and is not a complete summary or statement of all available data. Individual securities mentioned are intended as examples of portfolio holdings and are not intended as buy or sell recommendations. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not  take into account the particular investment objectives, financial situation or needs of individual investors.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, or a guarantee of future results, or investment advice. The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).

This material may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc.

This material is only for distribution in those countries and to those recipients listed.

All investors in the UK, professional clients and eligible counterparties in EU and EEA countries ex UK and Qualified Investors in Switzerland:
Issued and approved by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the Financial Conduct Authority. Client Services +44 (0)207 070 7444.

All Investors in Hong Kong and Singapore:
This material is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore

This material has not been reviewed by any regulatory authority in Hong Kong or Singapore.

Qualified domestic institutional investors in the People’s Republic of China (PRC), Distributors and existing investors in Korea and Distributors in Taiwan:

This material is provided by Legg Mason Asset Management Hong Kong Limited to eligible recipients in the PRC and Korea and by Legg Mason Investments (Taiwan) Limited (Registration Number: (98) Jin Guan Tou Gu Xin Zi Di 001; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently.

This material has not been reviewed by any regulatory authority in the PRC, Korea or Taiwan.

All Investors in the Americas:
This material is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which may include Legg Mason International - Americas Offshore. Legg Mason Investor Services, LLC, Member FINRA/SIPC, and all entities mentioned are subsidiaries of Legg Mason, Inc.

All Investors in Canada:
This material is provided by Legg Mason Canada Inc. Address: 220 Bay Street, 4th Floor, Toronto, ON M5J 2W4. Legg Mason Canada Inc. is affiliated with the Legg Mason companies mentioned above through common control and ownership by Legg Mason, Inc.

All Investors in Australia:
This material is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827) ("Legg Mason"). The contents are proprietary and confidential and intended solely for the use of Legg Mason and the clients or prospective clients to whom it has been delivered. It is not to be reproduced or distributed to any other person except to the client’s professional advisers.

FN1412928

Previous Editions

Click on a date to view that week's edition of charts.

Poll

Which Asian country will have the strongest growth in the coming year?








Poll

Which Asian country will have the strongest growth in the coming year?

Japan, as Shinzo Abe's policy initiatives take hold
(18%)
India, as Narendra Modi's new government enacts changes
(37%)
China, as Xi Jinping's reforms promote a stronger financial sector
(21%)
South Korea, as President Park Geun-hye's plan to boost growth bears fruit
(24%)



Previous month Poll

Go for growth: Where will a global recovery be strongest this year?

Europe, as countries emerge from bailouts
(43%)
US, as consumers regain optimism
(40%)
Japan, as stimulus programs begin to bear fruit
(7%)
China, as reform and pro-growth policies continue
(10%)