U.S. Unemployment Hits 17-year Low: How Good Can It Get?

May 11, 2018 Patrick Ercolano

 

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Like taking the temperature and blood pressure of a patient, measuring employment is perhaps the best way to determine the general health of an economy.

The more employment there is in a country, the more citizens feel secure about consuming goods and services, owning homes, paying down debt, saving for the future, and even having children.

Employment is a fundamental indicator. What’s happening these days?

In the world’s largest economy, U.S. unemployment has hit an astonishing 3.9%—a 17-year low. Canada has hit its own historical low at 5.8%, a far cry from the “double-digit” unemployment we experienced at other times in our recent history.

The U.K., despite all the negative talk about Brexit, has only 4.2% unemployment, its best number since the 1970s. Germany sits at 5.3% unemployment, the country’s best result since East and West reunified in 1990.

Wages are rising but under control

This is all very good news, but it gets even better.

When employment gets very full, a major concern among economists is wage growth pressure—this is when wages start rising. With higher wages, it can lead to price increases (inflation).

However, wage growth pressure in the U.S. seems to be under control at a reasonable 2.6% year-over-year. It did rise to 2.8% in January 2018, causing some observers to blame that increase for the market correction experienced during the late winter months. Though other factors were involved, investors need to remember that after 15 consecutive months of positive market returns, a negative month at some point was inevitable.

MD’s own bear market indicator considers wage growth to be a significant contributing factor only if it climbs above 3.5%, and we are still well below that mark.

At MD, we are interested in economics as a way to analyze its effects on the investment markets. While it is impossible to perfectly predict the future course of markets, economics is one of the best ways to determine what pressures the markets are facing. From a business perspective, the U.S. is closing out another good earnings season with most companies beating their estimates and continuing to improve earnings.

So, with our U.S. bear market indicator pointing to a low probability of a bear market over the next 12 months, there is also a higher probability that equities will outperform bonds over that period. Our indicator, based on four subcategories (inflation, economic growth, corporate earnings, capital markets), shows signs of moderate weakness only in capital markets. None of the other subcategories are near levels that would make them a concern.

‘Goldilocks’ economy is good news

In the U.S., it appears that a ‘Goldilocks’ scenario is still in play: not too hot, not too cold—seemingly just right. Since June 2016, we have overweighted U.S. equities, and with the kinds of economic numbers the U.S. is still posting, it’s hard to see when we would choose to be underweight.

Nevertheless, we keep examining the situation with a critical eye. First-quarter U.S. GDP of 2.3% may seem low, but the first quarter of the year has historically been lower, so a 2018 GDP of 3% seems fairly possible. With the core Consumer Price Index (inflation) approaching its target, the Fed will soon be able to say mission accomplished, leaving them room to maneuver and allow inflation to rise above target level after almost 10 years of staying below target.

Generally speaking, the key to the U.S. economy right now is that it’s gradually and consistently warming, but not boiling over. For example, house prices for the 20 major U.S. cities moved up by 6.8% in April, from a sustained rising trend that passed 5% in 2014. And, as the number of U.S. jobless claims trend in the very low 200,000s—numbers not seen since the 1960s—it seems that the economic rejuvenation of the U.S. will continue to unfold for a while.

Are there concerns about eventual inflation pressures on the economy, or even the fullness of current stock market valuations? Of course. But as these worries arise against a backdrop of undeniably balanced economic strength at the present time, we must simply see things for what they are.

 

About the Author

Patrick Ercolano

Patrick Ercolano, CFA, MBA, is a Lead Portfolio Manager with the Investment Management and Strategy team at MD Financial Management. He oversees strategic and tactical asset allocation mandates, alternative investment mutual funds and is a member of MD’s Tactical and Risk Allocation Committee.

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