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March 25, 2013

 

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John R. Deitrick, CFP� 
         
Featured Question of the Week...

What makes someone a success?


Thought for the Week:

The Fed Cannot Fix Unemployment


 

Synopsis

  • The Fed removed the mandate of 6.5% unemployment when making future policy decisions because they feel that deeper analysis is needed to truly gauge the health of the labor market.
  • Although we agree that the headline number for unemployment is highly misleading, we do not believe that the Fed possesses the tools to fix the problem.
  • The Investment Committee cannot point to much good that has come from artificially low interest rates, and the sooner that Quantitative Easing ends, the better.    

Quantitative Easing - Revisited

 

Back in September 2012, the Fed began a third round of Quantitative Easing (QE3) intended to spur economic activity. This program involved purchasing $85 billion in bonds each month in order to keep interest rates artificially low.

 

By buying bonds, the supply in the open market fell, thus resulting in the price of available bonds to rise considerably.  Yields move in the opposite direction of price, so as the price of bonds rose to record highs, their yields fell to record lows.

 

The Fed's plan was to keep bond yields artificially low to incentivize businesses to borrow dirt cheap money to hire new workers, build new plants, etc. As the economy improved over time, they argued that unemployment would subsequently fall. The Fed created a dual mandate that would be used to gauge the duration of QE consisting of:

  1. Targeting unemployment to fall below 6.5%.
  2. Keep inflation below 2.5%, which is where the Fed will typically act to cool down the economy.

The Investment Committee has been highly critical of the Fed's decision to move forward with QE3, and we continue to believe that the program has done very little to improve unemployment. Therefore, we still believe that the U.S. would be better off in the long run if it just went away.

 

NOTE: The Fed began reducing their bond buying, known as "tapering", by $10 million/month back in December 2013, and by this rate we would expect QE3 to be completed by August.

 

This week, the Fed announced that they will forgo the unemployment mandate and instead, look for more qualitative factors to gauge the real health of the labor market. While we strongly agree that the headline number for unemployment does not give an accurate representation of overall employment, we do not believe that the Fed can do anything material to fix it either.

 

The Devil's In the Details

 

Before we discuss why we feel that the Fed is ill-equipped to tackle unemployment, let's first define the major issues holding us back. The investment committee believes that there are two key problems in our labor market, and the first can be seen in the chart below: 

 

This chart is somewhat complex so let's walk through the story that it's telling step-by-step. Unemployment is broken into two parts: short-term and long-term. The threshold is 26 weeks, so if someone has been looking for a job for a year now, this individual would have been classified as "short-term" for the first 26 weeks, and after he/she would have been moved to the "long-term" bucket.

 

The blue line indicates the trend for short-term unemployment, and the blue dotted line indicates that the average since 1990 is just above 4%. Similarly, the orange line indicates the long-term unemployment trend, and the orange dotted line indicates that the average since 1990 is right around 1%.

 

Total unemployment is calculated by adding short-term and long-term unemployment together. Currently short-term unemployment is at 4.2%, and long-term unemployment is 2.5%, which gives us total unemployment of 6.7% (4.2 + 2.5 = 6.7).

 

Notice that short-term unemployment is slightly below its historic average, which is actually excellent news, but as the red circle indicates, long-term unemployment is way above its average (2.5% vs. 1%). This red circle indicates the first major problem with our labor market, and that is those who have been out of work for more than 26 weeks are having a really tough time finding jobs.

 

This group typically represents workers with less marketable skills or those who can no longer perform such skills, for example, an aging construction worker who can no longer endure the rigor of the job. The bottom line is that the time spent looking for a job falls dramatically when someone is moved to the long-term bucket because they become discouraged, and this represents a structural problem in our economy.

 

NOTE: The strength in short-term unemployment is an extremely important topic and one that will be discussed in next week's "Thought of the Week".

 

The second issue is slightly more difficult to quantify because it has to do with small business employment (classified as enterprises with fewer than 500 employees by the Small Business Administration). Small businesses are the life and blood of our economy because they represent over 50% of the working population and account for over 65% of net new jobs since 1995, according to census data. However, they have not been hiring much since the financial crisis of 2008.

 

Based on our analysis of available data and surveys, we strongly believe that a key reason for unemployment stems from uncertainty surrounding healthcare costs.

 

Just as markets hate uncertainty, so do managers because they are unable to accurately predict their costs. Small businesses that survived the "Great Recession" in 2008 are still recovering from the mental anguish of such a stressful business environment, and business owners are concerned of inflating their cost structures in any way. Since nobody really knows how Obamacare will ultimately shape healthcare costs for companies, small businesses of all sizes are hesitant to hire and are waiting for further clarity.

 

NOTE: The Investment Committee is not making a political statement regarding Obamacare. Rather, our point is that once small businesses have a better understanding of the impact to their bottom line, they can hire accordingly. For example, if healthcare costs rise by 20%, then companies can hire several more workers than if they go up by 200%. Business owners simply need clarity.

 

The Fed Cannot Help

 

Economic theory tells us that short-term phenomena are generally more cyclical, whereas long-term ones are more structural. Therefore, we do not believe that artificially low interest rates, a cyclical weapon, can:

  1. Fix Long-Term Unemployment: These workers generally have undesirable skill sets or other structural issues that prevent them from getting hired. Simply put, low interest rates cannot teach someone how to write software code or learn other marketable skills.
  2. Remove Obamacare Uncertainty: Low interest rates will bring no clarity to the uncertainty that plagues small businesses. Only time will tell the true impact of this program, and small businesses will likely wait and see rather than risk an unpredictable shift in their cost structures.
The bottom line is that we strongly disagree that QE3 can fix the structural issues in unemployment, and therefore we are anxious to see it wind down. Furthermore, the only real certainty to come from this change in Fed policy is that the "War on Seniors and Savers" will continue. Although we may not agree with the Fed, we must accept that we cannot change the rules, and therefore we will continue to search for attractive risk-adjusted yield in this artificially low interest rate environment. 

 

 

 

This commentary is not intended as investment advice or an investment recommendation. It is solely the opinion or our investment managers at the time of writing. Nothing in the commentary should be construed as a solicitation to buy or sell securities. Past performance is no indication of future performance. Liquid securities, such as those held within DIAS portfolios, can fall in value. Global Financial Private Capital is an SEC Registered Investment Adviser.  All charts courtesy of Bloomberg.

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I hope you find this information adds value. If you would like to talk to John regarding these, or any other financial concerns, please feel free to call us at (614) 602-6506 and we will be happy to schedule a visit.
 
Have a great week!  Enjoy His gift of today!

 

Investment Advisory Services offered on a fee basis through Global Financial Private Capital, LLC, an SEC Registered Investment Adviser. Past performance is not indicative of future results. This commentary is not intended as investment advice or an investment recommendation it is solely the opinion of our investment managers at the time of writing. Nothing in this commentary should be considered as a solicitation to buy or sell securities. Insurance and Annuity product guarantees are subject to the claims-paying ability of the issuing company, and are not offered through Global Financial Private Capital. 
 
 

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP�, CERTIFIED FINANCIAL PLANNER™ and the federally registered CFP (with flame design) in the US., which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.

In This Issue
Featured Question of the Week!
Thought for the Week:The Fed Cannot Fix Unemployment
Anyone Out There Looking for Help??
By The Numbers



John R. Deitrick,

CFP�,

  Founder

 

Advanced Retirement Design, LLC
 
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By The Numbers 
 
 MORE OUT - In addition to the fact that the USA had a $475 billion trade deficit in 2013 (imports in excess of
exports), Americans also bought $137 billion more in foreign stocks and bonds than the US stocks and bonds we 
sold to foreigners. Thus, for every $10 that left the USA because of excessive buying of foreign imports, $3 left 
the USA as Americans bought foreign financial assets (source: Commerce Department, Treasury Department)
 
DISCRETIONARY VS. MANDATORY - Over the next decade (fiscal years 2015-24), estimated discretionary 
spending of the US government will total $12 trillion, an amount that is dwarfed by the $31 trillion of projected 
mandatory spending (source: Office of Management and Budget).
 
AND BORROW WE DO - The yield on the 10-year Treasury note was 3.03% on 12/31/13. The yield on the 10-year
Treasury note was 4.26% on 12/31/03. Thus for the same annual cost of money, our government can borrow
+41% more money today than we did 10 years ago (source: BTN Research).
 
RADICAL REFORM - The tax reform plan proposed on Wednesday 2/26/14 by House Ways and Means
Committee Chairman Dave Camp (R-MI) has 979 pages of proposed changes that would repeal over 220
sections of the tax code, cutting the size of the tax code by 25% (source: House of Representatives).
 
JUST LEND IT - Excess bank reserves, i.e., amounts held at the regional fed banks by commercial banks instead
of lending the money, totaled $2.52 trillion as of 3/05/14 (source: Federal Reserve).
 
THAT'S A LONG TRAIN - The proposed Keystone XL pipeline would run 1,179 miles from Alberta, Canada into
the USA and would have the capability to move 830,000 barrels of crude oil a day, equal to a train with 1,200
railroad cars moving crude every day (source: State Department).
 
STILL TOO BIG TO FAIL - The 6 largest banks in the USA held $9.67 trillion of assets as of 12/31/13, 66% of
the $14.72 trillion of assets in the entire banking industry (source: Federal Deposit Insurance Corporation).
 
STARS - Barry Bonds won 7 MVP awards, the most ever by a major league baseball player. Bonds and Tom
Brady, NFL quarterback, went to the same high school in San Mateo, CA (source: Major League Baseball)..