“This time is different” has come to be known as the kiss of death phrase when regarding the future prospects of a particular asset or economic situation. Rightfully so, as we’ve seen bubbles like tech stocks and real estate blow up and burst while the majority of investors try to figure out where it all went wrong. Well, here we are today with the U.S. economy at a point that has many financial pundits warning of a recession or some type of crash. While I would not be so brash as to say such warnings have no basis, I would say that we need to look at what has happened to the economy that could actually make things different this time.
This past week we got several data points covering the services and manufacturing sides of the economy along with some employment data. It’s the employment data which I believe holds the key to understanding what is different this time around. While recessions can be triggered by many different things, what they all have in common is a rise in unemployment. The most recent weekly initial unemployment claims print came in at 265,000 which is a historically low number.
As I have stated before, until this number starts to rise consistently over 300,000 the labor market is strong which translates to a strong economy. That said, let’s take a look at what has changed in labor market dynamics.
According to the NBER, whose data begins in 1854, the economy has had 33 cycles (recessions). During that time, the economy has evolved from being manufacturing / export based to services / consumption based. This evolution has allowed the economy to be more self-sustaining as it is driven by domestic consumption versus being dependent on foreign demand. This evolution has in turn led to an extension of the average length of economic expansions. If we adjust the NBER business cycles to reflect the evolution of the economy, we get a good metric for average expansion lengths.
The current cycle stands at 81 months and can arguably go on considerably longer when we factor in the changes to the labor market. It’s been the shift from manufacturing based labor force to one of services that makes all the difference.
Services based jobs have a much more sustainable quality to them than export based ones. For example, healthcare and education services in the U.S. and most developed markets are nearly perpetual in nature. Then we have Professional and business services which includes computer code writers and other dynamic technology oriented professionals. Essentially, industries for which there is always demand. In the charts below, I have drawn a comparison between Manufacturing, Professional and business services (PBS) and Total private employment. All three categories are titled and defined by The Bureau of Labor Statistics which is the source of all data used in the charts. I chose PBS because it best represents a broad range of service industries. The below charts are based on every recession that has occurred since 1945 as defined by the NBER. 1945 is the earliest starting point for which data was available for all three series.
The first chart shows the average number of jobs lost on a monthly basis as a percentage of its total industry. For example, in the recession of 2001, manufacturing lost an average of .81% of its workforce on a monthly basis while PBS lost just .43%. Then in the Great Recession, they lost .83% and .47% respectively.
As you can see, throughout history, PBS has always been more resilient to downturns than manufacturing.
The second chart shows the monthly average number of jobs recovered (or decline in job loss) in the first six months after a recession has ended.
The takeaway from these charts is that PBS has outperformed manufacturing in terms of losing fewer jobs during a recession and then recovering them more quickly after a recession. This outperformance is a function of the self-sustaining nature of services labor and suggests that a longer than average expansionary cycle is possible. Furthermore, as the workforce becomes more services based, future recessions should be shorter lived as employment is able to recover more quickly. The great news here is that not only are we building a more sustainable workforce, but we are also building a workforce that earns more as PBS earns 18.6% more than manufacturing on an hourly basis. The table below puts the earnings significance of services in perspective. The top three service sectors account for 58% of total earnings and employs 57% of total private payrolls.
As for the actual manufacturing and services data received this past week, it was a fairly mixed bag. On the one hand, we actually got some strong manufacturing data from the Richmond Fed which goes along with other solid regional Fed data from New York and Philadelphia. Even the Kansas City Fed report, which had been abysmal, managed to come in less negative. Along with the regional Fed data, we got the Markit Flash Manufacturing PMI which came in at 51.4, up literally a tic from the previous month’s 51.3. A gain is a gain though. The Markit report also showed that employers increased their hiring.
Then, on the other hand, we got a very weak durable goods report on Thursday that took some of the steam out of the manufacturing recovery narrative. It’s still too early to tell what is going on in manufacturing, but it does look like activity is picking up overall. This is a welcome improvement from 2015 when manufacturing was basically missing in action all year.
On the services side of things, we got the Markit Flash U.S. Services PMI which moved back into expansionary territory at 51 from last month’s 49.7. While the Markit report had a pretty downbeat commentary, it did say “service providers signaled another solid increase in payroll numbers during March.” I look at employment as a leading indicator, so comments like that tell me business must be picking up. We also got a very favorable services report from the Richmond Fed which unfortunately went essentially unmentioned in the media. The report cited rising activity, wages and employment. So between general employment data and the various manufacturing and services reports, we have an economy that keeps chugging along.
To sum it all up, the economy remains on solid ground and is positioned to continue to grow. We have a significant amount of economic data due out this week which ends with the ever important nonfarm payroll report on Friday. A payroll report with both strong job creation and wage growth could be enough to push the Fed’s hand to raise in April. While such a move would most likely be rough for equities at the onset, a healthy economy will take them higher in the long run. While I would be surprised to see a rate hike next month, it is still possible. All this said, don’t be surprised if this expansion keeps on going and equities get to new highs. As history has proven, things change…It’s called evolution.