Behind America's facade

PORTFOLIO POINT: The figures might suggest US unemployment is trending down, but the participation rate and duration of unemployment offer more worrying reading.

I just finished reading Michael Lewis’ new book, Boomerang. He tours Europe visiting Iceland, Greece, Ireland, Germany and finishes in California. It’s a great account of how bankers and politicians from different countries all blew themselves up in a debt orgy. It’s very funny as well and I highly recommend it.

Many will remember that Meredith Whitney warned last year that this year we would see carnage and defaults in the US municipal bond market. Markets are all about timing. Whitney’s call of 2011 may have been wrong, but after reading the final chapter of Boomerang, I can’t help but think she will be proved right; perhaps 2012 is her year.

Below is the chart of the California credit default swap. Since its lows in June it has risen 116%. It recently broke above its March 2011 high and is now pushing up against a declining trend line from its 2008 high. A decisive break above current resistance and perhaps the bond vigilantes will start to move across the Atlantic.

The headlines on the Financial Times this morning were 'US jobs data lift recovery hopes’ and 'Confidence bolsters Obama’s re-election plan’. I smelt a rat the moment I saw them.

I hate to be the bearer of bad news but the headlines glossed over some important information. First, the US labour force participation rate. It fell from the previous month’s 64.2% to 64% and as you can see the trend is down. This is equal to the numbers that we saw in the early 1980s.

The next chart is even more disturbing. The duration that people are unemployed for in the US hit another record high last month of 40.9 weeks.

While the headline number dropped to 8.6% unemployed, that would be far more encouraging if it could do it concurrently with a drop in unemployment duration and a rise in the participation rate.

The population of the United States is considerably bigger now than it was in the early 1980s. If the participation rate actually increased to, say, 70% and no extra jobs were created, how you do think the unemployment figure would look then? How do you think Obama’s re-election campaign would look?

The labour force is defined as “the sum of the unemployed and the employed”. It seems there are hundreds of thousands of people dropping out the labour force. Part of the reason is that if it takes 41 weeks to get a job, some people give up; others are no longer eligible for unemployment claims, so they are dropping out of the race as well.

The other reason? Obama and his administration have a very good reason to keep the participation rate as low as possible. A better way to measure employment is employment to total population, which is currently at 58.5%; in December 2009 it was 58.2%.

A final point: here is a direct quote from the Bureau of Labor: “Government employment continued to trend down in November, with a decline in the US Postal Service (down 5000). Employment in both state government and local government has been trending down since the second half of 2008.”

After reading Lewis’s final chapter on California, it’s very hard to see how the US will come out of this quagmire for a very long time. The debts of individual counties, cities and states are so overwhelming that the austerity measures that have to be taken to get their house in order will continue to weigh on jobs, particularly from local governments.

Recent market action has actually made me more nervous, not less. The more manipulated the markets get, the less unstable they become. There is just too much debt in this world and central banks are only delaying the evitable.

I mentioned the big overhead resistance on the S&P 500 in Friday’s note. The S&P 500 futures made a high of 1262 which was the 200-day moving average; it finished at 1243. So far this area is proving formidable. If it is broken to the upside perhaps we will get that big Christmas rally that everyone has been waiting for.

But the bond market is telling you a different story. US 10-year notes in yield have rallied 15 basis points from their recent low. However, they are exactly where they were at the start of August and September. If risk assets were off to the races, I would have expected the bond market to reflect that in higher yields.

You should be very selective if you want to play this market. Two of my favourite defensive stocks made all the right technical signals on Friday and I jumped on board. First, Telstra closed at $3.20 on Friday, which is its highest yearly close and has closed above the ascending triangle. A higher close on Monday with bigger volume should be enough to see Telstra move to $3.44.

Second, Woolworths formed an inverse head and shoulders formation on a daily chart and the neckline was broken on Friday. This is a bullish signal which should see Woolworths test the 200-day moving average at $26, but the target should actually be higher. If the pattern unfolds correctly we should reach $26.79.

Buy yourself a copy of Boomerang for Christmas and have a great week.

Tom Lovell is an analyst and independent investor.