Time To Taper? Think Again.

The world markets and news agencies are buzzing ahead of the expected announcement from the Federal Open Market Committee (FOMC) this Wednesday regarding tapering of the bond-buying quantitative easing (QE) program.  While many are predicting that the announcement will herald in tapering with reports of economic recovery and an improved job market, we think those reports need to be looked at with a more critical eye.

GDP Growth:  Revised third quarter real GDP growth was recently reported at 3.6%, up from the original advance estimate of 2.8%, and represented the strongest performance in a year and a half.  Great news for the economy, right? Dig a little deeper and you will learn that final demand (sales) was revised to a 1.9% annual rate during that same period – down from 2.0%.  This means that capital expenditure and inventory restocking are the actual drivers behind this seemingly positive GDP growth.  Bottom line? Businesses were busy boosting their inventories in Q3, but not necessarily selling more to consumers.

Q3 GDP growth reflected businesses investing in themselves and preparing for the holiday season, not increased consumer spending, which only grew 0.96%.   Consumer spending was actually weaker in Q3 than it was in Q2, which was at 1.24%. While we may see final demand start to move upward in the near future, it’s far too early to declare victory.

Data Source: (http://www.economicpopulist.org/content/gdp-36-blowout-revision-q3-2013-5453)

The Current Job Market:  Despite data demonstrating unemployment rates dropping down to 7%, the job market is not as robust as that number may indicate.  This “U3” unemployment rate takes into account only those people who are actively engaged in the job market, and considers part-time workers, who could be working as little as one hour per week, “employed”.  The much less popular, but far more accurate, “U6” unemployment rate, which counts not only active job seekers but also marginally employed part-timers and discouraged workers who have stopped looking, demonstrates a bleaker rate of 13.2% in November.

In addition, the employment-population ratio is sitting at near recession-era lows of 59%, with only 6 out of 10 people considered active participants in the labor force.  Fewer people making up the employable population may create better looking statistics but this is hardly reflective of a strong and growing job market.

Data Source: (http://portalseven.com/employment/unemployment_rate_u6.jsp)

The Affordable Care Act:  While it’s not yet known what the full impact of the Affordable Care Act will be, it is fair to say that when it costs more to add a new full-time employee, businesses are less likely to hire.  Part-time workers become more attractive to businesses looking to keep labor costs low – one of the largest expenses on any company’s balance sheet.  It’s too early to tell exactly how job growth will be effected by the increased costs that come with the Affordable Care Act, but news agencies are already reporting fewer full-time job opportunities and even layoffs as employers adjust.

Interest Rates:  QE has kept interest rates low over the past few years.  Even the mere mention of tapering has seen interest rates rise over the past few months, and actual implementation is likely to cause further jumps.  Interest rate hikes would likely slow recent gains in the housing market and, once again, impact job growth.  Rising rates would also negatively affect those homeowners still saddled with adjustable rate mortgages and home equity loans.

At the end of the day, basing QE tapering on what amount to illusions of strong economic and job reports just isn’t realistic.   There are so many unknowns in the economy and the job market that it only makes sense to hold back on tapering until data comes in reflecting true, sustainable growth.

Here’s hoping the FOMC will ring in 2014 with a little patience.

- Greg Stewart, CIO