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Research Insights, June 07, 2016

May Employment Report: Start of Something New, or Simply Déjà vu?

Up to this year, the global economic story has been one of the U.S. and then the rest.  The U.S. continues to lead the economic pack, while the E.U. and Japan are stuck in tepid growth, fending off recession.  All the while, China attempts to stem its economic deceleration.   In 2016, it seems this narrative may be getting a rewrite, with the U.S. still playing the hero, but coming under more scrutiny about its ability to overcome domestic and external pressures.

Not Just May

  • Even taking into account the loss of 36,000 jobs related to the Verizon strike, May’s employment number was significantly below expectations.
  • While some may discount this report as a one-time occurrence, it may not be.  April’s employment gain of 123,000 jobs was also a significant downward shift from previous monthly employment gains. 

We’ve seen this trend before… but not to this magnitude or duration

  • While May’s report was dramatic and attention-grabbing, employment growth has been steadily declining since November.  However, until April’s job report, the decline was steady - which was to be expected as the labor market tightens and the availability of skilled employees diminishes. 
  • The question now is whether April and May employment numbers represent a permanent shift in the employment trend or an aberration. 
  • Although we’ve seen previous periods of downward trends in employment gains, including interim months of surprisingly weak job growth, each time the trend reversed and the rate of employment growth accelerated.   

There are two key differences in the current downward trend:

1. The two most recent periods of declining employment growth lasted four and two months, respectively, before reaching bottom.  The current downward trend is on its seventh month and has not yet bottomed.

2. Corporate profits are now declining, falling on a year-over-year basis for three consecutive quarters.

While this is currently being driven by declines in the energy sector and overseas profits, declining corporate profits remain an economic headwind, even when isolated. 

Balancing Extreme Reactions and What We Know

  • There is a tendency in the face of surprising data and increasing uncertainty to go to one of two extremes:  risky overreaction or careless disregard
  •  Extreme overreactions overemphasize the single data point, while disregard places less emphasis on the single data point than is warranted
  • Reality is usually found somewhere in the middle

What we do know is that in this increasingly uncertain economic environment, when asset prices are increasingly not meeting seller expectations and material differences between initial pricing guidance and final numbers emerging, now is the time to be more cautious in bidding than even just six months ago. 

Maintaining Focus

While the most recent job number should be carefully considered, remember it is only one part of answering today’s seminal question: is now the time to be more aggressive or more conservative? As we have maintained throughout the last several quarters, now is not the time to swing for the fences, as striking out today can have far greater ramifications.

In our November 2014 research piece titled, “Two Roads Diverge”, we recommended resisting the siren song of secondary markets. This is even more important today.  Now is the time to maintain focus on the markets that will be expected to outperform during periods of uncertainty and/or recessionary environments as opposed to chasing marginally higher yields into markets and assets that are likely to suffer the most in the event of an economic or market dislocation.  In the current economic environment, we are also focusing on:

  •  Markets with comparatively higher education and income levels
  •  Assets with longer-term leases
  • Assets with larger and more financially secure companies as tenants
  • The necessity of digging deeper into key tenant financials
  • Maintaining market diversification and specifically limiting industry concentration levels

Careful attention to these factors will go a long way in helping insulate a portfolio against the uncertainty that lies ahead in the employment market and can lay the groundwork for strong long-term investment performance in the future. 

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