11 Aug

Signals vs Noise and the case for pink diamonds

In any given month, there are literally thousands of economic data points released to the market. From retail sales, to consumer confidence, to inflation to gross domestic product, never a day goes by where there isn’t a news release which investors attempt to use to discern what’s happening in the economy, and how they can best position their portfolio to profit moving forward.

The problem is, that with so many data points it’s hard to know which ones to ignore, and which ones to pay attention to. Signals (the information that you want to focus on) are few and far between, while noise (information that you would be better to ignore) is everywhere.

In this week’s market update, we look at one key economic data point that is about as strong as it has ever been. This data point is definitely a signal, though, paradoxical as it may seem, the very strength of this data all but confirms that for most investors, the road ahead is going to be very difficult to navigate, with caution the order of the day.

This environment that we are heading toward will also create opportunities for investors who capitalise on such a period, focusing on assets that typically outperform when mainstream markets tend to struggle.

Pink diamonds are one such asset, as we will explain below.

When good news is bad news

Logically, high levels of employment, or low levels of unemployment, are a good thing, both at a macroeconomic level, but even more importantly, at a human level.

Low levels of unemployment mean that all other things being equal there is more tax revenue coming in for the government, less of a drain on that tax revenue (lower unemployment benefits), more consumer spending, more people able to invest in property and business and the stock market etc.

It’s a clear social good.

From this perspective, the global economy is booming, with unemployment rates at near record lows around the world, including in Australia.

In the United States, which still drives the global economy (and investment markets) the situation is so good that in July, the total number of people employed in the country increased for the 31st month in a row, with another 187,000 Americans joining the workforce.

This caused the unemployment rate to drop to just 3.5%, almost equal to the level reached in April of this year, when unemployment dropped to a 54-year low (that is not a typo) for this economic data point.

In roughly half of all the states that make up the United States, the unemployment rate is at or near its lowest levels since the 1970s, which is illustrated nicely in the chart below.

Record-Low Unemployment
Jobless rates in half of US states are now at or near record lows

Source: Bureau of Labor Statistics. Note: Latest data June 2023. Records start in 1976.

A time for caution

There is no doubt that the employment situation that we see today is a beautiful picture, and there is a lot to like about it.

The problem is that when something is going about as well as it ever has, in all likelihood it’s going to get worse, rather than better going forward. We are already starting to see this in the United States, with the jobs market in the US continuing to grow, but at its slowest pace in more than two years.

The number of people quitting jobs has also fallen to a more than two year low, which is also another warning sign, as it indicates that people may be staying in jobs where they already have tenure and a track record (even if they would rather do something new and hopefully get a pay rise) given the existing job likely offers greater safety and security.

From an investment perspective, there is something far worse than the changing trends in the job market discussed above. It is what historically low levels of unemployment tend to signal is about to happen in the economy.

As per the chart below, which shows the unemployment rate in the United States from the mid 1940s onward, low points in the unemployment rate tend to coincide with the beginning of recessions, when economic output falls, people lose jobs, and markets tend to tank hard.

Unemployment Rate

Shaded areas indicate U.S recession. Source: U.S. Bureau of Labor Statistics

The chart above is unambiguous on this, with the grey shaded areas signifying periods the United States entered a recession which include:

  • The late 1940s – the unemployment rate bottomed at around 4%.
  • The early 1950s – the unemployment rate bottomed at around 3%.
  • Late 50s – the unemployment rate bottomed at around 4%.
  • Early 60s – the unemployment rate bottomed at around 5%.
  • Late 60s – the unemployment rate bottomed at below 4%.
  • Early 70s – the unemployment rate bottomed at around 4mid.4s.
  • Late 70s – the unemployment rate bottomed at around 5.5%.
  • Early 80s – the unemployment rate bottomed at around 7.2%.
  • Early 1990s – the unemployment rate bottomed at around 5.4%.
  • Early 2000s – the unemployment rate bottomed at sub 4%.
  • Late 2007 – the unemployment rate bottomed around 4.5%.
  • Early 2020 – the unemployment rate bottomed in the mid 3% range.

In all cases, a recession was just around the corner, with the period in the 70s and 80s (bolded above) the one that may most closely indicate what we are facing going forward, given it was also a period when inflation was high.

That was a great period to avoid traditional investments and focus on hard assets like pink diamonds.

​​​​​As always, we hope you’ve enjoyed this week’s edition of “In the Loupe” and we look forward to any questions or comments you may have.


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