The silver lining to bad employment news

published 10 December 2008

The Bureau of Labor Statistics is the government department that keeps track of the unemployment rates in the United States. On the first Friday of every month, the BLS releases its report. This report generates more reaction in the stock, currency, and bond markets than any other regular economic report. It's because unemployment is such a political issue. The market knows this report directly influences the Fed's policy...

On Friday [5 December], the BLS published its report for November. It showed the sixth-largest monthly increase in unemployment since the BLS began keeping records in 1929. The United States lost 533,000 jobs, and the unemployment rate rose from 6.5% to 6.7%.

This data shocked the market. Economists had only expected 350,000 job cuts. The stock market dropped 200 points after the opening bell, and bond yields dropped to new all-time lows. Then a funny thing happened. Around midday, the market turned around and rallied 450 points higher. The bond market reversed, pushing interest rates back up.

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My theory is that investors realised this report would trigger more stimulus from the Fed and the Treasury to combat the recession. They hope this stimulus will put more liquidity in the market, soften the recession, and generate a new bull market in stock prices.

Here's the thing: I think unemployment rates will continue to rise as the recession gets more intense. Last week, for example, I read an interview in the Casey Report with a major commercial real estate player. His name is Andy Miller. Since he founded his company, he's bought over 30,000 apartment units, acquired several million square feet of retail space, and invested in large office projects all over the country. Today, his firm employs 500 people.

Miller says that many of his retail tenants have told him they're going to shut down their stores after Christmas. Christmas is the most profitable time of the year for retailers. If Miller's right, they'll sell as much as they can leading up to Christmas, then they'll fire their staff and vacate their properties in the new year.

It's not just retail properties closing down and firing employees. Miller says there's a crisis coming in all commercial real estate. He says it feels like a slow-motion car wreck. "Whether it's apartments, shopping centres, office buildings, industrial properties, hotels, senior [retirement] housing operating incomes are eroding. Cap rates [that's income yields] are eroding. Operating expenses are going up," he says.

When cap rates erode while profits fall, you see massive declines in price. It's the same way in the stock market with dividend stocks. If a company cuts its dividend by 50% while investors are demanding twice the dividend yield, you get a 75% decline in the stock's price.

A crisis in commercial real estate portends millions of job cuts. Occupancy falls in offices, malls cut jobs, property developers and construction companies cut labourers, and so on.

If a crisis in commercial real estate develops, you should anticipate some of the worst unemployment data since the Great Depression. And as a result, more and more stimulus from the Fed and the Treasury. This leads to a paradoxical situation: The worse the unemployment data, the more likely we get a rally in the stock market following the news releases.

This phenomenon will last until the public realises how damaging the Fed's stimulus is... which may take several years. In the meantime, expect fireworks on the first Friday of every month.

This article was written by Tom Dyson, co-editor of the free daily investment newsletter DailyWealth