There is certainly no shortage of commentary on the unemployment statistics that come out every month and most value investors do not make investment decisions based on macroeconomic factors alone. In general, it is always a good time to invest when securities can be found that provide solid return potential and have a large margin of safety. But does this mean that value investors should just ignore today’s Employment Situation Summary from the Bureau of Labor Statistics (BLS)?
At the risk of looking foolish several months or a year from now, I will go out on a limb and say that “this time it’s different” when it comes to assuming that earnings will bounce back to pre-recession levels very quickly. While investing based on macroeconomic forecasts is generally not recommended, bottom up analysis of a business often requires assumptions to be made regarding earnings power. Many value investors look at five or ten year average earnings to assess long term earnings power, but if the last several years represent an aberration, this could be a recipe for overpaying for stocks.
No Green Shoots in Employment
The speed of the job losses over the past year has been unprecedented in post-war history. This chart provided by the BLS shows the one month net change in employment for the past ten years and can be adjusted to provide even more history. The rate of job losses peaked at 741,000 in January 2009 but has remained at very high levels since then. In fact, the 263,000 jobs lost in September is higher than all but two of the months of the 2001-2002 recession (October and November 2001 in the immediate aftermath of 9/11). If it was not for the extreme severity of the economic downturn that followed the financial system meltdown in late 2008, we would still consider the current environment to be a very deep recession.
If we are indeed at a similar point today to the economic conditions prevailing toward the end of 2001, we should not expect any quick snap back in employment. That period was followed by more than eighteen months of continued job losses, with a few months of positive results, before the employment recovery began in earnest in late 2003.
While it is true that previous post-war recessions had quicker employment recoveries, the current situation is more like the 2001-2002 recession in terms of the overall structure of the economy. In many prior recessions, manufacturing was a much larger percentage of the civilian labor force than it is today and when factories restarted production, employment quickly recovered. Services and other non manufacturing occupations are more common today as a percentage of overall employment and there are many more opportunities for outsourcing than in the past. As even President Obama has stated, many of the lost manufacturing jobs will never come back.
The fact that consumer spending accounts for nearly 70 percent of Gross Domestic Product is well known and government policies have attempted to boost such spending. The most notable attempt was the cash-for-clunkers program which now appears to have mainly succeeded in accelerating automobile purchases from September into August. With savings rates still at very low levels and unemployment rates near double digits, consumers are unlikely to trigger a recovery.
From a value investing perspective, what all of this means is that maximum skepticism must be applied to the historical earnings of any business that is exposed to discretionary consumer spending. It will be tempting to spot “bargains” by looking at 2005 to 2008 earnings and thinking that stocks are cheap based on such “normalized” numbers. However, there is simply no reason to believe that 2010 will bring about a return to the spending habits of the boom years which were fueled by ever increasing home equity balances and a bubble mentality.
It does not seem inconsistent with a value investing philosophy to be aware of this reality and to conduct bottom up fundamental analysis with a skeptical eye toward historical earnings.