We have been hovering around 10% unemployment nationally for a while now. That's about double what we experienced prior to the housing bubble burst and banking nightmare. In many places, unemployment is more severe, such as Detroit, where unemployment is more than twice the national average. Yet the stock market has been rising as if this doesn't matter at all.
Perhaps on some level it actually doesn't matter. What if it actually makes things better?
When we had a 4.5% unemployment rate, which is generally accepted as full employment, it no doubt led to business inefficiencies, since companies were forced to hire less and less qualified people. This inefficiency is further exaggerated in unionized businesses, where pay is commonly set by job title instead of talent and performance.
What got me thinking about this was a comparison to the deteriorating office rental market. The vacancy factors have been increasing to a detrimental level as the economy has been shrinking, but in a strong market, experienced building owners understand that an ideal vacancy factor is not zero. The ideal vacancy factor is 6% to 8%. This is because any building that sustains 100% occupancy is not charging enough rent.
When you have a 100% occupancy, the fair value has not been established. It isn't until the rents reach a level that your prospective tenants walk away that you can adjust to the market's fair value. Having some vacancies allows the owner to receive the maximum income for the property. It also means that there are still choices for tenants, and an impetus to develop new offices.
I shared this notion with a friend in the hotel business and he confirmed that the same holds true for him; 100% occupancy is a tell-tale sign that room rates are too low.
Getting back to business and the stock market, in the current market it is very easy for companies to let go the least productive or income producing. This in turn puts heavy pressure on wages, also controlling costs. Anything that increases efficiency and controls costs is bound to find its way to the bottom line and thus energize stock prices.
Full employment can only work in an environment that is growing and earning at such a high rate that the inequities and inefficiencies are absorbed or concealed by unsustainable profits and cash flow. In the past ten years, this was accomplished with artificially low interest rates and extreme leverage, until it blew up in our faces.
I suspect that, like the real estate industry, in a more rational business environment, corporate America will find equilibrium at a lower unemployment rate, but that rate is likely closer to 7%, not 5%. The stock market is reacting to future prospects for real sustainable earnings. It's very unfortunate that the rapid economic shocks of the past two years have devastated workers and their families. However, it should be no shock that the stock market is a leading indicator and is rising before employment rates improve. It would make no sense for businesses to begin hiring before that.