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3 Ways You've Been Tricked Into Thinking the U.S. Economy Is Healthy

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To say that 2013 was a phenomenal year for the stock markets and its two most iconic indexes, the Dow Jones Industrial Average (DJINDICES: ^DJI  ) and the S&P 500 (SNPINDEX: ^GSPC  ) , would be a brutal understatement. With no sizable corrections, the Dow Jones and S&P 500 advanced by 27% and 30%, respectively, practically tripling their historic average annual return.

Without question, a lot of things went right for the stock market and the U.S. economy last year. The Federal Reserve maintained its accommodative low-interest-rate stance and consistently pumped $85 billion into the economy via long-term U.S. Treasury bond and mortgage-backed security purchases on a monthly basis. The jobs market improved dramatically, with initial weekly jobless claims falling well below a seasonally adjusted 400,000, and the unemployment rate dipping last week to a six-year low at 6.7%. And finally, the housing market found solid footing with home prices improving by a double-digit percentage throughout much of the country.

Source; TheNails, Flickr.

But all is not what it appears.

I'm certainly no doom-and-gloom forecaster, as I've witnessed significant progress in the U.S. economy since the recession in 2009, but the skeptic inside of me simply can't overlook some of the blatant ways that investors are being tricked into believing that the U.S. economy is perfectly healthy.

Here are three ways you've probably been duped into believing everything is A-OK:

A falling labor participation rate
Did you not find it even the slightest bit odd that the nonfarm payroll report from the U.S. Bureau of Labor Statistics last week showed a gain of just 74,000 jobs in December even though the ADP Employment Report and weekly initial jobless claims figure came in with significantly better-than-expected job growth earlier in the week? What's even odder is that the unemployment rate fell 0.3 percentage points to its lowest level in six years as the December jobs report missed estimates by about 125,000 jobs.

The answer to this riddle is actually quite simple: a falling labor participation rate.

"Why is a falling labor participation rate a concern?" you may be wondering. Primarily because it's not something we'd expect to see in a strengthening economy. A falling labor participation rate occurs when eligible adult workers drop out of the workforce for a number of reasons, which can include going back to college, retirement, or simply being discouraged in their attempt to find work. While going back to college and retirement will skew these results a bit and can be a positive for the economy, that group of discouraged workers who have simply dropped out of the labor force is a huge concern.

It's pretty easy to understand why unemployed workers get discouraged, given that the Bureau of Labor Statistics December figures show that the average duration of unemployment is 37.1 weeks (down just fractionally from the 38 weeks in the year-ago period), and that 53.7% of unemployed persons will spend at least 15 weeks unemployed before finding their next job, also down just fractionally from last year. The overall labor participation rate actually fell 0.2 percentage points in December to 62.8%, a 35-year low!

Source: U.S. Bureau of Labor Statistics.

To put this into a totally different context, total nonfarm payroll employment (seasonally adjusted) of 136.9 million is currently at levels comparable to what the BLS reported in July 2008 at 137.1 million. However, over that span the labor participation rate has actually fallen from 66.1% in July 2008 to 62.8% in December 2013. In other words, we've seen no improvement in actual jobs creation; we've just witnessed the number of people who want jobs declining -- that's not good!

The continuation of QE3
The Federal Reserve's decision to purchase long-term U.S. Treasury bonds and mortgage-backed securities on a monthly basis has been a welcome one for both investors and consumers. While helping provide a solid foundation for the housing market, the purchase of long-term U.S. Treasuries also has the effect of pushing yields lower. Since bond yields and bond prices have an inverse relationship, the monthly purchase of bonds has been instrumental in keeping lending rates historically low.

Federal Reserve Chairman Ben Bernanke. Source: DC Medill, Flickr.

Now don't get me wrong; I am not implying that what the Fed did by attempting to stimulate the economy was wrong. Low interest rates spur lending, home buying, and business expansion, so they can be very positive for the economy. Artificially keeping rates at historic lows for a long period of time, however, is another story.

Shortly after the Federal Open Market Committee announced last month that it would finally begin scaling back its $85 billion in monthly economic stimulus by $10 billion, long-term rates began to rise. The move isn't particularly surprising, as the purchasing of fewer long-term U.S. T-Bonds should mean lower bond prices and thus higher yields. What's really surprising, and discouraging, is how quickly mortgage loan activity has dried up in the wake of these higher rates even as lending rates still hover near historic lows. According to the weekly mortgage loan activity from the Mortgage Brokers Association, loan originations hit a nearly two-decade low in December.

For lack of a better word, the U.S. consumer has been absolutely spoiled with historically low lending rates for years. With what's essentially been a three-decade-long downtrend in lending yields, consumers are sitting on their hands until rates move even lower. With QE3 being an unsustainable long-term stimulus, it seems to me that if consumers don't wake up to the fact that rates are near all-time lows and use that to their advantage, we could be headed for a dramatic slowdown in housing growth and business expansion.

A dramatic increase in stock buybacks coupled with steep cost-cutting
Last, but certainly not least, we have the tried-and-true combination of share repurchases and cost-cutting that has helped fuel business growth since the recession.

Obviously, not all businesses are having to rely on cost cuts to drive growth. The majority of the technology sector and health-care industries have been abuzz with investor interest because of major investments in the cloud and disease research, respectively. But, for a number of other businesses, cost-cutting and share repurchases have been the only way for them to mask a genuine lack of top-line growth.

According to preliminary data from S&P Dow Jones Indices last month, over the trailing 12-month period (which ended in September 2013), S&P 500 companies increased their annual share buyback expenditures by 15% to $445.3 billion from $387.3 billion in the year-ago period. In the third quarter alone, share repurchases were up 23.6% over the corresponding 2012 period.

Share buybacks are a double-edged sword. On one hand they're a way of returning value to shareholders by reducing the number of shares outstanding in a company and helping to boost earnings per share. By boosting EPS, the company will theoretically be more attractive on the basis of valuation. On the flipside, share repurchases don't immediately put money into the pockets of shareholders like a dividend would, and they can artificially boost EPS while top-line growth remains stagnant.

The other factor here is that corporate cost-cutting has grown rampant across all industries. Based on data from S&P Capital IQ, the average sales growth of S&P 500 companies through the first half of 2013 was a meager 2.35% compared with the year-ago period, where it was 3.76%. While cost-cutting – which can include everything from wage reductions to job cuts -- can improve EPS temporarily, it's not a long-term strategy to growing a business and certainly doesn't help the top line. The really scary part is that we're seeing this combination from a variety of sectors.

Big-box retailer Best Buy (NYSE: BBY  ) , for example, enacted a $5 billion share repurchase program in 2011 and has been closing underperforming stores to reduce its costs. Shares of Best Buy more than doubled last year, yet consensus estimates call for a 13% revenue decline in 2014 despite only a marginal drop in EPS. Are Best Buy's results really that much improved, or are they masking ongoing weakness?

The same could be said for heavy-duty construction company Caterpillar (NYSE: CAT  ) , which announced two separate $1 billion share buybacks in 2013 as it continues to cut costs in lieu of weak commodity prices. These moves are being made to cover up the fact that Caterpillar's 2013 revenue is expected to contract 17% while regaining only 1% in 2014. Despite three earnings warnings in 2013, Caterpillar's stock actually managed to end the year higher!

Long story short: Corporate growth isn't anywhere near where it should be to support a 30% rally in the stock market.

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Read/Post Comments (24) | Recommend This Article (14)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 13, 2014, at 10:01 AM, dlwatib wrote:

    Most of us are aware of these facts and aren't that fooled by them. On a per capita basis, fewer and fewer jobs continue to be available as the recession lingers on. You also forgot to include the extremely high margin debt that the NYSE is reporting.

    I hate to be pedantic, but I can't let your misuse of "in lieu of" go without correction. "In lieu of" means "in substitution of" and is therefore not what you mean in "The same could be said for heavy-duty construction company Caterpillar (NYSE: CAT ) , which announced two separate $1 billion share buybacks in 2013 as it continues to cut costs in lieu of weak commodity prices." The sentence should have read "The same could be said for heavy-duty construction company Caterpillar (NYSE: CAT ) , which announced two separate $1 billion share buybacks in 2013 as it continues to cut costs in the face of weak commodity prices."

  • Report this Comment On January 13, 2014, at 10:10 AM, TMFHousel wrote:

  • Report this Comment On January 13, 2014, at 10:13 AM, TMFHousel wrote:

    <<"Why is a falling labor participation rate a concern?" you may be wondering. Primarily because it's not something we'd expect to see in a strengthening economy.>>

    It's exactly what you'd expect to see in a strengthening economy with poor demographics, which is why demographers predicted a falling participation rate years before anyone mumbled the words "financial crisis."

  • Report this Comment On January 13, 2014, at 10:15 AM, avanelle wrote:

    i am sorry to say we are going no where with our debt, healthcare, jobs, economy until we get rid of our community organizer. the only thing i give him a passing grade on is his 30 milion dollar hawaii vacations. the president and his family spend the tax payers money like drunk sailors. impeach obama for lying to the ameican people on obamacare for three years, knowingly. do it now, and save our country. vote every democrate out of offiice in 2014.

  • Report this Comment On January 13, 2014, at 10:16 AM, Chaseagee wrote:

    I find it interesting that in 5 years with reported hires of 150,000 per month, that the unemployment rate went down 3%. Now with 74,000 jobs added it goes down .3% something don't add up.

    And with the fed keeping interest rates low so people with less money can borrow and buying bonds pushing the bond market up will eventually blow.

    All points considered, with the stop of the war, contractors that make the beans and bullets for the Govt will start laying off. It aint even started yet. However, save yer money, market is going to correct.

  • Report this Comment On January 13, 2014, at 10:41 AM, rbrooks715 wrote:

    the economy has not been healthy since reagan.

  • Report this Comment On January 13, 2014, at 11:08 AM, christoffel wrote:

    We the free people of the world lets take our Gold out the federal reserve and invest in South Africa as we have plenty gold here and in Cape Town under the sea at a place Called Hout bay we have tons of natural gas lets all invest and start working again space race?

  • Report this Comment On January 13, 2014, at 11:14 AM, ajlondon wrote:

    Why mince words at all….

    Instead of being tricked… We are plain flat out be lied to.

  • Report this Comment On January 13, 2014, at 11:24 AM, cityperson wrote:

    We are lied to every day by our elected and re-elected politicians and others. We know what is happening or I should say some of us know what is going on with this no recission, employment and prices that keep climbing. It is hard to put blinders on to these facts.

  • Report this Comment On January 13, 2014, at 11:49 AM, Contingent wrote:

    92 million is the number of individuals that have dropped out of the workforce. The lies are big...

  • Report this Comment On January 13, 2014, at 11:52 AM, StockBeast wrote:

    Answer this clowns ....

    1. You never said any of this S when Bush was president .. the labor force has been shrinking for a few years now

    2. How long does it take to recover from a worldwide banking depression?

    HINT: the last one took 13 years ...

    3. Who is saying the economy is "healthy"?

    No one ..

  • Report this Comment On January 13, 2014, at 12:08 PM, WalterGeorge wrote:

    Honestly I think we've been tricked to think the economy is bad that way certain people can take more and more off the hard work of others without a second thought. How can we claim our economy is bad when we are still the wealthiest nation in the entire world? O that's right, we are the wealthiest the problem is fewer people actually contain or control that wealth. More people are in debt because our inability to compensate fairly. The economy is fine and would be fine if more people (I.E. consumers) had the true wealth to purchase the products in which drive our economy. Our economy is only as bad as we are willing to let it. The fewer of people that have the ability to consume on real wealth the worse of our economy will be. There is only one basket of wealth for all of us Americans to pull from. When fewer and fewer are taking more and more it leaves less for the rest of us resulting in fewer sales because people don't spend what they do not have. Fix the balance and you fix the economy. But running things our of spite and hate and I did this and you didn't so you deserve less is great for our images but not for the stability and safety of our country. We need to think about the bigger picture here. United we stand, divided we fall and all we are doing is financially and economically dividing ourselves over pride and spite resulting in hate and more negativity and less growth and accomplishment. The only people we have to blame is ourselves for selling our own people out for money.

  • Report this Comment On January 13, 2014, at 12:16 PM, jmgconsultants wrote:

    By listening to all the lies from people like Obama and Debbie Wasserman Schultz, by watching network news from people like MSNBC, CNN, ABC, NBC, and CBS. By not doing your own research and relying on others. Now when the American people feel the crisis personally and see the results caused by big government and the progressive policies of the left first handed, they now know the truth and will vote accordingly this November by voting out all the democrats including Debbie Wasserman Schultz!

  • Report this Comment On January 13, 2014, at 12:55 PM, tchams wrote:


    I believe you forget to mention Fox News, as they (nor all of those other stations you mentioned) should be exempt from being criticized for poor reporting.

    Have a good one!

  • Report this Comment On January 13, 2014, at 12:55 PM, jrosiak2 wrote:

    It seems that I'm not the only one who thinks that your title is misleading. On the other hand it got the far right folks to read it and gave them a chance to badmouth the President.

    I believe that the drop in the participation rate should be researched by someone credible. I think that it may have something to do with the fact that older employees seem to have lost hope of being hired and are looking for alternatives. I suspect that many have simply exhausted their other options in the job market since the extended unemployment benefits were not renewed. I would also expect that younger people may have moved to self employment.

    Of course we didn't learn anything about the actual facts because you made little if any effort to research them. Instead, you seemed to simply make a list of probable causes which we've heard before. Since I have wasted my time reading your article I decided to waste a bit more asking you to offer some actual information the next time you write an article.

  • Report this Comment On January 13, 2014, at 1:11 PM, RMengineer wrote:

    rbrooks715 - I don't know if Reagan is the demarcation or not, but in principle yes. For far too long we (meaning the Fed and our government - and by extension is suppose, "the people" for voting for their policies) have substituted wishful thinking that wealth can be created by fiat and decree for _real_ wealth that comes from _real_ healthy and sustainable economic growth. The problem is that _real_ wealth that comes from _real_ healthy and sustainable economic growth takes effort and patience - both of which are in short supply. So we go for the "quicky" route of fiat and decree. Which of course is unsustainable so we consign ourselves to an unending cycle of boom/bubble (from the fiat and decree) and bust/crisis (that inevitably results from a fiat created boom/bubble).

  • Report this Comment On January 13, 2014, at 2:27 PM, olddogs wrote:

    Where do you get your information that the job market has improved. You are the fool if you believe that

  • Report this Comment On January 13, 2014, at 2:33 PM, olddogs wrote:

    OH, and by the way. The unemployment rate is not 6.7 percent. It is much much higher. It's hard to be respectiful when you write lies like that. Do some research.

  • Report this Comment On January 13, 2014, at 3:06 PM, WhyDonald wrote:

    One great divide I see is between what economists determine is the labor participation rate and what is actually happening. The economy I see around me has many people servicing the retirement and labor intensive communities for cash under the table. While, at the same time, receiving government benefits. The parents, married in another country, collect unemployment, welfare, medicare, food stamps, etc. while working as pool serviceman, gardener, painter, maid, senior care giver, house cook, etc. for cash under the table. $80-100,000/yr easy.

  • Report this Comment On January 13, 2014, at 4:32 PM, veteran53 wrote:
  • Report this Comment On January 13, 2014, at 11:17 PM, TheAncient wrote:

    The market indexes are being overly inflated, way overvalued when one factors in other economic indicators like employment. It is NOT the government's job to create jobs nor is there sufficient evidence of the government hindering businesses nor their expansion. Businesses are doing it to themselves by inflating their bottomline to attract deep pocket investors. Demand for goods and services is incorrectly stated given the falling numbers of full time American jobs with livable wages. It is just as socialist to prop up businesses, relax existing rules and regulations as some people say it is to extend unemployment benefits. People see businesses engaged in questionable dealings so why can't the average worker do the same? Bartering, cash in the table, back room deals, all now common business practices.

  • Report this Comment On January 14, 2014, at 3:48 AM, Littleolme wrote:

    This article is very humorous and misleading. The author proposes from a standpoint that all is good in our world. All things are as reasonably close as could be expected. We have a form of mass insanity that is passed off as 'normal'. The only people that have been 'tricked into thinking the US economy is healthy' are the people that listen to, vote for, and support the gaggle of political central bank cheerleaders. We live in an insane asylum and NO ONE cares enough about HEALTH, economic or otherwise to shake the BS that their heads have been filled with out. America? Freedom? Don't make me laugh.

  • Report this Comment On January 14, 2014, at 7:58 AM, grudmaster54 wrote:

    In a healthy economy share buybacks are swell, but this is just corporations spending the huge amounts of horded wealth and other than lessening the float, adds zero to growth.

    Companies can't buy back shares to prosperity.

    The inflated market is due to FED fueled investment banks irrational exuberance and corporations cutting wages and benefits. And you can't print and cut your way to prosperity either.

    The current "prosperity" model is unsustainable.

    I can see the economy is a mess but I lost some $$'s shorting it.

  • Report this Comment On January 14, 2014, at 8:18 AM, EvilTwin2014 wrote:

    I have been saying this for years and I will say it again...When the workforce aged adults who have lost jobs and can't find work after a given amount of time will usually fall between the cracks as it were and seemingly what looks like less unemployment never reflects those who have simply been swept under the rug. In many terms while it looks like unemployment has dropped, you really have to wonder (without much work) what has happened to the people whose UI has simply run out and they are still not working. Then top this with folks like myself that never filed for unemployment in the first place. Too add to this is the number of older workers like myself that businesses seem to shun simply enough based on age, and you have a total number of people that have micro businesses you may never hear about or find out about, that are self employment jobs that will never be reflected!

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Sean Williams

A Fool since 2010, and a graduate from UC San Diego with a B.A. in Economics, Sean specializes in the healthcare sector and in investment planning topics. You'll usually find him writing about Obamacare, marijuana, developing drugs, diagnostics, and medical devices, Social Security, taxes, or any number of other macroeconomic issues.

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