Eight years after the Crash of 1929, the U.S. economy was still mired in the Great Depression. Fast forward to today, eight years after the financial crisis, which was the worst economic downturn since the 1930s, and the economy is looking as robust as ever.
In this episode of Industry Focus: Financials, The Motley Fool's Gaby Lapera and John Maxfield talk about the state of the U.S. economy right now, digging through the statistics and trends that matter most.
A full transcript follows the video.
This podcast was recorded on Dec. 5, 2016.
Gaby Lapera: Hello, everyone! Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. You are listening to the Financials edition, taped today on Monday, December 5th, 2016. My name is Gaby Lapera, and joining me on the phone is John Maxfield, one of The Motley Fool's top banking analysts. Hey, John! How's it going?
John Maxfield: It's going great. How are you doing, Gaby?
Lapera: I'm doing really well, for the most part. I threw out my back this weekend, so I am sitting here in agony to bring you guys this podcast -- just kidding, I'm feeling a lot better, but it's also the first time this has ever happened to me and I'm kind of aghast. I feel old. (laughs)
Maxfield: It probably doesn't help that the chair you're sitting on is too tall. I don't know what that does for a back. But just so listeners know, Gaby's feet, evidently, I just learned this, do not touch the ground in the chair she's sitting on.
Lapera: OK, to be clear, like I told you before, it's not that I'm so short, it's that the chair is too tall. I am 5'5, I feel like I should be able to touch the ground.
Maxfield: I'm just throwing that out there, because, like our viewers, I can't actually see you. It's only my imagination that's at work here.
Lapera: I'll get to that in a second. Before we get started, I wanted to announce that Industry Focus is planning on releasing another book list this year. But this time, we thought we'd ask for our listeners' recommendations. What investing book inspires you the most? Did you read a book that sheds light on human behavior, or on a particular sector, that helps you invest better? Send it to us at firstname.lastname@example.org. Feel free to send multiple recommendations. We're going to compile this all into a list and send it out later in the month, if you email us and ask for it. If you would like for your name and a place that you're from to be attached to the list, definitely send that in too. I've been really excited to see all the book recommendations that have been pouring in. I hope we can get something from you.
Also, a shout-out for Mitchell for sending in some constructive criticism -- we're going back to my earlier "uh." He noted that I say "um" a lot. It's true. It's a bad habit I'll try to fix. It comes from not being mindful enough of where I am in a conversation, and that's really annoying, so I will try really hard not to do that, but bear with me as I improve, uh -- oh, God, it's so hard! (laughs) If any other listeners have constructive criticism for me, please feel free to write in. Key word being "constructive." I can't really do anything about the pitch of my voice. People have written about that, too. (laughs) That just comes with the territory. I can start smoking, I guess, and doing shots of whiskey before the show. (laughs)
Maxfield: It's funny that you mention that, Gaby, because I've been obsessed with podcasts, I've been listening to so many hours of them over the last three or four weeks. And what you realize -- and you hear a podcast host talk about this all the time -- that it takes a lot of conscious effort to get those idiosyncrasies in your language out of your language when you're talking on a podcast, because when you're talking, you don't hear those things. But for a third party, they do hear them. So, I can completely understand where you're coming from. So, you have one fan in me, at least.
Lapera: I'm sure Mitchell is a fan. He was actually super nice in his email. He was really worried about offending me, which is so kind. Normally, when you get criticism emails, they're not that kind. So, thank you, Mitchell. Uh -- gosh darn it! I do have a friend who got his PhD in linguistics, and he said that "um" is used as processing time for your brain, which goes back to me not being mindful enough in my conversations. So, maybe that's what's going on -- my brain is just working too fast. I'm just going to put the most positive spin on this for me that I can. (laughs)
Maxfield: Sounds like it makes sense to me.
Lapera: So, this week, we thought we would talk about the American economy in general. The Fed recently released unemployment rates. Big news, the general unemployment rate dropped from 4.9% to 4.6%, which is a much bigger drop than it sounds like.
Maxfield: It is. And to be clear, it was actually the Labor Department that released that statistic.
Lapera: Oh, you're right.
Maxfield: I was having a conversation the other day with a good friend of mine. He's a doctor, a surgeon, so he's pretty zeroed in on what he does. He was asking me as somebody who's in the financial industry what the state of the U.S. economy was, because it's so easy when you read press and headlines and all these things to have a very dire perspective on where the United States economy is at right now. But the fact of the matter is, it is in a really, really strong position. What's crazy is, you have to keep in mind that we're, what, eight years after the second largest financial crisis over the past 100 years. If you go back to the Great Depression, if you go back to 1929, when that big crash was, and the Depression started the year or two after that, by 1937, they had gone back into another deep Depression. So, to Gaby's point, the fact that unemployment has dropped to 4.6% is quite a remarkable feat. And it really speaks volumes about the effectiveness of policy makers, both in the George W. Bush Administration last year, and how they dealt with the crisis at the very beginning, and also in the Obama Administration.
Lapera: Yeah. Just for some perspective, in October of 2009, it peaked at 10%, for the civilian unemployment rate, which is nuts, especially when you consider that we are all the way back down to 4.6% now. Um -- so, why is this important? Um, one of the reasons -- there were two more ums. I'm counting two, Mitchell. One of the reasons this 4.6% number is so interesting is because it means that the unemployment rate has dropped below the natural rate of unemployment. You might be asking yourself, "What is the natural rate of unemployment?" That is when the labor market is at equilibrium. That means that there's ... there's ...
Maxfield: Let me jump in here, Gaby.
Lapera: Sorry, thank you, I'm having a brain fart without my ums.
Maxfield: No, totally. If you think about it, there's never going to be 0% unemployment. That's always going to be people cycling in and out of the labor force, for whatever reason. There are going to be companies growing and dying, and when companies die, you're going to have layoffs, so you're going to have involuntary unemployment. That's what unemployment is. So you're going to have a certain amount of that in an economy that is changing. Well, the Fed Reserve has come out -- because the Federal Reserve's job, according to the Congressional mandate that dictates all of its policies -- its job is to keep unemployment at the natural rate -- basically to minimize involuntary unemployment -- and to keep price stability in order. In other words, you don't want too much inflation, but you don't want deflation either. So, the question is, what is that exact rate? The Federal Reserve and all their statisticians have come out and said, "Look, we think, based on our analysis, that the natural rate of unemployment, the healthy rate for an economy like ours, is 5%." Two months ago, in October, the unemployment rate was 4.9%, so it was already below that 5% equilibrium that Gaby was talking about. But it fell even further in November, all the way down to 4.6%. This is the lowest rate that it has been at since literally the economy was absolutely booming during the housing bubble. So, this is a really good sign for the economy.
Lapera: Absolutely. Let's talk about why unemployment dropped off so much, because it's not magic. Jobs didn't just magically appear, and people didn't magically disappear from the population to create this -- although, one might think that. Right, John?
Maxfield: Yeah, to a certain extent, that's true. You have to keep in mind, the unemployment rate, the way that it's calculated is, it takes the number of people who are involuntarily unemployed and actively looking for work, that's the denominator in the calculation. What that means is, there can be people who voluntarily take themselves out of the labor force. This is called the labor participation rate. Those people who take themselves out of that are no longer factored into the unemployment rate. That can happen a number of different ways. Either you voluntarily take yourself out, let's say, as the Baby Boomer generation is retiring, they are voluntarily withdrawing from the labor force. But you also have people who have stopped actively looking for work. That takes them out of the unemployment statistic, too.
What we saw last month was that 400,000 people came out of the labor force. So, that decreases that number in the unemployment rate. 400,000 is a huge number. But the reason they're falling out, they think at this point, has more to do with people retiring than with people being discouraged and stopping looking for work. But on the other side of the equation, they added a net 175,000 new jobs to the economy. So, you have that balance between the two things. But that 400,000 statistic outweighing the 175,000 statistic is the reason that it unexpectedly fell so much.
Lapera: Yes. And one of the thing you should look for is when unemployment rates drop, inflation tends to tick up.
Maxfield: That's exactly right. That is why that 5% rate is so important, also. If unemployment falls below that 5% rate, the theory is that, what employers are going to have to do is start increasing their wages for the laborers. And if you increase wages for laborers, you're putting more money in people's pockets. If you put more money in people's pockets, that allows them to go out and bid up the prices of goods and services. If you bid up the prices of goods and services, you're creating inflation. So this is a good sign when you consider that inflation, the other side of the Federal Reserve responsibility, has been below its target rate. It came in at 1.6% in October. But the Federal Reserve is looking for a 2% inflation rate. So, that's coming in below. So, as these pressures in the labor market come to play, that is theoretically going to push that inflation number up closer to what the Federal Reserve is looking for.
Lapera: Yeah. I will say, there is one figure that is not quite as heartening in this report, which is the youth unemployment rate. The youth unemployment rate peaked in 2010 at 18.7%, and right now it's hovering around 12%. Which is not great, at all. Youth unemployment rate is considered people who are not enrolled in school, who are high school graduates but have no college, and are between 16 to 24 years old. So, 12%, still not great. It is dropping, but it's something to keep in mind.
Let's talk a little bit about interest rates. Janet Yellen is probably going to stick to what she said in November. Consumer confidence is up, in general, and unemployment is down. It seems like it might be time to start raising the interest rates.
Maxfield: That's right. Let me back up for one point I want to make on inflation. In the United States, when you think about the last 40 years, inflation has really gotten a bad name. The reason it has gotten such a bad name traces back to the 1970s and 1980s, when inflation shot up into double digits. It was like 18%-20% at the peak of the inflationary cycle at that time period. And that is not a good thing, because it's such an uncertain environment. Then you start thinking about the Weimar Republic and Germany and all those different things. But, you do want some inflation. The question is, how much inflation do you want? The Federal Reserve says 2%. So, the question is, why do you want even some inflation? Why don't you just want perfect price stability? The reason is that, in the United States, our GDP -- and I'm sure listeners have heard this statistic a million times -- 70% of our GDP traces itself back to the consumer and consumer expenditures.
When you think about consumer expenditures, a lot of people buy things on debt. People buy houses on debt. I own a house. I actually don't own the house, Bank of America owns the house. (laughs) Same thing with most people and cars. They buy them and they get a loan for the car. Well, any time you're buying things on credit and you have inflation, that is making the cost of borrowing decrease each year. Let's say, mortgage rates right now are like 3.5%. Let's say inflation goes up to 2%. That means the real cost to borrow is only 1.5%. That incentivizes people to borrow, which then pushes consumer expenditures, which are 70% of the U.S. economy. That is why you do want some inflation, but you don't want it to get out of control, where you're adding uncertainty and impacting consumer confidence, on the other side of that.
Every month, the Federal Reserve either has a meeting, or its chairwoman, Janet Yellen, has to testify before Congress. When she does that, or when they have a meeting and release the notes, they give an update on the perspective of what they're thinking about in terms of interest rates. Janet Yellen came out last month and said, we will raise interest rates "relatively soon" if there continue to be positive metrics that suggest that the economy is improving. We just saw that, with that unemployment statistic. That is as straightforward a statistic as you can get to show the economy is improving. So, what this means is that -- and you can never predict for sure when the Fed is going to raise interest rates -- but it certainly suggests that, at the Fed's meeting this month, there is a very good chance that they will, in fact, do so.
Lapera: Not only is unemployment down, but consumer confidence is up. There was a study that was released recently showing that a lot of Americans, more than last year, came out to shop for Black Friday. Although they technically spent $10 less than they did last year, they were still spending $290 on average during Black Friday -- which is not an insubstantial amount of money. And not only that, but housing prices are up. They have exceeded the levels that they reached during the housing bubble in 2008.
Maxfield: Yeah. So, you start putting all these pieces together, and what does that puzzle look like? Unemployment at 4.6%, inflation slowly ticking up, consumer confidence is up -- the most recent survey is it was at 107.1 in November, and it was at 100.8 -- this is an index -- 100.8 in October. So, it was up 7% in November, presumably following the election. You have housing prices. That was one of the biggest bubbles in the history of the United States of America, the housing bubble in the lead-up to the Financial Crisis. And now, housing prices, on a nationwide basis, have now exceeded that as of last month. Now, there are certain pockets, like Las Vegas and Florida, where the speculative frenzy got out of control during the bubble, and housing prices are still far below. But once you put all these things together, and you look at how consumers were acting just two weeks ago, in the wake of Thanksgiving for Black Friday, one of the biggest shopping days in the entire year, and then you factor in that the consumer expenditures are 70% of the U.S. economy, and it really paints a picture of a very robust economy.
Lapera: I have a question. Do you think that houses are overpriced right now?
Maxfield: That is such a great question, Gaby. Let me tell you why. This is actually something I've been thinking about a lot. I live in Portland, Oregon, and there's something really interesting going on in the Portland, Oregon housing market. The way housing works is that, if the supply of houses in any particular month exceeds six months' worth of demand for houses, then the price of houses goes down. But if the supply of houses is less than six months' sales rate of houses over that same time period, the houses' prices will go up. Generally, in major metropolitan areas, the supply will be right around six months' worth of demand. It can fluctuate above and below that, but it won't fluctuate too far. Well, in places like Portland, the supply of houses is only equivalent to 1.5 months worth of demand. So, it is dramatically, dramatically lower. And what we are seeing is that prices are shooting way up. But then you wonder, is this another bubble? What's going on here?
I think there's a number of things going on, but I think one of them is the fact that the mortgage rates are 3.5%. So, when mortgage rates are 3.5%, the cost of your housing is going to be so much lower, which means you can offset that lower cost on the borrowing side with higher home prices. So, you have that interest rate thing coming into play. Also, I think, as home prices continue to improve in all these different cities, those people who bought at the top of the housing cycle during the housing bubble, they are coming into positive equity. So then, my guess is, you're probably going to see the supply open up a little bit, because these people will then feel comfortable selling their house, because they won't have to do so at a loss. So, I think it's a great question, I don't know the answer to it, but those are the dynamics that are at play, for anyone trying to figure out what's going on there.
Lapera: Quick question for you, where did you get the data housing supply?
Maxfield: I don't remember. I can't tell you exactly where I got that 1.5 months' worth number. It's just been in the local news here over the past few months -- well, really over the past couple years. I could tell you, we bought a house two and a half years ago, and we've had friends buy houses. I actually wrote an article about this maybe a year and a half ago. We had some friends come out and buy a house, and they put their house on the market on a Friday, and by the end of the weekend, they had 15 offers, the majority of which were above their asking price. So, it's just a crazy thing to think that this is happening only eight years after the Financial Crisis.
Lapera: Definitely. I want to reiterate a point you said earlier, which is that it looks like consumers are thinking about getting mortgages now, because interest rates are cheap, and they're worried about interest rates rising, although interest rates aren't going to rise so quickly that you need to rush out the door and get it right now. [...]
With that, we turn to energy prices. I don't know if you've noticed, but they are down.
Maxfield: They're way down. There's two ways to think about it. Over the longer term, they're way down. Going into the crisis, they were well above $100 a barrel. But now, they're around $50 a barrel. However, if you look at where we were in January when they were $25 a barrel, they're double that. Let me tie this back into inflation and all these different things. When you think about energy prices, they are one of the central components of inflation. That's even if you factor out the price changes in energy prices directly, because they have a big indirect impact on the economy. Let's say you want to buy something at whatever it is, Wal-Mart or Target. That thing has to get to Wal-Mart or Target, and they generally have to get there in a truck. Well, the truck takes gas. So the higher the price of gas, the higher the price of all those goods, because that all has to be factored in. Well, as gas has dropped over the past few years -- and then, consider that there were periods last year where there was deflation in the overall economy, it certainly doesn't seem like that's a coincidence. As these oil and gas prices come up, which they're likely to do because OPEC, Russia, and Iran just came to an agreement to cut production -- as those come up, that too is probably going to have a positive impact on inflation. So, all of these signs are pointing in the positive direction for the economy.
Lapera: Absolutely. Just so people who aren't as familiar with this/don't remember the 1970s, OPEC is the Organization of the Petroleum Exporting Countries. I believe that includes a lot of different countries, excepting Russia and a few others. So, it's interesting that they all managed to get together and agree to drop the amount of oil they're producing. And that doesn't just affect consumer stuff and whatnot, it also affects, obviously, the oil companies. Rig count is way down for the oil companies, because they're not going to be producing as much oil.
Maxfield: Yeah, if you look back at the beginning of January, this is according to the Baker Hughes U.S. crude oil rig count, there were roughly 1,600 U.S. crude oil rigs in operation. And this is the reason OPEC got together and said, "We're going to boost up supply to drop the price, in order to get these new frackers and higher-expense production companies in the United States, let's drive them into bankruptcy." And that's exactly what they've done, or at least caused them to close their rigs. Rig count has gone from 1,600 in the United States in January down to, it looks like it bottomed out maybe around 300 in April-June of this year. Now, it's back up, as energy prices have started to recover, to around something like 500. There is a huge impact that the United States is going to see as a result of rising oil prices.
Lapera: Absolutely. We'll see how that plays out domestically and politically at home. Do you have anything else that you would like to talk about today?
Maxfield: No. That covers it. But let me reiterate the point that the U.S. economy is in a very strong position right now. Now, does that mean that this is exactly where we want it to be? No, there are still areas we want to see improvement on, in inflation and stuff like that. But, as this incoming administration comes in, and if they are able to get their fiscal plans through Congress -- which, there is a very good possibility that they will be able to, because you have the same party in control of the executive branch and in charge of the legislative branches -- that's only going to further boost the economy, which will further boost inflation, which will further boost interest rates. If you look around the world today and you hear what's going on in Europe, and you hear what's going on potentially in China, and the dour outlook there, certainly the United States is a completely different story, and there is every reason for the Americans to be optimistic right now about the economy.
Lapera: Yeah. Talking about that is actually really interesting, because the U.S. dollar is super strong right now, which might mean that it's time to look abroad for investments. Maybe something we should consider in a future episode. As usual, people on the program may have interests in the stocks that they talk about, and The Motley Fool may have recommendations for or against, so don't buy or sell stocks based solely on what you hear. Also, I want to remind our listeners about our book list. Please email us. We're so excited to get your emails. I promise that I will personally write each and every one of you back. I would give you other listeners emails who have already written me as proof, but that is probably illegal. Austin, you're awesome. Have you read any books recently?
Austin Morgan: I have not.
Lapera: (laughs) OK. I challenge you to read a book for next week.
Morgan: It probably won't happen.
Lapera: (laughs) And that is totally OK. But if you do, you should tell me what it is, and we'll announce it to the world at large. Thanks to Austin for being our awesome producer. Contact us at email@example.com, or by tweeting us @MFIndustryFocus. Everyone, have a great week!