What If?

Ultimately, it will not be housing which determines the outcome of this crisis, nor will it likely be easing by the Federal Reserve. Rather, in our view, "jobs" will determine how and if this crisis soon resolves or whether it evolves into something much more devastating and long lasting. Indeed, until the last payroll employment report, this crisis appeared to be simply yet another temporary pause in an ongoing recovery (similar to the China scare in February or the first housing collapse scare in the summer of 2006). Even the Fed was not overly exercised until "Payroll Friday" suggested a shocking halt in job creation!

Housing activity peaked in late 2005 and has been declining for almost two years. Further weakness in housing alone is not that concerning. The real fear has always been and remains that the collapse in the housing industry would leak outward, destroying confidence, halting job creation, income growth and ultimately consumer spending. So, for the next few months while housing reports, retail numbers and Fed musings will dominate Wall Street mindsets, it will be job indicators which will determine the outcome.

There are many to choose from and all are being closely scrutinized. Bears point to the decline in the last payroll report, to much smaller gains in recent ADP employment, an ongoing slowdown in temporary job creation, a spike in layoff announcements, and a decline in the employment component of the ISM non-manufacturing employment survey. Bulls thus far take comfort in the ongoing labor market strength suggested by low weekly initial unemployment claims, the above 50 percent survey level of the manufacturing ISM employment report and early third quarter profit reports which have proved better than feared.

Factory Jobs to the Rescue???!

We believe manufacturing jobs could soon take center stage in the labor market. Indeed, factory jobs may prove the "white knight" of the crisis! Virtually no one is looking to be bailed out by the manufacturing sector. After all, job creation in this industry has been in almost perpetual decline for the last decade. Moreover, supposedly the manufacturing sector shed 43,000 jobs last month and 65,000 jobs in the last three months!

Why do we see hope in a job market which has been dismal for so long? As illustrated by the accompanying chart, there has been a close (although not perfect) relationship between the level of manufacturing jobs (solid line) and the U.S. trade deficit. No doubt the biggest loser of the prolonged period of "strong dollar policy and a perpetually worsening U.S. trade deficit" was the manufacturing sector. Likewise, this sector should also prove the biggest winner of the last 5 years of dollar exchange rate weakness and the forthcoming trend of trade improvement. Could a jump in factory jobs which surprises almost everyone come just at the right moment to avert what many currently fear is a preamble to recession?....

Manufacturing Has Improved ... Why Not Factory Jobs????

U.S. trade has improved significantly in the last few quarters. In the second quarter, trade "added" 1.5 percent to overall real GDP growth! Despite this noticeable improvement in U.S. international trade, domestic manufacturing jobs have reportedly continued to erode. Is this accurate or will manufacturing jobs soon be revised upwards? And even if recent months'
reports are accurate, will this divergence continue?

Noticeable U.S. trade improvement began late last year coincident with a similar acceleration in U.S. manufacturing activity. In January, the manufacturing ISM survey suggested contraction at 49.3 but subsequently steadily rose to a recent peak of 56.1 in June! After a pause in 2006,
industrial commodity prices surged to new cycle highs earlier this year. Manufacturing industrial production was flat between the summer of 2006 and early 2007, but in the last six months has risen at a healthy annualized pace of 4.8%. After declining by about 2 points between August 2006 and February 2007, manufacturing capacity utilization has since risen back
to recovery cycle highs. Finally, after peaking in the third quarter of 2006, manufacturing profits have been rising again since the beginning of this year.

Imagine the impact a modest but surprising upturn in factory jobs would have on economic outlooks and on business, consumer and investor confidence surrounding the durability of this recovery. It would certainly help offset any near-term, financial sector layoffs many are expecting. More importantly, it would mark a watershed shift in the negative trend of factory employment which has been so pronounced and persistent for more than a decade! And don’t forget, these jobs would be "good high paying" factory jobs which could significantly calm income and spending fears.