The Search for Yield: A Follow-up

In a recent series of articles[1], we looked at economic and market data to judge if the current narrow spread of high yield instruments and by implication high yield mutual funds was sufficient.  Our conclusion at the time was that a greater premium was needed given what economic data was telling us as well as what the market was saying.  Now that new economic data has appeared, we will examine them and see if our judgment about high yield spreads still holds.

The simple story is that though the headline number was good, the labor participation rate, the number of hours worked and other employment factors still continue to signal a tepid recovery.

Given these results, we decided to see if we could figure out if the employment data was indeed signally a structural employment problem, an hypothesis stated in the earlier articles exists or if indeed a transitory problem exists, which Janet Yellen and others have said is the case.

The easiest way of terming if structural unemployment issues exist is to build a Beveridge curve.  The Beveridge curve plots the number of unemployed on the x-axis and the number of job openings on the y-axis.  In a recession, the number of job openings is low and hence unemployment grows.  In the plot then, the curve begins to approach the x-axis.  As the economy recovers, the number of job openings increases and the number of unemployed tends to decrease (not necessarily in lock-step but typically with some lag).  The Beveridge plot in this case would show the curve bending back towards the y-axis because the number of unemployed has decreased and the number of job openings has increased.  We show the Beveridge curve for the U.S. economy in Figure 1.

Figure 1: Beveridge Plot for the U.S. Economy – December 2000 through March 2014 (Quarterly Data)

We have labeled the quarterly numbers on the plot that relate to the last recession and its aftermath.  As can be seen, we’ve moved from the end of the recession in the fourth quarter of 2009 – where there was the greatest number of unemployed and the lowest number of job offerings – to a first quarter 2014 number where the number of unemployed has decreased by about six million and the number of job openings has gone up approximately five million.  As good as these numbers appear, they are nothing like the recovery of the recession in the early part of the last decade.  In that recovery, the third quarter of 2007 saw the number unemployed at approximately seven million and job openings of 14 million.  Clearly the current recovery is tepid and some would say anemic give what occurred during the last recession.

In our Beveridge plot, we see no clear evidence of a structural employment problem but, as we noted above, a tepid recovery given past slowdowns.  To our mind, this argues for the point we raised in our prior articles – a higher risk premium is needed for high yielding instruments given the slow progress of the U.S. economy five years after the recession ended.