The U.S. population is growing at an average rate of a little more than 1% per year. It is reasonable to expect that the labor force should also be growing. However, the civilian labor force has declined on year-to-year basis three different times in 2009. See the following graph.
The year-over-year change in the labor force was negative in January, July and August 2009. This is the first time this has occurred since the 1950s and early 1960s. In those years, Korean War and pre-Vietnam War military needs were producing high draft levels, which had a negative impact on the civilian labor force until the number of women in the labor force started to increase more rapidly.
Declining Labor Force Growth
There is a well-defined downtrend in the growth of the labor force starting about 1970. It may not be obvious when first looking at the noisy data of the graph above, but when the same data are smoothed using 12-month moving averages combined with trend lines, the declining labor force growth rate is very evident. See the following graph.
Both the linear and the curved (quadratic) trend lines have similar R-squared values (0.61-0.65), indicating that each is equally well correlated to the data. However, the linear trend line would reach zero in about eleven more years. That is only reasonable if there is near-zero growth in the economy between now and 2020, so a curved trend line is probably a better representation of what to expect. However, if economic growth is less than we have come to expect based on the past 20-30 years, the curve may not flatten out a much as shown in this graph. It is possible that, under unfavorable economic conditions, the growth in the labor force could remain below the growth rate of the population for significant periods of time.
Cyclical Growth of the Labor Force
The growth rate of the labor force does respond to the business cycle; it declines during contraction and increases during expansion. What could be different this time? The key here lies in demographics.
One possible cause of the decline in the labor force could be an increasing number of retirements (and early retirements). The Department of Labor data do not show the age demographics of employment data, so this cannot be confirmed or denied. If this is part of the cause of the decline in the labor force, that part will not recover.
Since unemployment is high among the young and minorities, it is reasonable to assume that these demographics are also over-represented in the labor force decline. These demographics should substantially recover labor force losses in a recovery.
If you look back at the 1970-2009 graph, there are some cyclical trends evident that have not been emphasized. This is done in the following graph.
The decline in labor force growth represented by the curved black trend line (quadratic trend) is composed of five cycles over the past 40 years. The increasing rates of change last for the major part of a decade and the declines are quick, corresponding to recessions. Since 2002, the advance was much shorter and the decline longer. The only other time during this era that there was a quick advance in the 12-month rate of change was the late 1970s. Otherwise, this time is different.
Considerations for Investors
The growth in the labor force is cyclical. The cycles have been getting weaker over the past 40 years, and the 40-year growth trend is slowing. These factors must be considered by those who think that sector and broad-index investing successes of past business cycles can be repeated.
It has been typical of past business cycles that growth stocks have outperformed in the recovery phase of the business cycle. Sectors such as industrials, technology, transportation, basic materials and other sectors mentioned below have been good investment themes in past recoveries. This time technology may still do well, but some of the other traditional growth areas may be disappointing.
Subsistence commodities and sectors such as food, agriculture, health care, utilities and consumer staples could outperform sectors such as consumer discretionary, leisure and recreation, and real estate this time. Yes, the sectors selected are considered defensive, but if the growth of the labor force keeps slowing, particularly if growth remains below population growth, defensive stocks should do better than more aggressive selections.
Some ETFs in the favored sectors are
PowerShares DB Agriculture
PowerShares Dynamic Food & Beverage
Consumer Staples Select Sector SPDR
iShares Dow Jones US Healthcare
Vanguard Health Care
Utilities Select SPDR
The author, family members and clients are invested in the Vanguard Health Care Fund (VGHCX).
John B. Lounsbury is a financial planner and investment adviser, providing comprehensive financial planning and investment advisory services to a select group of families on a fee-only basis. He worked for 34 years with IBM, and spent 25 years in R&D management and corporate staff positions. He also was a Series 6, 7, 63 licensed representative with a major insurance company brokerage for nine years.
Specific interests include political and economic history and investment strategy analysis. He holds degrees from the University of Vermont, Columbia University and the Illinois Institute of Technology, where he studied chemistry, physics and mathematics. He is a contributor to Seeking Alpha and his own blog,