Dear MoneyNews Reader:

The Bureau of Labor recently announced that the rate of unemployment in October fell to 4.4% - its lowest level since May 2001. When the rate was at that same point five-and-a-half years ago, it was rising.

Investors pushed up yields on the 10-year U.S. government note, as they reconsidered whether the economy is in fact heading for a significant slowdown.

But when homebuilders began warning this week, Treasury prices rebounded very strongly. Perhaps investors had a rethink over just how strong the labor market is right now. If indeed it’s not as robust as a face value reading indicates, what implications will this have going forward?

At face value, the fact that the level of unemployment is heading towards its 3.8% low last seen in April 2001, looks like a bullish affair.

However, I looked at a couple of other measures to see if the data was as strong as it seemed in light of the slowdown in the housing market.

Take a look first of all at the last 15 years worth of unemployment in the following chart.

[Editor’s Note: Andrew’s subscribers recently banked gains of 158% trading Treasury notes. Go here now.

Now take a look at the chart of the participation rate. That takes the total number of workers, willing workers and those seeking jobs, and measures the number of people actually employed out of the overall pool.

Notice in the following chart how there is a degree of symmetry between this view of the labor market and the actual unemployment rate. Broadly speaking, as the unemployment rate declines, more workers are active in the labor market, driving the ratio higher. As unemployment falls, the number of workers joining in the labor market declines.

But I want to take a closer look at something in the chart, which is not evident in the headline story.

As I mentioned above when unemployment was last this low it was rising. At that time 66.7% of the labor pool was working. But the recent October report showed labor participation of 66.2%. It might not seem significant, but when you consider that over the 15-year period shown the entire participation range is only 1.5%, you might start to see the significance.

In a growing economy, each year’s worth of output is greater than the previous. As the economy grows, so does the population, which is why it’s key to measure the participation rate.

What the recent data is telling us is that when unemployment was last this low more people were working and contributing to the expansion.

So how about when the unemployment rate FELL to the same rate as today?

Well, that just makes the current situation look bleaker. In January 1999 when unemployment reached as low as it is today, the participation rate rose to 67.2%. That was pretty close to the peak in the data series, which occurred when unemployment declined to 3.8% just 15 months later in April 2000.

In conclusion, when the U.S. economy last hit skid row in 2000, it did so from a more robust employment stance. Back then more people were employed than today.

Today while it looks like the Fed has stopped lifting interest rates, the slowdown on the horizon is likely to deepen as the final few notches bite home.

Let’s turn now to worker productivity. All we need to know here is that productivity measures the output or the change in output per hour per worker. Over time, workers and business become more efficient and increased output without rising costs.

Over the last 15 years, productivity has risen on a quarterly basis by around 2.4%. When unemployment fell to its 2000 low, labor productivity was a healthy 8% at the time.

In the most recent report, productivity has stagnated at zero in the quarter ended September. That was a decline from a 1.2% pace in the second quarter.

Meanwhile, businesses were faced with a rising cost of labor at the same time. In the year to September labor costs rose 5.3% and 3.8% in the second quarter.

This combination of weaker productivity and rising labor costs is unlikely to convince certain Fed members to call for more interest rate increases.

However, the yield curve is telling us that inflation is not only low but also set to remain low in the future. The curve inversion is a pretty reliable indicator to impending economic slowdown.

Source: Hoisington Investment Management

That’s an interesting chart indeed from Hoisington Investment Management, which shows the power of investor savvy. As the vertical bars indicate, rarely did the yield curve invert without resulting in recession.

In my Hedge Fund Investing service, I’ve been telling readers to hold 10-year Treasury futures. Last week they hit my target for a 158% win. This week with the decline in yields, once again we’re seeing market pessimism over the performance of the economy in 2007.

I can’t help but feel that the recent peak for equity prices isn’t serving up a dose of misplaced euphoria to investors who are getting sucked into the belief that an expansion is on the horizon.

Bottom line is that it isn’t: A contraction is underway and according to everything I read, no one knows how bad things will get yet.

The trade then becomes to buy bonds and sell equities.

Have a great weekend!