October Employment Situation Preview

The monthly employment report is widely regarded as providing the most important economic data.  Yesterday's election put an exclamation point on the concern about jobs.

Whatever changes there are in economic policy — and I expect quite a few — the results will be measured in employment.  This is central to all economic problems, so it is important for investors to understand.

The significance of this report is the reason that I have done so much independent research on employment issues and the controversy about measuring job creation.  While many observers look at employment with a conclusion already in mind, I strongly urge a more objective stance.

Let's start by looking at our approach.

Our Own Estimate

The non-farm payroll report is based upon a monthly survey, attempting to estimate the total of all payroll jobs for the week including the 12th of the month.  Each month my team asks the question, "What change in payroll employment would be consistent with other economic data from the same time period (the week including the 12th of the prior month)?

My answer to this question is not a forecast, per se, since we do not posit any causal relationship among the variables in our model.  They are all concurrent indicators of economic activity. 

• We use the four-week moving average of initial unemployment claims, culminating in the week of the employment survey.  This is the best direct indicator of new job losses.  This is about the same as last month  — 459K versus 464K.  This value has declined significantly from the five-handle that was so worrisome a few months ago, but is still at levels that do not indicate a real recovery.

• We look at the University of Michigan sentiment survey, which we find to be more useful than the Conference Board's sentiment index.  Michigan uses a panel, where some families are carried over from month to month.  This is a good technique.    Sentiment is strongly influenced by employment.  When people have lost jobs, or know others who have, they get worried.  It is a very good concurrent indicator.  The Michigan index was down a touch (after a sharp decline in July) to 67.7, down from 68.2 last month.

• We use the ISM manufacturing index.  This is 56.9, a surprising uptick from 54.4 last month. The ISM index is an important read on employment, and it remains the most bullish of the various indicators.  Most people do not know much about interpreting this index.  The October reading, if annualized, is consistent with GDP growth of 5%.

Our long-term preview record has been very good, especially when compared to the final revised data.  This makes sense because our model was derived from the final data.  Our approach also makes logical sense, because it involves some factors related to jobs lost, and some related to job creation.

For the current month, our estimate is for a loss of 65,000 jobs.  This is a very pessimistic estimate, weaker than the other sources.

I have noted that the preliminary reports have been running "hot" by about 100K jobs, a problem I discussed in this article.  This was not true in Q409.  You must also keep in mind that the BLS estimate has a 90% confidence interval (just for sampling error) of+/- 100K jobs.  There is a wide range of possibilities for Friday's report.  The most recent BLS benchmarking data is much closer to the final reported numbers, but is still "over" by about 25K jobs per month.  (I am overdue in writing an update on this series).

Other Forecasts

It is always interesting to compare the job forecasts from different sources.  We follow several because of the widely varying methods they use.  A wise interpretation would be to consider all of  these disparate sources of information.

ADP has proprietary data because of its payroll management business.  Looking only at private sector jobs — no government, no census effect, ADP sees a gain of 43,000 private sector jobs.

TrimTabs has another valuable approach — tax deposits.  Their forecast is a gain of 95,000 private jobs.

Briefing.com cites the consensus as a gain of 60K overall and their own estimate as a bit lower.  With the end of the census jobs effect, the reason for distinguishing between public and private jobs has been reduced.

To summarize briefly, the market incorrectly focuses on predicting the BLS preliminary estimate — mostly ignoring the 100K confidence interval, the seasonal adjustments, and the benchmark revisions.  I am probably the strongest supporter of BLS methodology and integrity, but I still see their approach as only one method out of many.

The jobs report is so important — and we are all so interested — that we seize upon whatever information we have, even when we should accept the limitations.

Investment Implications

The jobs report presents a tricky trading challenge this month.  For the last several weeks, any negative economic data was seen as neutral or positive.  The idea was that the Fed would be even more aggressive if the economic data showed a problem.

While the general thesis is correct, the specific inference is not.  The Fed was not calibrating the QE2 program to weekly data reports.  Now that the general outlines of the Fed program are public, I doubt that the market will continue to see bad economic news as good.

Can we hope for neutral?  The Fed seems to be on the case, working for better economic growth.  It might be seen as reducing volatiliy.

Meanwhile, my approach to Friday's report is simply one of caution.  For new accounts I am waiting to invest until after the report.  There is plenty of risk, and there will be the usual negative spin by those who do not accept government data.

Little is lost by waiting until Friday afternoon to commit new investments.  Agile traders have been able to play the employment report on the short side for many months.  Even when the number is strong, there is a regular dip providing a chance to cover.