Have We Seen The Peak Of Employment?
In my November 5th report on employment I stated: "...when taking into account the recent slate of economic weakness, post-election we are likely to see many of the recent job gains revised away as the data aligns itself with overall economic activity. The STA composite employment index is likewise pointing towards higher jobless claims numbers in the months ahead and falling export orders will continue to impact corporate profitability and their need to increase employment." Since that time jobless claims did indeed rise, and with the release of the November jobs report, we saw the previous two month's gains in employment revised down by a total of 49,000. October employment of 171,000 was revised to just a 138,000 advance while September was brought down to 132,000 from 148,000.
What is important to remember is that the BLS only publishes revisions to the prior two months even though it has data for months prior. This is why the annual revisions to the employment data can be significant. Furthermore, given the weakness in the employment components of the major economic surveys, as shown by my composite employment index, we should expect to see negative revisions to the 2012 data employment data next year.
There has been much debate about whether the domestic economy is in a recession. A bulk of the arguments against recession are based on the four primary indicators used by the National Bureau of Economic Research (NBER) who officially date the beginning and end of recessionary periods. The inherent problem with this analysis is that the data is subject to annual revisions, which the NBER waits for before determining recessions, which potentially leads to a significant lag in the final determination of the recession. The chart below shows recessions and the announcement dates by the NBER.
As you can see the bulk of the damage to investors was done prior to the official announcement by the NBER. This is why there is significant debate currently about the economic state as investors try to determine when the next recession may occur. It is the problem of the data lag that requires additional analysis of a variety of other economic indicators which have both; 1) a strong history of recession indications and, 2) are not subject to large annual data revisions. Currently, many of those indicators from the economically sensitive sectors of manufacturing and production (see here, here, and here) are warning of economic weakness and should increase investor caution.
Employment, is one of those economic data series that are subject to large annual revisions. Currently, there is little argument that the economy is beginning to slow with even the major Wall Street firms ratcheting down Q4 GDP to 1% annualized growth. This brings into question the sustainability of employment in the future as businesses become more defensive to offset the impact of the ongoing recession in Europe and slowdown in China.
While the most recent employment report showed gains in November this is not necessarily an indication that an economic recession has been avoided. The table below shows every Post-WWII recession and where monthly employment stood prior to the start of the recession. With the exception of 1957 employment growth was positive, and in some cases expanding, prior to the recession.
The point here is that positive net changes to employment are not necessarily an indication that the economy is expanding. It is important to remember that businesses are generally reactionary, rather than proactive, about the current economic environment. Businesses make investment, and hiring decisions, on historical data from the previous month or quarter. This is why businesses are typically the last to hire and the last to fire as they react to trailing demand figures.
The chart below shows the three-month net change of employment.
As you can see employment tends to peak around 1,000,000 jobs. That peak was reached in 2010 and has slowly been deteriorating since. This is why Bernanke has been implementing extraordinary monetary policy in order to stimulate weak employment growth. Unfortunately, businesses do not hire employees due to monetary policy but rather increased consumer demand. The problem is that, according to the NFIB, "poor sales" remains one of the top concerns - not exactly a sign of strong end demand. While employment has grown on a monthly basis, as shown by the inset bar chart, the trend of that growth remains weak.
Commercial lending trends also point to a potential peak in employment. When an economy is expanding businesses need to typically borrow money to increase facilities, production and inventories. That expansion leads to increases in employment. The chart below shows the historically high correlation between the annual changes in commercial lending and employment.
While it is still very early to tell it appears that commercial lending may have recently topped and turned down. This would be consistent with the weaker economic trends seen recently which portends to weaker employment growth in the months ahead.
One of the arguments that we have made repeatedly in recent months has been that the nascent housing recovery is not fueling economic growth and employment as expected. The chart below shows residential construction employment versus housing starts. In the latest report construction employment declined for the fourth month in a row and is now down 7.1% on an annualized basis.
With housing only a small contributor to economic growth, roughly 2.5% of GDP, and the majority of the activity occurring in multi-family properties - the need for expanded employment has not materialized. The issue for housing remains the sustainability of economic growth which is rapidly being called into question.
As the economic underpinnings continue to deteriorate, as witnessed by corporate outlooks during the recent earnings reports, the drive to expand employment weakens. As we have been discussing since the beginning of this year the rising cost pressures into production have steadily deteriorated profit margins as cost cutting measures have been exhausted.
While it is too early to say that employment has peaked for this current recovery cycle - there is mounting evidence that this may indeed be the case. It will be some time before we get the final revisions to the 2012 economic data from which the NBER will be able to ascertain the official state of the economy. However, as history has shown, the damage to investor portfolios will have already been done. It is for this reason that we continue to review reports of underlying economic activity which can provide clues as to the strength, and trend, of economic growth. It is from that analysis that we can avoid a bulk of the recessionary drag before the NBER makes it official.