The Bureau of Economic Analysis (BEA) reported that payroll employment rose a better-than-expected 236,000 during the month of February, and that the unemployment rate fell to 7.7%. Investors celebrated this news as the stock market indices edged higher throughout the day. This was clearly a positive development on the employment front, but for those willing to scratch beneath the surface, the data was not as strong as portrayed by the headline numbers.
The 236,000 jobs reported include 102,000 jobs that the BEA added through what is called its "birth/death" adjustment. This adjustment counts jobs under the assumption that there were brand new employers hiring workers who were not accounted for in the survey results. The quality of the jobs created continues to deteriorate relative to the quality of the jobs lost. Bars and restaurants added 18,000 jobs, while 14,700 public school teacher jobs were lost. The motion picture industry hired 20,000 extras, while the federal government shed 10,000 employees. There were also 16,000 temporary workers included in the headline number. One bright spot in the report was the increase of 48,000 in construction employment.
The labor force contracted by 130,000, sending the participation rate down to 63.5% from 63.6%, the lowest reading since 1981. This has been the driving force behind the decline in the unemployment rate. What should be concerning investors is that the labor force participation rate is pro-cyclical. This means that it declines as economic growth deteriorates and discouraged workers leave the labor force, and it rises during economic recoveries and expansions as new entrants join the labor force. The continued decline in the labor force participation rate is not indicative of accelerating rates of economic growth.
The BEA also provides a household survey in its employment report that has a more expansive scope than the establishment survey, because it includes small businesses and the self-employed. The household survey saw an increase of only 170,000 jobs in February, which followed an increase of just 17,000 in January. In fact, household employment gains have averaged approximately 100,000 per month over the past year, while the establishment survey has averaged gains closer to 165,000. This is important. In the early stages of an economic recovery, the establishment survey has historically underestimated job creation when compared to the household survey, because it is a backward-looking estimate that incorporates the birth/death adjustment. The BEA assumes fewer firms are formed to employ new workers during the early stages of recovery. When economic growth is slowing, as it has over the past year, the establishment survey has overestimated employment gains, and the household survey is a more reliable figure.
At the end of the day, the jobs data are only relevant to the extent that it informs us about the growth in personal income. Jobs are a means to income. It is income that fuels the consumption that accounts for 70% of our economic growth. Because the BEA relies on historical data to formulate its estimate of job creation, rather than using the real-time data that is readily available, its monthly employment reports are useless lagging indicators. With respect to personal income, the February employment report was not just useless, but very misleading.
Charles Biderman, the CEO of Trim Tabs Investment Research, monitors real-time wage and salary data. In his most recent video blog, he points out that we have come to a pivotal turning point in the personal income data, which undermines the bullish interpretations of the employment report that sent stocks higher on Friday. In summary, despite payrolls rising more than expected and the unemployment rate falling to a four-year low, wages and salaries after taxes and inflation (real disposable income) are now declining year-over-year. Mr. Biderman notes that withheld income and employment taxes have increased 8.3% year-over-year from January 8 through February 25, when compared to the same time frame last year. The increase in payroll taxes accounts for 6% of this increase, while the increase in taxes on the wealthy accounts for another 2%, leaving after-tax income growth of just .3% for all workers. When we subtract the government's inflation estimate of approximately 2%, we see a meaningful decline in real disposable income. This is the data point that should be commanding investor attention. It is telling a very different story than the one told by rear-view looking government statistics.
Furthermore, the sequestration that began on March 1 will substantially reduce the monthly estimate of employment growth. It will also negatively impact an already declining rate of personal disposable income, because a significant percentage of the employee expense reductions will take the form of furloughs. Declining disposable income does not bode well for consumer spending. The declining rate of growth in consumer spending impacts the growth in industrial production, capital spending and services, which collectively drive corporate profits. This is why operating earnings for S&P 500 companies (SPY), as reported by S&P Dow Jones Indices, are declining on a sequential and year-over-year basis. The underbelly of this employment report and the disheartening decline in real disposable income run contrary to the expectations for accelerating rates of economic growth, revenues and earnings that we see from most analysts and economists. This is because they are using strong stock market performance as a discounting mechanism in their forecasts. The problem is that the wealth being created on Wall Street is not translating into the jobs and income growth on Main Street that serve as the foundation for a strong economy.
Additional disclosure: Additional disclosure: Lawrence Fuller is the Managing Director of Fuller Asset Management, a Registered Investment Adviser. This post is for informational purposes only. There are risks involved with investing including loss of principal. Lawrence Fuller makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by him or Fuller Asset Management. There is no guarantee that the goals of the strategies discussed by will be met. Information or opinions expressed may change without notice, and should not be considered recommendations to buy or sell any particular security.