Seeking Alpha
Long/short equity, deep value, registered investment advisor, CFA
Profile| Send Message| ()  

It often seems that only two things matter on Wall Street - central bank policy and the monthly jobs print. On the subject of employment, I wrote on my own website last week that the latest raw jobs data may be quite similar to the data of a year ago, with the main difference possibly due to a change in estimation methods by the Labor Department (BLS).

The gist of my point was that the establishment survey shows payroll growth through the first six months of 0.93% this year vs. 0.95% last year. Similar indeed. The latest benchmarking revision this year considerably raised the "final" tallies of last year's payroll numbers, and it's reasonable to assume that BLS is currently using estimation methods that, applied to last year's raw data, give a result that agrees with the revised totals. Ergo, the inference is that this year's raw data is the same as last year's, with the main difference being in the headline "beats" being contemporaneous instead of many months after the fact.

In supporting evidence that the labor market is essentially unchanged is that the JOLTS survey for May estimated that unadjusted 2013 hires were slightly below hires for May 2012. The hire rate declined fractionally as well, from 3.7% to 3.6%. Although the number of openings increased somewhat, by 1.3% - which the business press highlighted - hires did not and the so-called "quits rate," declined as well. A rising quits rate is supposed to signify increased confidence in the labor market.

I don't want to overstate the precision of the BLS statistics - though the market seems perfectly willing to do so - but there are some other interesting tidbits to think about. The average monthly gain in seasonally adjusted payrolls since October 2010 (33 months) is 0.14%. The increase last month was 0.14%. Does anyone but me detect a bit of smoothing? At any rate, it isn't as if job creation has suddenly gotten more robust.

According to the June household survey, the civilian labor force grew from 155.15 million to 155.84 million, a gain of 0.44%. But the increase in the "not in labor force" (NILF) category was much larger, from 88 million to 89.7mm, a gain of 1.94%. If the NILF category grew at the same rate as the civilian workforce and the difference was counted as "unemployed," then the unemployment rate would be 8.7%. As it was, many were quick to note that the alternative U-6 rate grew sharply to 14.3% (14.6% unadjusted). What's more, the quality of the new jobs is mostly poor, made up of no-skill jobs in restaurants, bars, home health care and the like, with a huge upsurge in part-timers this year.

Many are blaming the increase in part-time help on the impending provisions from so-called Obamacare, and no doubt there is some pre-positioning going on. But as this article from the Financial Post makes clear, the practice of minimizing labor inputs (because that's what it is to the average MBA) by treating workers as "non-employee employees" has been widespread for some time.

It's a topic that merits broader discussion in another forum. What's important about it so far as the economy and the Seeking Alpha community are concerned is the influence on the dynamic of the recovery. In recessions between the end of the second world war and the end of the century, higher-paying manufacturing jobs made up a much larger part of the workforce. When they returned to work. they were packing a bigger punch in terms of income and spending power, which added fuel to the recovery.

In the last two recoveries, above all the current one, the hiring mix is much more service-based and tilted to the low end of the scale. Ergo, the optics of the recovery are being distorted as the jobs totals appear satisfactory (relatively speaking, as 200,000 is thought of as the necessary minimum for employment stability), but the deteriorating mix means that today's 200,000 number, with manufacturing only 9% of the workforce (and shrinking in recent months) might be the equivalent of only 120,000 in a 1993 dynamic, when manufacturing was 15% of the workforce.

This explanation fits in with the mosaic of the other data I work with, which shows the economy broadly slowing in nearly every category but jobs. Here's an update on wholesale sales:

(click to enlarge)

source: US Dept Commerce, Avalon Asset Mgmt Co

Slowing demand plus rising stock prices equals growing divergence.

It's well-known that employment is a lagging indicator - total employment usually peaks entering a recession, while employment growth peaks as little as a few months to over a year ahead of time. How much the Street talks about that lagging nature is inversely related to the distance from the last trough.

Therein lies the grand conundrum for Seeking Alpha investors. Corrections come about from a number of reasons, including the simple fact of a market being overbought at the wrong time of year (at this point I have serious worries about August). But the last three bear markets didn't begin until the first negative print on payrolls showed up - and the last two times, equities went on to peak a few months later, thanks to the modern belief that central bank interest rate cuts are a golden elixir.

If you think that the simple answer is to stay invested until the first negative print, think again because the markets have a way of frustrating what everyone knows. Earlier bear markets began well before monthly employment rolls turned negative, and the 1987 crash occurred during a period of rising employment. Two useful inferences to be drawn are that one, the earlier bear markets occurred during times when the central bank was not thought to be omnipotent - in the 1970s, it was quite the opposite - and two, runaway markets can get tipped over in an unexpected way. Circuit breakers mean we can't duplicate Black Monday of 1987 again - hopefully - but we could still do it over a few days' time instead of one.

To take an example, it's still more than possible for the EU to have a nasty incident that freezes the global credit markets. In such a case the European Central Bank might not be able to do anything to stop the bleeding (think of the Bank of England and George Soros) and of a sudden, the investing world's childlike faith in central banks could be shaken. What's more, said incident could happen while we were still printing positive monthly job numbers, with the first negative one coming after an EU crisis.

Meantime, the halo effect of the headline BLS print of 195,000 jobs in June, combined with the weak news that keeps coming out of China and Europe has further stepped up the magnetic attraction of US equities to fund managers. I expect the markets to keep rising through at least the retail sales report this Monday - no predictions there, but if we did get a negative print it would probably freeze the current move, give or take a percent or so. If we get past that report with a number that's within expectations, then expect the markets to gravitate towards the chart lure of 1670 on the S&P 500.

Keep in mind, though, that while stock prices sing one song, the data say that the US is not pulling the rest of the globe out of its slowdown, but that the rest of the globe is pulling the US down. I think it more likely than not that this huddling of money into US equities is little more than another visit to the last chance saloon.

The market's focus on monthly payroll numbers could be shifted quite suddenly and violently by events from overseas, as happened in 1998, or some similar revelation that adding another 50,000 bar restaurant workers isn't quite as relevant as believed. John Mauldin recently sent out a letter featuring work by Charles and Louis Gave (I can't provide a link because it's subscription-only), noting that among other important divergences, other markets are mostly falling while the US is rising. Historically that hasn't worked out well for US equities.

In sum, markets are currently set to try to keep rising through the end of next week, though I feel less strongly about it now than a week ago and we'll need a reasonable number from the retail sales report to get by.

If so, expect the volume of hosannas about the US economy to grow, making it harder for the average Joe to get out and probably luring in a few more late arrivals, God rest their souls. If the music gets to you, I suggest you follow the example of Ulysses and strap yourself to the mast. Do not fall in love with this rally (though if we discover cold fusion by next week, please disregard the last remark). In a week or two we should have a clearer picture of where to start looking for hiding places.

Source: The Divergence Between Equities, Jobs And The Real Economy