John Hussman: Impulse Response

by: John Hussman

Excerpt from the Hussman Funds' Weekly Market Comment (9/13/10):

Except for a burst of census hiring that briefly pushed payroll growth above trend during the second quarter of this year, job growth has been perpetually below trend over the past two years. During the post-war period, the civilian labor force has historically grown at about 0.15% each month, which currently implies that normal "trend" job growth should be about 225,000 jobs per month.

While last month's labor report was favorably received by Wall Street, that reception was based strictly on the fact that job losses were not as bad as anticipated, given concerns about a "double dip" in the economy. The problem with this celebration, however, is that analysts continue to overlook the typical lags between deterioration in leading indicators and deterioration in coincident measures, much less lagging ones. As I've noted frequently in recent commentaries, the typical lag between deterioration in say, the ECRI Weekly Leading Index and the ISM Purchasing Managers Index is about 13 weeks, and sometimes longer. The typical lag with respect to new claims for unemployment is about 23-26 weeks (which puts the likely window of deterioration at about the October - November time frame), and the typical lag with respect to the payroll unemployment report is, not surprisingly, about 4 weeks beyond that. The critical risk area here extends for several months, not a few weeks.

The labor reports of the past three months cannot possibly be considered to be favorable from a macroeconomic perspective. The reason for this is that these reports were each more than 500,000 jobs short of what should have been expected.

To provide some perspective on this, below is a simple estimate of what economists call an "impulse response" profile for the U.S. labor market. When we deal with economic variables - such as employment - that are subject to positive or negative "shocks," it is often helpful to estimate how those shocks tend to "propagate" over time. For employment, a 1% shock in job creation or destruction (versus trend growth) tends to be followed over the following year by an additional 1% movement in jobs in the same direction. After that, the impulse gradually attenuates over a larger period of years, as the initial positive or negative burst is followed by a trajectory back toward trend growth. In effect, positive and negative "shocks" to job creation have very strong tendency to "cluster," propagating in the same direction for a period of about 12 months, and then gradually attenuating toward the long-term trend.