February Employment Report Preview: Time for a Real Rebound?

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 |  Includes: DIA, QQQ, SPY
by: Jeff Miller

The most important data of the week will come Friday morning: The Employment Situation Report. Here is what you need to know.

This week's employment situation report is more important than ever. The January numbers, as I predicted, were so confusing that it was hard to draw any confident conclusions.

  • It was the time of the annual "benchmark revisions" so the payroll series was adjusted.
  • It was the decennial adjustment in the population benchmark, so many people incorrectly concluded that there was a mass exodus from the labor force.
  • There were weather effects.

Some people will expect an offsetting effect in this month's report, but there is little support for that conclusion. Weather is the only one of these effects where there could be a rebound.

I am on record as forecasting that we will have a significant gain in jobs at some point. The lag in employment growth is frustrating for policymakers, and for everyone who hopes for a strong US and global economy.

Meanwhile, I am guided by the data rather than by hopes and dreams.

Simply put, if employment were better, we would have fewer initial claims and higher consumer confidence.

I expect a robust rebound, but not yet.

A Small Preview

There is a lot of attention to jobs lost, especially in manufacturing. Prominent pundits ask where the new jobs are coming from, but they do not look very hard. I wonder if readers can think of areas where there are gains in new occupations. A related question is whether we need to know the categories of new jobs. But this is a subject for a different article.

Background on the Employment Preview

The "official" monthly verdict comes from the Bureau of Labor Statistics in the form of the Employment Situation Report. This includes a survey of businesses and a survey of people. Most focus on the business survey, the payroll employment report and the monthly change.

For several years I have written about the variation and error bands in this report. Others have been much more aggressive in criticizing the official results. This is especially true for those who lack the time or expertise to evaluate the data.

At the time of the benchmark revisions, the BLS acknowledges the errors in their past forecasts and recalibrates. This is an exemplary professional attitude.

Everyone else should do the same! The "official" scorecard is what the actual state employment data shows, something we know about nine months later. At the time of the monthly report, the BLS, ADP, TrimTabs, and NewArc are all making an estimate. The market unwisely deems the BLS estimate to be accurate, when the other approaches all yield interesting information, and might actually be better.

Traders must try to guess the BLS number, because that is what everyone else is doing. Investors can focus on the underlying economics. With this in mind, let me review 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. The current level is 419K, with plenty of wild variations in the last few weeks. 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. Please note that today's report and also last week's were not part of this survey period. Many observers get confused on this point.
  • 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 is at 77.5, better than recent levels, but far from what we see in good times and about ten points lower than "normal" times.
  • We use the ISM manufacturing index. The January report came in at a very strong 61.4. 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 February reading, if annualized, is consistent with GDP growth of 6.6%.

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 gain of about 100,000 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. The last two years have included annual "benchmark revisions" that have lowered the final job change results. In the final tally, our estimates look much better, but they seemed to pessimistic in real time.

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. Each method provides an independent measure of important 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 217,000 private sector jobs.

TrimTabs has another valuable approach -- tax deposits. Published reports cite their forecast as a gain of 158,000 jobs.

Briefing.com cites the consensus as a gain of 183K overall and their own estimate as 200K.

For a deeper look, especially into the ADP report, check out Steve Hansen's preview at Global Economic Intersection. I have a number of fundamental disagreements with Steve's approach, but the data are interesting. Perhaps Steve will take a look at the approach I suggest, and he will see why it is wrong for everyone to "guess"the original BLS estimate. I also strongly disagree with the value-laden statement that the BLS numbers are "over-manipulated."

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 and Trading Conclusion

I have a long-standing rule for employment Fridays: Play the short side. The pre-market spin on this number is amazing. It could be a subject for a PhD thesis. Between the 8:30 release and the 9:30 market opening the CNBC folks get bombarded with emails and tweets about what is "wrong" with the number. Bearish traders can count on Rick Santelli to (incorrectly) recommend subtracting any birth/death adjustments. If you are short, you usually get a good chance to cover on an apparently strong number and you cash in on a bad number.

For investment accounts, I will be shopping on Friday, but cautious today.