A Brand New Way To Track The Labor Market

Summary

• The Fed recently released a brand new way to track labor market conditions.
• The Labor Market Conditions Index has 19 underlying indicators.
• The LMCI is a useful tool for predicting recessions.

The Fed takes a lot of heat for a lot of things. But credit should be given when credit is due. And the Fed deserves some credit for its brand new monthly Labor Market Conditions Index. The LMCI is a "dynamic factor model that extracts the primary common variation from 19 labor market indicators." In plain English, the Fed takes 19 labor market data points and compiles them into one index. In no particular order, the components underlying the index are:

Unemployment and Underemployment

Unemployment rate

Labor force participation rate

Part time for economic reasons

Employment

Private payroll employment

Government payroll employment

Temporary help employment

Workweeks

Average weekly hours (production)

Average weekly hours of persons at work

Wages

Average hourly earnings (production)

Vacancies

Composite help-wanted index

Hiring

Hiring rate

Transition rate from unemployment to employment

Layoffs

Insured unemployment rate

Job losers unemployed less than 5 weeks

Quits

Quit rate

Job leavers unemployed less than 5 weeks

Consumer and Business Surveys

Jobs plentiful versus hard to get

Hiring plans

Jobs hard to fill

Click to enlarge

Why should you care about this new way to track labor market conditions? Here's why: The LMCI is a useful indicator for predicting recessions. How good is it? Let's take a look.

The Fed backtested the LMCI using data from July 1976 on. Since 1976, the U.S. has had five recessions. Preceding each of those recessions, the LMCI dropped below zero. As the chart below shows, not every time the LMCI drops below zero does it mean a recession is on the horizon. But every time there is a recession, it is preceded by the LMCI dropping below zero.

Where does the index stand today? At this time, the index sits at 4.0, down from its January 2012 cycle high of 11.8.

On a final note, you may be wondering when the latest number is released and where to find it. The index, which debuted last month, is currently scheduled to be released on the first business day following the Bureau of Labor Statistics' monthly Employment Situation report. You can find the latest data here.

Analyst’s Disclosure: The author is long SPY. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.