The June jobs report surprised everyone and cranked out 287K jobs. Has that shifted the paradigm? Well, it has, but it has not shifted it back. It is a report that continues to shift the paradigm toward a view of a riskier less strong economy despite that outsized gain. Why? In a word: CONTEXT.
After last month's report when the Fed shifted its view so radically, Janet Yellen also paradoxically said we should be careful not to place too much emphasis on any single economic report. You can draw an infinite number of lines through one point and one line through two points. For three points you might need to restore to statistical analysis since they may not all stand on one line…or at least not on a straight one.
Paradoxically despite the huge job gains in this report the monthly nonfarm job gains' moving averages are still moving lower. That downshift is still in place because the May gain was revised down to 11K or if you prefer to look at private sector jobs to -6K in May. Yes, private jobs contracted in May- there was a modest strike effect.
The numbers game
Year on year private sector job gains average 194K down from 232K at this time last year. Moreover, the three month average is 135K, the six month average is 181K. Despite the June 'pop' in jobs the growth is slowing. Construction jobs are slowing and shrinking over three 3- and 6-months. Manufacturing jobs are up on the month but near flat on all broader horizons. Mining jobs are still contracting because of oil-field and oil-price issues. Private services, the engine of job growth shows a three-month average gain of 150K compared to 182K over 6-months and 189K over 12-months and of 200K for the 12-month average in June of 2015.
Best supporting factors, the nominees are…
The labor force participation rate is a tick higher in June unchanged over 12-months and net lower over 24 months. Hours worked- the real job market metric that accounts for the number of workers and the hours that each works - have slowed to a 1.5% annual rate over three-months from 1.6% over 12-months; that compares to a 2.4% pace in June of 2015. Hours worked have slowed sharply in the past year. Wages are creeping higher but not by much. The quick-and-dirty average hourly earnings gauge is up at just a 2.1% pace over three-months compare to 2.4% over 12-months a net deceleration - not the acceleration that many are looking for. Weakness lingers…
The winner is: The unemployment rate rises to the occasion
But the real fly in the ointment is the rise in the rate of unemployment to 4.9% from 4.7%. And here is why: the unemployment rate basically has two gears: higher and lower. It rarely moves sideways. And it is very Newtonian. Once it starts in a direction it continues in that direction. This is late in a business expansion. A rise in the rate of unemployment is a very bad development at this time. There is no law saying that it has to continue to rise. It could be sputtering and could extend its string of declines. But there are other signs of slowing in this economy and there is weakness overseas. The odds seem to have shifted away from the buoyant path. We would do well to see the shift.
New paradigm/paradigm lost
The paradigm lost is the never ending too-slow but relentless expansion. The paradigm not attained is the one the Fed saw with growth accelerating this year. The paradigm gained is the sideways rocky road and presence of unexpected downdrafts and the risk that one of them could become a sink-hole called recession. That game is on.
Vehicle sales lose momentum
Already vehicle sales have hit harder times. Sales of vehicles had soared over 18mln units last year and when they did that, I pointed out that as 'good as the news was' historically an 18mu pace could not be sustained and that vehicle sales would likely stop being a contributor to growth in 2016. Sales hit 18mu in September-November of 2015. And that slowdown has since happened. This month auto sales are prepared to make a significant subtraction from retail sales. Sales fell to 16.66mu in June down from 17.45mu in May. Auto sales gains have been built on a base of subprime credit a pipeline that is likely to narrow as the economy cools and banks have to start being more wary of risk and their performance under Fed stress tests. Of course, most auto loans are securitized these days and do not reside on bank balance sheets but that will be a problem for the credit markets to sort out. Don't be sorted out along with it. It would be a good time to avoid those sorts of securities.
Consumers get an attitude
Consumer attitude surveys are still reasonably firm in this cycle but they show signs of plateauing and their weakest part is their expectations component- not a good sign.
Growth Vs risk
So the macroeconomic gods are no longer aligned with growth but rather with risk. Stocks are still priced for reasonably good times and bonds are being heavily discounted by business-cycle handicappers because of the abnormally large influence of foreign bonds and the negative effect their negative yields are having on the US market. But ignoring that could be a mistake. Maybe the low bond yield and flat yield curve are signals that the stock market is ignoring?
The fly in the ointment is alive but stuck
You can go anywhere (the St Louis FRED database for example) and find a long term plot of the rate of unemployment and convince yourself that the rate usually rises or falls and is rarely moves sideways. The chart I instead present below is the one constructed to create a recession signal and it does a remarkably accurate job. It is probably better to call this a recession diagnostic because it identifies a recession as in force very quickly and has no lead time at all. The signal stays in gear long after the recession has ended; it is not a recession-end signal just a start signal. This signal is topical or one month late is signaling recession most cycles. Because it does not turn off quickly. It stayed in effect and did pre-date the second recession of the double dip in 1981, It was, however, four months late in dating the 1973 recession and three-months late in dating the 1968 recession. All in all it is still much faster than the NBER recession dating committee at calling recession start. There are no false signals.
The signal itself: This signal is constructed by taking the difference between the 24month low in the unemployment rate and the current unemployment rate. When the current level is MORE THAN 0.5 percentage points higher than its previous 24month minimum, the signal is tripped (I plot it as the arbitrary value 0.5 on the chart below). This explains my interest in the 0.2 percentage point rise in the unemployment rate in June.
A I mentioned above there is no law saying that the unemployment rate has to continue to rise but in this new regime I think the risks are shifted and whereas last year we would not be looking at such a chart or signal this year it is suddenly appropriate. You may have noticed that more economists are dragging out various models that calculate the probability of recession. All of that is part of the new paradigm.
To condense the meaning of this signal, it is this: that reasonably large and sufficiently abrupt rises in the rate of unemployment are a good recession signal/diagnostic. And because the signal (on this algorithm) is topical it means that the unemployment rate always has started its trip higher ahead on the onset of recession. That is why we are now on notice.
I have in a previous piece (Is it Time to Drag Out the Recession Forecasting Models? here) showed how low jobless claims actually are a good leading signal of recession. The labor market is very regularly related to recessions. Claims tend to hit their low point more than year ahead of a recession's start. There are also signals from the yield curve, but because of international distortions those are being set aside.
The signal's usefulness to investors
The point of the unemployment signal is not to use it to tell if we are in recession or not; that's not really all that useful but to raise awareness that increases in the unemployment rate even increases that do not seem so large can in fact foreshadow the onset of recession. It is a good plan to be out of stocks (or to reduce exposure to high volatility shares) before this signal is full processed or very soon after it emerges.
Two paradigms beat an empty house
To me this is now the operative paradigm. Unlike the Fed that remains data dependent, we now have some idea what the paradigm is and what the risks are. We are looking at data and for various signals but with a certain prejudice because, in this paradigm, the risks are stacked more to one side. That is why unlike those who reject this paradigm we are quicker to see a large job gain as an anomaly and to process it as something that has not shifted this paradigm while those without such a structure may be confused by it or even see it as sign that the old paradigm has life or is back. It does not have life; it is not back. The four-rate-hike Fed is OFF the table
Still…rate hike ahead!
And while the Fed still may hike rates in this paradigm (it often does hike them right ahead of the onset of recession) its actions in no way invalidate the paradigm itself. The Fed's own paradigm was wrong. In December the Fed decided that the economy had progressed into a more enduring state of growth and that it could take (or might require) four rate hikes this year alone. Instead look at how the contrary signals and events have emerged. Now the Fed has shed its old paradigm and we do not have a clue what it wants to do next except that it still seems likely to think that it can sneak in another rate hike this year. The Fed's paradigm is unclear to us and our paradigm is as yet unclear to the Fed. The Fed's old paradigm was so wrong that the Fed is having a hard time clearing its head and setting its sights on the new reality. Don't make the same mistake.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.