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Each month market participants wait with bated breath for the payroll employment report. No other piece of government data gets more attention.

This month, the significance is even greater. Many see employment changes as the true indicator of potential recession conditions. There will be plenty of commentary -- all delivered in serious and authoritative tones.

None of the commentary will be accurate!!

To our continuing amazement, no one seems to understand the payroll employment report. There is one group that sees it as the official government number. It is the result against which everyone else's estimates are measured. This happens because we really would like to know what the job change is each month. The government reports a number, and most take it seriously. Billions of dollars of market cap will swing on whether people think it shows a recession in progress.

Another group will maintain a consistent negative bias about the report, suggesting that job creation is inflated by the BLS. This is mostly because of the consistent and erroneous bashing of the Birth/Death adjustment.

No one seems to understand the process. The journalists in mainstream media publicize comments without doing any real education. Everyone who is invited to comment on TV or for the Wall Street Journal is happy to do so. There is a cottage industry in looking at the "internals" of the report. None of these analysts will mention sampling error or statistical significance.

A Dash of Insight on this Report

Let us state first that this report is generated with the highest level of skill and professionalism. We have interviewed the BLS researchers. Our own experts -- highly skilled research professionals -- have reviewed the methodology. It is excellent. There is no political bias. The revisions that occur come from delays in reporting companies, not from the BLS. There is no way to predict them. The much-criticized Birth/Death adjustment has improved the actual estimate in every period since it has been used. We know this by comparing the (eventual) state data, reported months later, with the BLS estimate.

So What is the Problem?

The BLS has been asked to do something that is nearly impossible. They estimate the number of jobs in the economy each month. That is about 140 million jobs. They then take the estimates for two consecutive months and subtract them to generate a difference. The process is a good survey of establishments with some excellent adjustments.

Even if they do a great job of estimating jobs in both months -- a large number -- the error in the difference between the months is quite large.

When they are all finished, all revisions, all employers reporting (which we do not see for two more months) they are subtracting one survey from another. The sampling error has a 90% confidence interval of +/- 100,000 jobs. (And by the way, the estimate from the household survey is +/- 400K jobs.)

Think about this. As our old stat prof explained it, suppose that God whispered in your ear and told you the TRUTH about the actual job change. One-third of the time, the official number would be 50K or more light and another third it would be 50K or more heavy. Meanwhile, the market draws inferences from much smaller deviations. You can know the truth, and still be voted wrong by the market.

The "internals" of the report have a similar proportionate sampling error.

Current Forecasts

ADP attempts to forecast the report with their own analysis of companies in their database. While their method has gotten a lot of criticism from some big misses, an analysis by Bespoke Investment Group shows that it is actually pretty good. ADP is looking for a gain of 2000 jobs.

Our own model, based upon the four-week moving average of initial claims, Michigan consumer sentiment, and the ISM report suggests a decline for February of 37,000 jobs. One must be careful in doing this analysis, using data from mid-month, since that is when the official survey is taken. Tomorrow's jobless claims, for example, will not be reflected in Friday's employment report. We are "solving" for a job change that is consistent with other concurrent economic data. No factor "causes" another. They are independent reads on the economy.

Economists have a consensus estimate of a gain of 20,000 jobs.

Any government result ranging from a job loss of 80,000 to a gain of 60,000 does not prove any of these forecasts to be incorrect, in terms of statistical significance. And that is after we have all of the data -- many months from now. The initial report has an even wider range, since the sample is not complete.

Resources

For more detail, interested readers might check out this article, or read more widely from our past analyses.

We also have a comprehensive article available upon request.

Readers can also see the effects at our sister site, The Payroll Employment Game. You can plug in your own guess at "truth" and see the range of possible BLS survey results.

Making Money from this Knowledge

Quite frankly, there is no good method for assuring an edge in trading. That is the point of highlighting the wide error band. Whatever happens will be given undue weight by the market. Having said this, we see significant downside risk in Friday's report, mostly because our own forecast is so much lower than the consensus.

We all want so much to know what is happening with employment, that the monthly survey gets too much weight. It is a case of the data we have versus the data we need.

Source: February's Employment Data: Watch Out!