U.S. Economy: I Want My ADP!

by: Eric Parnell, CFA

"I Want My MTV!"

--MTV Music Television, 1981

When MTV was first launched on cable television in August 1981, it certainly did not mark the beginning of rock music. After all, the genre had already been in place for several decades. Instead, MTV transformed the music industry by providing a new way for audiences to access the music and its performers. Although far less exciting to teen audiences, the same could be said of the ADP National Employment Report as it relates to the U.S. economy. And as we continue to navigate through this extended period of uncertainty, it is a reading that is more important than ever for several key reasons.

First some quick background. The Bureau of Labor Statistics (BLS), which is a division of the U.S. Department of Labor, releases its monthly employment report focused on both the private and public sectors on the first Friday of every month. Investors watch this reading very closely, as it provides an important reading on the strength and health of the U.S. economy and its various sectors. Given the importance of this release, Automatic Data Processing (ADP), which is a major payroll processing firm, releases its own employment report focused only on the private sector on the Wednesday before the Friday BLS report to provide financial markets with a first look into the employment situation for the month.

So in short, we have two employment reports each month. The U.S. government provides one report. And ADP, a private sector company, provides the other.

In today's uncertain market climate, the ADP employment report is critical for two key reasons.

First, it provides another data point to evaluate the economy. Historically, the correlation between the total private employment data from BLS and the ADP report has been very high at +0.95. But variances do occur from month to month, with some deviations greater than others. Overall, the average difference between the two readings is roughly +/- 60,000 jobs. These deviations have caused the ADP report to come under fire at times, and the most recent reading for June 2012 was no exception.

After ADP showed private sector job gains of +176,000 last Wednesday, the BLS posted a total private payroll increase of just +84,000. Thus, a difference of 92,000 private sector jobs existed between the two reports for June 2012. This caused several commentators in the media to openly question the worth of the ADP report. But I counter this idea with the following point. What says that the BLS report is correct and the ADP report is incorrect? Perhaps the ADP report more accurately projected the private sector employment situation in June than the BLS. Given the various levels of estimation and seasonal adjustments that are required to construct these monthly data, the potential for deviations and tracking error clearly exist in any given month in both series. And both data are subject to monthly revisions. This is why it is helpful to have two data points so that those monitoring the economy and markets have more information to evaluate in making decisions.

The second reason why the ADP report is particularly critical in the current environment is a bit subtler. At present, investment markets are increasingly struggling with a crisis of confidence. And what the recent LIBOR scandal has explicitly introduced is the notion that some in the public sector charged to oversee the markets may have involvement in encouraging misinformation at any given point in time. So while I fully believe in the integrity of the BLS data including those who construct it, one must now question whether the potential exists for this important employment report data to be "managed" one way or another in any given month. Does the potential exist for monthly employment numbers to be "encouraged" higher in order to send a particular signal to the markets? Conversely, does the potential exist for this data to be "adjusted" lower to make a more aggressive policy response more palatable? While I do not believe that such activities are taking place, it is a risk that must now be considered more closely in light of recent events.

This is where the ADP report is particularly helpful. The ADP employment report, which is issued by an independent and private firm, provides a check on the government generated BLS data to help insure the integrity of the information. The historical relationship between the two data series including the generally high correlation provides a framework to test the accuracy of the employment reporting on a monthly basis. And as long as these two reports remain within the range of their historical relationship going forward, it elevates the integrity of the BLS data even further.

This is why I want my ADP data each month. For it helps provide investors with some additional trust in the integrity of one of the most important data series affecting the markets today. And any place where trust can be reinforced in the current environment is certainly a good thing.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.