The September non farm payrolls report has caused quite the uproar and quite frankly, everyone is asking the wrong questions. The report, which showed the U.S. added 114,000 jobs in September and put the unemployment rate at 7.8%, has led a number of observers to conclude that the books were cooked by the White House to increase the chances of the President securing a second term.
Former GE Chairman and CEO Jack Welch was particularly incredulous, noting that he has been doing his own research on the matter all week long and the 14 businesses he examined apparently didn't report a growth rate consistent with what Friday's jobs report would suggest:
"I've been reviewing 14 businesses all week, and...it's impossible that we can be running at a 5% GDP growth rate which is what this (7.8%) number is implying."
While I understand the sentiment, someone should probably remind Mr. Welch that a sample size of 14 isn't even sufficient to ensure that the central limit theorem applies. In other words, one cannot conclude anything from a sample of 14 businesses.
Welch wasn't the only skeptic. When the report was released CNBC's Rick Santelli exclaimed (with a sarcastic grin spread across his face):
"I told you they'd get it under 8%, you let America decide how they got there."
Even former presidential candidate John McCain jumped into the fray noting that although he is no economist, he "wouldn't put anything past" the Obama administration.
Surprisingly, it was Larry Kudlow (not exactly someone you might expect to defend a democratic incumbent) representing the voice of reason, noting that
"I've worked in the White House under Reagan and there's no way those numbers can be manipulated."
What is absurd about the whole debate is that one doesn't have to posit some far-reaching conspiracy in order to claim that the economy is still stuck in neutral. In other words, rather than spending time worrying about how the numbers may or may not have been massaged, one might consider actually looking at the numbers first to ensure that they are indeed positive.
Mohamed El-Erian for example had the following to say about the conspiracy theories:
"This is just what happens when you have two different ways of collecting data."
This gets to the heart of the matter. There are two different surveys to consider. One survey polls employers while the other is a phone survey with 50,000 households. The household survey is what yields the unemployment rate. While the establishment survey showed the economy added 114,000 jobs in September, the household survey showed the U.S. added an astounding 873,000 new positions during the month. This was the largest monthly increase in the household survey number in 29 years.
This epic rise in the household survey is what accounted for the decline in the headline unemployment rate and this is where critics should be looking to determine the reason for the increase rather than simply claiming that the number must be fictitious. As I noted in an article published early Friday, a quick look at the data on the Bureau of Labor Statistics web page reveals the reason for the sharp increase in the household survey:
"...'part time jobs for economic reasons' rose by 582,000 in September, the largest monthly increase since the first quarter of 2009 when the U.S. was mired in the financial crisis."
Put simply, 67% of the new jobs reported by households were part time jobs taken because full time employment was not available. As a result of this, the U-6 'underemployment' measure didn't budge from August, remaining at 14.7%. From Goldman:
"One anomaly in the household data is that the U-6 measure of underemployment remained at the 14.7% level reported for August; this is due to a large increase in the number of workers working part time for economic reasons." (emphasis mine)
The takeaway here is that the right way to criticize this jobs number is to point out that the numbers suggest America is becoming a nation of part time workers. Critics might also have mentioned that the report showed manufacturing jobs fell by 16,000 in September providing further evidence of soft demand. This would have made for a far more defensible critique of the data than claiming a vast conspiracy.
At the end of the day however, most serious observers don't think September's jobs report means much in terms of foreshadowing an appreciable increase in the pace of the economic recovery. Specifically, Mohamed El-Erian opined that fundamentals are still very weak and do not justify equity valuations:
"So far, we've had a rally based on chopping off the tails of catastrophe between what the Fed and ECB have been doing...but in order to keep going, we need the handoff to fundamentals...the rally can only continue if the fundamentals take control."
These sentiments were echoed by Goldman's David Kostin:
"...our top-down 2012 S&P 500 EPS estimate has remained unchanged at $100 since the start of the year. Meanwhile, consensus sales and earnings estimates have dropped by 1% and 5%, respectively, since early 2012. Despite that, valuation is notably higher. The forward P/E multiple has expanded by 15% to 13.4x."
This analysis is entirely consistent with what I have been saying for quite some time now: equities have been rising on multiple expansion alone and this is not sustainable.
The takeaway from this is that all conspiracy theories aside, the economy is weak and the jobs market is soft. The unemployment rate fell in September based on a volatile household survey which, when analyzed shows that gains are coming from a dramatic rise in part time employment necessitated by harsh economic realities.
This is the backdrop against which investors have been bidding up stock prices even as EPS estimates fall. Given this, and given the uncertainty surrounding the fiscal cliff, Goldman sees the S&P 500 falling 14% in the next three months:
Source: Goldman Sachs
It is hard to argue with their logic. Recommendation: short U.S. equities.