What Do Non-Farm Payrolls Tell Us About Recession?

by: The Fundamental Analyst

After Friday's better than expected non-farm payroll report, there was a flood of TV talking heads and blog posts announcing that the employment numbers prove that the US economy is not in recession or about to tip into a recession. It seemed to be enough for most that NFPs were positive, and the trend not worsening, to conclude that they weren't recessionary. The problem with that kind of analysis is that it completely ignores the historical evidence.

No doubt given the positive revisions to July and especially August payrolls, the employment situation looks a little healthier than originally believed a month ago. However, put in a historical context, current payrolls do not confirm either that the US economy is in recession or not in recession. This is not an opinion, just a fact of the data.

The above chart shows the level of non-farm payrolls 1 month prior to recession, at the start of recession and 1 month after the start of each recession going back to 1945. The black line represents an average of the 13 recessions over the past 66 years. If you were of the opinion that a new recession began in September, then the current data set would fit comfortably into historical experience tracking closely to the black line representing the average.

The problem, of course, is that you could find many instances that would fit into this historical data set that didn't coincide with recession. So whilst the current non-farm payroll data doesn't confirm the US economy is in recession, nor does it validate the view that the economy isn't in recession.

If you're not happy with just 3 months, take a look at the exact same graph using the 3 month moving average of non-farm payrolls 1 month prior to, at the start of and 1 month after the start of each recession. The story is the same, the current experience would track quite closely to the black line representing the historical average.

The historical record is quite clear, in only 3 out of 13 recessions since 1945 did payrolls actually turn negative 1 month before the recession started or in the actual month the recession started. 1 month after the start of the recession 10 out of 13 instances payrolls had turned negative. So you don't need negative payroll numbers to confirm recession is either imminent or underway.

There is also one large caveat to this analysis that needs to borne in mind and that is that all the historical data has been revised several times whereas the July and August data has only been revised once and the September data not at all. We might find out after the BLS annual benchmark revisions that NFPs were considerably stronger or weaker than reported in July, August and September.

Also a final note on the most recent report in relation to the striking Verizon workers. If you take out the Verizon effect, the trend in NFPs appears to be getting worse, but again that trend will subject to revisions in the coming months.

Remember that non-farm payrolls are a lagging or at best coincident economic indicator, they tell you what has happened, not what will happen. Also beware of commentators that quickly form a view based on one data point of one indicator. Spotting recession signals involves confirmation of a much wider set of conditions.

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