The Good, Bad And Ugly From November's Jobs Report
- The Federal Reserve is tightening policy into a cyclical slowdown.
- Employment population ratios increased (good).
- Employment growth declined (bad).
- Real income growth continues to decline through November (ugly).
- The Federal Reserve is making a policy error.
- This idea was discussed in more depth with members of my private investing community, EPB Macro Research. Learn More »
The Bureau of Labor Statistics released their monthly Employment Situation update for the month of November, and the details confirmed the ongoing cyclical slowdown in the rate of economic growth.
In this note, we will start by providing background and context around this ongoing cyclical slowdown and then highlight the good, the bad, and the ugly from this employment release.
Lastly, we'll summarize the key takeaways for investors and what to think about as we head into 2022.
Tightening Into A Slowdown
At EPB Macro Research, we provide independent analysis on the most critical secular and cyclical trends and the resulting impact on asset prices.
Secular economic trends are driven mainly by debt and demographics and play out over 3-5+ years.
Cyclical economic trends refer to the accelerations and decelerations in growth that occur within a business cycle, most commonly the 6-18 month time window.
Anything shorter than a six-month trend is noise for the economic cycle investor as macroeconomic conditions are slow-moving and take time to ripple through asset markets.
To monitor these cyclical trends, the focus of this report, we look at a consistent group of data points called "coincident indicators." Coincident data are not "leading" indicators and do not tell us where the economy is headed but rather provide an objective view of what is going on right now.
It's important to take the most reliable measure of real growth from the "four corners" of the economy, including production, employment, income, and consumption.
Charted below, you can see the four consistent and reliable measures of real economic growth that we use to determine the current trend in the direction of economic growth.
As the chart shows, all four corners of the economy marked a critical inflection point in March or April of 2021. Over the last 6-8 months, the growth rate has declined, which means the economy is in an empirically observable "cyclical downturn."
Whenever the economy is in a cyclical downturn, long-term interest rates decline, the US dollar tends to rise, and defensive assets outperform cyclical assets.
To make this point clear, since the end of March, long-term Treasury bonds, defined by ETF (TLT), have increased more than 15%, while more cyclical areas of the stock market, such as the Russell 2000 index (IWM), declined 2.5%.
Back in September, in a note titled "Tightening Into A Slowdown," I outlined the risks of a tightening cycle colliding with a deceleration in economic growth.
Anytime the economy is in a period where the real growth rate is falling, asset markets are at higher risk and volatility is generally elevated. A growth rate cycle downturn would imply that investors should shift or "tilt" in the direction of defensive assets such as Treasury bonds over higher-risk parts of the portfolio.
The added risk of tighter monetary policy amplifying the slowing conditions is another factor that would cause the prudent investor or the tactical investor to reduce gross exposure, increase cash and look at various ways to hedge recent gains as the real growth rate in the economy comes down.
Since that September report, growth has continued to soften while the Federal Reserve has become increasingly hawkish.
With the background of tighter monetary policy into slowing economic growth, let's have a look at the internals of the employment report.
Employment Report: The Good
It was not all bad news in the November jobs report. We know that the U-3 unemployment rate is not a great gauge of the true employment conditions in the economy. Rather, the employment-to-population ratio is where we should focus for a more reliable measure of "true" employment.
The peak employment-population ratio for the US economy occurred in April 2000 at 64.7%. This reading is the best measure of "full-employment," so we can measure today's employment-to-population ratio against that peak rate for a reading on the "true" unemployment rate.
The employment-to-population ratio continued to increase in November, and thus the distance from the 2000-peak is narrowing, signaling that the "true" unemployment rate is roughly 5.5%.
This declining trend is clearly a very good sign and one that shows a healing labor market.
Demographics and an aging population influence these trends, so we can also perform the same analysis on the prime-age or the 25-54-year-old employment-to-population ratio.
The prime-age "true" unemployment rate likely stands close to 3.1%.
The improving trend in the employment-to-population ratios is an unambiguously good sign.
We know, however, that the labor market leans closer to a "lagging" indicator, so we need to look deeper for more timely signals.
Employment Report: The Bad
Asset markets respond to the "rate of change" rather than nominal or static figures. Rather than looking at the headline rate of job creation and stating the number was "good" or "bad," we must contextualize the labor report in growth rate terms and look at the trend.
As noted in the first section, the growth rate of all coincident data points are declining.
Zooming in on total non-farm payrolls growth, we can see that the growth rate in employment peaked in April 2021 at a rate of 5.6% and has since cooled to 4.5%.
We cannot look at this trend and say "4.5% is still good" because when the growth rate was at 5.6%, that's what asset markets were pricing in. As the growth rate changes (declines), asset markets have to respond to a lower growth rate, which is why long-term bond yields have declined since that April peak.
If we look at "aggregate manufacturing hours," which is an early proxy on industrial production, we can see the trend has declined meaningfully since March (6.5%) and has now flattened out.
Aggregate manufacturing hours growth is updated for November, while industrial production growth is updated as of October. Today's employment report and the aggregate manufacturing hours growth proxy implies that we should not expect a material acceleration in industrial production growth in the November report.
Employment Report: The Ugly
We have four major coincident indicators of the economy. In November, we know that employment growth ticked lower and implied production growth ticked higher, but still remains meaningfully below the cyclical inflection of March 2021.
We won't have our first read on consumption growth until the retail sales report, but we can get an early look at real income growth through an "aggregate earnings" proxy.
If we take total non-farm payrolls "average weekly hours worked" average hourly earnings, we arrive at "aggregate earnings."
We must convert this aggregate earnings figure into a "growth rate," but it's important to remember that this figure is in nominal dollars or including inflation.
Aggregate earnings are increasing at a 9.5% annualized rate in November, roughly flat since April 2021, but how much of this is simply coming from inflation?
We can deflate this metric by the consumer price index to arrive at a proxy for "real aggregate earnings."
Once we net out inflation, we can see that real aggregate earnings growth is increasing at just a 1.9% annualized rate, massively lower than the 4.8% real growth rate of April 2021.
Again, the trend or rate of change matters the most, and this trend is slowing from nearly 5% to roughly 2%, exactly in line with the (weak) pre-COVID trend.
This real aggregate earnings proxy is important because it's closely correlated to the more reliable income measure from the BEA Personal Income & Outlays report called "Real Personal Income excluding Transfer Payments."Taking the early clues from the employment situation report, we know that employment growth is trending down, production growth is trending lower but has flattened out, and real income growth is still declining.
What To Do
Again, these are "coincident" measures of economic growth. "Leading indicators" will provide more predictive power.
At EPB Macro Research, we also provide monthly updates to "leading" indicators, and so far, through the October reporting period, there are no major inflection points that are in the cards over the next couple of months.
So what is the prudent economic cycle investor to do with this information?
The takeaway is very much the same as the September "Tightening Into A Slowdown" update.
When economic growth is declining, it's historically prudent to shift into defensive assets like long-term Treasury bonds and more defensive parts of the equity market like utilities, large-cap, and quality balance sheets.
When the Federal Reserve is tightening policy, that's another good time to pump the brakes on a lot of cyclical risk exposure.
When both economic growth is declining, and the Federal Reserve is tightening policy at the same time, that's the most opportune time to reduce risk, get defensive and stay alert for pending risk pockets like we have seen over the last several weeks.
EPB Macro Research provides independent analysis on the most critical secular and cyclical economic trends impacting interest rates and asset prices.
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This article was written by
Eric Basmajian is an economic cycle analyst and the Founder of EPB Macro Research, an economics-based research firm focusing on inflection points in economic growth and the impact on asset prices.
Prior to EPB Macro Research, Eric worked on the buy-side of the financial sector as an analyst at Panorama Partners, a quantitative hedge fund specializing in equity derivatives.
Eric holds a Bachelor’s degree in economics from New York University.
EPB Macro Research offers premium economic cycle research on Seeking Alpha.
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