Employment Report: Is Stagnant Employment Growth Bad For Stocks?

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Includes: EEM, GLD, IWM, SPY, XLF
by: Parsimony Investment Research

While the ongoing European fiscal crisis continues to drag down the US equity market, investors are looking for any signs of stability on the homefront and will be laser-focused in on the employment numbers this week.

The May ADP employment report is due out this morning and nonfarm payrolls are due out on Friday.

Last month, private employment increased by 119,000 in April, the smallest gain in seven months, after rising by 201,000 in March (according to a report published by ADP). As shown in the chart below, the ADP report has a strong historical correlation (0.95) with BLS estimates of total nonfarm payroll employment.

According to consensus estimates, private payrolls and nonfarm payrolls are expected to rise by 154,000 and 150,000, respectively in May. Even if actual payrolls come in close to consensus estimates, monthly employment growth continues to hover below the magic 200,000 number that signals a strong job market. Payroll growth below this level has historically been negative for stocks.

Employment and Stocks

After troughing in mid-2009, monthly payroll growth turned positive again in early 2010 and the job market appeared to be stabilizing (see chart above). The equity market also began to strengthen, rallying significantly throughout 2010 and early 2011.

Payroll growth dropped below 200,000 in May 2011 and stayed below that level for seven consecutive months (through October 2011). As shown in the chart above, the S&P 500 (NYSEARCA:SPY) was down over 18% from peak to trough over that period. Note: SPY is currently down over 6% since payroll growth dipped back below 200,000 last month.

The Russell 2000 (NYSEARCA:IWM) fared even worse, declining over 25% over that period (see chart below).

Other high beta sectors like Financials (NYSEARCA:XLF) and Emerging Markets (NYSEARCA:EEM) were down over 30% during this sustained period of slow payroll growth (see charts below).

On a positive note, Gold (NYSEARCA:GLD) was up over 20% between May 2011 and October 2011.

Conclusion

If the payroll report last month was the start of a new trend of stagnant employment growth, equities could be in trouble in the coming months.

Investors should continue to monitor the employment market very closely and consider hedging their equity positions and/or diversifying into asset classes that will perform better in a "risk off" environment (like precious metals).

Disclosure: I am long GLD.

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