Key Points
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Although the unemployment rate was last week’s jobs report highlight; payrolls underperformed expectations and wage growth was weak.
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Trends matter at least as much as levels; with payrolls and job openings having already rolled over, and unemployment claims on the watch list.
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Be wary when you hear “the consumer is strong so there’s no risk of a recession.”
It’s been quite a few months since I penned a comprehensive report on the state of the labor market; and given the attention to the subject heading into last Friday’s jobs report, let’s get to it. It was a mixed report, with the good news being the decline in the unemployment rate from 3.7% to 3.5%, a five-decade low courtesy of strong household employment of 391k (from which the unemployment rate is calculated). Both the labor force participation rate, and the rate for prime-age workers, were consistent with last month’s at 63.2% and 82.6%, respectively.
On the other hand, nonfarm payrolls were below expectations at 136k, with private sector payrolls a lesser 114k; but the prior two months were revised higher by a collective 45k jobs. The revisions were welcome news after a four month run of negative revisions. Given recent disappointing economic news—notably the ISM manufacturing and non-manufacturing indices (including their employment components)—the “whisper number” heading into Friday’s report was lower than the consensus. Sector gainers in terms of jobs were: healthcare, business services, government and transportation. Sector flatliners/losers were: mining, construction, manufacturing, wholesale trade, information, financial activities, leisure/hospitality, and retail (the biggest loser).
There was no movement in average hourly earnings (AHE) relative to the prior month; while the year-over-year growth rate slowed from 3.2% to 2.9%. The weakness was concentrated in managers’ pay; while production/non-supervisory wages, although softer for the month, are up 3.5% year-over-year. Wages historically follow corporate earnings, with about a one-year lag; so the significant deterioration in profits growth this year suggests further downward pressure on wages. Indeed, although still high in absolute terms, job openings have rolled over.
Job Openings Have Rolled Over
Source: Charles Schwab, Bloomberg, Bureau of Labor Statistics, as of July 31, 2019.
We can also compare the unemployment rate (a lagging indicator) to AHE to gauge potential economic inflection points. The chart below compares the two, and shows that historically once they converged and began diverging, recessions weren’t far behind; so this is something on which we will focus over the next few months.
Unemployment Rate and Wages Meet
Source: Charles Schwab, Bloomberg, Bureau of Labor Statistics, as of September 30, 2019. *Average hourly earnings for production and nonsupervisory workers.
The trend may not be our friend
In trend terms, private nonfarm payrolls’ 12-month average is now 167k—near its lowest level in more than two years (with expected downward revisions coming in February as part of the annual benchmark revisions). The trend confirms a weak pace of hiring, in part due to the tightness of the labor market; but also likely due to uncertainty with regard to the trade war. There was enough trend weakness to keep alive the prospects of the Federal Reserve cutting rates again at the end of this month when the Federal Open Market Committee (FOMC) meets again. The report does little to refute the ISM-based notion that surveys and business sentiment point to a deeper slowing in economic activity that could increasingly impact hiring in the future.
Below is a handy chart that connects the dots between payroll growth and the unemployment rate looking ahead. In order for the unemployment rate to remain at 3.5%, we will need to see at least 107k jobs created monthly on average; whereas if payroll growth slows, you can see the progression of increases in the unemployment rate.
Payrolls Needed for Unemployment Rate Thresholds
Source: Charles Schwab, Bureau of Labor Statistics, Department of Labor, Federal Reserve Bank of Atlanta, as of October 4, 2019.
In another connect the dots exercise, we can look at what is called “private labor earnings growth” which is the product of payrolls, average hourly earnings, and average weekly hours. As you can see in the chart below, there has been a notable descent from the October 2018 year-over-year peak growth rate of 5.7%, to 4.2% in September.
Labor “Earnings Growth” Well Off Peak
Source: Charles Schwab, Bianco Research LLC, Bloomberg, Bureau of Labor Statistics. Private labor earnings growth represents the product of y/y % change in private payrolls, average hourly earnings and average weekly hours.
Keep an eye on claims
With the moderation in hiring, the most important data on which to keep an eye is weekly unemployment claims (a leading economic indicator). Although still near multi-decade lows, you can see below that they’ve been range-bound for the past year. Any meaningful uptick from here would be troubling.
Unemployment Claims Leveling Out
Source: Charles Schwab, Bloomberg, Bureau of Labor Statistics, as of September 27, 2019.
Already, we’ve seen more significant increases in claims among some of the trade- and energy-hit states, especially those with larger manufacturing or agriculture drivers. (DC seems to be an outlier; with their increase in the minimum wage likely a partial culprit.) With the percentages in parentheses representing the increase in the four-week average of claims from their January 2018-to-date troughs through September 21, 2019 (the most recent week of data), here are the 10 states with the largest upticks:
- DC (51%)
- Kansas (48%)
- West Virginia (39%)
- Tennessee (32%)
- Oklahoma (30%)
- Montana (29%)
- Arkansas (27%)
- Michigan (26%)
- North Carolina (26%)
- North Dakota (22%)
Business investment vs. consumption
We have spilled a lot of ink on the impact of the trade war to-date; with much of the hit falling on corporate confidence, business capital spending and manufacturing. During the span of the trade war, consumption has remained fairly strong; which suggests to some that even with manufacturing in a recession and business investment weak, that consumption is all-but-guaranteed to keep the economy out of recession. I still don’t see present signs of a recession; but a little history lesson is in order to combat the notion that positive consumption is a failsafe for the economy.
The chart below is one I retweeted last week from John P. Hussman of Hussman Strategic Advisors. It shows that in the post-WWII era, although consumption is nearly 70% of U.S. gross domestic product (GDP); 90% of quarterly GDP declines historically have been from gross domestic investment. Put another way, and shown on the chart directly, there have been 41 total quarters with negative GDP since the end of WWII. Of those, there were 25 (61%) during which consumption stayed positive, but investment was negative. So be wary when you hear that manufacturing/capital investment is weak, but the “consumer is in great shape,” so there’s nothing to worry about.
Consumption Growth Not Always Economic Failsafe
Source: Charles Schwab, Bureau of Economic Analysis, Hussman Strategic Advisors.
In sum
Employment releases are generally the most influential economic indicators for economists—and the stock market—as they guide expectations for consumer spending, consumer confidence, inflation, and income growth. But they have taken on even greater importance lately for two reasons:
- To gauge whether the weakness in manufacturing is beginning to bleed into the services/consumer segments of the economy.
- The Fed has moved from a predetermined path for interest rates to a data dependent path, with “full employment” representing half of the Fed’s dual mandate (the other being “price stability”).
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