Employment – Weaker Than Narrative
Markets yawned at the April issue of the payroll survey (+428K) despite the media’s characterization of the report as “strong”. Indeed, upon further analysis, the most charitable description would be, in our view, “mixed”. In fact, “disturbing” would be our best characterization. Here’s why:
- The overall payroll figure comes from a monthly survey of large and medium-sized companies. Because it does not survey small businesses, the BLS “adds” the jobs it assigns to this segment. This is called the “Birth-Death” model. For April, +160,000 jobs were added thanks to the “magic” of this “adjustment”. This means that the net new jobs that were actually counted in the survey were +268K, a figure which we believe would have disappointed the markets, as it would have been interpreted as a significant slowdown from the previous month and in below +400K. Wall Street Consensus. The chart above is taken from the ADP jobs report released Wednesday, May 4. Note the sharp drop in small business employment in April. Because ADP is the largest payroll services company in the United States, this data is highly credible. If this more realistic -120K had been used instead of +160K (“Birth-Death”), the net for the Payroll Survey would have been +148K, not +428K! And the discourse on the “recession” would have made the rounds of the street.
- The household survey indicates that net employment actually contracted by -353K in April. We wouldn’t call it “strong”. Worse still, -651,000 full-time jobs in this survey disappeared. Although the household survey is a bit more volatile than the wage survey, it tends to lead at cyclical turning points. It did so in February 2001 and December 2007. This is because small businesses are at the heart of the US economy and react to economic conditions much faster than large businesses.
- A survey by the National Federation of Independent Businesses (NFIB) suggested that small businesses are cutting back on their hiring plans. Additionally, job postings on Indeed.com are down. These also tend to be leading indicators of employment.
- The household survey is the one on which the unemployment rates are based. The overall unemployment rate (U3) held steady at 3.6%, slightly disappointing the general view that it would fall to 3.5%. The labor force participation rate (LFPR) (the percentage of the working-age population either employed or actively seeking one) fell from 62.4% to 62.2%. As a result, the labor force decreased by -363K. Strong labor markets do not experience such declines.
- 665,000 people who had a job in March but lost it in April simply left the labor market. This phenomenon is a feature of weakening, not strengthening, employment trends. If these people had not left the labor market and if they had started to look for another job (that is, if the LFPR had maintained its March level), the U3 unemployment rate would have increased to 3.8%.
- The broader measure of unemployment (U6), which includes people working part-time but wanting to work full-time, fell from 6.9% to 7.0%.
- Here’s an interesting observation from economist David Rosenberg: “…employment in the employment services sector fell by 10,500…What do you think that means for labor market prospects when job hunters heads are starting to cut off their heads? »
- Our conclusion here is that we are only just beginning to see the tip of the employment iceberg. We expect much more weakness over the next few months.
Stock Market Volatility – A Sign of “Bear”
The table shows the variations of the major indices from their near highs and for the week ended May 6. Despite the relatively small percentage changes for the week, volatility was the main feature of the market. The DJIA rarely moves more than 1% in a single session, let alone 2% or 3%. But the DJIA accomplished that in back-to-back sessions on Wednesday (+2.8%) and Thursday (-3.1%). Similar movements were observed for the Nasdaq (+3.2% and -5.0%), for the S&P 500 (+3.0%, -3.6%) and for the Russell 2000 (+2.7 %, -4.0%).
As noted, there was a lot of volatility for a rather benign week/week result. This type of volatility typically occurs in “bear” markets. And look at the middle column of the table; The Nasdaq and the Russell are both in the jaws of the “Bear” (down more than 20% from the nearby peak), while the S&P is in “Correction” (down more than 10%).
Readers of this blog know that we believe recent Fed and market actions will push the economy into a recession in a shorter time frame than might be expected from past tightening cycles. That’s because the markets have, in just over a month, fully applied the Fed’s “terminal” rate, a rate that will require several more rate hikes of 50 basis points (0.5 points). In past tightening cycles, the Fed has never issued forward guidance, so markets have never pushed rates much higher than where the Fed was. Therefore, as the markets have fully implemented the Fed’s 18-month plan, in this tightening cycle the recession will appear earlier than in previous tightening cycles. We are confident in this call and incoming data continues to confirm our view.
- The chart shows the breakdown of preliminary Q1 real GDP.
- In the first quarter, the 2.7% gain in consumer spending was supported by a decline in consumer savings. The savings rate is now lower than it was before the pandemic, so the spending cushion is now exhausted. Moreover, 80% of the growth in the first quarter occurred in January, so the transition to the second quarter was quite weak.
- Moreover, despite rising wages, average real weekly earnings continue to contract (see chart) and are lower than they were during the Great Recession. With savings depleting, prices rising faster than wages, and interest rates rising dramatically, rising consumption levels don’t seem like a good bet.
- While markets initially seemed to ignore the -1.4% real GDP print in the first quarter, the chart shows the percentage change in real GDP by month. Note that we haven’t seen positive real consumption growth since October, when consumers shopped “early” for the holiday season due to the then-widespread talk of “shortages”.
- In recent months, consumer opinion surveys from the University of Michigan have indicated significantly lower intentions to buy big-ticket items. We note that spending on durable goods fell by -0.9% M/M in March, is down two months in a row (and down in four of the last five). Non-durable goods also fell -0.3% in March after falling -0.7% in February.
- The housing market is weakening. Sales of new and existing homes are down. Remember that people buy houses, cars, and other big-ticket items based on the monthly payment. Given rising house prices (the median house price has risen from $326,000 to $375,000 over the past year) and the rise in the 30-year fixed mortgage rate (from 3.1% to 5.5%), the house that the consumer could have bought a year ago for $326,000 with a down payment of $65,000 and a monthly payment of $1,115, would now cost $375,000, would require $75,000 as down payment, and the monthly payment would have skyrocketed 53% to $1,703. The graph shows what happened to mortgage applications to buy due to rising rates.
- Additionally, mortgage applications to refinance an existing mortgage have fallen off a cliff. Refis are often a source of cash for large purchases, another reason why we believe we will see a noticeable slowdown in consumption very soon.
Rest of the world
Needless to say, Europe and China have their own major problems. Europe is facing serious energy problems due to the war in Ukraine. Industrial production is falling in France and Germany. And the Chinese economy is at a standstill due to both the implosion of its real estate sector and the confinement of its major cities (zero tolerance Covid policy). The graph of subway traffic in Shanghai and Beijing shows the impact of these closures.
The case of bonds
During the first four months of the year, we witnessed dramatic falls in equity and fixed income markets. First Trust has done a study of what has happened historically in the following time periods where stocks and bonds fall simultaneously. There have been 16 such episodes since 1977. The chart shows that one year after such episodes, 73% of the time stocks have risen in value, while this number is 100% for bonds.
The last chart shows eleven bond market drawdowns over 3% since 1979 and how many subsequent months it took to reach a new high; less than a year in all cases.
Incoming data tells us that a recession is unfolding. Once this recession is recognized by the business community, the Fed will be forced to stop tightening. If the Fed never reaches its declared “terminal” rate, markets, which have already priced in those rates, will have to adjust to a lower rate. Under these conditions, bonds look cheap!
(Joshua Barone contributed to this blog)